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PALOMAR HOLDINGS, INC. – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our historical results of operations and our liquidity and capital resources should be read together with the consolidated financial statements and related notes that appear elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, this Annual Report on Form 10-K contains "forward-looking statements." You should review the "Special Note Regarding Forward-Looking Statements" and "Risk Factors" sections of this Annual Report on Form 10-K for factors and uncertainties that may cause our actual future results to be materially different from those in our forward-looking statements. Forward-looking statements in this Annual Report on Form 10-K are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statements.
Overview
We are a rapidly growing and innovative insurer focused on providing specialty
insurance to residential and commercial customers. Our underwriting and
analytical expertise allow us to concentrate on certain markets that we
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believe are underserved by other insurance companies, such as the markets for
earthquake, hurricane, inland marine, and flood insurance. We use proprietary
data analytics and a modern technology platform to offer our customers flexible
products with customized and granular pricing for both the admitted and excess
and surplus lines ("E&S") markets.
We provide admitted insurance products through our Oregon domiciled insurance
company, Palomar Specialty Insurance Company ("PSIC"), and non-admitted
insurance products through our Arizona domiciled surplus lines insurance
company, Palomar Excess and Surplus Insurance Company ("PESIC"). We distribute
our products through multiple channels, including retail agents, program
administrators, wholesale brokers, and partnerships with other insurance
companies. Our business strategy is supported by a comprehensive risk transfer
program with reinsurance coverage that we believe reduces earnings volatility
and provides appropriate levels of protection from catastrophic events. Our
management team combines decades of insurance industry experience across
specialty underwriting, reinsurance, program administration, distribution, and
analytics.
Founded in 2014, we have significantly grown our business and have generated
attractive returns. We have organically increased gross written premiums from
$16.6 million in our first year of operations to $535.2 million for the year
ended December 31, 2021 , which reflects a compound annual growth rate of
approximately 64%. For the year ended December 31, 2021 , 55% of our gross
written premiums were generated by our Residential Earthquake, Commercial
Earthquake and Hawaii Hurricane lines of business, all of which are not subject
to attritional losses. We experienced average monthly premium retention rates
above 89% overall for these lines of business, providing strong visibility into
future revenue.
In February 2014 , PSIC was awarded an "A-" rating from A.M. Best Company ("A.M.
Best"), a leading rating agency for the insurance industry. An "A-" rating is
categorized by A.M. Best as an excellent rating and indicates a stable outlook.
In July 2020 , PESIC was also awarded an "A-" rating by A.M. Best . In May 2021 ,
A.M. Best affirmed the "A-"rating of PSIC and PESIC. These ratings reflect A.M.
Best's opinion of our subsidiaries' financial strength, operating performance,
and ability to meet obligations to policyholders and are not an evaluation
directed towards the protection of investors.
We received regulatory approval for PESIC during the second quarter of 2020 and
capitalized PESIC with approximately $100 million in initial surplus. PESIC is
domiciled in the State of Arizona and licensed in Arizona to transact across all
our existing lines of business. We believe that the underwriting acumen and
market expertise we have established in the admitted insurance market is also
applicable to the non-admitted market (also known as the "surplus lines" or
"E&S" market), and that PESIC enables us to serve certain risks that our
admitted products cannot currently satisfy. We began writing E&S business on a
national basis during the third quarter of 2020.
We believe that our market opportunity, distinctive products, and differentiated
business model position us to grow our business profitably.
COVID-19 Update
The COVID-19 Pandemic (the "Pandemic") continues to impact businesses,
households, communities, and financial markets.
Since the beginning of the Pandemic, our focus has been to protect the health of
the public and our employees while serving our policyholders and ensuring
business continuity. We recently began allowing all employees to return to our
offices on a voluntary basis, with established protocols to ensure operational
reliability and employee safety. In addition, we have been taking extra physical
security and cybersecurity measures to safeguard our systems to serve the
operational needs of our workforce and ensure uninterrupted service to our
brokers and policyholders.
We have experienced business interruption claims related to the Pandemic. Our
All Risk and Commercial Earthquake (Difference in Conditions or "DIC") policies
offer business interruption coverage for insureds for a loss in business income
caused by physical damage to the structure. Each of our All Risk policies has a
virus and/or communicable disease exclusion. Our DIC policies require physical
damage to the structure caused by the covered
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perils, whether it be an earthquake or flood. We do not expect additional
business interruption claims from the Pandemic and have acknowledged and
adjudicated each claim received.
The Pandemic's ultimate impact on our results of operations remains uncertain. Since the onset of the Pandemic, we have experienced volatility in the fair value of our investment portfolio due to unrealized losses and gains on our fixed income securities. Additional financial volatility caused by the Pandemic may have a negative impact on our investment portfolio and results of operations. Inflationary pressures caused by the Pandemic may increase our operating expenses and the average size of our loss claims. We have not seen a significant impact on the growth rate of our gross written premiums since the beginning of the Pandemic. However, the Pandemic continues to impact many aspects of the economy and society and the macroeconomic effects of the Pandemic may persist for an indefinite period, even after the Pandemic has subsided. We cannot anticipate all the ways in which the Pandemic or other similar global health crises could adversely impact our business in the future.
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: ? Volume of new business submissions in existing products or partnerships;
? Binding of new business submissions in existing products or partnerships into
policies;
? Entrance into new partnerships or the offering of new types of insurance
products;
? Renewal rates of existing policies; and
? Average size and premium rate of bound policies.
Our gross written premiums are also impacted when we assume unearned in-force
premiums due to new partnerships or other business reasons. In periods where we
assume a large volume of unearned premiums, our gross written premiums may
increase significantly compared to prior periods and the increase may not be
indicative of future trends.
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 losses and to provide additional capacity for growth. We cede premiums
primarily through excess of loss ("XOL") agreements and quota share agreements.
Ceded written premiums are earned pro-rata over the period of risk covered. The
volume of our ceded written premiums is impacted by the amount of our gross
written premiums and our decisions to increase or decrease limits or retention
levels in our XOL agreements and co-participation levels in our quota share
agreements.
Our ceded written premiums can be impacted significantly in certain periods due
to changes in quota share agreements. In periods where we modify a quota share
agreement, ceded written premiums may increase or decrease significantly
compared to prior periods and these fluctuations may not be indicative of future
trends. In addition, our XOL costs as a percentage of gross earned premiums may
vary each period due to changes of premium in-force during the XOL contract
period or due to acceleration of XOL charges or the need to purchase additional
reinsurance due to losses.
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Net Earned Premiums
Net earned premiums represent the earned portion of our gross written premiums,
less the earned portion that is ceded to third-party reinsurers under our
reinsurance agreements. Our insurance policies generally have a term of one year
and premiums are earned pro rata over the term of the policy.
Commission and Other Income
Commission and other income consist of commissions earned on policies written on behalf of third party insurance companies where we have no exposure to the insured risk and certain fees earned in conjunction with underwriting policies. Commission and other income are earned on the effective date of the underlying policy.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses represent the costs incurred for losses, net of any losses ceded to reinsurers. These expenses are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying coverage. Certain policies we write subject us to attritional losses such as building fires. In addition, most of the policies we write subject us to catastrophe losses. Catastrophe losses are certain losses resulting from events involving multiple claims and policyholders, including earthquakes, hurricanes, floods, convective storms, terrorist acts or other aggregating events. Our losses and loss adjustment expenses are generally affected by:
? The occurrence, frequency and severity of catastrophe events in the areas where
we underwrite policies relating to these perils;
? The occurrence, frequency and severity of non-catastrophe attritional losses;
? The mix of business written by us;
? The reinsurance agreements we have in place at the time of a loss;
? The geographic location and characteristics of the policies we underwrite;
? Changes in the legal or regulatory environment related to the business we
write;
? Trends in legal defense costs; and
? Inflation in housing and construction 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 multiple years. Acquisition Expenses Acquisition expenses are principally comprised of the commissions we pay retail agents, program administrators and wholesale brokers, net of ceding commissions we receive on business ceded under quota share reinsurance contracts. In addition, acquisition expenses include premium-related taxes and other fees. Acquisition expenses related to each policy we write are deferred and expensed pro rata over the term of the policy.
