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PROASSURANCE CORP – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion generally focuses on the change in financial condition, results of operation and cash flows for the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 and should be read in conjunction with the Consolidated Financial Statements and Notes to those statements which accompany this report. For a full discussion of the changes in the financial condition, results of operations and cash flows for the year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 , please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" section ofProAssurance's December 31, 2020 report on Form 10-K. Throughout the discussion we use certain terms and abbreviations, which can be found in the Glossary of Terms and Acronyms at the beginning of this report. In addition, a glossary of insurance terms and phrases is available on the investor section of our website. Throughout the discussion, references to "ProAssurance ," "PRA," "Company," "organization," "we," "us" and "our" refer toProAssurance Corporation and its consolidated subsidiaries. The discussion contains certain forward-looking information that involves significant risks, assumptions and uncertainties. As discussed under the heading "Caution Regarding Forward-Looking Statements," our actual financial condition and results of operations could differ significantly from these forward-looking statements.
ProAssurance Overview
ProAssurance Corporation is a holding company for property and casualty insurance companies. Our wholly owned insurance subsidiaries provide professional liability insurance, liability insurance for medical technology and life sciences risks and workers' compensation insurance. We also provide capital to Syndicate 1729 atLloyd's of London . We operate in five segments which are based on our internal management reporting structure for which financial results are regularly evaluated by our CODM to determine resource allocation and assess operating performance. Descriptions ofProAssurance's five operating and reportable segments are as follows: •Specialty P&C - This segment includes our professional liability business and medical technology liability business. Our professional liability insurance is primarily comprised of medical professional liability products offered to healthcare providers and institutions and includes the business acquired through the NORCAL transaction that closed onMay 5, 2021 . To a lesser extent, we also offer professional liability insurance to attorneys and their firms. Medical technology liability insurance is offered to medical technology and life sciences companies that manufacture or distribute products including entities conducting human clinical trials. We also offer custom alternative risk solutions including loss portfolio transfers, assumed reinsurance and captive cell programs for healthcare professional liability insureds. For our alternative market captive cell programs, we cede either all or a portion of the premium to certain SPCs in our Segregated Portfolio Cell Reinsurance segment. •Workers' Compensation Insurance - This segment includes our workers' compensation insurance business which is provided primarily to employers with 1,000 or fewer employees. Our workers' compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market solutions. Alternative market program premiums are 100% ceded to either SPCs in our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer. •Segregated Portfolio Cell Reinsurance - This segment includes the results (underwriting profit or loss, plus investment results, net ofU.S. federal income taxes) of SPCs at Inova Re and Eastern Re, our Cayman Islands SPC operations. Each SPC is owned, fully or in part, by an individual company, agency, group or association, and the results of the SPCs are attributable to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to a high of 85%. SPC results attributable to external cell participants are reflected as an SPC dividend expense (income) in our Segregated Portfolio Cell Reinsurance segment. The SPCs assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from ourWorkers' Compensation Insurance and Specialty P&C segments. •Lloyd's Syndicates - This segment includes the results from our participation in Lloyd's of London Syndicate 1729 (5% for the 2021 underwriting year) and Syndicate 6131 (50% for the 2021 underwriting year). The results of this segment are normally reported on a quarter lag, except when information is available that is material to the current period. Syndicate 1729 underwrites risks over a wide range of property and casualty insurance and reinsurance lines in both theU.S. and international markets. EffectiveJanuary 1, 2022 , Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's business is retained within Syndicate 1729 beginning with the 2022 underwriting year. Premium from our participation in the results of Syndicate 6131 from open underwriting years prior to 2022 will continue to earn out pro rata over the entire policy period of the underlying business. Prior toJanuary 1, 2022 , Syndicate 6131 was an SPA which focused on contingency and specialty 40
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property business. For the 2022 underwriting year, our participation in the
results of Syndicate 1729 remains unchanged at 5%.
•Corporate - This segment includes our investment operations, including the investment operations of NORCAL since the date of acquisition and excludes those reported in our Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments. In addition, this segment includes corporate expenses, interest expense,U.S. income taxes and non-premium revenues generated outside of our insurance entities.
Additional information regarding our segments is included in Note 19 of the
Notes to Consolidated Financial Statements, Part I and in the Segment Results
sections that follow.
Growth Opportunities and Outlook
Over the long-term we expect our growth to come primarily through controlled expansion of our existing operations. In addition, we may identify opportunities for growth through the acquisition of other insurers, service providers or books of business. OnMay 5, 2021 , we completed our acquisition ofNORCAL Insurance Company . The addition of NORCAL broadens our geographic reach allowing us to create a truly national platform for our Healthcare Professional Liability Business. Through this greater scale, we believe we can create operating efficiencies and increase our product offerings that will allow us to deliver value to our customers, business partners and other stakeholders. See further discussion on the NORCAL acquisition in Note 2 of the Notes to Consolidated Financial Statements and under the heading "Business Combinations and Ventures" in the Liquidity and Capital Resources and Financial Condition section that follows. We continue to see new opportunities from each of our acquisitions and believe each will provide organic growth through expansion in their existing markets and relationships. We operate in very competitive markets and face strong competition from other insurance companies for all of our insurance products. Our Specialty P&C segment includes our HCPL insurance which represents the largest product line in our consolidated gross premiums written (51% in 2021). The Specialty P&C segment also includes our Medical Technology Liability (4% in 2021) and Small Business Unit (11% in 2021) lines of business. The healthcare market in theU.S. is continuing to consolidate, which brings competitive challenges. This consolidation initially took the form of hospitals acquiring physician practices and later the growth of physician groups owned by outside investors. As these trends continue most physicians no longer practice medicine as owners of an independent practice. Large single and multi-specialty practices often operate in many states. Healthcare delivery settings are changing with the growth of retail delivery by allied healthcare professionals as well as physicians in distributed clinics, pharmacies, large consumer stores and online. These larger commercial enterprises have differing risk management needs from those in the traditional small physician practices. In response to these trends, we have enhanced our coverage offerings to fit the needs of combined hospital/physician entities, multi-state medical groups, telemedicine companies, miscellaneous facilities, allied healthcare professionals and self-insured entities even as we continue to service that portion of the market maintaining more traditional practice structures. Our Medical Technology Liability and Small Business Unit lines of business are less affected by these consolidation trends. Our operations at Eastern, a provider of workers' compensation insurance, represents the second largest product line in our consolidated gross premiums written (25% in 2021, including alternative market premiums). The workers' compensation market is highly competitive in our operating territories and multi-line insurers continue to leverage workers' compensation in their product offerings, which has resulted in a reduction of new business writings. We believe our workers' compensation product offerings allow us to provide flexibility in offering solutions to our customers at a competitive price. In addition, we believe that our claims handling and risk management services are attractive to our customers and provide us with a competitive advantage even when our pricing is higher than our competitors, which has contributed to strong renewal retention. Our Lloyd's Syndicates segment represents 4% of our consolidated gross premiums written in 2021. EffectiveJanuary 1, 2022 , Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's business is retained within Syndicate 1729 beginning with the 2022 underwriting year. Our participation in Syndicate 1729 for the 2014 through 2021 underwriting years has ranged from a low of 5% to a high of 62%. For the 2022 underwriting year, our participation in the results of Syndicate 1729 remains unchanged at 5%. Our participation in Syndicate 6131 ranged from a low of 50% to a high of 100% for the 2018 through 2021 underwriting years. We believe our emphasis on the fair treatment of our insureds and other important stakeholders through our commitment to "Treated Fairly" has enhanced our market position and differentiated us from other insurers. We will continue to uphold our values of integrity, leadership, relationships and enthusiasm in all of our activities. We will honor these values in the execution of "Treated Fairly" to perform our Mission and realize our Vision. We believe that as we reach more customers with this message we will continue to improve retention and add new insureds. 41
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Key Performance Measures
We are committed to disciplined underwriting, pricing and loss reserving practices as well as conservative investment practices, even during difficult market conditions. We are also committed to maintaining prudent operating and financial leverage. We recognize the importance that our customers and producers place on the financial strength of our insurance subsidiaries, and we manage our business to protect our financial security.
In evaluating our performance, we consider a number of performance measures,
including the following:
•The net loss ratio which is calculated as net losses and loss adjustment expenses incurred divided by net premiums earned and is a component of underwriting profitability. •The underwriting expense ratio which is calculated as underwriting, policy acquisition and operating expenses incurred divided by net premiums earned and is a component of underwriting profitability. •The combined ratio which is the sum of the net loss ratio and the underwriting expense ratio and measures underwriting profitability. •The investment income ratio which is calculated as net investment income divided by net premiums earned and measures the contribution investment earnings provide to our overall profitability. •The operating ratio which is the combined ratio, less the investment income ratio. This ratio provides the combined effect of underwriting profitability and investment income. •The tax ratio which is calculated as total income tax expense (benefit) divided by income (loss) before income taxes and measures our effective tax rate. •ROE which is calculated as net income (loss) divided by the average of beginning and ending shareholders' equity. This ratio measures our overall after-tax profitability and shows how efficiently capital is being used. •Book value per share which is calculated as total shareholders' equity at the balance sheet date divided by the total number of common shares outstanding. This ratio measures the net worth of the Company to shareholders on a per-share basis. The declaration of dividends decreases book value per share. Growth in book value per share, adjusted for dividends declared, is an indicator of overall profitability. In particular, we focus on our combined ratio and investment returns, both of which directly affect our ROE and growth in our book value. Currently, we target a dynamic long-term ROE of 700 basis points above the 10-yearU.S. Treasury rate, which atDecember 31, 2021 was approximately 8.5%. To achieve our long-term ROE target, we emphasize rate adequacy, selective underwriting, effective claims management, operational efficiency gained by leveraging our enhanced scope and scale and prudent investment management. We closely monitor premium revenues, losses and loss adjustment expenses, and underwriting and policy acquisition expenses. Our overall investment strategy is to focus on maximizing current income from our investment portfolio while maintaining appropriate credit risk, liquidity, duration, portfolio diversification and capital efficiency. While we engage in activities that generate other income, these activities, such as insurance agency services, do not constitute a significant use of our resources or a significant source of revenues or profits. 42
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Critical Accounting Estimates
Our Consolidated Financial Statements are prepared in conformity with GAAP. Preparation of these financial statements requires us to make estimates and assumptions that affect the amounts we report on those statements. We evaluate these estimates and assumptions on an ongoing basis based on current and historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances, including the potential impacts of the COVID-19 pandemic (see "Item 1A, Risk Factors" included in this report for additional information). We can make no assurance that actual results will conform to our estimates and assumptions; reported results of operations may be materially affected by changes in these estimates and assumptions. Management considers the following accounting estimates to be critical because they involve significant judgment by management and those judgments could result in a material effect on our financial statements.
Reserve for Losses and Loss Adjustment Expenses
The largest component of our liabilities is our reserve for losses and loss
adjustment expenses ("reserve for losses" or "reserve"), and the largest
component of expense for our operations is incurred losses and loss adjustment
expenses (also referred to as "losses and loss adjustment expenses," "incurred
losses," "losses incurred" and "losses"). Incurred losses reported in any period
reflect our estimate of losses incurred related to the premiums earned in that
period as well as any changes to our previous estimate of the reserve required
for prior periods.
As of December 31, 2021 , our reserve is comprised almost entirely of long-tail
exposures. The estimation of long-tailed losses is inherently difficult and is
subject to significant judgment on the part of management. Due to the nature of
our claims, our loss costs, even for claims with similar characteristics, can
vary significantly depending upon many factors, including but not limited to the
specific characteristics of the claim and the manner in which the claim is
resolved. Long-tailed insurance is characterized by the extended period of time
typically required both to assess the viability of a claim and potential
damages, if any, and to reach a resolution of the claim. The claims resolution
process may extend to more than five years. The combination of continually
changing conditions and the extended time required for claim resolution results
in a loss cost estimation process that requires actuarial skill and the
application of significant judgment, and such estimates require periodic
modification.
Our reserve is established by management after taking into consideration a
variety of factors including premium rates, historical paid and incurred loss
development trends and our evaluation of the current loss environment including
frequency, severity, expected effect of inflation, general economic and social
trends, and the legal and political environment. We also take into consideration
the conclusions reached by our internal and consulting actuaries. We update and
review the data underlying the estimation of our reserve for losses each
reporting period and make adjustments to loss estimation assumptions that we
believe best reflect emerging data. Both our internal and consulting actuaries
perform an in-depth review of our reserve for losses on at least a semi-annual
basis using the loss and exposure data of our insurance subsidiaries.
We partition our reserves by accident year, which is the year in which the claim
becomes our liability. For claims-made policies, the insured event generally
becomes a liability when the event is first reported to us. For occurrence
policies, the insured event becomes a liability when the event takes place. For
retroactive coverages, the insured event becomes a liability at inception of the
underlying contract. As claims are incurred (reported) and claim payments are
made, they are aggregated by accident year for analysis purposes. We also
partition our reserves by reserve type: case reserves and IBNR reserves. Case
reserves are established by our claims departments based upon the particular
circumstances of each reported claim and represent our estimate of the future
loss costs (often referred to as expected losses) that will be paid on reported
claims. Case reserves are decremented as claim payments are made and are
periodically adjusted upward or downward as estimates regarding the amount of
future losses are revised; reported loss for an individual claim is the case
reserve at any point in time plus the claim payments that have been made to
date. IBNR reserves are estimated by accident year and represent our estimate in
the aggregate of future development on losses that have been reported to us and
our estimate of losses that have been incurred but not reported to us.
Our reserving process can be broadly grouped into three areas: the establishment
of the reserve for the current accident year (the initial reserve), the
re-estimation of the reserve for prior accident years (development of prior
accident years) and the establishment of the initial reserve for risks assumed
in business combinations, applicable only in periods in which acquisitions occur
(the acquired reserve). A summary of the activity in our net reserve for losses
during 2021 and 2020 is provided under the heading "Losses" in the Liquidity and
Capital Resources and Financial Condition section that follows.
Current Accident Year - Initial Reserve
Considerable judgment is required in establishing our initial reserve for any
current accident year period, as there is limited data available upon which to
base our estimate (see further discussion that follows under the heading "Use of
Judgment"). Our process for setting an initial reserve considers the unique
characteristics of each product, but in general we rely heavily on the loss
assumptions that were used to price business, as our pricing reflects our
analysis of loss costs that we expect to incur relative to the insurance product
being priced.
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Specialty P&C Segment. Loss costs within this segment are impacted by many factors including but not limited to the nature of the claim, including whether or not the claim is an individual or a mass tort claim, the personal situation of the claimant or the claimant's family, the outcome of jury trials, the legislative and judicial climate where any potential litigation may occur, general economic and social trends and, for claims involving bodily injury, the trend of healthcare costs. Within our Specialty P&C segment, for our professional liability business (88% of our consolidated gross reserve for losses and loss adjustment expenses as ofDecember 31, 2021 ; predominately comprised of our HCPL products), we set an initial reserve based upon our evaluation of the current loss environment including frequency, severity, economic inflation, social inflation and legal trends. The current accident year net loss ratio in the Specialty P&C segment has ranged from 87% to 106% in recent years, excluding the effect of a single large national healthcare account that generated outsized losses and distorted results for 2019 and 2020. We observed a reduction in claims frequency in 2020 that continued into 2021, some of which is due to our re-underwriting efforts while some of which we believe is associated with the COVID-19 pandemic including the disruption of the court systems. Given the consistent and prolonged nature of these favorable trends, we recognized some of these favorable frequency trends in our HCPL current accident year reserve during the third and fourth quarters of 2021. We continue to remain cautious in recognizing the full impact of these favorable trends due to the long-tailed nature of our HCPL claims as well as the uncertainty surrounding the length and severity of the pandemic. See further discussion in our Segment Results - Specialty Property & Casualty section that follows under the heading "Losses and Loss Adjustment Expenses." The risks insured in our Medical Technology Liability business (2% of our consolidated gross reserve for losses and loss adjustment expenses as ofDecember 31, 2021 ) are more varied, and policies are individually priced based on the risk characteristics of the policy and the account. The insured risks range from startup operations to large multinational entities, and the larger entities often have significant deductibles or self-insured retentions. Reserves are established using our most recently developed actuarial estimates of losses expected to be incurred based on factors which include results from prior analysis of similar business, industry indications, observed trends and judgment. Claims in this line of business primarily involve bodily injury to individuals and are affected by factors similar to those of our HCPL line of business. For the Medical Technology Liability business, we also establish an initial reserve using a loss ratio approach, including a provision in consideration of historical loss volatility that this line of business has exhibited. Workers' Compensation Insurance Segment. Many factors affect the ultimate losses incurred for our workers' compensation coverages (5% of our consolidated gross reserve for losses and loss adjustment expenses as ofDecember 31, 2021 ) including but not limited to the type and severity of the injury, the age, health and occupation of the injured worker, the estimated length of disability, medical treatment and related costs, and the jurisdiction and workers' compensation laws of the state of the injury occurrence. We use various actuarial methodologies in developing our workers' compensation reserve, combined with a review of the payroll exposure base. For the current accident year, given the lack of seasoned information, the different actuarial methodologies produce results with significant variability; therefore, more emphasis is placed on supplementing results from the actuarial methodologies with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things, to select an ultimate loss indication. As in our Specialty P&C segment, we observed a reduction in claims frequency in 2020. Claims frequency in 2021 continues to be below pre-pandemic levels in ourWorkers' Compensation Insurance segment, some of which is likely associated with the COVID-19 pandemic. While claims frequency is down, we have experienced an increase in 2021 accident year reported losses throughDecember 31, 2021 , including increased severity-related claim activity, reflecting workers returning to full employment in 2021 after the lifting of pandemic-related restrictions and the labor shortage. The increase in reported claim activity is attributable to workers being out of "work shape" as they returned to employment in 2021 as well as the lack of training, alternative work arrangements and employee fatigue due to the labor shortage. Segregated Portfolio Cell Reinsurance Segment. The factors that affect the ultimate losses incurred for the workers' compensation and HCPL coverages assumed by the SPCs at Inova Re and Eastern Re (2% of our consolidated gross reserve for losses and loss adjustment expenses as ofDecember 31, 2021 ) are consistent with that of ourWorkers' Compensation Insurance and Specialty P&C segments, respectively. Lloyd's Syndicates Segment. Initial reserves for Syndicate 1729 and Syndicate 6131 are primarily recorded using the loss assumptions by risk category incorporated into each Syndicate's business plan submitted to Lloyd's with consideration given to loss experience incurred to date (3% of our consolidated gross reserve for losses and loss adjustment expenses as ofDecember 31, 2021 ). The assumptions used in each business plan are consistent with loss results reflected in Lloyd's historical data for similar risks. The loss ratios may also fluctuate due to the mix of earned premium from different open underwriting years which we participate in to varying degrees, as well as the timing of earned premium adjustments. Such adjustments may be the result of premiums for certain policies and assumed reinsurance contracts being reported subsequent to the coverage period and may be subject to adjustment based on loss experience. 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as reports are received under delegated underwriting authority programs. When reports are received, the premium, exposure and corresponding loss estimates are revised accordingly. Changes in loss estimates due to premium or exposure fluctuations are incurred in the accident year in which the premium is earned. For significant property catastrophe exposures, Syndicate 1729 uses third-party catastrophe models to accumulate a listing of potentially affected policies. Each identified policy is given an estimate of loss severity based upon a combination of factors including the probable maximum loss of each policy, market share analytics, underwriting judgment, client/broker estimates and historical loss trends for similar events. These models are inherently uncertain, reliant upon key assumptions and management judgment and are not always a representation of actual events and ensuing potential loss exposure. Determination of actual losses may take an extended period of time until claims are reported and resolved, including coverage litigation.