Other Underwriting Expenses
Other underwriting expenses represent the general and administrative expenses of
our insurance operations including employee salaries and benefits, software and
technology costs, office rent, stock-based compensation, licenses and fees, and
professional services fees such as legal, accounting, and actuarial services.
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Interest Expense
For the year ended December 31 2021 , interest expense consists of the unused
line fee and amortization of the commitment fee on our credit agreement. We did
not incur any interest expense during the year ended December 31, 2020 .
Net Investment Income
We earn investment income on our portfolio of invested assets. Our invested assets are primarily comprised of fixed maturity securities, and may also include cash and cash equivalents, and equity securities. The principal factors that influence net investment income are the size of our investment portfolio, the yield on that portfolio, and investment management expenses. As measured by amortized cost, which excludes changes in fair value, caused by changes in interest rates, the size of our investment portfolio is mainly a function of our invested capital along with premium we receive from our insureds, less payments on policyholder claims and other operating expenses. Our balance of invested capital may be impacted in the future by repurchases of shares of our common stock.
Net Realized and Unrealized Gains and Losses on Investments
Net realized and unrealized gains and losses on investments are a function of the difference between the amount received by us on the sale of a security and the security's cost-basis, mark-to-market adjustments, and credit losses recognized in earnings.
Income Tax Expense
Currently our income tax expense consists mainly of federal income taxes imposed
on our operations. Our effective tax rates are dependent upon the components of
pretax earnings and the related tax effects.
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Key Financial and Operating Metrics
We discuss certain key financial and operating metrics, described below, which
provide useful information about our business and the operational factors
underlying our financial performance.
Underwriting revenue is a non-GAAP financial measure defined as total revenue, excluding net investment income and net realized and unrealized gains and losses on investments. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total revenue calculated in accordance with GAAP to underwriting revenue. Underwriting income is a non-GAAP financial measure defined as income before income taxes excluding net investment income, net realized and unrealized gains and losses on investments and interest expense. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of income before income taxes calculated in accordance with GAAP to underwriting income. Adjusted net income is a non-GAAP financial measure defined as net income excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook, net of tax impact. We calculate the tax impact only on adjustments which would be included in calculating our income tax expense using the estimated tax rate at which the company received a deduction for these adjustments. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income calculated in accordance with GAAP to adjusted net income.
Return on equity is net income expressed on an annualized basis as a percentage
of average beginning and ending stockholders' equity during the period.
Adjusted return on equity is a non-GAAP financial measure defined as adjusted net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of return on equity calculated using unadjusted GAAP numbers to adjusted return on equity.
Loss ratio, expressed as a percentage, is the ratio of losses and loss
adjustment expenses, to net earned premiums.
Expense ratio, expressed as a percentage, is the ratio of acquisition and other
underwriting expenses, net of commission and other income to net earned
premiums.
Combined ratio is defined as the sum of the loss ratio and the expense ratio. A combined ratio under 100% generally indicates an underwriting profit. A combined ratio over 100% generally indicates an underwriting loss. Adjusted combined ratio is a non-GAAP financial measure defined as the sum of the loss ratio and the expense ratio calculated excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of combined ratio calculated using unadjusted GAAP numbers to adjusted combined ratio. Diluted adjusted earnings per share is a non-GAAP financial measure defined as adjusted net income divided by the weighted-average common shares outstanding for the period, reflecting the dilution which could occur if equity-based awards are converted into common share equivalents as calculated using the treasury stock method. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of diluted earnings per share calculated in accordance with GAAP to diluted adjusted earnings per share.
Catastrophe loss ratio is a non-GAAP financial measure defined as the ratio of
catastrophe losses to net earned premiums. See "Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of loss ratio calculated using
unadjusted GAAP numbers to catastrophe loss ratio.
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Adjusted combined ratio excluding catastrophe losses is a non-GAAP financial
measure defined as adjusted combined ratio excluding the impact of catastrophe
losses. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation
of combined ratio calculated using unadjusted GAAP numbers to adjusted combined
ratio excluding catastrophe losses.
Tangible stockholders' equity is a non-GAAP financial measure defined as
stockholders' equity less intangible assets. See "Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of stockholders' equity calculated in
accordance with GAAP to tangible stockholders' equity.
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Results of operations
Year ended
The following table summarizes our results for the years endedDecember 31, 2021 and 2020: Year Ended December 31, Percent 2021 2020 Change Change ($ in thousands, except per share data) Gross written premiums $ 535,175 $ 354,360$ 180,815 51.0 % Ceded written premiums (223,443) (155,102) (68,341) 44.1 % Net written premiums 311,732 199,258 112,474 56.4 % Net earned premiums 233,826 155,068 78,758 50.8 % Commission and other income 3,608 3,295 313 9.5 %
Total underwriting revenue (1) 237,434 158,363 79,071 49.9 % Losses and loss adjustment expenses 41,457
64,115 (22,658) (35.3) % Acquisition expenses 95,433 64,041 31,392 49.0 % Other underwriting expenses 53,723 34,084 19,639 57.6 %
Underwriting income (loss) (1) 46,821
(3,877) 50,698 NM Interest expense (40) - (40) NM Net investment income 9,080 8,612 468 5.4 % Net realized and unrealized gains on investments 1,277 1,488 (211) (14.2) % Income before income taxes 57,138 6,223 50,915 818.2 % Income tax expense (benefit) 11,291 (34) 11,325 NM Net income 45,847 6,257 39,590 632.7 % Adjustments: Expenses associated with transactions and stock offerings 563 708 (145) (20.5) % Stock-based compensation expense 5,584 2,167 3,417 157.7 % Amortization of intangibles 1,251 - 1,251 NM Expenses associated with catastrophe bond 1,704 399 1,305 327.1 % Tax impact (1,506) (664) (842) 126.8 % Adjusted net income (1) 53,443 $ 8,867$ 44,576 502.7 % Key Financial and Operating Metrics Annualized return on equity 12.1 % 2.1 % Annualized adjusted return on equity (1) 14.1 % 3.0 % Loss ratio 17.7 % 41.3 % Expense ratio 62.2 % 61.2 % Combined ratio 80.0 % 102.5 % Adjusted combined ratio (1) 76.1 % 100.4 % Diluted earnings per share $ 1.76 $ 0.24
Diluted adjusted earnings per share (1) $ 2.05 $
0.35 Catastrophe losses $ 5,015 $ 50,986 Catastrophe loss ratio (1) 2.1 % 32.9 % Adjusted combined ratio excluding catastrophe losses (1) 73.9 % 67.5 % NM-Not Meaningful
Indicates non-GAAP financial measure; see "Reconciliation of Non-GAAP
(1) Financial Measures" for a reconciliation of the non-GAAP financial measures
to their most directly comparable financial measures prepared in accordance
with GAAP.
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Gross Written Premiums
Gross written premiums were$535.2 million for the year endedDecember 31, 2021 compared to$354.4 million for the year endedDecember 31, 2020 , an increase of$181.8 million , or 51.0%. Premium growth was primarily due to an increased volume of policies written across our lines of business which was driven by new business generated with existing partners, strong premium retention rates for existing business, expansion of our products' geographic and distribution footprint, and new partnerships. For commercial products, substantial rate increases also contributed to premium growth. The following table summarizes our gross written premiums by line of business and shows each line's percentage of total gross written premiums for each period: Year Ended December 31, 2021 2020 ($ in thousands) % of % of Amount GWP Amount GWP Change % Change Product Residential Earthquake$ 171,048 32.0 %$ 140,934 39.8 %$ 30,114 21.4 % Commercial Earthquake 90,552 16.9 % 58,890 16.6 % 31,662 53.8 % Specialty Homeowners 67,894 12.7 % 49,849 14.1 % 18,045 36.2 % Inland Marine 57,124 10.7 % 15,423 4.3 % 41,701 270.4 % Commercial All Risk 38,640 7.2 % 53,933 15.2 % (15,293) (28.4) % Hawaii Hurricane 30,298 5.6 % 13,824 3.9 % 16,474 119.2 % Residential Flood 11,652 2.2 % 8,176 2.3 % 3,476 42.5 % Other 67,967 12.7 % 13,331 3.8 % 54,636 409.8 % Total Gross Written Premiums$ 535,175 100.0 %$ 354,360 100.0 %$ 180,815 51.0 %
During the fourth quarter of 2020, we ceased offering Commercial All Risk
products on an admitted basis and only offered them on an E&S basis during 2021.
This transition caused a decline in premium in our Commercial All Risk line.
The following table summarizes our gross written premiums by insurance
subsidiary:
Year Ended December 31,
2021 2020
($ in thousands)
% of % of
Amount GWP Amount GWP Change % Change
Subsidiary
PSIC $ 383,063 71.4 % $ 324,870 91.7 % $ 58,193 17.9 %
PESIC 152,111 28.6 % 29,490 8.3 % 122,621 415.8 %
Total Gross Written Premiums $ 535,175 100.0 % $ 354,360 100.0 % $ 180,814 51.0 %
Ceded Written Premiums
Ceded written premiums increased $68.3 million , or 44.1 %, to $223.4 million for
the year ended December 31, 2021 from $155.1 million for the year ended December
31, 2020 . The increase was primarily due to increased quota share ceding due to
growth in written premium lines subject to quota shares. In addition, XOL
reinsurance expense increased due to growth in exposure and additional charges
from Winter Storm Uri ("Uri"), which impacted our Specialty Homeowners and
Commercial All Risk lines during the first quarter of 2021.
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Catastrophe losses from Uri caused us to utilize certain layers of our XOL program which increased our XOL reinsurance expense. During the year endedDecember 31, 2021 , we incurred an additional$7.9 million of expense associated with the reinstatement of our reinsurance program as a result of Winter Storm Uri. During 2020, we also incurred specific XOL expenses resulting from castastrophe events. As a result of hurricanes occurring in the third and fourth quarters of 2020, we fully utilized portions of our XOL coverage and incurred charges of$7.0 million related to the acceleration of XOL expenses and the purchase and utilization of a backup XOL layer.
Ceded written premiums as a percentage of gross written premiums slightly
decreased to 41.8% for the year ended
ended
premiums growing at a faster rate than ceded written premiums.
Net Written Premiums
Net written premiums increased$112.4 million , or 56.4%, to$311.7 million for the year endedDecember 31, 2021 from$199.3 million for the year endedDecember 31, 2020 . The increase was primarily due to higher gross written premiums, primarily in our Earthquake and Inland Marine lines, offset by increased ceded written premiums. Net Earned Premiums Net earned premiums increased$78.7 million , or 50.8%, to$233.8 million for the year endedDecember 31, 2021 from$155.1 million for the year endedDecember 31, 2020 due primarily to the earned portion of the higher gross written premiums offset by the earned portion of the higher ceded written premiums. The table below shows the amount of premiums we earned on a gross and net basis for each period presented: Year Ended December 31, 2021 2020 Change % Change ($ in thousands)
Gross earned premiums$ 433,999 $ 301,457 $ 132,542 44.0 % Ceded earned premiums (200,173) (146,389) (53,784) 36.7 % Net earned premiums$ 233,826 $ 155,068 $ 78,758 50.8 %
Net earned premium ratio 53.9% 51.4%
Commission and Other Income
Commission and other income increased$0.3 million , or 9.5%, to$3.6 million for the year endedDecember 31, 2021 from$3.3 million for the year endedDecember 31, 2020 due primarily to an increase in policies written through our internal managing general agency,Palomar Insurance Agency .
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses decreased$22.6 million , or 35.3%, to$41.5 million for the year endedDecember 31, 2021 from$64.1 million for the year endedDecember 31, 2020 . During the year endedDecember 31, 2021 , losses were primarily attributable to attritional losses and catastrophe losses from Hurricanes Ida and Nicholas and Winter Storm Uri which impacted our Specialty Homeowners and Commercial All Risk lines of business. We also experienced a single castastrophe loss from an excess liability indemnity policy covered by PESIC. During the year endedDecember 31, 2020 , losses were primarily attributable to catastrophe events occurring during the third and fourth quarters in our Specialty Homeowners and Commercial All Risk lines of business. 64 Table of Contents Losses and loss adjustment expenses consisted of the following elements during the respective periods: Year Ended December 31, 2021 2020 Change % Change ($ in thousands) Catastrophe losses$ 5,015 $ 50,986 $ (45,971) NM Non-catastrophe losses 36,442 13,129
23,313 177.6 %
Total losses and loss adjustment expenses
NM- not meaningful Our catastrophe loss ratio was 2.1% during the year endedDecember 31, 2021 . Catastrophe losses primarily included losses from losses from Hurricanes Ida and Nicholas, Winter Storm Uri, and a single loss from an excess liability indemnity policy covered by PESIC. Our catastrophe loss ratio was 32.9% during the year endedDecember 31, 2020 . Catastrophe losses primarily included losses from Hurricanes Sally, Laura, Hanna and Zeta. Our non-catastrophe loss ratio was 15.6% for the year endedDecember 31, 2021 compared to 8.5% during the year endedDecember 31, 2020 . Non-catastrophe losses increased due mainly to a higher percentage of business in lines subject to attritional losses such as Specialty Homeowners, Inland Marine, Flood, and assumed reinsurance.
Acquisition Expenses
Acquisition expenses increased$31.4 million , or 49.0%, to$95.4 million for the year endedDecember 31, 2021 from$64.0 million for the year endedDecember 31, 2020 . The primary reason for the increase was increased commissions due to higher earned premiums, offset by increased ceding commissions from quota share arrangements. Acquisition expenses as a percentage of gross earned premiums were 22.0% for the year endedDecember 31, 2021 compared to 21.2% for the year endedDecember 31, 2020 . Acquisition expenses as a percentage of gross earned premiums increased due to changes in business mix and changes in our Specialty Homeowners ceding arrangements which increased the percentage of premiums we retained and decreased our ceding commissions. Acquisition expenses as a percentage of gross earned premiums fluctuates based on mix of business produced and quota share arrangements in place. Other Underwriting Expenses Other underwriting expenses increased$19.7 million , or 57.6%, to$53.7 million for the year endedDecember 31, 2021 from$34.1 million for the year endedDecember 31, 2020 . The increase was primarily due to the Company incurring higher payroll, technology, stock-based compensation, and professional fees associated with its growth. In addition, during the first quarter of 2021, other underwriting expenses were significantly impacted by expenses associated with the issuance of a catastrophe bond. Other underwriting expenses as a percentage of gross earned premiums were 12.4% for the year endedDecember 31, 2021 compared to 11.3% for the year endedDecember 31, 2020 . Excluding the impact of expenses relating to transactions and stock offerings, stock-based compensation, amortization of intangibles, and catastrophe bonds, other underwriting expenses as a percentage of gross earned premiums were 10.3% for the year endedDecember 31, 2021 compared to 10.2% for the year endedDecember 31, 2020 . Other underwriting expenses as a percentage of gross earned premiums may fluctuate period over period based on timing of certain expenses relative to premium growth.
Net Investment Income and Net Realized and Unrealized Gains (Losses) on
Investments
Net investment income increased$0.5 million , or 5.4%, to$9.1 million for the year endedDecember 31, 2021 from$8.6 million for the year endedDecember 31, 2020 . The increase was primarily due to a higher average balance of 65
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investments during the year endedDecember 31, 2021 due primarily to proceeds from ourJune 2020 stock offering and the investing of our cash generated from operations, partially offset by lower yields on recently invested funds. Net realized and unrealized gains on investments decreased$0.2 million , to a$1.3 million gain for the year endedDecember 31, 2021 from a$1.5 million gain for the year endedDecember 31, 2020 . This change was due to fluctuations in performance of equity securities held. The following table summarizes the components of our investment income for each period presented: Year Ended December 31, 2021 2020 Change % Change ($ in thousands) Interest income$ 9,119 $ 8,554 $ 565 6.6 % Dividend income 461 489 (28) (5.7) %
Investment management fees and expenses (500) (431) (69) 16.0 % Net investment income 9,080 8,612 468 5.4 % Net realized and unrealized gains on investments 1,277 1,488
(211) (14.2) % Total$ 10,357 $ 10,100 $ 257 2.5 % Income Tax Expense (Benefit) Income tax expense increased to$11.3 million for the year endedDecember 31, 2021 versus an immaterial benefit during the year endedDecember 31, 2020 . For the year endedDecember 31, 2021 , the difference between our tax rate and the 21% statutory rate relates primarily to a benefit from the permanent component of employee stock option exercises and charges related to state tax accruals. For the year endedDecember 31, 2020 , the difference relates primarily the permanent component of employee stock option exercises.