Development of Prior Accident Years
In addition to setting the initial reserve for the current accident year, we
reassess the amount of reserve required for prior accident years each period.
The foundation of our reserve re-estimation process is an actuarial analysis that is performed by both our internal and consulting actuaries. This very detailed analysis projects ultimate losses based on partitions which include line of business, geography, coverage layer and accident year. The procedure uses the most representative data for each partition, capturing its unique patterns of development and trends. We believe that the use of consulting actuaries provides an independent view of our loss data as well as a broader perspective on industry loss trends. For the Specialty P&C,Workers' Compensation Insurance and Segregated Portfolio Cell Reinsurance segments, the analysis performed by the consulting actuaries analyzes each partition of our business in a variety of ways and uses multiple actuarial methodologies in performing these analyses, including: •Bornhuetter-Ferguson (Paid and Reported) Method •Paid Development Method •Reported (Incurred) Development Method •Average Paid Value Method •Average Reported Value Method
A brief description of each method follows.
Bornhuetter-Ferguson Method. We use both the Paid and the Reported Bornhuetter-Ferguson Methods. The Paid Method assigns partial weight to initial expected losses for each accident year (initial expected losses being the first established case and IBNR reserves for a specific accident year) and partial weight to paid to date losses. The Reported Method assigns partial weight to the initial expected losses and partial weight to current expected losses. The weights assigned to the initial expected losses decrease as the accident year matures.Paid Development and Reported (Incurred) Development Methods. These methods use historical, cumulative losses (paid losses for the Paid Development Method, reported losses for the Reported (Incurred) Development Method) by accident year and develop those actual losses to estimated ultimate losses based upon the assumption that each accident year will develop to estimated ultimate cost in a manner that is analogous to prior years, adjusted as deemed appropriate for the expected effects of known changes in the claim payment environment (and case reserving environment for the Reported (Incurred) Development Method); and to the extent necessary, supplemented by analyses of the development of broader industry data. Average Paid Value and Average Reported Value Methods. In these methods, average claim cost data (paid claim cost for the Average Paid Value Method and reported claim cost for the Reported Value Method) is developed to an ultimate average cost level by report year based on historical data. Claim counts are similarly developed to an ultimate count level. The average claim cost (after rounding and adjustment, if necessary, to accommodate report year data that is not considered to be predictive) is then multiplied by the ultimate claim counts by report year to derive ultimate loss and ALAE. Generally, methods such as the Bornhuetter-Ferguson Method are used on more recent accident years where we have less data on which to base our analysis. As time progresses and we have an increased amount of data for a given accident year, we begin to give more confidence to the development and average methods, as these methods typically rely more heavily on our own historical data. These methods emphasize different aspects of loss reserve estimation and provide a variety of perspectives for our decisions. Certain of the methodologies utilized to estimate the ultimate losses for each partition of our reserves consider the actual amounts paid. Paid data is particularly influential when a large portion of known claims have been closed, as is the case for older accident years. In selecting a point estimate for each partition, management considers the extent to which trends are emerging consistently for all partitions and known industry trends. Thus, actual, rather than estimated severity trends are given more consideration. If actual severity trends are lower than those estimated at the time that reserves were previously 45
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established, the recognition of favorable development is indicated. This is
particularly true for older accident years where our actuarial methodologies
give more weight to actual loss costs (severity).
The various actuarial methods discussed above are applied in a consistent manner from period to period. In addition, we perform statistical reviews of claims data such as claim counts, average settlement costs and severity trends when establishing our reserves. We utilize the selected point estimates of ultimate losses to develop estimates of ultimate losses recoverable from reinsurers, based on the terms and conditions of our reinsurance agreements. An overall estimate of the amount receivable from reinsurers is determined by combining the individual estimates. Our net reserve estimate is the gross reserve point estimate less the estimated reinsurance recovery. For ourWorkers' Compensation Insurance segment and for the workers' compensation exposures in our Segregated Portfolio Cell Reinsurance segment, we utilize the Reported (Incurred) Development Method, Paid Development Method and Bornhuetter-Ferguson Method, to develop our reserve for each accident year. The actuarial review includes the stratification of claims data (lost time claims, medical only claims) using different variations that allow us to identify trends that may not be readily identifiable if the data was evaluated only in the aggregate. Reported and paid loss development factors are key assumptions in the reserve estimation process and are based on our historical reported and paid loss development patterns. As accident years mature, the various actuarial methodologies produce more consistent loss estimates.
For our Lloyd's Syndicates segment we rely on the analysis of actual loss
experience on the book of business written by Syndicate 1729 to determine loss
development by accident year.
Acquired Reserve The acquisition of NORCAL increased our gross reserves by$1.2 billion which was the fair value of NORCAL's gross loss reserve at the time of acquisition. The fair value estimate of NORCAL's gross reserve for losses and loss adjustment expenses was based on three components: an actuarial estimate of the expected future net cash flows, a reduction to those cash flows for the time value of money determined utilizing theU.S. Treasury Yield Curve and a risk margin adjustment to reflect the net present value of profit that an investor would demand in return for the assumption of the development risk associated with the reserve. The fair value of NORCAL's gross reserve, including the risk margin adjustment, exceeded the actuarial estimate of NORCAL's undiscounted gross loss reserve by approximately$42.2 million as ofMay 5, 2021 . This fair value adjustment was recorded to the reserve for losses and loss adjustment expenses and will be amortized over a period utilizing loss payment patterns as a reduction to prior accident year net losses and loss adjustment expenses. We also recorded other adjustments to NORCAL's reserve as a result of purchase accounting including negative VOBA on NORCAL's assumed unearned premium and assumed DDR reserve. See further discussion on these other purchase accounting adjustments in this section under the heading "Business Combinations" or in Note 2 of the Notes to Consolidated Financial Statements for more information. The acquisition of Eastern onJanuary 1, 2014 increased our loss reserve by$153.2 million which represented the fair value of Eastern's loss reserve at the time of the acquisition. The fair value of the reserve for losses and loss adjustment expenses and related reinsurance recoverables was based on an actuarial estimate of the expected future net cash flows, a reduction of those cash flows for the time value of money determined utilizing theU.S. Treasury Yield Curve, and a risk adjustment to reflect the net present value of profit that an investor would demand in return for the assumption of the associated risks. Expected net cash flows were derived from the expected loss payment patterns included in an actuarial analysis of Eastern's reserve performed as ofDecember 31, 2013 . The fair value of the reserve, including the risk margin discussed above, exceeded the undiscounted loss reserve previously established by Eastern by$9.3 million ; this fair value adjustment was amortized over the average expected life of the reserve of 6 years. The fair value adjustment was fully amortized as ofDecember 31, 2019 .
Use of Judgment
The process of estimating reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both views of internal and external events, such as changes in views of economic inflation, legal trends and legislative changes, as well as differentiating views of individuals involved in the reserve estimation process, among others. We continually refine our estimates in a regular, ongoing process as historical loss experience develops and additional claims are reported and settled. Our objective is to consider all significant facts and circumstances known at the time. Changes in economic conditions and steps taken by the federal government and theFederal Reserve in response to COVID-19 could lead to inflation trends that are different from those we anticipated when establishing our reserves, which could in turn lead to an increase or decrease in our loss costs and the need to strengthen or reduce reserves.
We use various actuarial methods in the process of setting reserves. Each
actuarial method generally returns a different value, and for the more recent
accident years the variations among the various methodologies can be
significant. In order to
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project ultimate losses, we partition our reserves for analysis such as by line of business, geography, coverage layer or accident year. For each partition of our reserves, we evaluate the results of the various methods, along with the supplementary statistical data regarding such factors as closed with and without indemnity ratios, claim severity trends, the expected duration of such trends, changes in the legal and legislative environment and the current economic environment to develop a point estimate based upon management's judgment and past experience. The series of selected point estimates is then combined to produce an overall point estimate for ultimate losses. HCPL. Over the past several years the most influential factor affecting the analysis of our HCPL reserves and the related development recognized has been an observed increase in claim severity for the broader medical professional liability industry as well as higher initial loss expectations on incurred claims. The severity trend is an explicit component of our pricing models and directly impacts the reserving process. Our estimate of this trend and our expectations about changes in this trend impact a variety of factors, from the selection of expected loss ratios to the ultimate point estimates established by management. Because of the implicit and wide-ranging nature of severity trend assumptions on the loss reserving process, it is not practical to specifically isolate the impact of changing severity trends. However, because severity is an explicit component of our HCPL pricing process we can better isolate the impact that changing severity can have on our loss costs and loss ratios in regards to our pricing models for this business component. Our current HCPL pricing models assume severity trends in the range of 2% to 5% depending on state, territory and specialty. In some portions of our HCPL business we have observed and reflected higher severity trends in our estimates of losses and loss adjustment expenses. Due to the long-tailed nature of our claims and the previously discussed historical volatility of loss costs, selection of a severity trend assumption is a subjective process that is inherently likely to prove inaccurate over time. Given the long tail and volatility, we are generally cautious in making changes to the severity assumptions within our pricing models. All open claims and accident years are generally impacted by a change in the severity trend, which compounds the effect of such a change. Although the future degree and impact of the ultimate severity trend remains uncertain due to the long-tailed nature of our business, we have given consideration to observed loss costs in setting our rates. For our HCPL business, this practice had generally resulted in rate reductions as claim frequency declined and remained at historically low levels. However, from early 2017 to the current period, the average pricing on renewed business has steadily increased reflective of the rising loss cost environment, and we anticipate further renewal pricing increases due to increasing loss severity. More recently, another factor affecting our analysis of our HCPL reserves and the related development recognized is the reduction in claims frequency in 2020, some of which is likely associated with the COVID-19 pandemic, as previously discussed. In 2020, we established a$10 million IBNR reserve related to COVID-19. Given the consistent and prolonged nature of the favorable claims frequency trend and the fact that early first notices have not materialized into claims, we recognized net favorable prior accident year reserve development of$1 million associated with our COVID-19 IBNR reserve during the third quarter of 2021. Similar to our views on our current accident year reserve, we continue to remain cautious in recognizing the full impact of these favorable frequency trends in our prior accident year reserve due to the long-tailed nature of our HCPL claims as well as the uncertainty surrounding the length and severity of the pandemic. AtDecember 31, 2021 , we maintain a$9 million IBNR reserve related to COVID-19 which represents our best estimate of future COVID-19 related losses not already captured by our claims process based on currently available information and reported incidents. Workers' Compensation. The projection of changes in claim severity trend has not historically been an influential factor affecting our analysis of workers' compensation reserves, as claims are typically resolved more quickly than the industry norm. As previously mentioned, the determination and calculation of loss development factors, in particular, the selection of tail factors which are used to extend the projection of losses beyond historical data, requires considerable judgment. 47
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Professional Liability
Our professional liability line of business includes both our HCPL and Small Business Unit lines, with our HCPL line representing the largest component of our reserve. Our HCPL line of business also includes the business acquired through the NORCAL transaction that closed onMay 5, 2021 . In support of our concern that the decline in frequency will result in a higher severity trend for our HCPL claims, we saw our closed-with-indemnity-payment ratio (i.e., the number of claims closed with an indemnity or loss payment as compared to the total number of closed claims) for our claims increase from 15% in 2012 to 18% in 2021 (ratios exclude NORCAL claims). The following table presents additional information about the loss development for our professional liability line of business, excluding loss development for HCPL coverages assumed by the SPCs at Inova Re and Eastern Re. Furthermore, loss development for our professional liability line of business for the year endedDecember 31, 2021 includes the business acquired through the NORCAL transaction since the date of acquisition, excluding the amortization of the purchase accounting fair value adjustment: ($ in thousands) 2021 2020 2019 Estimated Ultimate Reserve Reserve Losses, Net of Development Reserve Development Development Reinsurance, (favorable) % of Known (favorable) % of Known (favorable) % of Known Accident Years December 31, 2021 unfavorable Claims Closed unfavorable Claims Closed unfavorable Claims Closed 2021$ 397,814 N/A 25.9 % N/A N/A N/A N/A 2020$ 480,001 $ (4,947) 54.1 % N/A 22.0 % N/A N/A 2019$ 493,573 $ (20,426) 73.7 % $ 1,361 48.7 % N/A 25.3 % 2018$ 527,420 $ 9,418 81.0 % $ 1,218 65.1 %$ 69,518 46.9 % 2017$ 433,764 $ (2,342) 88.4 % $ (2,741) 77.9 %$ 35,591 67.8 % 2016$ 400,534 $ (2,739) 89.5 % $ (1,760) 88.8 % $ 1,848 82.1 % 2015$ 369,185 $ 6,011 97.1 % $ (4,489) 93.7 %$ (27,495) 89.6 % 2014$ 325,486 $ (1,017) 98.5 % $ (8,930) 96.6 %$ (17,412) 93.9 % 2013$ 358,696 $ (260) 98.9 % $ (133) 98.0 %$ (12,799) 96.9 % 2012$ 374,938 $ (2,999) 99.5 % $ (1,835) 99.2 %$ (9,173) 98.7 %
Prior to 2012$ 8,282,412 $ 2,389 $ (1,578)$ (21,572) Development recognized during 2021 principally related to accident years 2015 through 2020. In addition, we recognized favorable prior year reserve development of$1 million in 2021 related to the 2020 accident year associated with our COVID-19 IBNR reserve, as previously discussed, due to the fact that early first notices have not materialized into claims. We continue to remain cautious in our evaluation of our prior accident year reserve due to the long-tailed nature of our HCPL claims as well as the uncertainty surrounding the length and severity of the pandemic. Not included in the table above, is$7.9 million of amortization of the purchase accounting fair value adjustment on NORCAL's assumed net reserve and amortization of the negative VOBA associated with NORCAL's DDR reserve which is recorded as a reduction to prior accident year net losses and loss adjustment expenses in 2021. We have not recognized any development related to NORCAL's prior accident year reserves since the date of acquisition. See Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition and the related purchase accounting adjustments. Development recognized during 2020 principally related to accident years 2014 through 2017. Not included in the above table, as previously discussed, is$2.5 million and$4.4 million of favorable development recognized during 2021 and 2020, respectively, in our Segregated Portfolio Cell Reinsurance segment related to the HCPL coverages assumed by the SPCs atInova Re and Eastern Re. During 2019 the loss experience in our Specialty line of business deteriorated further, particularly in regard to the reserves we established for a large national healthcare account. This deterioration is the primary driver of the unfavorable development we recognized in 2019 for accident years 2016 through 2018. 48
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This can also be seen in looking at both the absolute amount of reserve development recognized for the less developed accident years as well as the size of such development when compared to established ultimates for those same accident years at the end of the preceding calendar year. The following table provides this information for years endedDecember 31, 2021 , 2020 and 2019 with respect to the three then most recent prior accident years: ($ in millions) 2021 2020 2019 Prior accident years 2018-2020 2017-2019 2016-2018 Net favorable (unfavorable) development recognized for the specified years $ 16.0 $ 0.2$ (107.0) Development as a % of established ultimates, prior calendar year end 1.1 % - % (8.5 %)
Medical Technology Liability
Our Medical Technology Liability line of business has not experienced the change
in claims frequency previously described for HCPL. However, the nature of the
risks insured and volatility of the loss experience in this line of business has
produced more variable loss development, as presented in the following table:
($ in thousands) 2021 2020 2019
Estimated
Ultimate Losses,
Net of
Reinsurance, Reserve Development Reserve Development Reserve Development
December 31, (favorable) % of Known (favorable) % of Known (favorable) % of Known
Accident Years 2021 unfavorable Claims Closed unfavorable Claims Closed unfavorable Claims Closed
2021 $ 16,929 N/A 32.0 % N/A N/A N/A N/A
2020 $ 14,489 $ (248) 59.2 % N/A 41.0 % N/A N/A
2019 $ 13,584 $ 722 47.5 % $ (1,047) 41.8 % N/A 13.4 %
2018 $ 8,807 $ (3,091) 85.1 % $ (352) 75.2 % $ (1,856) 68.2 %
2017 $ 6,017 $ (2,192) 94.1 % $ (3,854) 90.1 % $ (2,166) 85.6 %
2016 $ 8,611 $ (2,126) 97.3 % $ (486) 96.7 % $ (1,249) 65.9 %
2015 $ 7,983 $ (638) 97.0 % $ (663) 96.3 % $ (1,548) 85.8 %
2014 $ 9,374 $ (317) 99.6 % $ (458) 98.9 % $ (1,823) 94.3 %
2013 $ 4,600 $ (128) 100.0 % $ (294) 100.0 % $ (291) 98.7 %
2012 $ 8,423 $ (12) 99.2 % $ (69) 99.2 % $ (1,362) 99.2 %
Prior to 2012 $ 585,081 $ (94) $ (1,370) $ (2,470)
Approximately $7.6 million of the $8.1 million total net favorable development
recognized in 2021 related to the 2015 through 2020 accident years. The
development for the 2015 through 2020 accident years represents an 11.3%
reduction to the ultimates established for those reserves at December 31, 2020 .
Approximately $5.3 million of the $8.6 million total net favorable development
recognized in 2020 related to the 2017 through 2019 accident years. The
development for the 2017 through 2019 accident years represents a 13.7%
reduction to the ultimates established for those reserves at December 31, 2019 .
Approximately $6.8 million of the $12.8 million total net favorable development
recognized in 2019 related to the 2014 through 2017 accident years. The
development for the 2014 through 2017 accident years represents a 13.7%
reduction to the ultimates established for those reserves at December 31, 2018 .
In 2021, 2020 and 2019 the development was largely attributable to favorable
results from claims closed during the year. As time has elapsed we have
recognized that actual loss experience has on average been better than
estimated. We have been cautious in recognizing the improvement, but as claims
have matured and claims are closed or have become more certain for the remaining
open claims, we have revised reserve estimates. We believe the need for a
cautious approach is required as outcomes are uncertain and results can be
significantly affected by outcomes for a small number of cases.
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Workers' Compensation
Claims in our workers' compensation line of business have historically closed at
a faster rate than in our HCPL or Medical Technology Liability lines of
business. This faster disposition rate, along with a lower net retention after
the application of reinsurance, has resulted in less volatility in loss
estimates on a net basis. However, a change in the number of individually-severe
claims can create volatility in a given accident year. The following table
presents additional information about the loss development for our workers'
compensation line of business:
($ in thousands) 2021 2020 2019
Estimated
Ultimate Losses,
Net of
Reinsurance, Reserve Development Reserve Development Reserve Development
December 31, (favorable) % of Known (favorable) % of Known (favorable) % of Known
Accident Years 2021 unfavorable Claims Closed unfavorable Claims Closed unfavorable Claims Closed
2021 $ 145,232 N/A 45.4 % N/A N/A N/A N/A
2020 $ 141,076 $ (1,493) 85.1 % N/A 41.6 % N/A N/A
2019 $ 154,166 $ (4,030) 92.1 % $ (6,160) 81.6 % N/A 43.0 %
2018 $ 159,563 $ (1,503) 95.2 % $ 584 91.7 % $ (2,561) 81.8 %
2017 $ 129,533 $ (2,375) 97.3 % $ (3,372) 96.0 % $ (4,349) 91.4 %
2016 $ 110,633 $ (1,230) 97.8 % $ (3,048) 97.1 % $ (8,923) 95.2 %
2015 $ 117,792 $ (1,538) 98.4 % $ (3,919) 98.0 % $ (2,128) 96.9 %
2014 $ 117,939 $ (873) 99.3 % $ (2,136) 98.9 % $ (363) 98.9 %
2013 $ 114,460 $ (646) 99.5 % $ (592) 99.5 % $ 2,405 99.4 %
2012 $ 94,295 $ (383) 99.7 % $ (126) 99.7 % $ (72) 99.7 %
Prior to 2012 $ 563,334 $ (649) $ (403) $ (399)
In 2021, we recognized $7.6 million of net favorable development in our
Segregated Portfolio Cell Reinsurance segment related to workers' compensation
business and $7.1 million of net favorable development in our Workers'
Compensation Insurance segment. In 2020, we recognized $12.1 million of net
favorable development in our Segregated Portfolio Cell Reinsurance segment
related to workers' compensation business and $7.0 million of net favorable
development in our Workers' Compensation Insurance segment. In 2019, we
recognized $10.1 million of net favorable development in our Segregated
Portfolio Cell Reinsurance segment, all related to workers' compensation
business, and $7.8 million of net favorable development in our Workers'
Compensation Insurance segment. Not included in the table above, net favorable
development in our Workers' Compensation Insurance segment in 2019 included $1.6
million related to the amortization of the purchase accounting fair value
adjustment. As previously discussed, this fair value adjustment has been fully
amortized as of December 31, 2019 .
Variability of Loss Reserves
As previously noted, the number of data points and variables considered and the
subjective process followed in establishing our loss reserve makes it
impractical to isolate individual variables and demonstrate their impact on our
estimate of loss reserves. However, to provide a better understanding of the
potential variability in our reserves, we have modeled implied reserve ranges
around our single point net reserve estimates for our various lines of business
assuming different confidence levels. The ranges have been developed by
aggregating the expected volatility of losses across partitions of our business
to obtain a consolidated distribution of potential reserve outcomes. The
aggregation of this data takes into consideration correlations among our
geographic and specialty mix of business. The result of the correlation approach
to aggregation is that the ranges are narrower than the sum of the ranges
determined for each partition.
We have used this modeled statistical distribution to calculate an 80% and 60%
confidence interval for the potential outcome of our consolidated net reserve
for losses. The high and low end points of the distributions are as follows:
Low End Point Carried Net Reserve
80% Confidence Level
60% Confidence Level
Any change in our estimate of net ultimate losses for prior years is reflected
in net income (loss) in the period in which such changes are made.
Due to the size of our consolidated reserve for losses and the large number of
claims outstanding at any point in time, even a small percentage adjustment to
our total reserve estimate could have a material effect on our results of
operations for the period in which the adjustment is made, as was the case in
2021, 2020 and 2019.
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Reinsurance
We use insurance and reinsurance (collectively, "reinsurance") to provide capacity to write larger limits of liability, to provide reimbursement for losses incurred under the higher limit coverages we offer, to provide protection against losses in excess of policy limits and, in the case of risk sharing arrangements, to align our objectives with those of our strategic business partners and to provide custom insurance solutions for large customer groups. The purchase of reinsurance does not relieve us from the ultimate risk on our policies; however, it does provide reimbursement for certain losses we pay. We make a determination of the amount of insurance risk we choose to retain based upon numerous factors, including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, the volume of business, our level of experience with a particular set of exposures and our analysis of the potential underwriting results. We purchase excess of loss reinsurance to limit the amount of risk we retain and we do so from a number of companies to mitigate concentrations of credit risk. As ofDecember 31, 2021 , there is no reinsurer, on an individual basis, for which our recoverables for both paid and unpaid claims (net of amounts due to the reinsurer) and our prepaid balances are more than$52 million , in aggregate. We utilize reinsurance brokers to assist us in the placement of these reinsurance programs and in the analysis of the credit quality of our reinsurers. The determination of which reinsurers we choose to do business with is based upon an evaluation of their then current financial strength, rating, stability and claims payment practices. We evaluate each of our ceded reinsurance contracts at inception to confirm that there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting guidance. AtDecember 31, 2021 , all ceded contracts were accounted for as risk transferring contracts. Our receivable from reinsurers on unpaid losses and loss adjustment expenses represents our estimate of the amount of our reserve for losses that will be recoverable under our reinsurance programs. We base our estimate of funds recoverable upon our expectation of ultimate losses and the portion of those losses that we estimate to be allocable to reinsurers based upon the terms and conditions of our reinsurance agreements. Our assessment of the collectability of the recorded amounts receivable from reinsurers considers the payment history of the reinsurer, publicly available financial and rating agency data, our interpretation of the underlying contracts and policies and responses by reinsurers. Given the uncertainty inherent in our estimates of losses and related amounts recoverable from reinsurers, these estimates may vary significantly from the ultimate outcome. Under the terms of certain of our reinsurance agreements, the amount of premium that we cede to our reinsurers is based in part on the losses we recover under the agreements. Therefore, we make an estimate of premiums ceded under these reinsurance agreements subject to certain minimums and maximums. Any adjustments to our estimates of losses recoverable under our reinsurance agreements or the premiums owed under our agreements are reflected in current operations. Due to the size of our reinsurance balances, an adjustment to these estimates could have a material effect on our results of operations for the period in which the adjustment is made. Our reinsurance receivables are exposed to credit losses but to date have not experienced any significant amount of credit losses. To partially mitigate our exposure to credit losses, reinsurance receivables totaling approximately$97.9 million were collateralized by letters of credit or funds withheld as ofDecember 31, 2021 . We measure expected credit losses on our reinsurance receivables on a collective basis when similar risk characteristics exist or on an individual basis if we determine a receivable does not share similar risk characteristics. We measure expected credit losses associated with our reinsurance receivables (related to both paid and unpaid losses) at the consolidated level as our reinsurance receivables share similar risk characteristics including type of financial asset, type of industry and similar historical and expected credit loss patterns. We measure expected credit losses over the average contractual term of our reinsurance receivables utilizing a loss rate method. Historical internal credit loss experience is the basis for our assessment of expected credit losses; however, we may also consider historical credit loss information from external sources. We also consider reasonable and supportable forecasts of future economic conditions in our estimate of expected credit losses. Expected credit losses associated with our reinsurance receivables (related to both paid and unpaid losses) were nominal in amount as ofDecember 31, 2021 and 2020. No reinsurance balances were written off for credit reasons during the years endedDecember 31, 2021 or 2020. Should our expected credit loss analysis or other facts or circumstances lead us to believe that any reinsurer may not meet its obligations to us, adjustments to the allowance for expected credit losses or to reinsurance receivables would be reflected in current operations. Such an adjustment has the potential to be material to the results of operations in the period in which it is recorded; however, we would not expect such an adjustment to have a material effect on our capital position or our liquidity. For further information on our allowance for expected credit losses related to our receivables from reinsurers see Note 1 of the Notes to Consolidated Financial Statements. 51
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Investment Valuations
We record the majority of our investments at fair value as shown in the table below. AtDecember 31, 2021 , the distribution of our investments based on GAAP fair value hierarchies (levels) was as follows: Distribution by GAAP Fair Value Hierarchy Total Level 1 Level 2 Level 3 Not Categorized Investments Investments recorded at: Fair value 8% 82% 1% 6% 97% Other valuations 3% Total Investments 100%
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. All of our fixed maturity and equity
investments are carried at fair value. The fair value of our short-term
securities approximates the cost of the securities due to their short-term
nature.
Because of the number of securities we own and the complexity of developing accurate fair values, we utilize multiple independent pricing services to assist us in establishing the fair value of individual securities. The pricing services provide fair values based on exchange-traded prices, if available. If an exchange-traded price is not available, the pricing services, if possible, provide a fair value that is based on multiple broker/dealer quotes or that has been developed using pricing models. Pricing models vary by asset class and utilize currently available market data for securities comparable to ours to estimate a fair value for our securities. The pricing services scrutinize market data for consistency with other relevant market information before including the data in the pricing models. The pricing services disclose the types of pricing models used and the inputs used for each asset class. Determining fair values using these pricing models requires the use of judgment to identify appropriate comparable securities and to choose a valuation methodology that is appropriate for the asset class and available data. The pricing services provide a single value per instrument quoted. We review the values provided for reasonableness each quarter by comparing market yields generated by the supplied value versus market yields observed in the marketplace. We also compare yields indicated by the provided values to appropriate benchmark yields and review for values that are unchanged or that reflect an unanticipated variation as compared to prior period values. We utilize a primary pricing service for each security type and compare provided information for consistency with alternate pricing services, known market data and information from our own trades, considering both values and valuation trends. We also review weekly trades versus the prices supplied by the services. If a supplied value appears unreasonable, we discuss the valuation in question with the pricing service and make adjustments if deemed necessary. Historically our review has not resulted in any material changes to the values supplied by the pricing services. The pricing services do not provide a fair value unless an exchange-traded price or multiple observable inputs are available. As a result, the pricing services may provide a fair value for a security in some periods but not others, depending upon the level of recent market activity for the security or comparable securities. Level 1 Investments Fair values for a majority of our equity securities and portions of our short-term and convertible securities are determined using exchange-traded prices. There is little judgment involved when fair value is determined using an exchange-traded price. In accordance with GAAP, we classify securities valued using an exchange-traded price as Level 1 securities.
Level 2 Investments
Most fixed income securities do not trade daily; thus, exchange-traded prices are generally not available for these securities. However, market information (often referred to as observable inputs or market data, including but not limited to, last reported trade, non-binding broker quotes, bids, benchmark yield curves, issuer spreads, two-sided markets, benchmark securities, offers and recent data regarding assumed prepayment speeds, cash flow and loan performance data) is available for most of our fixed income securities. We determine fair value for a large portion of our fixed income securities using available market information. In accordance with GAAP, we classify securities valued based on multiple market observable inputs as Level 2 securities.
When a pricing service does not provide a value for one of our fixed maturity
securities, management estimates fair value using either a single non-binding
broker quote or pricing models that utilize market based assumptions which have
limited observable inputs. The process involves significant judgment in
selecting the appropriate data and modeling techniques to use in the valuation
process. In accordance with GAAP, we classify securities valued using limited
observable inputs as Level 3 securities.
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Fair Values Not Categorized
We hold interests in certain investment funds, primarily LPs/LLCs, which measure fund assets at fair value on a recurring basis and provide us with a NAV for our interest. As a practical expedient, we consider the NAV provided to approximate the fair value of the interest. In accordance with GAAP, we do not categorize these investments within the fair value hierarchy.
Nonrecurring Fair Value Measurements
We measure the fair value of certain assets on a nonrecurring basis when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. These assets include investments carried principally at cost, investments in tax credit partnerships, fixed assets, goodwill and other intangible assets. These assets would also include any equity method investments that do not provide a NAV. During the third quarter of 2020, we recognized a nonrecurring fair value measurement related to the goodwill in our Specialty P&C reporting unit with a carrying value of$161.1 million prior to the fair value measurement. This nonrecurring fair value measurement resulted in the goodwill being written down to its implied fair value of zero resulting in an impairment of the goodwill of$161.1 million (see following discussion under the heading "Goodwill / Intangibles" and Note 8 of the Notes to Consolidated Financial Statements). The inputs used in the fair value measurement were non-observable and, as such, were categorized as a Level 3 valuation. We did not have any other assets or liabilities that were measured at fair value on a nonrecurring basis atDecember 31, 2021 orDecember 31, 2020 .
Investments - Other Valuation Methodologies
Certain of our investments, in accordance with GAAP for the type of investment, are measured using methodologies other than fair value. AtDecember 31, 2021 , these investments represented approximately 3% of total investments, and are detailed in the following table. Additional information about these investments is provided in Note 3 and Note 4 of the Notes to Consolidated Financial Statements. (In millions) Carrying Value GAAP Measurement Method Other investments: Other, principally FHLB capital stock $ 3.2 Principally Cost Investment in unconsolidated subsidiaries: Investments in tax credit partnerships 12.4 Equity Equity method investments, primarily LPs/LLCs 52.3 Equity 64.7 BOLI 81.8 Cash surrender value
Total investments - Other valuation methodologies
Impairments
We evaluate our available-for-sale investment securities, which atDecember 31, 2021 andDecember 31, 2020 consisted entirely of fixed maturity securities, on at least a quarterly basis for the purpose of determining whether declines in fair value below recorded cost basis represent an impairment loss. We consider a credit-related impairment loss to have occurred: •if there is intent to sell the security; •if it is more likely than not that the security will be required to be sold before full recovery of its amortized cost basis; or •if the entire amortized basis of the security is not expected to be recovered. The assessment of whether the amortized cost basis of a security is expected to be recovered requires management to make assumptions regarding various matters affecting future cash flows. The choice of assumptions is subjective and requires the use of judgment. Actual credit losses experienced in future periods may differ from management's estimates of those credit losses. Methodologies used to estimate the present value of expected cash flows are: The estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. We consider various factors in projecting recovery values and recovery time frames, including the following: •third-party research and credit rating reports; •the current credit standing of the issuer, including credit rating downgrades, whether before or after the balance sheet date; •the extent to which the decline in fair value is attributable to credit risk specifically associated with the security or its issuer; 53
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Table of Contents •internal assessments and the assessments of external portfolio managers regarding specific circumstances surrounding an investment, which indicate the investment is more or less likely to recover its amortized cost than other investments with a similar structure; •for asset-backed securities, the origination date of the underlying loans, the remaining average life, the probability that credit performance of the underlying loans will deteriorate in the future and our assessment of the quality of the collateral underlying the loan; •failure of the issuer of the security to make scheduled interest or principal payments; •any changes to the rating of the security by a rating agency; •recoveries or additional declines in fair value subsequent to the balance sheet date; •adverse legal or regulatory events; •significant deterioration in the market environment that may affect the value of collateral (e.g., decline in real estate prices); •significant deterioration in economic conditions; and •disruption in the business model resulting from changes in technology or new entrants to the industry. If deemed appropriate and necessary, a discounted cash flow analysis is performed to confirm whether a credit loss exists and, if so, the amount of the credit loss. We use the single best estimate approach for available-for-sale debt securities and consider all reasonably available data points, including industry analyses, credit ratings, expected defaults and the remaining payment terms of the debt security. For fixed rate available-for-sale debt securities, cash flows are discounted at the security's effective interest rate implicit in the security at the date of acquisition. If the available-for-sale debt security's contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the LIBOR, or theU.S. Treasury bill weekly average, that security's effective interest rate is calculated based on the factor as it changes over the life of the security. If we intend to sell a debt security or believe we will more likely than not be required to sell a debt security before the amortized cost basis is recovered, any existing allowance will be written off against the security's amortized cost basis, with any remaining difference between the debt security's amortized cost basis and fair value recognized as an impairment loss in earnings. Exclusive of securities where there is an intent to sell or where it is not more likely than not that the security will be required to be sold before recovery of its amortized cost basis, impairment for debt securities is separated into a credit component and a non-credit component. The credit component of an impairment is the difference between the security's amortized cost basis and the present value of its expected future cash flows, while the non-credit component is the remaining difference between the security's fair value and the present value of expected future cash flows. An allowance for expected credit losses will be recorded for the expected credit losses through income and the non-credit component is recognized in OCI. The amount of impairment recognized is limited to the excess of the amortized cost over the fair value of the available-for-sale debt security.