Reconciliation of Non-GAAP Financial Measures
Underwriting Revenue
We define underwriting revenue as total revenue excluding net investment income
and net realized and unrealized gains and losses on investments. Underwriting
revenue represents revenue generated by our underwriting operations and allows
us to evaluate our underwriting performance without regard to investment income.
We use this metric as we believe it gives our management and other users of our
financial information useful insight into our underlying business performance.
Underwriting revenue should not be viewed as a substitute for total revenue
calculated in accordance with GAAP, and other companies may define underwriting
revenue differently.
Total revenue calculated in accordance with GAAP reconciles to underwriting
revenue as follows:
Year Ended
December 31,
2021 2020
(in thousands)
Total revenue $ 247,791 $ 168,463
Net investment income (9,080) (8,612)
Net realized and unrealized gains on investments (1,277) (1,488)
Underwriting revenue $ 237,434 $ 158,363
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Underwriting Income
We define underwriting income as income before income taxes excluding net
investment income, net realized and unrealized gains and losses on investments,
and interest expense. Underwriting income represents the pre-tax profitability
of our underwriting operations and allows us to evaluate our underwriting
performance without regard to investment income. We use this metric as we
believe it gives our management and other users of our financial information
useful insight into our underlying business performance. Underwriting income
should not be viewed as a substitute for pre-tax income calculated in accordance
with GAAP, and other companies may define underwriting income differently.
Income before income taxes calculated in accordance with GAAP reconciles to
underwriting income as follows:
Year Ended
December 31,
2021 2020
(in thousands)
Income before income taxes $ 57,138 $ 6,223
Net investment income (9,080) (8,612)
Net realized and unrealized gains on investments (1,277) (1,488)
Interest expense
40 - Underwriting income (loss)$ 46,821 $ (3,877)
Adjusted Net Income
We define adjusted net income as net income excluding the impact of certain
items that may not be indicative of underlying business trends, operating
results, or future outlook, net of tax impact. We calculate the tax impact only
on adjustments which would be included in calculating our income tax expense
using the estimated tax rate at which the company received a deduction for these
adjustments. We use adjusted net income as an internal performance measure in
the management of our operations because we believe it gives our management and
financial statement users useful insight into our results of operations and our
underlying business performance. Adjusted net income does not reflect the
overall profitably of our business and should not be viewed as a substitute for
net income calculated in accordance with GAAP. Other companies may define
adjusted net income differently.
Net income calculated in accordance with GAAP reconciles to adjusted net income
as follows:
Year Ended December 31,
2021 2020
(in thousands)
Net income $ 45,847 $ 6,257
Adjustments:
Expenses associated with transactions and stock offerings 563 708 Stock-based compensation expense 5,584 2,167 Amortization of intangibles 1,251 - Expenses associated with catastrophe bond 1,704 399 Tax impact (1,506) (664) Adjusted net income$ 53,443 $ 8,867 Adjusted Return on Equity
We define adjusted return on equity as adjusted net income expressed on an
annualized basis as a percentage of average beginning and ending stockholders'
equity during the period. We use adjusted return on equity as an internal
performance measure in the management of our operations because we believe it
gives our management and financial statement users useful insight into our
results of operations and our underlying business performance. Adjusted return
on
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equity should not be viewed as a substitute for return on equity calculated
using unadjusted GAAP numbers, and other companies may define adjusted return on
equity differently.
Adjusted return on equity is calculated as follows:
Year Ended December 31,
2021 2020
($ in thousands)
Numerator: Adjusted net income $ 53,443 $ 8,867
Denominator: Average stockholder's equity 378,941 291,135
Adjusted return on equity
14.1 % 3.0 % Adjusted Combined Ratio We define adjusted combined ratio as the sum of the loss ratio and the expense ratio calculated excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook. We use adjusted combined ratio as an internal performance measure in the management of our operations because we believe it gives our management and financial statement users useful insight into our results of operations and our underlying business performance. Adjusted combined ratio should not be viewed as a substitute for combined ratio calculated using unadjusted GAAP numbers, and other companies may define adjusted combined ratio differently.
Adjusted combined ratio is calculated as follows:
Year Ended December 31,
2021 2020
($ in thousands)
Numerator: Sum of losses, loss adjustment expenses,
underwriting, acquisition and other underwriting expenses,
net of commission and other income
$ 187,005 $ 158,945 Denominator: Net earned premiums$ 233,826 $ 155,068 Combined ratio 80.0 % 102.5 % Adjustments to numerator: Expenses associated with transactions and stock offerings (563) (708) Stock-based compensation expense (5,584) (2,167) Amortization of intangibles (1,251) - Expenses associated with catastrophe bond (1,704) (399) Adjusted combined ratio 76.1 % 100.4 %
Diluted adjusted earnings per share
We define diluted adjusted earnings per share as adjusted net income divided by
the weighted-average common shares outstanding for the period, reflecting the
dilution which could occur if equity-based awards are converted into common
share equivalents as calculated using the treasury stock method. We use diluted
adjusted earnings per share as an internal performance measure in the management
of our operations because we believe it gives our management and financial
statement users useful insight into our results of operations and our underlying
business performance. Diluted adjusted earnings per share should not be viewed
as a substitute for diluted earnings per share calculated in accordance with
GAAP, and other companies may define diluted adjusted earnings per share
differently.
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Diluted adjusted earnings per share is calculated as follows:
Year Ended December 31,
2021 2020
(in thousands
except shares and per share data)
Adjusted net income $ 53,443 $ 8,867 Weighted-average common shares outstanding, diluted 26,111,904 25,598,647 Diluted adjusted earnings per share $ 2.05 $ 0.35 Catastrophe Loss Ratio
Catastrophe loss ratio is defined as the ratio of catastrophe losses to net earned premiums. Although we are inherently subject to catastrophe losses, the frequency and severity of catastrophe losses is unpredictable and their impact on our operating results may vary significantly between periods and obscure other trends in our business. Therefore, we are providing this metric because we believe it gives our management and other financial statement users useful insight into our results of operations and trends in our financial performance without the volatility caused by catastrophe losses. Catastrophe loss ratio should not be viewed as a substitute for loss ratio calculated using unadjusted GAAP numbers, and other companies may define catastrophe loss ratio differently.
Catastrophe loss ratio is calculated as follows:
Year Ended December 31,
2021 2020
($ in thousands)
Numerator: Losses and loss adjustment expenses
Denominator: Net earned premiums
$ 233,826 $ 155,068 Loss ratio 17.7 % 41.3 % Numerator: Catastrophe losses$ 5,015 $ 50,986 Denominator: Net earned premiums$ 233,826 $ 155,068 Catastrophe loss ratio 2.1 % 32.9 %
Adjusted Combined Ratio Excluding Catastrophe Losses
Adjusted combined ratio excluding catastrophe losses is defined as adjusted
combined ratio excluding the impact of catastrophe losses. Although we are
inherently subject to catastrophe losses, the frequency and severity of
catastrophe losses is unpredictable and their impact on our operating results
may vary significantly between periods and obscure other trends in our
business. Therefore, we are providing this metric because we believe it gives
our management and other financial statement users useful insight into our
results of operations and trends in our financial performance without the
volatility caused by catastrophe losses. Adjusted combined ratio excluding
catastrophe losses should not be viewed as a substitute for combined ratio
calculated using unadjusted GAAP numbers, and other companies may define
adjusted combined ratio excluding catastrophe losses differently.