Pension
As a result of our NORCAL acquisition, we sponsor a frozen qualified defined benefit pension plan which covers substantially all NORCAL employees (except those that were previous employees ofMedicus Insurance Company andFD Insurance Company , employees of PPM RRG as well as new hires afterDecember 31, 2013 ). Accounting for pension benefits requires the use of assumptions for the valuation of the PBO and the expected performance of the plan assets. We useDecember 31 as the measurement date for calculating our obligation related to this defined benefit pension plan and for estimating net periodic benefit cost (credit) for the subsequent year. The PBO for pension benefits represents the present value of all future benefits earned as of the measurement date for vested and non-vested employees. At each measurement date, we review the various assumptions impacting the amounts recorded for the pension plan including the discount rates, which impacts the recorded value of the PBO and interest costs, and the expected return on plan assets. To estimate the discount rate at the measurement date, we use a bond yield curve model, developed based on pricing and yield information for high quality corporate bonds. The assumption for the expected return on plan assets is based on the anticipated returns that will be earned by the portfolio over the long-term. The expected return on plan assets is influenced, but not determined, by historical portfolio performance. We assumed a 3.75% expected return on plan assets on our pension plan assets for the year endedDecember 31, 2021 . For 2022, we increased our expected return on plan assets assumption to 4.0% based on our long-term outlook for the capital markets. 54
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The following table summarizes the estimated changes in our projected benefit
obligation and net periodic benefit cost (income) for a hypothetical change in
our discount rate and expected return on plan assets:
Shift in Basis Points
December 31, 2021
($ in millions) (100) Current 100
Change in Discount Rate:
Benefit Obligation $ 124.1 $ 106.9 $ 93.1
Net periodic benefit cost (income) $ (0.5) $ (0.5) $ (0.5)
Change in Expected Return on Plan Assets:
Net periodic benefit cost (income) $ 0.2 $ (0.5) $ (1.2)
Accounting standards provide for the delayed recognition of differences between
actual results and expected or estimated results. This delayed recognition of
the differences is amortized into earnings over time. The differences between
actual results and expected or estimated results are recognized in full in AOCI.
Amounts recognized in AOCI are reclassified to earnings in a systematic manner
over the average future service period of participants. During 2022, we expect
to recognize net pension income of approximately $1.1 million and we do not
expect that contributions to the pension plan will be required during 2022 nor
do we anticipate making any discretionary contributions.
Deferred Policy Acquisition Costs
Policy acquisition costs (primarily commissions, premium taxes and underwriting salaries) which are directly related to the successful acquisition of new and renewal premiums are capitalized as DPAC and charged to expense, net of ceding commissions earned, as the related premium revenue is recognized. We evaluate the recoverability of our DPAC typically at the segment level each reporting period or in a manner that is consistent with the way we manage our business. Any amounts estimated to be unrecoverable are charged to expense in the current period. As part of our evaluation of the recoverability of DPAC, we also evaluate our unearned premiums for premium deficiencies. A premium deficiency is recognized if the sum of anticipated losses and loss adjustment expenses, unamortized DPAC and maintenance costs, net of anticipated investment income, exceeds the related unearned premium. If a premium deficiency is identified, the associated DPAC is written off, and a PDR is recorded for the excess deficiency as a component of net losses and loss adjustment expenses in our Consolidated Statements of Income and Comprehensive Income and as a component of the reserve for losses and loss adjustment expenses on our Consolidated Balance Sheets. For the years endedDecember 31, 2021 and 2020, we did not determine any DPAC to be unrecoverable. For the year endedDecember 31, 2019 , a nominal amount of DPAC was charged to expense as it was determined to be unrecoverable and a$9.2 million PDR was established in our Specialty P&C segment related to a large national healthcare account. The$9.2 million PDR was fully amortized during 2020.
Deferred Taxes
Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Our temporary differences principally relate to our loss reserves, unearned and advanced premiums, DPAC, NOL and tax credit carryforwards, compensation related items, unrealized investment gains (losses) and basis differences on fixed assets, intangible assets and operating leases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be in effect when such benefits are realized. We review our deferred tax assets quarterly for impairment. If we determine that it is more likely than not that some or all of a deferred tax asset will not be realized, a valuation allowance is recorded to reduce the carrying value of the asset. In assessing the need for a valuation allowance, management is required to make certain judgments and assumptions about our future operations based on historical experience and information as of the measurement period regarding reversal of existing temporary differences, carryback capacity, future taxable income of the appropriate character (including its capital and operating characteristics) and tax planning strategies. A valuation allowance was established in a prior year against the deferred tax asset related to the NOL carryforwards for theU.K. operations and in 2020 against a portion of the deferred tax asset related to theU.S. state NOL carryforwards. In addition, a valuation allowance was established in 2021 against the net deferred tax asset of ProAssurance American Mutual, aRisk Retention Group . As a taxpayer separate from the consolidated group, this entity has experienced cumulative losses in recent years. Management concluded that it was more likely than not that these deferred tax assets will not be realized. We also established a valuation allowance in a prior year against the deferred tax assets of certain SPCs at our wholly ownedCayman Islands reinsurance subsidiary, Inova Re. Due to the cumulative losses incurred in recent years by these SPCs, management 55
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concluded that a valuation allowance was required. We evaluated the realizability of the deferred tax assets acquired from NORCAL during our accounting for the acquisition and management concluded that it was more likely than not that the acquired deferred tax assets would be realized. As ofDecember 31, 2021 , management concluded that the previously recorded valuation allowances were still required against the deferred tax assets related to the NOL carryforwards for theU.K. operations, against the deferred tax assets related to theU.S. state NOL carryforwards and against the deferred tax assets of certain SPCs at Inova Re. Management's assessment of the need for these valuation allowances atDecember 31, 2021 included an analysis of the available sources of income, including projections of income for the consolidated group following the NORCAL acquisition. See further discussion onProAssurance's deferred tax assets in Note 7 of the Notes to Consolidated Financial Statements.
Coronavirus Aid, Relief and Economic Security Act
In response to COVID-19, the CARES Act was signed into law onMarch 27, 2020 and contains several provisions for corporations and eased certain deduction limitations originally imposed by the TCJA. See further discussion in Note 7 of the Notes to Consolidated Financial Statements. Temporary changes regarding NOL carryback provisions included in the CARES Act had a favorable impact on our liquidity, as we were able to carryback our 2019 and 2020 net operating losses to claim refunds (see discussion that follows in the Liquidity and Capital Resources and Financial Condition section under the heading "Taxes"). See further discussion in Note 7 of the Notes to Consolidated Financial Statements.
American Rescue Plan Act of 2021
In response to economic concerns associated with COVID-19, the American Rescue Plan Act of 2021 was signed into law onMarch 11, 2021 and includes an expansion of the number of employees covered by the limitation on the deductibility of compensation in excess of$1 million . This provision is effective for tax years beginning afterDecember 31, 2026 . We have evaluated this provision as well as the other provisions of the American Rescue Plan Act of 2021 and concluded that they will not have a material impact on our financial position or results of operations as ofDecember 31, 2021 . See further discussion in Note 7 of the Notes to Consolidated Financial Statements.
Unrecognized Tax Benefits
We evaluate tax positions taken on tax returns and recognize positions in our financial statements when it is more likely than not that we will sustain the position upon resolution with a taxing authority. If recognized, the benefit is measured as the largest amount of benefit that has a greater than 50% probability of being realized. We review uncertain tax positions each quarter, considering changes in facts and circumstances, such as changes in tax law, interactions with taxing authorities and developments in case law, and make adjustments as we consider necessary. Adjustments to our unrecognized tax benefits may affect our income tax expense, and settlement of uncertain tax positions may require the use of cash. Other than differences related to timing, no significant adjustments were considered necessary during 2021 or 2020. AtDecember 31, 2021 , our liability for unrecognized tax benefits approximated$3.0 million .Goodwill / IntangiblesGoodwill and intangible assets are tested for impairment annually or more frequently if circumstances indicate an impairment may have occurred. The date of our annual impairment testing isOctober 1 . Impairment of goodwill is tested at the reporting unit level, which is consistent with our reportable segments identified in Note 19 of the Notes to Consolidated Financial Statements.
Interim Impairment Assessments
During the third quarter of 2020, we performed interim impairment assessments of the goodwill and definite and indefinite lived intangible assets in our Specialty P&C,Workers' Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units due to the significant market volatility impacting our actual and projected results along with a decline in our stock price. The goodwill analysis indicated an impairment of the goodwill associated with our Specialty P&C reporting unit and accordingly we recorded a$161.1 million charge to goodwill (see further discussion in Note 8 of the Notes to Consolidated Financial Statements). The analysis of our definite and indefinite lived intangible assets indicated no impairment atSeptember 30, 2020 .
Annual Impairment Assessment
When testing goodwill for impairment on our annual test date, we have the option
to first assess qualitative factors to determine whether the existence of events
or circumstances leads to a determination that it is more likely than not that
the estimated fair value of a reporting unit is less than its carrying amount.
If we elect to perform a qualitative assessment and
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determine that an impairment is more likely than not, we are then required to
perform a quantitative impairment test; otherwise, no further analysis is
required. We also may elect not to perform the qualitative assessment and,
instead, proceed directly to the quantitative impairment test.
Performance of the qualitative goodwill impairment assessment requires judgment in identifying and considering the significance of relevant key factors, events, and circumstances that affect the fair values of our reporting units. This requires consideration and assessment of external factors such as macroeconomic, industry, and market conditions, as well as entity-specific factors, such as our actual and planned financial performance. We also give consideration to the difference between each reporting unit's fair value and carrying value as of the most recent date that a fair value measurement was performed. If the results of the qualitative assessment conclude that it is not more likely than not that the fair value of a reporting unit exceeds its carrying value, additional quantitative impairment testing is performed. The quantitative goodwill impairment test involves comparing the fair value of a reporting unit with its carrying value including goodwill. If the fair value of a reporting unit exceeds its carrying value, the reporting unit's goodwill is considered not to be impaired. However, if the carrying value of a reporting unit exceeds its fair value, an impairment loss is recorded in an amount equal to that excess. Any impairment charge recognized is limited to the amount of the respective reporting unit's allocated goodwill. Determining the fair value of a reporting unit under the quantitative goodwill impairment test requires judgment and often involves the use of significant estimates and assumptions, including an assessment of external factors such as macroeconomic, industry, and market conditions, as well as entity-specific factors, such as actual and planned financial performance. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the magnitude of any such charge. To assist management in the process of determining any potential goodwill impairment, we may review and consider appraisals from accredited independent valuation firms. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches involve significant estimates and assumptions, including projected future cash flows (including timing), discount rates reflecting the risks inherent in those future cash flows, perpetual growth rates, and selection of appropriate market comparable metrics and transactions. During 2021, we experienced an increase in accident year reported losses, including increased severity-related claim activity in ourWorkers' Compensation Insurance segment. We primarily attribute this increase in reported losses and severity-related claim activity to workers being out of "work shape" as they returned to employment in 2021, as well as the lack of training, alternative work arrangements and employee fatigue due to the labor shortage. As a result, we increased our 2021 current accident year loss ratio in ourWorkers' Compensation Insurance reporting unit during the third quarter of 2021. Due to the increase in the current accident year loss ratio, management decided to bypass the optional qualitative impairment test and proceed directly to the quantitative impairment test for both theWorkers' Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units for the most recent goodwill impairment test performed onOctober 1, 2021 . In applying the quantitative approach, management estimated the fair value of theWorkers' Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units using both an income approach and market approach using the aforementioned valuation methodologies and process for developing assumptions. To corroborate the reporting units' valuation, we performed a reconciliation of the estimate of the aggregate fair value of the reporting units toProAssurance's market capitalization, including consideration of a control premium. As a result of the quantitative assessments, management concluded that the fair value of each of theWorkers Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units exceeded the carrying value as of the testing date; therefore, goodwill was not impaired and no further goodwill impairment testing was required. No goodwill impairment was recorded during the year endedDecember 31, 2021 . See Note 8 of the Notes to Consolidated Financial Statements for additional information about our goodwill. The analysis of our definite and indefinite lived intangible assets indicated no impairment atDecember 31, 2021 .
Acquired Intangibles
The acquisition of NORCAL added$14 million to identifiable intangible assets as of the acquisition date. Intangible assets acquired in the NORCAL acquisition included the following: Estimated Fair Value on Acquisition (In thousands) Date Estimated Useful Life Trade name $ 1,000 3 Licenses 13,000 Indefinite Total $ 14,000
See further information on the intangible assets acquired in the NORCAL
acquisition in Note 2 of the Notes to Consolidated Financial Statements and
additional information regarding our goodwill and intangible assets is included
in Note 1 and Note 8 of the Notes to Consolidated Financial Statements.
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Business Combinations
We accounted for our acquisition of NORCAL in accordance with GAAP relating to business combinations which required us to make certain estimates and assumptions including determining the fair value of the non-cash components of the acquisition consideration and the acquisition date fair values of the acquired tangible and identifiable intangible assets and assumed liabilities of NORCAL. Subsequent to the preliminary valuation of the non-cash components of the purchase consideration and net assets acquired, any adjustment identified associated with the purchase price allocation will be evaluated to determine whether the adjustment represents a measurement period adjustment in accordance with GAAP. If the adjustment is deemed to be a measurement period adjustment and is identified within one year of the acquisition, then the measurement period adjustment will be recorded in the current reporting period with a corresponding adjustment to the gain on bargain purchase.
Contingent Consideration
Contingent consideration in a business combination is recorded at fair value on the date of the acquisition and remeasured each subsequent reporting period with changes in fair value recognized in earnings. The purchase consideration in the NORCAL acquisition included contingent consideration with an acquisition date fair value of approximately$24 million . NORCAL policyholders who tendered NORCAL stock toProAssurance are eligible for a share of contingent consideration in an amount of up to approximately$84 million depending upon the after-tax development of NORCAL's ultimate net losses betweenDecember 31, 2020 andDecember 31, 2023 . The estimated fair value of this contingent consideration was$24 million as ofDecember 31, 2021 , which did not change from the acquisition date ofMay 5, 2021 , and was derived utilizing a stochastic model. This estimate does not guarantee that contingent consideration will ultimately be paid. Depending on NORCAL's actual ultimate net loss development betweenDecember 31, 2020 andDecember 31, 2023 , the actual amount due to eligible policyholders may be greater than or less than the$24 million current fair value estimate. See further discussion around the contingent consideration in Note 2 and Note 11 of the Notes to Consolidated Financial Statements.
VOBA
VOBA is an intangible asset (or liability) that reflects the estimated fair value of in-force contracts acquired in an acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is based on actuarially determined projections, and in instances where the in-force business is expected to generate an underwriting loss, the value of VOBA may be negative. Negative VOBA is reported in the reserve for losses and loss adjustment expenses on the Consolidated Balance Sheets. We recognized negative VOBA of$11.7 million in connection with our acquisition of NORCAL, representing the value of future losses expected to be recognized over the lifetime of the contracts acquired determined using a discount rate and other relevant assumptions. The negative VOBA will be amortized over a period in proportion to the earn-out of the premium as a reduction to current accident year net losses and loss adjustment expenses on the Consolidated Statements of Income and Comprehensive Income. See Note 2 of the Notes to Consolidated Financial Statements for more information.
Gain on Bargain Purchase
As a result of the NORCAL acquisition, we recognized a preliminary gain on bargain purchase of$74.4 million during the second quarter of 2021 representing the excess of the fair value of the identifiable assets acquired and liabilities assumed over the purchase consideration. A gain on bargain purchase is recognized in earnings and is considered unusual, infrequent and non-recurring in nature. We exclude gains on bargain purchases from Non-GAAP operating income (loss) as they do not reflect normal operating results. See further discussion around the gain on bargain purchase recognized in the second quarter of 2021 from the NORCAL acquisition in Note 2 of the Notes to Consolidated Financial Statements. Accounting Changes We did not have any change in accounting estimate or policy that had a material effect on our results of operations or financial position during 2021. We are not aware of any accounting changes not yet adopted as ofDecember 31, 2021 that could have a material effect on our results of operations, financial position or cash flows. 58
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Overview
ProAssurance Corporation is a holding company and is a legal entity separate and distinct from its subsidiaries. As a holding company, our principal source of external revenue is our investment revenues. In addition, dividends from our operating subsidiaries represent another source of funds for our obligations, including debt service and shareholder dividends. We also charge our operating subsidiaries within our Specialty P&C (excluding the acquired operating subsidiaries of NORCAL) andWorkers' Compensation Insurance segments a management fee based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary. AtDecember 31, 2021 , we held cash and liquid investments of approximately$73 million outside our insurance subsidiaries that were available for use without regulatory approval or other restriction. We also have$250 million in permitted borrowings available under our Revolving Credit Agreement as well as the possibility of a$50 million accordion feature, if successfully subscribed. As ofFebruary 17, 2022 , no borrowings were outstanding under our Revolving Credit Agreement. During 2021, our operating subsidiaries paid dividends to us of approximately$51 million . In the aggregate, our insurance subsidiaries are permitted to pay dividends of approximately$147 million over the course of 2022 without prior approval of state insurance regulators. However, the payment of any dividend requires prior notice to the insurance regulator in the state of domicile, and the regulator may reduce or prevent the dividend if, in its judgment, payment of the dividend would have an adverse effect on the surplus of the insurance subsidiary. We make the decision to pay dividends from an insurance subsidiary based on the capital needs of that subsidiary and may pay less than the permitted dividend or may also request permission to pay an additional amount (an extraordinary dividend). Cash Flows
Cash flows between periods compare as follows:
Year Ended
(In thousands) 2021 2020
Change
Net cash provided (used) by:
Operating activities$ 73,970 $ 92,343 $ (18,373) Investing activities (85,526) (8,484) (77,042) Financing activities (60,624) (43,446) (17,178) Increase (decrease) in cash and cash equivalents$ (72,180) $ 40,413 $ (112,593) Year Ended December 31 (In thousands) 2020 2019 Change
Net cash provided (used) by:
Operating activities$ 92,343 $ 148,166 $ (55,823) Investing activities (8,484) 50,522 (59,006) Financing activities (43,446) (103,790) 60,344
Increase (decrease) in cash and cash equivalents
The principal components of our operating cash flows are the excess of premiums collected and net investment income over losses paid and operating costs, including income taxes. Timing delays exist between the collection of premiums and the payment of losses associated with the premiums. Premiums are generally collected within the twelve-month period after the policy is written, while our claim payments are generally paid over a more extended period of time. Likewise, timing delays exist between the payment of claims and the collection of any associated reinsurance recoveries. The decrease in operating cash flows of$18.4 million in 2021 as compared to 2020 was partially offset by additional net cash receipt from NORCAL of approximately$27.7 million primarily associated with net premium receipts, partially offset by transaction-related expenses. Excluding NORCAL, operating cash flows decreased by$46.1 million in 2021 as compared to 2020 primarily due to a decrease in net premium receipts of$61.9 million driven by our Lloyd's Syndicates and Specialty P&C segments. The decrease in premium receipts in our Lloyd's Syndicates segment reflected our decreased participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021 underwriting year. The decrease in premium receipts in our Specialty P&C segment was due to our re-underwriting efforts, the dissolution of our arrangement with CAPAssurance and the effect of$14.3 million of tail premium received from a large national healthcare account during the second quarter of 2020 (see further discussion in our Segment Operating Results - Specialty Property & Casualty section that follows). Additionally, the decrease in operating cash flows was due to a decrease in cash received from investment income of$14.6 million driven by a 59
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decrease in distributed earnings and redemptions from our portfolio of investments in LPs/LLCs. Furthermore, the decrease in operating cash flows reflected the prior year effect of an increase in net cash received of$6.8 million associated with the cash settlement of a quota share reinsurance agreement between our Specialty P&C segment and one of its reinsurers in 2020. The decrease in operating cash flows was partially offset by a decrease in paid losses of$21.8 million driven by our Specialty P&C and Segregated Portfolio Cell Reinsurance segments. The decrease in paid losses in our Specialty P&C segment was primarily due to a smaller number of claims resolved with large indemnity payments as compared to the prior year period, some of which is likely associated with the COVID-19 pandemic including the disruption of the court systems. The decrease in paid losses in our Segregated Portfolio Cell Reinsurance segment reflected the effect of the payment of a$10 million claim during the first quarter of 2020 by an SPC at Eastern Re in which we do not participate. This claim payment related to a reserve established by the SPC in 2019 related to an errors and omissions liability policy. Additionally, the decrease in operating cash flows was partially offset by a decrease in cash paid for operating expenses of$7.6 million driven by the effect of one-time expenses of$5.4 million primarily related to employee severance and early retirement benefits paid to certain employees during the third quarter of 2020 and, to a lesser extent, a decrease in premium taxes due to a lower volume of premium written. In addition, the decrease in cash paid for operating expenses was due to our decreased participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021 underwriting year. The remaining variance in operating cash flows in 2021 as compared to 2020 was comprised of individually insignificant components. The decrease in operating cash flows in 2020 as compared to 2019 of$55.8 million was primarily due to an increase in paid losses of$89.1 million driven by our Specialty P&C and Segregated Portfolio Cell Reinsurance segments. The increase in paid losses in our Specialty P&C segment was primarily due to higher average claim payments. The increase in paid losses in our Segregated Portfolio Cell Reinsurance segment reflected the aforementioned payment of a$10 million claim during the first quarter of 2020. Furthermore, the decrease in operating cash flows reflected a decrease in net cash received of$7.4 million associated with the cash settlement of the 2017 calendar year quota share reinsurance agreement between our Specialty P&C segment and Syndicate 1729 due to the reduction in premiums ceded to Syndicate 1729. The decrease in operating cash flows also reflected the aforementioned one-time expenses of$5.4 million . Additionally, the decrease in operating cash flows reflected a decrease in cash received from investment income of$3.5 million primarily due to a reduction in dividends received on our equity portfolio resulting from a decrease in our allocation to this asset category. The decrease in operating cash flows was somewhat offset by an increase in net premium receipts of$28.1 million and a decrease in 2020 net tax payments as compared to 2019 of$9.8 million . The increase in net premium receipts was driven by our Specialty P&C segment due to$14.3 million of tail premium, as previously discussed. The decrease in net tax payments was primarily due to refunds received in 2020. Furthermore, the decrease in operating cash flows was partially offset by an increase in net cash received of$6.8 million associated with the cash settlement of a quota share reinsurance agreement, as previously discussed. The remaining variance in operating cash flows in 2020 as compared to 2019 was comprised of individually insignificant components. We manage our investing cash flows to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations as discussed in this section under the heading "Investing Activities and Related Cash Flows."
Our financing cash flows are primarily comprised of dividend payments and
borrowings and repayments under our Revolving Credit Agreement. See further
discussion of our financing activities in this section under the heading
"Financing Activities and Related Cash Flows."
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Operating Activities and Related Cash Flows
Losses
The following table, known as the Analysis ofReserve Development , presents information over the preceding ten years regarding the payment of our losses as well as changes to (the development of) our estimates of losses during that time period. As noted in the table, we have completed various acquisitions over the ten year period which have affected original and re-estimated gross and net reserve balances as well as loss payments. The table includes losses on both a direct and an assumed basis and is net of anticipated reinsurance recoverables. The gross liability for losses before reinsurance, as shown on the balance sheet, and the reconciliation of that gross liability to amounts net of reinsurance are reflected below the table. We do not discount our reserve for losses to present value. Information presented in the table is cumulative and, accordingly, each amount includes the effects of all changes in amounts for prior years. The table presents the development of our balance sheet reserve for losses; it does not present accident year or policy year development data. Conditions and trends that have affected the development of liabilities in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table.
The following may be helpful in understanding the Analysis of
Development
•The line entitled "Reserve for losses, undiscounted and net of reinsurance
recoverables" reflects our reserve for losses and loss adjustment expense, less
the receivables from reinsurers, each as reported in our Consolidated Balance
Sheets at the end of each year (the Balance Sheet Reserves).
•The section entitled "Cumulative net paid, as of" reflects the cumulative
amounts paid as of the end of each succeeding year with respect to the
previously recorded Balance Sheet Reserves.
•The section entitled "Re-estimated net liability as of" reflects the
re-estimated amount of the liability previously recorded as Balance Sheet
Reserves that includes the cumulative amounts paid and an estimate of the
remaining net liability based upon claims experience as of the end of each
succeeding year (the Net Re-estimated Liability).
•The line entitled "Net cumulative redundancy (deficiency)" reflects the
difference between the previously recorded Balance Sheet Reserve for each
applicable year and the Net Re-estimated Liability relating thereto as of the
end of the most recent fiscal year.
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Analysis of Reserve Development
December 31
(In thousands) 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Reserve for losses, undiscounted
and net of reinsurance
recoverables $ 2,000,114 $ 1,860,076
$ 1,712,796 $ 1,776,027 $ 1,955,818 $ 2,032,092 $ 3,128,199 Cumulative net paid, as of: One Year Later 300,703 311,835 343,197 390,849 383,062 369,682 412,711 458,991 501,969 499,369 Two Years Later 526,903 563,805 571,690 646,878 633,246 644,422 704,830 787,223 839,117 Three Years Later 682,576 704,795 732,892 804,624 818,102 824,686 900,421 1,007,970 Four Years Later 763,703 800,189 826,384 917,236 918,403 958,735 1,041,817 Five Years Later 821,742 852,873 891,615 971,392 994,771 1,035,280 Six Years Later 852,119 893,529 924,334 1,012,975 1,039,669 Seven Years Later 876,840 915,730 952,118 1,037,853 Eight Years Later 891,820 930,375 967,945 Nine Years Later 899,969 941,468 Ten Years Later 911,079 Re-estimated net liability as of: End of Year 2,000,114 1,860,076 1,825,304 1,820,300 1,755,976 1,719,953 1,712,796 1,776,027 1,955,818 2,032,092 One Year Later 1,728,076 1,644,203 1,644,516 1,659,120 1,612,198 1,585,593 1,620,680 1,764,244 1,905,419 1,994,516 Two Years Later 1,498,158 1,472,259 1,483,378 1,519,078 1,485,357 1,481,292 1,541,237 1,716,096 1,882,368 Three Years Later 1,342,996 1,331,828 1,358,560 1,396,130 1,380,687 1,373,145 1,501,138 1,706,893 Four Years Later 1,224,597 1,231,337 1,252,605 1,296,074 1,279,877 1,340,191 1,488,345 Five Years Later 1,148,793 1,157,493 1,173,975 1,228,480 1,253,245 1,333,861 Six Years Later 1,091,646 1,108,716 1,126,308 1,211,706 1,252,096 Seven Years Later 1,056,053 1,078,057 1,121,087 1,206,875 Eight Years Later 1,034,690 1,075,277 1,119,984 Nine Years Later 1,033,435 1,070,161 Ten Years Later 1,031,800 Net cumulative redundancy (deficiency)$ 968,314 $ 789,915
$ 224,451 $ 69,134 $ 73,450 $ 37,576 Original gross liability - end of year$ 2,247,772 $ 2,051,428
Reinsurance recoverables
(247,658) (191,352) (247,518) (237,966) (249,350) (273,475) (335,585) (343,820) (390,708)
(385,087)
Original net liability - end of year$ 2,000,114 $ 1,860,076
$ 1,712,796 $ 1,776,027 $ 1,955,818 $ 2,032,092 Gross re-estimated liability - latest$ 1,158,598 $ 1,191,990
$ 1,800,829 $ 2,021,075 $ 2,212,946 $ 2,346,497 Re-estimated reinsurance recoverables (126,798) (121,829) (142,051) (158,473) (197,179) (239,369) (312,484) (314,182) (330,578)
(351,981)
Net re-estimated liability - latest$ 1,031,800 $ 1,070,161
$ 1,488,345 $ 1,706,893 $ 1,882,368 $ 1,994,516 Gross cumulative redundancy (deficiency)$ 1,089,174 $ 859,438 $ 810,787 $ 692,918 $ 556,051 $ 420,198 $ 247,552 $ 98,772 $ 133,580 $ 70,682
See table notes on following page.
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Table Notes
•We have elected to present reserve history for acquired entities on a
prospective basis in the table above; therefore, certain items will not agree to
the following table which details activity in our net reserve for losses.
•Reserves for 2012 and thereafter include gross and net reserves acquired in 2012 business combinations of$21.8 million and$19.2 million , respectively, which considers reductions of$3.6 million and$3.3 million , respectively, recorded in 2013 due to the re-estimation of the fair value of the acquired reserves.
•Reserves for 2013 include gross and net reserves acquired in 2013 business
combinations of
•Reserves for 2014 include gross and net reserves acquired in 2014 business
combinations of
•Reserves for 2021 include gross and net reserves acquired in 2021 business
combinations of
In each year reflected in the table, we have estimated our reserve for losses
utilizing the management and actuarial processes discussed under the heading
"Reserve for Losses and Loss Adjustment Expenses" in the Critical Accounting
Estimates section. Factors that have contributed to the variation in loss
development are primarily related to the extended period of time required to
resolve professional liability claims and include the following:
•The HCPL legal environment deteriorated in the late 1990's and severity began
to increase at a greater pace than anticipated in our rates and reserve
estimates. We addressed the adverse severity trends through increased rates,
stricter underwriting and modifications to claims handling procedures, and
reflected this adverse severity trend when we established our initial reserves
for subsequent years.
•These adverse severity trends later moderated, with that moderation becoming
more pronounced beginning in 2009. We were cautious in giving full recognition
to indications that the pace of severity increase had slowed, however we gave
measured recognition of the improved trend in our reserve estimates. The
favorable development was most pronounced for years 2004 to 2008, as the initial
reserves for these accident years were established prior to substantial
indication that severity trends were moderating. We gave stronger recognition to
the lower severity trend as time elapsed and a greater percentage of claims were
closed.
•A general decline in claims frequency has also been a contributor to favorable
loss development. A significant portion of our policies through 2003 were issued
on an occurrence basis, and a smaller portion of our ongoing business results
from the issuance of extended reporting endorsements which have occurrence-like
exposure. As claims frequency declined, the number of reported claims related to
these coverages was less than originally expected.
•Beginning in 2017, we identified potential higher severity trends in the
broader HCPL industry. These trends were also reflected in increases in
estimates of ultimate losses for open HCPL claims for earlier accident years,
which resulted in a lower amount of favorable development recognized in 2018 and
2017 as compared to prior years.
•During 2019 the loss experience in our Specialty line of business deteriorated
further, particularly in regard to the reserves we established for a large
national healthcare account that experienced losses far exceeding the
assumptions we made when underwriting the account, beginning in 2016. As a
result, we strengthened our Specialty reserves through the recognition of net
unfavorable development on prior accident years and a higher current accident
year net loss ratio in our Specialty P&C segment in 2019.
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Activity in our net reserve for losses during 2021, 2020 and 2019 is summarized
below:
Year Ended December 31
(In thousands) 2021 2020 2019
Balance, beginning of year $ 2,417,179 $
2,346,526
Less reinsurance recoverables on unpaid losses and
loss adjustment expenses
385,087 390,708 343,820 Net balance, beginning of year 2,032,092 1,955,818 1,776,027 Net reserves acquired from acquisitions 1,089,103 - - Net losses: Current year(1)(2)(3) 797,732 711,846 765,698 Favorable development of reserves established in prior years, net(3) (45,483) (50,399) (11,783) Total 752,249 661,447 753,915 Paid related to: Current year (109,925) (83,204) (115,133) Prior years (635,320) (501,969) (458,991) Total paid (745,245) (585,173) (574,124) Net balance, end of year 3,128,199 2,032,092 1,955,818
Plus reinsurance recoverables on unpaid losses and
loss adjustment expenses
451,741 385,087 390,708 Balance, end of year$ 3,579,940 $ 2,417,179 $ 2,346,526 (1) Current year net losses for the year endedDecember 31, 2019 included incurred losses of$2.1 million related to a loss portfolio transfer entered into during 2019 in the Specialty P&C segment. In addition, current year net losses for the year endedDecember 31, 2019 included a PDR of$9.2 million associated with the unearned premium of a large national healthcare account's claims-made policy in the Specialty P&C segment. Current year net losses for the year endedDecember 31, 2020 included the amortization of the aforementioned$9.2 million PDR which offsets the impact of the losses incurred associated with the premium earned related to the large national healthcare account's claims-made policy. (2) During 2020, the aforementioned large national healthcare account did not renew on terms offered by the Company and exercised its contractual option to purchase extended reporting endorsement or "tail" coverage. As a result, we recognized total current year losses of$60.0 million (assumes a full limit loss) within the Specialty P&C segment for the year endedDecember 31, 2021 .
(3) Current year net losses and prior accident year development for the year
ended
associated with our acquisition of NORCAL. See Note 10 of the Notes to
Consolidated Financial Statements for additional information.
AtDecember 31, 2021 our gross reserve for losses included case reserves of approximately$2.1 billion and IBNR reserves of approximately$1.4 billion . Our consolidated gross reserve for losses on a GAAP basis exceeds the combined gross reserves of our insurance subsidiaries on a statutory basis by approximately$0.3 billion , which is principally due to the portion of the GAAP reserve for losses that is reflected for statutory accounting purposes as unearned premiums. These unearned premiums are applicable to extended reporting endorsements ("tail" coverage) issued without a premium charge upon death, disability or retirement of an insured who meets certain qualifications.
Reinsurance
Within our Specialty P&C segment, we use insurance and reinsurance (collectively, "reinsurance") to provide capacity to write larger limits of liability, to provide reimbursement for losses incurred under the higher limit coverages we offer and to provide protection against losses in excess of policy limits. Within ourWorkers' Compensation Insurance segment, we use reinsurance to reduce our net liability on individual risks, to mitigate the effect of significant loss occurrences (including catastrophic events), to stabilize underwriting results and to increase underwriting capacity by decreasing leverage. In both ourSpecialty P&C and Workers' Compensation Insurance segments, we use reinsurance in risk sharing arrangements to align our objectives with those of our strategic business partners and to provide custom insurance solutions for large customer groups. Within our Lloyd's Syndicates segment, Syndicate 1729 utilizes reinsurance to provide capacity to write larger limits of liability on individual risks, to provide protection against catastrophic loss and to provide protection against losses in excess of policy limits. The purchase of reinsurance does not relieve us from the ultimate risk on our policies; however, it does provide reimbursement for certain losses we pay. We pay our reinsurers a premium in exchange for reinsurance of the risk. In certain of our excess of loss arrangements, the premium due to the reinsurer is determined by the loss experience of the business 64
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reinsured, subject to certain minimum and maximum amounts. Until all loss amounts are known, we estimate the premium due to the reinsurer. Changes to the estimate of premium owed under reinsurance agreements related to prior periods are recorded in the period in which the change in estimate occurs and can have a significant effect on net premiums earned. We offer alternative market solutions whereby we cede certain premiums from ourWorkers' Compensation Insurance and Specialty P&C segments to either the SPCs at Inova Re or Eastern Re, ourCayman Islands reinsurance subsidiaries which are reported in our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer for one program. The majority of these policies are reinsured to the SPCs at Inova Re or Eastern Re, net of a ceding commission. Each SPC at Inova Re and Eastern Re is owned, fully or in part, by an individual company, agency, group or association and the results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to a high of 85%. SPC results attributable to external cell participants are reported as an SPC dividend expense (income) in our Segregated Portfolio Cell Reinsurance segment. See further discussion on our SPC operations in the Segment Results - Segregated Portfolio Cell Reinsurance section that follows. The alternative market workers' compensation policies are ceded from ourWorkers' Compensation Insurance segment to the SPCs under 100% quota share reinsurance agreements. The alternative market healthcare professional liability policies are ceded from our Specialty P&C segment to the SPCs under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program. The portion of the risk that is not ceded to an SPC is retained in our Specialty P&C segment and may also be reinsured under our standard healthcare professional liability reinsurance program, depending on the policy limits provided. The remaining premium written in our alternative market business is 100% ceded to an unaffiliated captive insurer.