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Adjusted combined ratio excluding catastrophe losses is calculated as follows:
Year Ended December 31,
2021 2020
($ in thousands)
Numerator: Sum of losses and loss adjustment expenses,
acquisition expenses, and other underwriting expenses, net
of commission and other income
$ 187,005 $ 158,945 Denominator: Net earned premiums$ 233,826 $ 155,068 Combined ratio 80.0 % 102.5 % Adjustments to numerator: Expenses associated with transactions and stock offerings$ (563) $ (708) Stock-based compensation expense (5,584)
(2,167)
Amortization of intangibles (1,251) - Expenses associated with catastrophe bond (1,704)
(399)
Catastrophe losses (5,015)
(50,986)
Adjusted combined ratio excluding catastrophe losses 73.9
% 67.5 % Tangible Stockholders' Equity We define tangible stockholders' equity as stockholders' equity less intangible assets. 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 calculated in accordance with GAAP reconciles to tangible
stockholders' equity as follows:
December 31,
2021 2020
(in thousands)
Stockholders' equity $ 394,169 $ 363,713
Intangible assets (9,501) (11,512)
Tangible stockholders' equity $ 384,668 $ 352,201
Liquidity and Capital Resources
Sources and Uses of Funds
We operate as a holding company with no business operations of our own. Consequently, our ability to pay dividends to stockholders and pay taxes and administrative expenses is largely dependent on dividends or other distributions from our subsidiaries and affiliates, whose ability to pay us is highly regulated. The Company'sU.S. insurance company subsidiaries, PSIC and PESIC are restricted by the statutes as to the amount of dividends that they may pay without prior approval by state insurance commissioners. UnderCalifornia andOregon statute which govern PSIC, dividends paid in a consecutive twelve month period cannot exceed the greater of (i) 10% of an insurance company's statutory policyholders' surplus as ofDecember 31 of the preceding year or (ii) 100% of its statutory net income for the preceding calendar year. Any dividends or distributions in excess of these amounts would require regulatory approval. In addition, underOregon statute PSIC may only declare a dividend from earned surplus, which does not include contributed capital. Surplus arising from unrealized 70
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capital gains or revaluation of assets is not considered part of earned surplus. Based on the above restrictions, PSIC may pay a dividend or distribution of no greater than$45.7 million in 2022 without approval by theCalifornia andOregon Insurance Commissioners. UnderArizona statute with governs PESIC, dividends paid in a consecutive twelve month period cannot exceed the lesser of (i) 10% of an insurance company's statutory policyholders' surplus as ofDecember 31 of the preceding year or (ii) 100% of its statutory net income for the preceding calendar year. Based on the above restrictions, PESIC may pay a dividend or distribution of no greater than$4.1 million in 2022 without approval of theArizona Insurance Commissioner. In addition to the above limitations, any dividend or distribution declared is also subject to state regulatory approval prior to payment. In the future, state insurance regulatory authorities may adopt statutory provisions and dividend limitations more restrictive than those currently in effect. Insurance companies inthe United States are also required by state law to maintain a minimum level of policyholder's surplus. State insurance regulators have a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of the insurer's assets and liabilities and its mix of net written premium. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As ofDecember 31, 2021 andDecember 31, 2020 , the total adjusted capital of PSIC and PESIC were in excess of their respective prescribed risk-based capital requirements.
Under the Insurance Act and related regulations, our
subsidiary, PSRE, is required to maintain certain solvency and liquidity levels,
which it maintained as of
PSRE maintains a Class 3A license and thus must maintain a minimum liquidity ratio in which the value of its relevant assets is not less than 75% of the amount of its relevant liabilities for general business. Relevant assets include cash and cash equivalents, fixed maturity securities, accrued interest income, premiums receivable, losses recoverable from reinsurers, and funds withheld. The relevant liabilities include total general business insurance reserves and total other liabilities, less sundry liabilities. As ofDecember 31, 2021 andDecember 31, 2020 , we met the minimum liquidity ratio requirement.Bermuda regulations limit the amount of dividends and return of capital paid by a regulated entity. A Class 3A insurer is prohibited from declaring or paying a dividend if it is in breach of its minimum solvency margin, its enhanced capital requirement, or its minimum liquidity ratio, or if the declaration or payment of such dividend would cause such a breach. If a Class 3A insurer has failed to meet its minimum solvency margin on the last day of any financial year, it will also be prohibited, without the approval of theBermuda Monetary Authority ("BMA"), from declaring or paying any dividends during the next financial year. Furthermore, the Insurance Act limits the ability of PSRE to pay dividends or make capital distributions by stipulating certain margin and solvency requirements and by requiring approval from the BMA prior to a reduction of 15% or more of a Class 3A insurer's total statutory capital as reported on its prior year statutory balance sheet. Moreover, an insurer must submit an affidavit to the BMA, sworn by at least two directors and the principal representative inBermuda of the Class 3A insurer, at least seven days prior to payment of any dividend which would exceed 25% of that insurer's total statutory capital and surplus as reported on its prior year statutory balance sheet. The affidavit must state that in the opinion of those swearing the declaration of such dividend has not caused the insurer to fail to meet its relevant margins. Further, under the Companies Act, PSRE may only declare or pay a dividend, or make a distribution out of contributed surplus, if it has no reasonable grounds for believing that: (1) it is, or would after the payment be, unable to pay its liabilities as they become due or (2) the realizable value of its assets would be less than its liabilities. Pursuant toBermuda regulations, the maximum amount of dividends and return of capital available to be paid by a reinsurer is determined pursuant to a formula. Under this formula, the maximum amount of dividends and return of capital available from PSRE during 2022 is calculated to be approximately$4.2 million . However, this dividend amount is subject to annual enhanced solvency requirement calculations. During the year endedDecember 31 2021 , PSRE paid 71
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dividends of
payments were approved by the BMA. There were no dividends declared or paid
during the year ended
One of our insurance company subsidiaries, PSIC, is a member of theFederal Home Loan Bank of San Francisco (FHLB). Membership allows PSIC access to collateralized advances, which may be used to support and enhance liquidity management. The amount of advances that may be taken is dependent on statutory admitted assets. As ofDecember 31, 2021 and 2020, there are no advances outstanding under the FHLB facility.
Cash Flows
Our primary sources of cash flow are written premiums, investment income, reinsurance recoveries, sales and redemptions of investments, and proceeds from offerings of debt and equity securities. We use our cash flows primarily to pay operating expenses, losses and loss adjustment expenses, and income taxes.
Our cash flows from operations may differ substantially from our net income due
to non-cash charges or due to changes in balance sheet accounts.
The timing of our cash flows from operating activities can also 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. Therefore, their timing can influence cash flows from operating activities in any given period. The potential for a large claim under an insurance or reinsurance contract means that our insurance subsidiaries may need to make substantial payments within relatively short periods of time, which would have a negative impact on our operating cash flows. We generated positive cash flows from operations for the years endedDecember 31, 2021 and 2020. Management believes that cash receipts from premium, proceeds from investment sales and redemptions, and investment income and reinsurance recoveries, if necessary, are sufficient to cover cash outflows in the foreseeable future. The following table summarizes our cash flows for the years endedDecember 31, 2021 and 2020: Year ended December 31, 2021 2020 ($ in thousands) Cash provided by (used in): Operating activities$ 87,814 $ 57,493 Investing activities (58,188) (185,385) Financing activities (13,041) 128,329
Change in cash, cash equivalents, and restricted cash
437
Our cash flow from operating activities has been positive in each of the last two years. Variations in operating cash flow between periods are primarily driven by variations in our gross and ceded written premiums and the volume and timing of premium receipts, claim payments, and reinsurance payments. In addition, fluctuations in losses and loss adjustment expenses and other insurance operating expenses impact operating cash flow.
Cash used in investing activities for each of the last two years related
primarily to purchases of fixed income and equity securities in excess of sales
and maturities.