Excess of Loss Reinsurance Agreements
We generally reinsure risks under treaties (our excess of loss reinsurance agreements) pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. Generally, these agreements are negotiated and renewed annually. Our HCPL and Medical Technology Liability treaties renew annually onOctober 1 . As ofOctober 1, 2021 , our HCPL treaty renewed with a lower gross rate and also incorporated NORCAL policies. For the NORCAL excess of loss reinsurance arrangement in effect prior toOctober 1, 2021 , NORCAL policies were reinsured under separate reinsurance agreements, primarily excess of loss, which have historically renewed annually onJanuary 1 . For the NORCAL excess of loss reinsurance arrangement that renewed onJanuary 1, 2021 , retention was generally the first$2 million in risk and coverages in excess of this amount are ceded up to$24 million . There were no significant changes in the cost or structure of our Medical Technology Liability treaty upon the latest renewal onOctober 1, 2021 . Our Workers' Compensation treaty renews annually onMay 1 . Our traditional workers' compensation treaty renewed May 1, 2021 at a higher rate than the previous agreement, with an increase in the AAD to 3.50% from 3.16% of ceded earned premium, in excess of the$0.5 million retention per loss occurrence; all other material treaty terms were consistent with the expiring agreement. The significant coverages provided by our current excess of loss reinsurance agreements are detailed in the following table. 65
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Excess of Loss Reinsurance Agreements
[[Image Removed: pra-20211231_g1.jpg]]
Healthcare Medical Technology &
Workers'
Professional Liability Life Sciences Products Compensation - Traditional
(1) EffectiveOctober 1, 2020 , one prepaid limit reinstatement of$21M and a second limit reinstatement of up to$21M for the second layer, subject to reinstatement premium, which attaches after the first reinstatement has been completely exhausted. All limit reinstatements thereafter require no additional premium. EffectiveOctober 1, 2021 , limits can be reinstated a maximum of four times.
(2) Prior to
(3) Historically, retention has ranged from 2.5% to 32.5%.
(4) Historically, retention has ranged from
(5) Includes an AAD where retention is 3.5% of subject earned premium in annual
losses otherwise recoverable in excess of the
occurrence.
Large HCPL risks that are above the limits of our basic reinsurance treaties may be reinsured on a facultative basis, whereby the reinsurer agrees to insure a particular risk up to a designated limit. We also have in place a number of risk sharing arrangements that apply to the first$1 million of losses for certain large healthcare systems and other insurance entities, as well as with certain insurance agencies that produce business for us. 66
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Other Reinsurance Arrangements
For the workers' compensation business ceded to Inova Re and Eastern Re, each
SPC has in place its own reinsurance arrangements; which are illustrated in the
following table.
Segregated Portfolio Cell Reinsurance
[[Image Removed: pra-20211231_g2.jpg]]
Per Occurrence Coverage Aggregate Coverage
(1) The attachment point is based on a percentage of written premium within
individual cells, ranges from 85% to 94%, and varies by cell.
Each SPC has participants and the profit or loss of each cell accrues fully to
these cell participants. As previously discussed, we participate in certain SPCs
to a varying degree. Each SPC maintains a loss fund initially equal to the
difference between premium assumed by the cell and the ceding commission. The
external participants of each cell provide collateral to us, typically in the
form of a letter of credit that is initially equal to the difference between the
loss fund of the SPC (amount of funds available to pay losses after deduction of
ceding commission) and the aggregate attachment point of the reinsurance. Over
time, an SPC's retained profits are considered in the determination of the
collateral amount required to be provided by the cell's external participants.
Within our Lloyd's Syndicates segment, Syndicate 1729 utilizes reinsurance to
provide capacity to write larger limits of liability on individual risks, to
provide protection against catastrophic loss and to provide protection against
losses in excess of policy limits. The level of reinsurance that Syndicate 1729
purchases is dependent on a number of factors, including its underwriting risk
appetite for catastrophic exposure, the specific risks inherent in each line or
class of business written and the pricing, coverage and terms and conditions
available from the reinsurance market. Reinsurance protection by line of
business is as follows:
•Reinsurance is utilized on a per risk basis for the property insurance and
casualty coverages in order to mitigate risk volatility.
•Catastrophic protection is utilized on both our property insurance and casualty
coverages to protect against losses in excess of policy limits as well as
natural catastrophes.
•Both quota share reinsurance and excess of loss reinsurance are utilized to
manage the net loss exposure on our property reinsurance coverages.
•Property umbrella excess of loss reinsurance is utilized for peak catastrophe
and frequency of catastrophe exposures.
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Table of Contents •Prior toJanuary 1, 2022 , external excess of loss reinsurance was utilized by Syndicate 1729 to manage the net loss exposure on the specialty property and contingency coverages ceded to Syndicate 6131; Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's business was incorporated into Syndicate 1729 beginning with the 2022 year of account. For the second half of 2020, external quota share reinsurance was utilized by Syndicate 6131 to manage the net loss exposure on the specialty property and contingency coverages it assumed from Syndicate 1729 by ceding essentially half of the premium assumed to an unaffiliated insurer; this agreement was non-renewed onJanuary 1, 2021 (see further discussion in the Segment Results - Lloyd's Syndicates section that follows). Syndicate 1729 may still be exposed to losses that exceed the level of reinsurance purchased as well as to reinstatement premiums triggered by losses exceeding specified levels. Cash demands on Syndicate 1729 can vary significantly depending on the nature and intensity of a loss event. For significant reinsured catastrophe losses, the inability or unwillingness of the reinsurer to make timely payments under the terms of the reinsurance agreement could have an adverse effect on Syndicate 1729's liquidity.
Taxes
We are subject to the tax laws and regulations of theU.S. ,Cayman Islands andU.K. We file a consolidatedU.S. federal income tax return that includes the parent company and itsU.S. subsidiaries, except for ProAssurance American Mutual, aRisk Retention Group . Our filing obligations include a requirement to make quarterly payments of estimated taxes to theIRS using the corporate tax rate effective for the tax year. We did not make any quarterly estimated tax payments during the year endedDecember 31, 2021 or 2020. As a result of the CARES Act that was signed into law onMarch 27, 2020 , as previously discussed, we were permitted to carryback NOLs generated in tax years 2019 and 2020 for up to five years. See further discussion in Note 7 of the Notes to Consolidated Financial Statements. We generated an NOL of approximately$33.3 million from the 2020 tax year that was carried back to the 2015 tax year that resulted in a claim for a refund of approximately$11.7 million , which we anticipate to receive during the first half of 2022. Additionally, we had an NOL of approximately$25.6 million from the 2019 tax year which was carried back to the 2014 tax year and generated a tax refund of approximately$9.0 million which we received inFebruary 2021 . Furthermore, we received a tax refund of$1.3 million during the second quarter of 2021 due to the repeal of a previous election we made under the TCJA related to discounted loss reserves. As a result of our acquisition of NORCAL, we recorded$46.8 million of net deferred tax assets reflecting the remeasurement of NORCAL's historical net deferred tax assets. The net deferred tax assets acquired from NORCAL were subject to recalculation following application of all purchase accounting adjustments and our assessment of the realizability of NORCAL's deferred tax assets. As a result of the NORCAL acquisition, we haveU.S. federal NOL carryforwards which as ofDecember 31, 2021 were approximately$43.0 million . These NOL carryforwards are subject to limitation by Internal Revenue Code Section 382 and will begin to expire in 2035. 68
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Investing Activities and Related Cash Flows
Our investments atDecember 31, 2021 andDecember 31, 2020 are comprised as follows: December 31, 2021 December 31, 2020 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Fixed maturities, available for sale: U.S. Treasury obligations $ 238,507 5 % $ 107,059 3 % U.S. Government-sponsored enterprise obligations 20,234 1 % 12,261 1
%
State and municipal bonds 519,196 11 % 332,920 10 % Corporate debt 1,898,556 39 % 1,329,342 39 % Residential mortgage-backed securities 453,941 9 % 276,541 8 % Commercial mortgage-backed securities 245,624 5 % 126,402 4 % Other asset-backed securities 457,664 9 % 273,006 8 % Total fixed maturities, available-for-sale 3,833,722 79 % 2,457,531 73 % Fixed maturities, trading 43,670 1 % 48,456 1 % Total fixed maturities 3,877,392 80 % 2,505,987 74 % Equity investments(1) 214,807 4 % 120,101 4 % Short-term investments 216,987 4 % 337,813 10 % BOLI 81,767 2 % 67,847 2 % Investment in unconsolidated subsidiaries 335,576 7 % 310,529 9 % Other investments 101,794 3 % 47,068 1 % Total investments$ 4,828,323 100 %$ 3,389,345
100 %
(1)Includes
ended
AtDecember 31, 2021 , 100% of our investments in available-for-sale fixed maturity securities were rated and the average rating was A+. The distribution of our investments in available-for-sale fixed maturity securities by rating were as follows: December 31, 2021 December 31, 2020 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Rating* AAA$ 1,129,136 29 % $ 717,187 29 % AA+ 130,077 3 % 103,996 4 % AA 254,570 7 % 168,452 7 % AA- 194,661 5 % 122,733 5 % A+ 221,473 6 % 197,274 8 % A 521,598 14 % 323,044 13 % A- 364,147 9 % 245,464 10 % BBB+ 292,984 8 % 189,971 8 % BBB 300,650 8 % 190,385 8 % BBB- 127,982 3 % 59,847 2 % Below investment grade 296,444 8 % 133,607 5 % Not rated - - % 5,571 1 % Total$ 3,833,722 100 %$ 2,457,531 100 %
*Average of three NRSRO sources, presented as an S&P equivalent. Source: S&P, Copyright ©2021, S&P Global Market Intelligence
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Our acquisition of NORCAL added the following to our investment holdings as of
(In thousands)
Fixed maturities, available for sale $ 1,100,058
Equity investments 374,484
Short-term investments 61,289
BOLI 12,581
Investment in unconsolidated subsidiaries 26,948
Other investments 32,461
Total investments $ 1,607,821
A detailed listing of our investment holdings as of December 31, 2021 is located
under the Financial Information heading on the Investor Relations page of our
website which can be reached directly at
https://investor.proassurance.com/financial-information/quarterly-investment-supplements/default.aspx
or through links from the Investor Relations section of our website,
investor.proassurance.com.
We manage our investments to ensure that we will have sufficient liquidity to
meet our obligations, taking into consideration the timing of cash flows from
our investments, including interest payments, dividends and principal payments,
as well as the expected cash flows to be generated by our operations.
Furthermore, we managed our investments as part of our capital planning in
anticipation of closing our acquisition of NORCAL. In addition to the interest
and dividends we will receive from our investments, we anticipate that between
$70 million and $130 million of our portfolio will mature (or be paid down) each
quarter over the next twelve months and become available, if needed, to meet our
cash flow requirements. The primary outflow of cash at our insurance
subsidiaries is related to paid losses and operating costs, including income
taxes. The payment of individual claims cannot be predicted with certainty;
therefore, we rely upon the history of paid claims in estimating the timing of
future claims payments with consideration to current and anticipated industry
trends and macroeconomic conditions. To the extent that we may have an
unanticipated shortfall in cash, we may either liquidate securities or borrow
funds under existing borrowing arrangements through our Revolving Credit
Agreement and the FHLB system. Permitted borrowings under our Revolving Credit
Agreement are $250 million with the possibility of an additional $50 million
accordion feature, if successfully subscribed. Given the duration of our
investments, we do not foresee a shortfall that would require us to meet
operating cash needs through additional borrowings. Additional information
regarding our Revolving Credit Agreement is detailed in Note 13 of the Notes to
Consolidated Financial Statements.
At December 31, 2021 , our FAL was comprised of fixed maturity securities with a
fair value of $36.6 million and cash and cash equivalents of $1.2 million
deposited with Lloyd's. See further discussion in Note 4 of the Notes to
Consolidated Financial Statements. During the second and fourth quarters of
2021, we received a return of approximately $24.5 million and $8.0 million ,
respectively, of cash from our FAL balances given the reduction in our
participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021
underwriting year. Further, during the fourth quarter of 2021, ProAssurance
received a return of approximately $26.6 million of cash from our FAL balances
given Syndicate 6131 ceased underwriting on a quota share basis with Syndicate
1729 as Syndicate 6131's business is retained within Syndicate 1729 beginning
with the 2022 underwriting year. See further discussion on the return of FAL in
the Segment Results - Lloyd's Syndicates section that follows.
Our investment portfolio continues to be primarily composed of high quality
fixed income securities with approximately 92% of our fixed maturities being
investment grade securities as determined by national rating agencies. The
weighted average effective duration of our fixed maturity securities at
December 31, 2021 was 3.71 years; the weighted average effective duration of our
fixed maturity securities combined with our short-term securities was 3.51
years.
The carrying value and unfunded commitments for certain of our investments were
as follows:
Carrying Value December 31, 2021
($ in thousands, except expected funding December 31, Unfunded Expected funding
period) December 31, 2021 2020 Commitment period in years
Qualified affordable housing project tax
credit partnerships (1) $ 12,424 $ 27,719 $ 581 5
All other investments, primarily investment
fund LPs/LLCs 323,152 282,810 168,379 4
Total $ 335,576 $ 310,529 $ 168,960
(1) The carrying value reflects our total commitments (both funded and unfunded) to the partnerships, less any
amortization, since our initial investment. We fund these investments based on funding schedules maintained by the
partnerships.
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Investment fund LPs/LLCs are by nature less liquid and may involve more risk than other investments. We manage our risk through diversification of asset class and geographic location. AtDecember 31, 2021 , we had investments in 34 separate investment funds with a total carrying value of$323.2 million which represented approximately 7% of our total investments. Our investment fund LPs/LLCs generate earnings from trading portfolios, secured debt, debt securities, multi-strategy funds and private equity investments, and the performance of these LPs/LLCs is affected by the volatility of equity and credit markets. For our investments in LPs/LLCs, we record our allocable portion of the partnership operating income or loss as the results of the LPs/LLCs become available, typically following the end of a reporting period.
Business Combinations and Ventures
OnMay 5, 2021 , we completed the acquisition of NORCAL by purchasing 98.8% of the converted company stock in exchange for total consideration transferred of$449 million . OnSeptember 16, 2021 , we acquired the remaining 1.2% interest in NORCAL for$3 million of cash. OnMay 5, 2021 ,ProAssurance funded the transaction with$248 million of cash on hand and NORCAL paid$2 million to policyholders who elected to receive the discounted cash option for their allocated share of the converted company's equity. Additional consideration with a principal amount of$191 million and a fair value of$175 million , is in the form of Contribution Certificates issued to certain NORCAL policyholders in the conversion, and those instruments are an obligation ofNORCAL Insurance Company , the successor ofNORCAL Mutual Insurance Company (see Note 13 of the Notes to Consolidated Financial Statements for further discussion of the terms of the Contribution Certificates). Policyholders who tendered NORCAL stock toProAssurance are also eligible for a share of contingent consideration in an amount of up to approximately$84 million depending upon the after-tax development of NORCAL's ultimate net losses betweenDecember 31, 2020 andDecember 31, 2023 . The estimated fair value of this contingent consideration was$24 million as ofMay 5, 2021 andDecember 31, 2021 . The Agreement and Plan of Acquisition is included as Exhibit 2.1 of this report. Additional information regarding our acquisition of NORCAL is included in Note 2 of the Notes to Consolidated Financial Statements. There were no business combinations during the year endedDecember 31, 2020 .
Financing Activities and Related Cash Flows
Treasury Shares
(In thousands) 2021 2020 2019
Treasury shares at the beginning of the period 9,325 9,325 9,352
Shares reissued, primarily those reissued pursuant to the
value of approximately
- - (27) Treasury shares at the end of the period 9,325 9,325 9,325 We did not repurchase any common shares subsequent toDecember 31, 2021 and as ofFebruary 17, 2022 our remaining Board authorization was approximately$110 million .
ProAssurance Shareholder Dividends
Our Board declared cash dividends during 2021, 2020 and 2019 as follows:
Quarterly Cash Dividends Declared, per Share
2021 2020 2019
First Quarter $ 0.05 $ 0.31 $ 0.31
Second Quarter $ 0.05 $ 0.05 $ 0.31
Third Quarter $ 0.05 $ 0.05 $ 0.31
Fourth Quarter $ 0.05 $ 0.05 $ 0.31
Each dividend was paid in the month following the quarter in which it was
declared. Cash dividends totaling $11 million , $39 million and $93 million were
paid during the years ended December 31, 2021 , 2020 and 2019, respectively. Any
decision to pay future cash dividends is subject to the Board's final
determination after a comprehensive review of financial performance, future
expectations and other factors deemed relevant by the Board.
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Debt
AtDecember 31, 2021 , our debt included$250 million of outstanding unsecured senior notes. The notes bear interest at 5.3% annually and are due in 2023 although they may be redeemed in whole or part prior to maturity. There are no financial covenants associated with these notes.NORCAL Insurance Company , successor toNORCAL Mutual Insurance Company , issued Contribution Certificates, which bear interest at 3.0% annually and are due in 2031, to certain NORCAL policyholders in the conversion. The Contribution Certificates have a principal amount of$191 million and were recorded at their fair value of$175 million at the date of the NORCAL acquisition. The difference of$16 million between the recorded acquisition date fair value and the principal balance of the Contribution Certificates will be accreted utilizing the effective interest method over the term of the certificates of ten years as an increase to interest expense. Furthermore, interest payments, which begin inApril 2022 , are subject to deferral if we do not receive permission from theCalifornia Department of Insurance prior to payment. See Note 2 and Note 13 of the Notes to Consolidated Financial Statements for additional information on the Contribution Certificates issued in the NORCAL acquisition. There are no financial covenants associated with these certificates. We have a Revolving Credit Agreement, which expires inNovember 2024 , that may be used for general corporate purposes, including, but not limited to, short-term working capital, share repurchases as authorized by the Board and support for other activities. Our Revolving Credit Agreement permits borrowings of up to$250 million as well as the possibility of a$50 million accordion feature, if successfully subscribed. AtDecember 31, 2021 , there were no outstanding borrowings on our Revolving Credit Agreement; we are in compliance with the financial covenants of the Revolving Credit Agreement. Two of our subsidiaries,ProAssurance Indemnity Company, Inc. andProAssurance Insurance Company of America , had Mortgage Loans with one lender in connection with the recapitalization of two office buildings, with scheduled maturities inDecember 2027 . The Mortgage Loans accrued interest at three-month LIBOR plus 1.325% with principal and interest payable on a quarterly basis. During 2021, we repaid the balance outstanding on the Mortgage Loans of approximately$35.3 million . Interest expense on the Mortgage Loans during the year endedDecember 31, 2021 included the write-off of the unamortized debt issuance costs which were nominal in amount.