Cash used in financing activities for the year endedDecember 31, 2021 related to the repurchase of$15.9 million of our common stock offset by$2.8 million in proceeds from common stock issued via stock option exercises and our employee stock purchase plan. Cash provided by financing activities for year endedDecember 31, 2020 was related to the receipt of$35.5 million in net proceeds from theJanuary 2020 stock offering, the receipt of$90.1 million in net proceeds from theJune 2020 stock offering, the receipt of$0.7 million in proceeds related to the issuance of 72
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common stock via our employee stock purchase plan, and the receipt of
million
We do not have any current plans for material capital expenditures other than current operating requirements. We believe that we will generate sufficient cash flows from operations to satisfy our liquidity requirements for at least the next 12 months and beyond. The key factor that will affect our future operating cash flows is the frequency and severity of catastrophic loss events. To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had$516.3 million in cash and investment securities available atDecember 31, 2021 . We also have the ability to access additional capital through pursuing third-party borrowings including our credit agreement, sales of our equity or debt securities or entrance into a reinsurance arrangement.
Contractual Obligations and Commitments
The following table illustrates our contractual obligations and commercial
commitments by due date as of
One Year Three Years
Less Than to Less Than to Less Than More Than
Total One Year Three Years Five Years Five Years
(in thousands)
Reserves for losses and loss
adjustment expenses $ 173,366 $ 136,638 $ 17,522 $ 15,879 $ 3,327
Operating lease obligations 2,244 904 1,340 - -
Total $ 175,610 $ 137,542 $ 18,862 $ 15,879 $ 3,327
The reserve for losses and loss adjustment expenses represent management's estimate of the ultimate cost of settling losses. As more fully discussed in "-Critical Accounting Policies-Reserve for Losses and Loss Adjustment Expenses" below, the estimation of the reserve for losses and loss adjustment expenses is based on various complex and subjective judgments. Actual losses paid may differ, perhaps significantly, from the reserve estimates reflected in our consolidated financial statements. Similarly, the timing of payment of our estimated losses is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid can be significantly different from the amounts disclosed above. The amounts in the above table represent our gross estimates of known liabilities as ofDecember 31, 2021 and do not include any allowance for claims for future events within the time period specified. Accordingly, it is highly likely that the total amounts of obligations paid by us in the time periods shown will be greater than those indicated in the table.
Share repurchases
During the year endedDecember 31, 2021 , our Board of Directors authorized a$40 million share repurchase program and we repurchased$15.9 million of shares under this program in 2021. Subsequent toDecember 31, 2021 , our Board of Directors approved a new share repurchase program, replacing the existing program and authorizing the repurchase by the Company of up to$100 million of our outstanding shares of common stock over the period ending onMarch 31, 2024 . Through this program, we may use our capital to repurchase our shares in the future. The timing and amount of future share repurchases will depend on several factors, including our stock price performance, ongoing capital planning considerations, general market conditions, and applicable legal requirements.
Credit Agreement
InDecember 2021 , we entered into a Credit Agreement (the "Credit Agreement") withU.S. Bank National Association which provides a revolving credit facility of up to$100 million throughDecember 8, 2026 . Interest on the credit facility accrues on each SOFR rate loan at the applicable SOFR (as defined in the Credit Agreement) plus 1.75% and on each base rate loan at the applicable Alternate Base Rate (as defined in the Credit Agreement) plus 0.75%. A loan 73
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may be either a SOFR rate loan or a base rate loan, at our discretion. Outstanding amounts under the Credit Agreement may be prepaid in full or in part at any time with no prepayment premium and may be reduced in full or in part at any time upon prior notice.
As of
Credit Agreement, but we may seek to borrow under the Credit Agreement in the
future.
Financial Condition Stockholders' Equity AtDecember 31, 2021 total stockholder's equity was$394.2 million and tangible stockholders' equity was$384.7 million , compared to total stockholders' equity of$363.7 million and tangible stockholders' equity of$352.2 million as ofDecember 31, 2020 . Stockholder's equity increased primarily due to net income and due to issuance of common stock and stock-based compensation expense from our equity compensation plans, offset by unrealized losses on our fixed income securities and company repurchases of our common stock. Stock-based compensation expense is treated as an additional paid-in-capital and increases stockholder's equity.
Tangible stockholders' equity is a non-GAAP financial measure. See
"Reconciliation of Non-GAAP Financial Measures" for a reconciliation of
stockholders' equity in accordance with GAAP to tangible stockholders' equity.
Investment Portfolio
Our primary investment objectives are to maintain liquidity, preserve capital and generate a stable level of investment income. We purchase securities that we believe are attractive on a relative value basis and seek to generate returns in excess of predetermined benchmarks. Our Board of Directors approves our investment guidelines in compliance with applicable regulatory restrictions on asset type, quality and concentration. Our current investment guidelines allow us to invest in taxable and tax-exempt fixed maturities, as well as publicly traded mutual funds and common stock of individual companies. Our cash and invested assets consist of cash and cash equivalents, fixed maturity securities, and equity securities. As ofDecember 31, 2021 , the majority of our investment portfolio, or$432.7 million , was comprised of fixed maturity securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. Also included in our investment portfolio were$33.3 million of equity securities. In addition, we maintained a non-restricted cash and cash equivalent balance of$50.3 million atDecember 31, 2021 . Our fixed maturity securities, including cash equivalents, had a weighted average effective duration of 3.99 and 3.96 years and an average rating of "A1/A" and "A2/A" atDecember 31, 2021 andDecember 31, 2020 , respectively. Our fixed income investment portfolio had a book yield of 2.23% as ofDecember 31, 2021 , compared to 2.27% as ofDecember 31, 2020 .
At
available-for-sale securities were as follows:
Amortized Fair % of Total
December 31, 2021 Cost or Cost Value Fair Value
($ in thousands)
Fixed maturities:
U.S. Governments $ 16,713 $ 16,870 3.9 %
States, territories, and possessions 3,789 4,014 0.9 %
Political subdivisions 6,295 6,380 1.5 %
Special revenue excluding mortgage/asset-backed securities 43,301 44,498 10.3 %
Industrial and miscellaneous 245,064 249,046 57.5 %
Mortgage/asset-backed securities 110,960 111,874 25.9 %
Total available-for-sale investments $ 426,122 $ 432,682 100.0 %
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Amortized Fair % of Total
December 31, 2020 Cost or Cost Value Fair Value
($ in thousands)
Fixed maturities:
U.S. Governments $ 16,308 $ 17,059 4.3 %
States, territories, and possessions 6,208 6,636 1.7 %
Political subdivisions 2,027 2,152 0.5 %
Special revenue excluding mortgage/asset-backed securities 39,704 41,227 10.4 %
Industrial and miscellaneous 234,049 245,360 61.6 %
Mortgage/asset-backed securities 82,983 85,553 21.5 %
Total available-for-sale investments $
381,279
The following tables provide the credit quality of investment securities as of
Estimated % of
December 31, 2021 Fair Value Total
($ in thousands)
Rating
AAA $ 97,209 22.5 %
AA 65,308 15.1 %
A 165,770 38.3 %
BBB 93,051 21.5 %
BB 11,057 2.5 %
B 268 0.1 %
CCC&Below 125 - %
$ 432,788 100.0 %
Estimated % of
December 31, 2020 Fair Value Total
($ in thousands)
Rating
AAA $ 91,156 22.9 %
AA 54,342 13.7 %
A 149,977 37.7 %
BBB 88,817 22.3 %
BB 11,425 2.9 %
NA/NR 2,270 0.5 %
$ 397,987 100.0 %
The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as ofDecember 31, 2021 were as follows: Amortized Fair % of Total December 31, 2021 Cost Value Fair Value ($ in thousands) Due within one year$ 21,435 $ 21,550 5.0 %
Due after one year through five years 133,235 134,946 31.2 %
Due after five years through ten years 113,264 115,897 26.8 %
Due after ten years 47,228 48,415 11.2 %
Mortgage and asset-backed securities 110,960 111,874 25.8 %
$ 426,122 $ 432,682 100.0 %
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Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations. See "Critical Accounting Policies
and Estimates- Investment Valuation and Fair Value" for discussion of investment
valuation considerations.