Additional information regarding our debt is provided in Note 13 of the Notes to
Consolidated Financial Statements.
Three of our insurance subsidiaries are members of an FHLB. Through membership,
those subsidiaries have access to secured cash advances which can be used for
liquidity purposes or other operational needs. In order for us to use FHLB
proceeds, regulatory approvals may be required depending on the nature of the
transaction. To date, those subsidiaries have not materially utilized their
membership for borrowing purposes.
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Results of Operations - Year Ended
Selected consolidated financial data for each period is summarized in the table
below.
Year Ended December 31
($ in thousands, except per share data) 2021 2020 Change
Revenues:
Net premiums written $ 882,721 $ 747,701 $ 135,020
Net premiums earned $ 971,668 $ 792,715 $ 178,953
Net investment result 119,496 60,077 59,419
Net investment gains (losses) 24,310 15,678 8,632
Other income 8,936 6,470 2,466
Total revenues 1,124,410 874,940 249,470
Expenses:
Net losses and loss adjustment expenses 752,249 661,447 90,802
Underwriting, policy acquisition and operating expenses 268,246
237,881 30,365 SPC U.S. federal income tax expense 1,947 1,746 201 SPC dividend expense (income) 10,050 14,304 (4,254) Interest expense 19,719 15,503 4,216 Goodwill impairment - 161,115 (161,115) Total expenses 1,052,211 1,091,996 (39,785) Gain on bargain purchase 74,408 - 74,408 Income (loss) before income taxes 146,607 (217,056) 363,663 Income tax expense (benefit) 2,483 (41,329) 43,812 Net income (loss)$ 144,124 $ (175,727) $ 319,851 Non-GAAP operating income (loss)$ 75,892 $ (27,741) $ 103,633 Earnings (loss) per share: Basic $ 2.67$ (3.26) $ 5.93 Diluted $ 2.67$ (3.26) $ 5.93 Non-GAAP operating income (loss) per share: Basic $ 1.41$ (0.52) $ 1.93 Diluted $ 1.40$ (0.52) $ 1.92 Net loss ratio 77.4% 83.4% (6.0 pts) Underwriting expense ratio 27.6% 30.0% (2.4 pts) Combined ratio 105.0% 113.4% (8.4 pts) Operating ratio 97.7% 104.3% (6.6 pts) Effective tax rate 1.7% 19.0% (17.3 pts) Return on equity* 5.3% (12.3%) 17.6 pts *See further discussion on this calculation in the Executive Summary of Operations section under the heading "ROE." In all tables that follow, the abbreviation "nm" indicates that the information or the percentage change is not meaningful. 73
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Table of Contents Executive Summary of Operations The following sections provide an overview of our consolidated and segment results of operations for the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 . See the Segment Results sections that follow for additional information regarding each segment's results. For a full discussion of the changes in the financial condition, results of operations and cash flows for the year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 , please refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" section ofProAssurance's December 31, 2020 report on Form 10-K. Revenues
The following table shows our consolidated and segment net premiums earned:
Year Ended
($ in thousands) 2021 2020
Change
Net Premiums Earned
Specialty P&C$ 695,008 $ 477,365 $
217,643 45.6 %
Workers' Compensation Insurance 164,600 171,772
(7,172) (4.2 %)
Segregated Portfolio Cell Reinsurance 63,688 66,352
(2,664) (4.0 %) Lloyd's Syndicates 48,372 77,226 (28,854) (37.4 %) Consolidated total$ 971,668 $ 792,715 $ 178,953 22.6 % For the year endedDecember 31, 2021 , consolidated net premiums earned included additional earned premiums of$214.6 million in our Specialty P&C segment from our acquisition of NORCAL. Excluding NORCAL, consolidated net premiums earned decreased$35.6 million in 2021 as compared to 2020 driven by a decrease in net premiums earned in our Lloyd'sSyndicates and Workers' Compensation Insurance segments, partially offset by an increase in net premiums earned in our Specialty P&C segment. The decrease in our Lloyd's Syndicates segment was due to our decreased participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021 underwriting year. For both ourWorkers' Compensation Insurance and Segregated Portfolio Cell Reinsurance segments, the decrease in net premiums earned reflected the competitive workers' compensation market conditions and, for ourWorkers' Compensation Insurance segment, the impact of audit premium returned to policyholders. Net premiums earned in our Specialty P&C segment, excluding NORCAL, increased in 2021 due to the beneficial impacts of our re-underwriting efforts and focus on rate adequacy, partially offset by the prior year effect of a tail policy associated with a large national healthcare account which resulted in$14.3 million of one-time premium written and fully earned during the second quarter of 2020.
The following table shows our consolidated net investment result:
Year Ended
($ in thousands) 2021 2020 Change
Net investment income $ 70,522 $ 71,998 $ (1,476) (2.1 %)
Equity in earnings (loss) of unconsolidated
subsidiaries* 48,974 (11,921) 60,895 510.8 %
Net investment result $ 119,496 $ 60,077 $ 59,419 98.9 %
*Equity in earnings (loss) of unconsolidated subsidiaries includes our share of the operating results of interests we
hold in certain LPs/LLCs as well as operating losses associated with our tax credit partnership investments, which are
designed to generate returns in the form of tax credits and tax-deductible project operating losses.
Our consolidated net investment result for the year ended December 31, 2021
included additional net investment income of $13.1 million from NORCAL.
Excluding NORCAL, consolidated net investment income decreased $14.6 million for
the year ended December 31, 2021 as compared to 2020 driven by lower yields on
our corporate debt securities and short-term investments given the continued low
interest rate environment and, to a lesser extent, lower income from our equity
portfolio due to a decrease in our allocation to this asset category during the
first half of 2021. Furthermore, the decline in net investment income during
2021 reflected the impact of capital planning in anticipation of closing the
NORCAL acquisition. The increase in our investment results from our portfolio of
investments in LPs/LLCs for 2021 as compared to 2020 was due to higher earnings
from several of our LPs/LLCs and the prior year effect of the volatility in the
global financial markets related to COVID-19. Our consolidated net investment
result for 2021 also included additional earnings from our acquired interests in
four LPs from NORCAL of approximately $1.4 million ; given the results of our
investments in LPs/LLCs are often reported to us on a one quarter lag, the
earnings from these investments were not reflected in our results until the
third quarter of 2021.
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Expenses
The following table shows our consolidated and segment net loss ratios and net
prior accident year reserve development.
Year
Ended
($ in millions) 2021 2020 Change
Current accident year net loss ratio
Consolidated ratio 82.1 % 89.8 % (7.7 pts)
Specialty P&C 87.5 % 104.2 % (16.7 pts)
Workers' Compensation Insurance 74.0 % 69.0 % 5.0 pts
Segregated Portfolio Cell Reinsurance 67.1 % 69.6 % (2.5 pts)
Lloyd's Syndicates 51.9 % 64.2 % (12.3 pts)
Calendar year net loss ratio
Consolidated ratio 77.4 % 83.4 % (6.0 pts)
Specialty P&C 82.8 % 98.5 % (15.7 pts)
Workers' Compensation Insurance 69.7 % 64.9 % 4.8 pts
Segregated Portfolio Cell Reinsurance 51.1 % 44.6 % 6.5 pts
Lloyd's Syndicates 61.6 % 65.0 % (3.4 pts)
Favorable (unfavorable) net loss development, prior
accident years
Consolidated $ 45.5 $ 50.4 $ (4.9)
Specialty P&C $ 32.9 $ 27.5 $ 5.4
Workers' Compensation Insurance $ 7.1 $ 7.0 $ 0.1
Segregated Portfolio Cell Reinsurance $ 10.2 $ 16.5 $ (6.3)
Lloyd's Syndicates $ (4.7) $ (0.6) $ (4.1)
The primary drivers of the change in our consolidated current accident year net
loss ratio for the year ended
follows:
Increase (Decrease)
(In percentage points)
2021 versus 2020
Estimated ratio increase (decrease) attributable to:
Large National Healthcare Account
(5.9 pts)
COVID-19 IBNR Reserve (1.3 pts)
NORCAL Operations 2.7 pts
NORCAL Acquisition - Purchase Accounting Adjustment (0.9 pts)
All other, net (2.3 pts)
Decrease in the consolidated current accident year net loss ratio (7.7 pts)
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Excluding the impact of the items specifically identified in the table above, our consolidated current accident year net loss ratio for the year endedDecember 31, 2021 decreased 2.3 percentage points driven by our Specialty P&C and Lloyd's Syndicates segments, somewhat offset by a higher ratio in ourWorkers' Compensation Insurance segment. The improvement in the current accident year net loss ratio in our Specialty P&C segment was driven by decreases to certain loss ratios during the first quarter of 2021 in our Standard Physician and Specialty lines of business as we continue to recognize the beneficial impacts of our re-underwriting efforts and focus on rate adequacy. In addition, we observed a reduction in claims frequency in 2020 in our Specialty P&C segment that continued into 2021, some of which is due to our re-underwriting efforts while some of which we believe is associated with the COVID-19 pandemic including the disruption of the court systems. Given the consistent and prolonged nature of this favorable claims frequency trend, we further reduced certain loss ratios in our Standard Physician line of business during the third and fourth quarters of 2021. For our Lloyd's Syndicates segment, the lower current accident year net loss ratio reflected higher reinsurance recoveries as a proportion of gross losses as compared to the prior year period, partially offset by certain catastrophe related losses. In ourWorkers' Compensation Insurance segment, the increase in the current accident year loss ratio primarily reflects workers returning to full employment after the lifting of pandemic-related restrictions and the labor shortage. We have experienced an increase in reported claim activity in 2021, including increased severity-related claim activity, which we attribute to workers being out of "work shape" as they returned to employment in 2021 as well as the lack of training, alternative work arrangements and employee fatigue due to the labor shortage. Initial loss ratios associated with NORCAL policies were higher than the average for the other books of business in our Specialty P&C segment; however, we reduced certain NORCAL loss ratios during the fourth quarter of 2021 due to favorable frequency trends, as previously discussed. The net impact of NORCAL operations resulted in a 2.7 percentage point increase in our consolidated current accident year net loss ratio in 2021. Also as a result of our acquisition of NORCAL, our consolidated current accident year loss ratio during 2021 was impacted by amortization of the negative VOBA associated with NORCAL's assumed unearned premium which is recorded as a reduction to current accident year net losses and accounted for a 0.9 percentage point decrease in our consolidated current period ratio. See Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition and the related purchase accounting adjustments. During 2020, our consolidated current accident year loss ratio was higher due to the effect of a large national healthcare account, net of the impact of related PDR amortization, which accounted for 5.9 percentage points of the decrease in the current period ratio as compared to the prior year period. In addition, our consolidated current accident year loss ratio for 2020 was impacted by a$10 million IBNR reserve we recorded during the second quarter of 2020 for COVID-19 which accounted for 1.3 percentage points of the decrease in the ratio as compared to the prior year period. In both 2021 and 2020, our consolidated calendar year net loss ratio was lower than our consolidated current accident year net loss ratio due to the recognition of net favorable prior year reserve development, as shown in the previous table. The net favorable loss development recognized in 2021 primarily reflected a lower than anticipated claims severity trend (i.e., the average size of a claim) in our Specialty P&C segment, primarily related to the 2015 through 2020 accident years. For ourWorkers' Compensation Insurance and Segregated Portfolio Cell Reinsurance segments, the net favorable development in 2021 reflected overall favorable trends in claim closing patterns. Further, favorable development recognized in 2021 included$7.9 million related to the amortization of the purchase accounting fair value adjustment on NORCAL's assumed net reserve and amortization of the negative VOBA associated with NORCAL's DDR reserve which is recorded as a reduction to prior accident year net losses and loss adjustment expenses. We have not recognized any development related to NORCAL's prior accident year reserves since the date of acquisition in 2021. See Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition and the related purchase accounting adjustments. We also recognized favorable prior year reserve development of$1 million during the third quarter of 2021 in our Specialty P&C segment associated with our COVID-19 IBNR reserve due to the fact that early first notices have not materialized into claims. We continue to remain cautious in our evaluation of our reserves our Specialty P&C segment due to the uncertainty surrounding the length and severity of the pandemic. See additional discussion on our COVID-19 IBNR reserve in the Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses". 76
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Our consolidated and segment underwriting expense ratios were as follows:
Year Ended December 31
2021 2020 Change
Underwriting Expense Ratio
Consolidated (1) 27.6 % 30.0 % (2.4 pts)
Specialty P&C 18.4 % 23.0 % (4.6 pts)
Workers' Compensation Insurance 31.8 % 32.9 % (1.1 pts)
Segregated Portfolio Cell Reinsurance 34.0 % 31.2 % 2.8 pts
Lloyd's Syndicates 37.1 % 39.0 % (1.9 pts)
Corporate (2) 2.7 % 3.0 % (0.3 pts)
(1) Includes transaction-related costs associated with our acquisition of NORCAL that are not included in a segment as
we do not consider these costs in assessing the financial performance of any of our operating or reportable segments.
See Note 18 of the Notes to Consolidated Financial Statements for a reconciliation of our segment results to our
consolidated results.
(2) There are no net premiums earned associated with the Corporate segment. Ratios shown are the contribution of the
Corporate segment to the consolidated ratio (Corporate operating expenses divided by consolidated net premiums earned).
The change in our consolidated underwriting expense ratio for the year ended
following:
Increase (Decrease)
(In percentage points)
2021 versus 2020
Estimated ratio increase (decrease) attributable to:
Decrease in Net Premiums Earned and DPAC amortization(1)
(0.4 pts) NORCAL Operations (5.3 pts) Transaction-related Costs 2.6 pts Large National Healthcare Account Tail Premium(2) 0.6 pts All other, net 0.1 pts Decrease in the consolidated underwriting expense ratio (2.4 pts) (1) Excludes earned premium and DPAC amortization contributed by NORCAL since the date of acquisition as well as$14.3 million of earned premium 2020 associated with a large national healthcare account tail policy. See further discussion in Segment Results - Specialty Property & Casualty section that follows. (2) See previous discussion under the heading "Revenues" Our consolidated underwriting expense ratio for 2021 was impacted by our acquisition of NORCAL. The additional expenses of NORCAL of$19.3 million had only a nominal effect on the consolidated underwriting expense ratio as they were more than offset by the favorable effect on the ratio of NORCAL net premiums earned of$214.6 million , as previously discussed. The impact of NORCAL decreased our consolidated underwriting expense ratio for 2021 by 5.3 percentage points. Included in NORCAL's expenses for 2021 was approximately$9.4 million of DPAC amortization associated with NORCAL policies written subsequent to our acquisition; however, this level of DPAC amortization is approximately$13.4 million lower than would be considered normal for the period of time post-acquisition due to the application of GAAP purchase accounting rules whereby the capitalized policy acquisition costs for policies written prior to the acquisition date were written off through purchase accounting rather than being expensed pro rata over the remaining term of the associated policies. Normalizing this amortization would have increased our consolidated expense ratio in 2021 by an estimated 1.4 percentage points. Please see Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition. For 2021, our consolidated underwriting expense ratio was also impacted by transaction-related costs of$25.0 million associated with our acquisition of NORCAL which accounted for an increase of 2.6 percentage points in our current period ratio. We do not consider transaction-related costs in assessing the financial performance of our segments, and thus these costs are only included in our consolidated operating expenses. Please see Note 18 of the Notes to Consolidated Financial Statements for a reconciliation of our segment results to our consolidated results. Excluding the impact of NORCAL and the other items specifically identified in the table above, our consolidated underwriting expense ratio remained relatively unchanged in 2021 as compared to 2020. 77
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For the year endedDecember 31, 2021 , the underwriting expense ratios in our Specialty P&C and Corporate segments also reflected the impact of a reduction to the management fee charged to the operating subsidiaries of our Specialty P&C segment (excluding the acquired operating subsidiaries of NORCAL) by our Corporate segment effectiveJanuary 1, 2021 (see further discussion in our Segment Results - Specialty Property & Casualty and Segment Results - Corporate sections that follow). This change had no impact to our consolidated underwriting expense ratio.
Gain on Bargain Purchase
As a result of the NORCAL acquisition, we recognized a non-taxable preliminary gain on bargain purchase of$74.4 million during the second quarter of 2021 representing the excess of the fair value of the identifiable assets acquired and liabilities assumed over the purchase consideration. We do not consider this gain in assessing the financial performance of any of our operating or reportable segments and therefore, we have excluded it from the Segment Results sections that follow. See further discussion around the gain on bargain purchase recognized from the NORCAL acquisition in Note 2 of the Notes to Consolidated Financial Statements. Taxes Our effective tax rates for the years endedDecember 31, 2021 and 2020 were as follows: Year Ended December 31 ($ in thousands) 2021 2020
Change
Income (loss) before income taxes
Income tax expense (benefit) 2,483 (41,329) 43,812 106.0%
Net income (loss) $ 144,124 $ (175,727) $ 319,851 182.0%
Effective tax rate 1.7% 19.0% (17.3 pts)
We recognized income tax expense in 2021 of $2.5 million and an income tax
benefit of $41.3 million in 2020. The most significant item impacting our
effective tax rate for the year ended December 31, 2021 , which caused it to be
lower than the statutory federal income tax rate of 21%, was the aforementioned
non-taxable $74.4 million gain on bargain purchase related to the NORCAL
acquisition. Additionally, our effective tax rates for the years ended
December 31, 2021 and 2020 include the benefit recognized from the tax credits
transferred to us from our tax credit partnership investments. Our effective tax
rate in 2020 was also impacted by the non-deductible portion of the goodwill
impairment related to the Specialty P&C reporting unit recognized during the
third quarter of 2020. See further discussion of the goodwill impairment in the
Critical Accounting Estimates section under the heading "Goodwill / Intangibles"
and Note 8 of the Notes to Consolidated Financial Statements and further
information on other notable items impacting our effective tax rates for the
years ended December 31, 2021 and 2020 in the Segment Results - Corporate
section that follows under the heading "Taxes."