Critical Accounting Policies and Estimates
We identified the accounting estimates below as critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and which require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
Reserve for Losses and Loss Adjustment Expenses
The reserve for losses and loss adjustment expenses represents our estimated
ultimate cost of all reported and unreported losses and loss adjustment expenses
incurred and unpaid at the balance sheet date. We do not discount this reserve.
We seek to establish reserves that will ultimately prove to be adequate.
We categorize our reserves for unpaid losses and loss adjustment expenses into
two types: case reserves and reserves for incurred but not yet reported losses
("IBNR"). Through our third-party administrators ("TPAs"), we generally are
notified of losses by our insureds or their agents or brokers. Based on the
information provided by the TPAs, we establish initial case reserves by
estimating the ultimate losses from the claim, including administrative costs
associated with the ultimate settlement of the claim. Our personnel use their
knowledge of the specific claim along with internal and external experts,
including underwriters and legal counsel, to estimate the expected ultimate
losses.
We establish IBNR reserves to provide for (i) the estimated amount of future
loss payments on incurred claims not yet reported, and (ii) potential
development on reported claims. IBNR reserves are estimated based on generally
accepted actuarial reserving techniques that consider quantitative loss
experience data and, where appropriate, qualitative factors. With the assistance
of an independent actuarial firm, we use statistical analysis to estimate the
cost of losses and loss adjustment expenses related to IBNR. Those estimates are
based on our historical information, industry information and practices, and
estimates of trends that may affect the ultimate frequency of incurred but not
reported claims and changes in ultimate claims severity.
We regularly review our reserve estimates and adjust them as necessary as
experience develops or as new information becomes known to us. Such adjustments
are included in current operations. During the loss settlement period, if we
have indications that claims frequency or severity exceeds our initial
expectations, we generally increase our reserves for losses and loss adjustment
expenses. Conversely, when claims frequency and severity trends are more
favorable than initially anticipated, we generally reduce our reserves for
losses and loss adjustment expenses once we have sufficient data to confirm the
validity of the favorable trends. Even after such adjustments, the 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.
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The following tables summarize our gross and net reserves for unpaid losses and
loss adjustment expenses at
December 31, 2021
Gross % of Total Net
% of Total
Loss and Loss Adjustment Reserves ($ in thousands) Case reserves$ 91,715 52.9 %$ 26,595 58.6 % IBNR 81,651 47.1 % 18,824 41.4 % Total reserves$ 173,366 100.0 %$ 45,419 100.0 % December 31, 2020 Gross % of Total Net % of Total Loss and Loss Adjustment Reserves Case reserves$ 74,296 57.6 %$ 18,447 53.5 % IBNR 54,740 42.4 % 16,023 46.5 % Total reserves$ 129,036 100.0 %$ 34,470 100.0 % The process of estimating the reserves for losses and loss adjustment expenses requires a high degree of judgment and is subject to several variables. On a quarterly basis, we perform an analysis of our loss development and select the expected ultimate loss ratio for each of our product lines by accident year. In our actuarial analysis, we use input from our TPAs and our underwriting departments, including premium pricing assumptions and historical experience. Multiple actuarial methods are used to estimate the reserve for losses and loss adjustment expenses. These methods utilize, to varying degrees, the initial expected loss ratio, detailed statistical analysis of past claims reporting and payment patterns, claims frequency and severity, paid loss experience, industry loss experience, and changes in market conditions, policy forms, exclusions, and exposures. The actuarial methods used to estimate loss reserves are:
Reported and/or Paid Loss Development Methods-Ultimate losses are estimated
based on historical reported and/or paid loss patterns. Reported losses are the
? sum of paid and case losses. Industry development patterns are substituted for
historical development patterns when sufficient historical data is not available.
IBNR-to-Case Reserve Ratio Method-This method calculates ratios of IBNR to case
reserves based on incurred and paid development factors from the development
? methods. Estimated IBNR equals the product of case reserves and the
IBNR-to-case reserve ratio. These IBNR amounts are added to the
reported-to-date amount to derive ultimate losses.
Reported Bornhuetter-Ferguson Severity Method-Under this method, ultimate
losses are estimated as the sum of cumulative reported losses and estimated
? IBNR losses. IBNR losses are estimated based on expected average severity,
estimated ultimate claim counts and the historical development patterns of
reported losses.
Reported Bornhuetter Ferguson Pure Premium Method-Under this method, ultimate
? losses are estimated as the sum of cumulative reported losses and estimated
IBNR losses. IBNR losses are estimated based on expected pure premium and on
the historical development patterns of reported losses.
The method(s) used vary based on the line of business and the nature of the loss event. Development patterns for catastrophic events are based on the time since event versus an accident quarter and year pattern used for non-catastrophic events. Considering each of the alternative ultimate estimates, we select an estimate of ultimate loss for each line of business. For Earthquake and "Difference in Conditions" policies, more emphasis is placed on reported methods. For the remainder, a weighted average is selected.
Loss Adjustment Expense reserves are estimated based on the ratio of paid loss
adjustment expense to paid loss, which is estimated separately by line of
business as well as split by hurricane and excluding hurricane. We then apply
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this ratio to our estimated unpaid loss, by multiplying the ratio times 50% of
loss case reserves and 100% of loss IBNR reserves. This is applied by line of
business and accident year to arrive at estimated unpaid loss adjustment expense
on a gross basis. We then add the estimated unpaid loss adjustment expense on a
gross basis to the paid loss adjustment expense to calculate estimated ultimate
loss adjustment expense.
On a quarterly basis, the leaders of our executive management, accounting,
actuarial, and claims teams meet to review the recommendations made by the
independent actuarial consultant and use their best judgment to determine the
best estimate to be recorded for the reserve for losses and loss adjustment
expenses on our balance sheet.
Our reserves are driven by several important factors, including litigation and regulatory trends, legislative activity, climate change, social and economic patterns and claims inflation assumptions. Our reserve estimates reflect current inflation in legal claims' settlements and assume we will not be subject to losses from significant new legal liability theories. Our reserve estimates assume that there will not be significant changes in the regulatory and legislative environment. The impact of potential changes in the regulatory or legislative environment is difficult to quantify in the absence of specific, significant new regulation or legislation. In the event of significant new regulation or legislation, we will attempt to quantify its impact on our business, but no assurance can be given that our attempt to quantify such inputs will be accurate or successful. The table below quantifies the impact of potential reserve deviations from our carried reserve atDecember 31, 2021 . We applied sensitivity factors to incurred losses for the three most recent accident years and to the carried reserve for all prior accident years combined. We believe that potential changes such as these would not have a material impact on our liquidity. Net Ultimate Potential Impact LLAE December 31, 2021 on 2021 Accident Sensitivity Net Ultimate Net LLAE Pretax Stockholders' Sensitivity Year Factor Incurred LLAE Reserve income Equity* ($ in thousands) Sample increases 2021 5.0 %$ 45,045 $ 32,876 $ 2,252 $ 1,779 2020 2.5 %$ 61,001 $ 10,904 $ 1,525 $ 1,205 Prior 1.0 %$ 33,497 $ 1,639 $ 335 $ 265 Sample decreases 2021 (5.0) %$ 45,045 $ 32,876 $ (2,252) $ (1,779) 2020 (2.5) %$ 61,001 $ 10,904 $ (1,525) $ (1,205) Prior (1.0) %$ 33,497 $ 1,639 $ (335) $ (265)
* Effective tax rate estimated to be 21%
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
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unresolved claims. We reflect favorable or unfavorable development of loss
reserves in the results of operations in the period the estimates are changed.
The following tables present the development of our loss reserves by accident year on a gross basis and net of reinsurance recoveries during each of the
below
calendar years:
Gross Ultimate Loss and LAE
Development- (Favorable) Unfavorable
Calendar Year 2018 to 2019 to 2020 to
Accident Year 2018 2019 2020 2021 2019 2020 2021
(in thousands)
Prior $ 57,602 $ 56,651 $ 55,706 $ 61,740 $ (951) $ (945) $ 6,034
2019 25,127 22,797 22,156 - (2,330) (641)
2020 171,470 194,752 - - 23,282
2021 171,922 - - -
$ (951) $ (3,275) $ 28,675
Net Ultimate Loss and LAE
Development- (Favorable) Unfavorable
Calendar Year 2018 to 2019 to 2020 to
Accident Year 2018 2019 2020 2021 2019 2020 2021
(in thousands)
Prior $ 28,377 $ 28,196 $ 28,019 $ 27,988 $ (181) $ (177) $ (21)
2019 5,772 5,885 5,499 - 113 (386)
2020 64,179 61,001 - - (3,178)
2021 45,042 - - -
$ (181) $ (64) $ (3,585)
During the year ended December 31, 2021 , our gross incurred losses for accident
years 2020 and prior developed unfavorably by $28.7 million . The gross
unfavorable development was due primarily to losses on certain 2020 Hurricanes
emerging at a higher severity than expected, primarily in our special property
lines of business. On a net basis, the development was favorable by $3.6 million
due to the effect of ceding gross unfavorable development under our reinsurance
program. The catastrophe events which experienced unfavorable development were
primarily subject to ceding under our XOL treaties while the catastrophe events
which experienced favorable development were subject to a lower amount of
ceding.
During the year ended December 31, 2020 , our gross incurred losses for
accident years 2018 and prior developed favorably by $3.3 million . The gross
favorable development was due to reported losses emerging at a lower level than
expected, primarily in our homeowners and special property lines of business,
offset by higher frequency and severity of losses emerging in our assumed
reinsurance line. The net favorable development of $0.1 million reflects the
effect of ceding the gross favorability under our reinsurance program.
During the year ended December 31, 2019 , our gross incurred losses for
accident years 2018 and prior developed favorably by $1.0 million . This
favorable development was due to reported losses emerging at a lower level than
expected, primarily in our Specialty Homeowners business, offset by higher
frequency and severity of claims in our special property lines of business. The
net favorable development of $0.2 million reflects the effect of ceding the
gross favorability under our reinsurance program.
Although we believe that our reserve estimates are reasonable, it is possible
that our actual loss experience may not conform to our assumptions.
Specifically, our actual ultimate loss ratio could differ from our initial
expected loss ratio or our actual reporting and payment patterns could differ
from our expected reporting and payment patterns, which are based on our own
data and industry data. Accordingly, the ultimate settlement of losses and the
related loss adjustment expenses may vary significantly from the estimates
included in our financial statements. 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 the results of current operations.
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Investment Valuation and Fair Value
We invest in a variety of investment grade fixed maturity securities, includingU.S. government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds. All of our investments in fixed maturity securities and equity securities are carried at fair value, defined as the price that we would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market of the investment. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. In our disclosure of the fair value of our investments, we utilize a hierarchy 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-Unadjusted quoted prices are available in active markets for identical
investments as of the reporting date.
Level 2-Pricing inputs are quoted prices for similar investments in active markets; quoted prices for identical or similar investments in inactive markets; or valuations based on models where the significant inputs are observable or can be corroborated by observable market data.
Level 3-Pricing inputs into models are unobservable for the investment. The
unobservable inputs require significant management judgment or estimation.
We use independent pricing sources to obtain the estimated fair values of investments. The fair value is based on quoted market prices, where available. In cases where quoted market prices are not available, the fair value is based on a variety of valuation techniques depending on the type of investment. The fair values obtained from independent pricing sources are reviewed for reasonableness and any discrepancies are investigated for final valuation. The fair value of our investments in fixed maturity securities is estimated using relevant inputs, including available market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. An Option Adjusted Spread model is also used to develop prepayment and interest rate scenarios. These fair value measurements are estimated based on observable, objectively verifiable market information rather than market quotes; therefore, these investments are classified and disclosed in Level 2 of the hierarchy.
The fair value of our investments in equity securities is based on quoted prices
available in active markets and classified and disclosed in Level 1 of the
hierarchy.
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. Unrealized gains and losses on our
fixed maturity securities are included in accumulated other comprehensive income
as a separate component of total stockholders' equity. Equity securities are
carried at fair value with unrealized gains and losses included as a component
of net income on the Company's consolidated statement of income. Prior to 2018,
unrealized gains and losses on equity securities were included in accumulated
other comprehensive income as a separate component of stockholders' equity.
All financial assets measured at amortized cost, including available-for-sale
securities are required to be presented at the net amount expected to be
collected by means of an allowance for credit losses that is included in net
income. Credit losses relating to available-for-sale debt securities are also
required to be recorded through a reversible allowance for credit losses, but
the allowance is limited to the amount by which fair value is less than
amortized cost.
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The Company reviews all securities with unrealized losses on a regular basis to
assess whether the decline in the securities fair value necessitates the
recognition of an allowance for credit losses. Factors considered in the review
include the extent to which the fair value has been less than amortized cost,
and current market interest rates and whether the unrealized loss is
credit-driven or a result of changes in market interest rates. The Company also
considers factors specific to the issuer including the general financial
condition of the issuer, the issuers industry and future business prospects, any
past failure of issuer to make scheduled interest or principal payments, and the
payment structure of the investment and the issuers ability to make contractual
payments on the investment.
The Company also considers whether it intends to sell the security or if it is
more likely than not that it will be required to sell the security before
recovery of its amortized cost. When assessing whether it intends to sell a
fixed-maturity security or if it is likely to be required to sell a
fixed-maturity security before recovery of its amortized cost, the Company
evaluates facts and circumstances including, but not limited to, decisions to
reposition the investment portfolio, potential sales of investments to meet cash
flow needs, and potential sales of investments to capitalize on favorable
pricing.
For fixed-maturity securities where a decline in fair value is below the
amortized cost basis and the Company intends to sell the security, or it is more
likely than not that the Company will be required to sell the security before
recovery of its amortized cost, a credit-loss charge is recognized in net income
based on the fair value of the security at the time of assessment. For
fixed-maturity securities that the Company has the intent and ability to hold,
the Company compares the estimated present value of the cash flows expected to
be collected to the amortized cost of the security. The extent to which the
estimated present value of the cash flows expected to be collected is less than
the amortized cost of the security represents the credit-related portion of the
impairment, which is recognized in net income through an allowance for credit
losses. Any remaining decline in fair value represents the noncredit portion of
the impairment, which is recognized in other comprehensive income.
The Company reports accrued interest receivable as a component of accrued
investment income on its consolidated balance sheet which is presented
separately from available-for-sale securities. The Company does not measure an
allowance for credit losses on accrued interest receivable and instead would
write off accrued interest receivable at the time an issuer defaults or is
expected to default on payments.
Deferred Income Taxes
We account for taxes under the asset and liability method, under which we record
deferred income taxes as assets or liabilities on our balance sheet to reflect
the net tax effect of the temporary differences between the carrying amount of
assets and liabilities for financial reporting purposes and their respective tax
bases. Deferred tax assets and liabilities are measured by applying enacted tax
rates in effect for the years in which such differences are expected to reverse.
Our deferred tax assets result from temporary differences primarily attributable
to unearned premiums and net operating losses ("NOLs"). Our deferred tax
liabilities result primarily from deferred acquisition costs and unrealized
gains in the investment portfolio. On a quarterly basis, we review our deferred
tax assets and, if we determine that it is more likely than not that some
portion or all of the deferred tax assets will not be realized, we reduce our
deferred tax asset with a valuation allowance. The assessment requires
significant judgement and review of all positive and negative evidence to reach
a conclusion that it is more likely than not that all or some of portion of the
deferred tax asset will not be realized. We consider multiple factors, including
the nature and amount of the deferred tax asset, the expected timing of when an
asset will be used, and the historical profitability of our entities.
Recent Accounting Pronouncements
See "Note 2-Recent Accounting Pronouncements" in the Notes to Consolidated
Financial Statements included in this Annual Report on Form 10-K for a
discussion of accounting pronouncements recently adopted and recently issued
accounting pronouncements not yet adopted and their potential impact to our
financial statements.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements (as defined by applicable regulations of theSEC ) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
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