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Operating Ratio
Our operating ratio is our combined ratio, less our investment income ratio. This ratio provides the combined effect of underwriting profitability and investment income. Our operating ratio for the years endedDecember 31, 2021 and 2020 was as follows: Year Ended December 31 2021 2020 Change Combined ratio 105.0 % 113.4 % (8.4 pts) Less: investment income ratio 7.3 % 9.1 % (1.8 pts) Operating ratio 97.7 % 104.3 % (6.6 pts) Combined ratio, excluding transaction-related costs* 102.4 % 113.4 % (11.0 pts) *Our consolidated combined ratio as reported in 2021 includes$25.0 million of transaction-related costs included in consolidated operating expenses associated with our acquisition of NORCAL. Given these costs do not reflect normal operating expenses we have excluded their impact from our calculation of the consolidated combined ratio in the table above. See previous discussion under the heading "Expenses."
The primary drivers of the change in our operating ratio were as follows:
Increase (Decrease)
(In percentage points) 2021 versus 2020
Estimated ratio increase (decrease) attributable to:
NORCAL Underwriting Results
1.0 pts NORCAL Acquisition - Purchase Accounting Adjustments (1.5 pts) NORCAL Investment Results (1.3 pts) Transaction-related Costs 2.6 pts Large National Healthcare Account (1) (5.6 pts) COVID IBNR Reserve (1) (1.4 pts) Investment Results (2) 3.1 pts All other, net (3.5 pts) Decrease in the operating ratio (6.6 pts)
(1) See previous discussion under the heading "Revenues" and "Expenses."
(2) Excludes net investment income contributed by NORCAL since the date of
acquisition. See previous discussion under the heading "Revenues."
Excluding the impact of the items specifically identified in the table above, our operating ratio for 2021 decreased by 3.5 percentage points as compared to 2020 primarily due to an improvement in the net loss ratio in our Specialty P&C segment, partially offset by a higher net loss ratio in ourWorkers' Compensation Insurance segment. See previous discussion in this section under the heading "Expenses" and further discussion in our Segment Operating Results sections that follow.ROE ROE is calculated as net income (loss) divided by the average of beginning and ending shareholders' equity. This ratio measures our overall after-tax profitability and shows how efficiently capital is being used. The$74.4 million gain on bargain purchase recognized during the second quarter of 2021 was excluded in our calculation of ROE for 2021 consistent with our treatment of gains on bargain purchases from previous acquisitions. ROE for the years endedDecember 31, 2021 and 2020 was as follows: Year Ended December 31 2021 2020 Change ROE 5.3 % (12.3 %) 17.6 pts Our ROE in 2021 was impacted by our acquisition of NORCAL. NORCAL operations since the date of acquisition, excluding purchase accounting adjustments, decreased our ROE in 2021 by 0.6 percentage points largely due to the fact that loss ratios associated with NORCAL policies are higher than the average for the other books of business in our Specialty P&C segment, partially offset by a lower than normal amount of DPAC amortization due to the application of GAAP purchase 79
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accounting rules (see previous discussion under the heading "Expenses"). Furthermore, the remaining purchase accounting adjustments associated with the acquisition increased our ROE by 1.1 percentage points. See Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition and the related purchase accounting adjustments. Excluding the NORCAL acquisition, ROE for 2021 increased 17.1 percentage points driven by the prior year effect of a$161.1 million pre-tax goodwill impairment recognized related to the Specialty P&C reporting unit during the third quarter of 2020. Additionally, the increase in our ROE for 2021 as compared to 2020, excluding NORCAL, reflected higher earnings from certain LPs/LLCs, realized gains from the sale of certain available-for-sale fixed maturity securities and other investments as well as improved underwriting results.
Book Value per Share
Book value per share is calculated as total shareholders' equity at the balance sheet date divided by the total number of common shares outstanding. This ratio measures the net worth of the Company to shareholders on a per share basis. Our book value per share atDecember 31, 2021 as compared toDecember 31, 2020 is shown in the following table. Book Value Per Share Book Value Per Share at December 31, 2020 $ 25.04 Increase (decrease) to book value per share during the year endedDecember 31, 2021 attributable to: Dividends declared (0.20) Net income (loss) (1) 2.67 OCI (2) (1.09) Other 0.04 Book Value Per Share at December 31, 2021 $ 26.46
(1) Includes the
acquisition of NORCAL, which accounted for
per share. See further discussion in Note 2 of the Notes to Consolidated
Financial Statements.
(2) Primarily the impact of unrealized investment gains (losses) on our
available-for-sale fixed maturity investments. See Note 14 of the Notes to
Consolidated Financial Statements for additional information.
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Table of Contents Non-GAAP Financial Measures Non-GAAP operating income (loss) is a financial measure that is widely used to evaluate performance within the insurance sector. In calculating Non-GAAP operating income (loss), we have excluded the effects of the items listed in the following table that do not reflect normal results. We believe Non-GAAP operating income (loss) presents a useful view of the performance of our insurance operations, however it should be considered in conjunction with net income (loss) computed in accordance with GAAP.
The following table is a reconciliation of net income (loss) to Non-GAAP
operating income (loss):
Year Ended
(In thousands, except per share data) 2021 2020
Net income (loss) $
144,124
Items excluded in the calculation of Non-GAAP operating income
(loss):
Net investment (gains) losses (24,310) (15,678)
Net investment gains (losses) attributable to SPCs which no
profit/loss is retained (1)
3,253 2,436 Transaction-related costs (2) 24,977 - Goodwill impairment - 161,115 Guaranty fund assessments (recoupments) 228 97 Gain on bargain purchase (3) (74,408) - Pre-tax effect of exclusions (70,260) 147,970 Tax effect, at 21% (4) 2,028 16 After-tax effect of exclusions (68,232) 147,986 Non-GAAP operating income (loss)$ 75,892 $ (27,741) Per diluted common share: Net income (loss)$ 2.67 $ (3.26) Effect of exclusions (1.27) 2.74
Non-GAAP operating income (loss) per diluted common share
(1) Net investment gains (losses) on investments related to SPCs are recognized
in our Segregated Portfolio Cell Reinsurance segment. SPC results, including any
net investment gain or loss, that are attributable to external cell participants
are reflected in the SPC dividend expense (income). To be consistent with our
exclusion of net investment gains (losses) recognized in earnings, we are
excluding the portion of net investment gains (losses) that is included in the
SPC dividend expense (income) which is attributable to the external cell
participants.
(2) Transaction-related costs associated with our acquisition of NORCAL. We are
excluding these costs as they do not reflect normal operating results and are
unique and non-recurring in nature.
(3) Gain on bargain purchase associated with our acquisition of NORCAL which is
considered unusual, infrequent and non-recurring in nature. As such, we have
excluded the gain on bargain purchase from Non-GAAP operating income (loss) as
it does not reflect normal operating results.
(4) The 21% rate is the statutory tax rate associated with the taxable or tax
deductible items listed above. The taxes associated with the net investment
gains (losses) related to SPCs in our Segregated Portfolio Cell Reinsurance
segment are paid by the individual SPCs and are not included in our consolidated
tax provision or net income (loss); therefore, both the net investment gains
(losses) from our Segregated Portfolio Cell Reinsurance segment and the
adjustment to exclude the portion of net investment gains (losses) included in
the SPC dividend expense (income) in the table above are not tax effected. The
2021 gain on bargain purchase is non-taxable and therefore had no associated
income tax impact. The portion of 2020 goodwill impairment loss that is tax
deductible was tax effected at the statutory tax rate (21%). The remaining
portion of the 2020 goodwill impairment loss is not tax deductible and therefore
had no associated income tax benefit.
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Segment Results - Specialty Property & Casualty
Our Specialty P&C segment focuses on professional liability insurance and medical technology liability insurance as discussed in Note 19 of the Notes to Consolidated Financial Statements. OnMay 5, 2021 , we completed our acquisition of NORCAL, an underwriter of healthcare professional liability insurance (Note 2 of the Notes to Consolidated Financial Statements provides additional information regarding this acquisition). Segment results reflected pre-tax underwriting profit or loss from these insurance lines, including the pre-tax underwriting results of NORCAL since the date of acquisition as well as certain purchase accounting adjustments. Segment results for the year endedDecember 31, 2021 exclude transaction-related costs and a$74.4 million gain on bargain purchase related to the NORCAL acquisition as we do not consider these items in assessing the financial performance of the segment. Segment results included the following: Year Ended December 31 ($ in thousands) 2021 2020 Change Net premiums written$ 626,147 $ 451,019 $ 175,128 38.8 % Net premiums earned$ 695,008 $ 477,365 $ 217,643 45.6 % Other income 3,370 3,908 (538) (13.8 %)
Net losses and loss adjustment expenses (575,164) (470,074)
(105,090) 22.4 % Underwriting, policy acquisition and operating expenses (127,709) (109,599) (18,110) 16.5 % Segment results$ (4,495) $ (98,400) $ 93,905 95.4 % Net loss ratio 82.8 % 98.5 % (15.7 pts) Underwriting expense ratio 18.4 % 23.0 % (4.6 pts) Premiums Written Changes in our premium volume within our Specialty P&C segment are generally driven by four primary factors: (1) the amount of new business written, (2) our retention of existing business, (3) the premium charged for business that is renewed, which is affected by rates charged and by the amount and type of coverage an insured chooses to purchase and (4) the timing of premium written through multi-period policies. In addition, premium volume may periodically be affected by shifts in the timing of renewals between periods. For the year endedDecember 31, 2021 , our premium volume was primarily affected by our acquisition of NORCAL (see Note 2 of the Notes to Consolidated Financial Statements). The professional liability market, which accounts for a majority of the revenues in this segment, remains challenging as physicians continue joining hospitals or larger group practices and are thus no longer purchasing individual or group policies in the standard market. In addition, some competitors have chosen to compete primarily on price; both factors may impact our ability to write new business and retain existing business. Furthermore, the insurance and reinsurance markets have historically been cyclical, characterized by extended periods of intense price competition and other periods of reduced competition. The professional liability area has been particularly affected by these cycles. Underwriting cycles are generally driven by an excess of capacity available and actively pursuing business that is deemed profitable. Changes in the frequency and severity of losses may affect the cycles of the insurance and reinsurance markets significantly. During "soft markets" where price competition is high and underwriting profits are poor, growth and retention of business become challenging which may result in reduced premium volumes.
Gross, ceded and net premiums written were as follows:
Year Ended December
31
($ in thousands) 2021 2020
Change
Gross premiums written
Less: Ceded premiums written 55,362 71,892 (16,530) (23.0 %)
Net premiums written $ 626,147 $ 451,019 $ 175,128 38.8 %
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Gross Premiums Written
Gross premiums written by component were as follows:
Year Ended
($ in thousands) 2021 2020 Change
Professional Liability
HCPL
Standard Physician(1)(14)
Twelve month term $ 209,938 $ 208,993 $ 945 0.5 %
Twenty-four month term - 8,314 (8,314) nm
NORCAL Standard Physician(2) 111,673 - 111,673 nm
Total Standard Physician 321,611 217,307 104,304 48.0 %
Specialty
Custom Physician(3)(14) 46,210 64,367 (18,157) (28.2 %)
NORCAL Custom Physician(4) 16,394 - 16,394 nm
Hospitals and Facilities(5)(14) 51,310 49,244 2,066 4.2 %
NORCAL Hospitals and Facilities(6) 9,955 - 9,955 nm
Senior Care(7)(14) 6,708 6,300 408 6.5 %
Reinsurance assumed(8) 37,755 14,467 23,288 161.0 %
Total Specialty 168,332 134,378 33,954 25.3 %
Total HCPL 489,943 351,685 138,258 39.3 %
Small Business Unit(9) 103,083 100,061 3,022 3.0 %
Tail Coverages(10)(14) 30,637 34,767 (4,130) (11.9 %)
NORCAL Tail Coverages(11) 16,092 - 16,092 nm
Total Professional Liability 639,755 486,513
153,242 31.5 %
Medical Technology Liability(12) 40,997 35,563 5,434 15.3 %
Other(13) 757 835 (78) (9.3 %)
Total $ 681,509 $ 522,911 $ 158,598 30.3 %
(1) Standard Physician premium was our greatest source of premium revenues in
both 2021 and 2020 and is predominantly comprised of twelve month term policies.
The increase in twelve month term policies in 2021 as compared to 2020 was
driven by an increase in renewal pricing, the conversion of twenty-four month
term policies and, to a lesser extent, new business written, partially offset by
retention losses. In addition, twelve month term policies in 2020 included the
impact of premium credits granted as a result of the COVID-19 pandemic. Renewal
pricing increases during 2021 reflect the rising loss cost environment and new
business written reflects general market conditions. Retention losses in 2021
were largely attributable to the loss of two large policies totaling $5.9
million during the third quarter of 2021 due to the insureds' decision to enter
into captive arrangements and the loss of two large policies totaling $1.4
million during the first quarter of 2021 due to price competition. Retention
losses in 2021 also reflected our targeted state strategy to reassess our
underwriting appetite in certain unprofitable states. We will continue to
perform a detailed evaluation of venues, specialties and other areas to improve
our underwriting results. We also continue to focus on underwriting discipline
as we emphasize careful risk selection, rate adequacy, improved contract terms
and a willingness to walk away from business that does not fit our goal of
achieving a long-term underwriting profit. While retention for 2021 has
recovered somewhat from the impact of our re-underwriting efforts over the past
two years, it remains lower than our historical average for this line of
business as we continue to reevaluate certain states and set our rates to
reflect our observations of higher severity trends. Standard Physician premium
in 2020 also included twenty-four month term policies that were offered to
physician insureds in one selected jurisdiction. We ceased offering twenty-four
month term policies beginning in the second quarter of 2020, and the majority of
the policies that were up for renewal in 2021 were renewed to twelve month term
policies; however, a portion of the premium from 2020 related to policies that
will be subject to renewal and conversion in 2022.
(2) NORCAL Standard Physician premium represents premium contributed by NORCAL
since the date of acquisition and is comprised of three and twelve month term
policies. NORCAL Standard Physician premium in 2021 was
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impacted by an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses, including the loss of one large policy during the second quarter of 2021. (3) Custom Physician premium includes large complex physician groups, multi-state physician groups and non-standard physicians and is written primarily on an excess and surplus lines basis. The decrease in Custom Physician premium in 2021 was driven by retention losses, including the loss of a$10.4 million policy due to price competition and the non-renewal of two large policies totaling$7.3 million due to our focus on underwriting discipline. The decrease in Custom Physician premium in 2021 also reflected the impact of the dissolution of our arrangement with CAPAssurance as a result of our acquisition of NORCAL, which also resulted in the loss of a large program and two large policies inCalifornia totaling$10.2 million during the first quarter of 2021. Partially offsetting the decrease in Custom Physician premium in 2021 was new business written, including the addition of four large policies totaling$5.6 million , and, to a lesser extent, an increase in renewal pricing. Renewal pricing increases for 2021 reflect the rising loss cost environment and new business written reflects general market conditions. The retention rate in our Custom Physician book in 2021 was lower than 2020 which also reflects the impact of the aforementioned dissolution of our arrangement with CAPAssurance as well as the loss of the$10.4 million policy due to price competition, which resulted in a decrease to our Specialty retention rate of 13.6 percentage points. While retention for 2021 has recovered somewhat from the impact of our re-underwriting efforts over the past two years, it remains lower than our historical average for this line of business as our rates are set to reflect our observations of higher severity trends. (4) NORCAL Custom Physician premium represents premium contributed by NORCAL since the date of acquisition and includes large complex physician groups, multi-state physician groups and non-standard physicians and is written primarily on an excess and surplus lines basis. NORCAL Custom Physician premium in 2021 was impacted by retention losses, including the loss of a$9.0 million policy during the fourth quarter of 2021 due to price competition, partially offset by an increase in renewal pricing and, to a lesser extent, new business written. (5) Hospitals and Facilities premium (which includes hospitals, surgery centers and miscellaneous medical facilities) increased in 2021 as compared to 2020 driven by new business written, primarily miscellaneous medical facilities, and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Renewal pricing increases in 2021 reflect rate increases and contract modifications that we believe are appropriate given the current loss environment and new business written reflects general market conditions. Retention losses in 2021 were driven by the loss of a$2.3 million policy due to price competition, the loss of a$2.0 million policy due to an insured's decision to enter into a captive arrangement, and our decision not to renew certain products. As we substantially completed our re-underwriting efforts on this book of business as of the end of the third quarter of 2020, retention rates have started to normalize. (6) NORCAL Hospitals and Facilities premium represents premium contributed by NORCAL since the date of acquisition and includes hospitals, surgery centers and miscellaneous medical facilities. NORCAL Hospitals and Facilities premium in 2021 was impacted by retention losses, partially offset by new business written and, to a lesser extent, an increase in renewal pricing. (7) Senior Care premium includes facilities specializing in long term residential care primarily for the elderly ranging from independent living through skilled nursing. Our Senior Care premium remained relatively unchanged in 2021 as compared to 2020 as retention losses were offset by new business written and renewal pricing increases. The increase in renewal pricing in 2021 was primarily the result of an increase in the rate charged for certain renewed policies in select states. Retention losses in 2021 were driven by our decision not to renew certain classes of Senior Care business based on our expectations of poor loss performance. As we completed our re-underwriting efforts on this book of business during the third quarter of 2020, retention rates have started to normalize. (8) We offer custom alternative risk solutions including assumed reinsurance. The increase in premium in 2021 primarily reflected an increase premiums assumed on a quota share basis through a strategic partnership since 2016 with an international medical professional liability insurer. For 2021, we increased our participation in the original program and entered into another program with this insurer in a new international territory. We anticipate the volume of premium assumed through this partnership will continue to grow going forward. Our custom alternative risk solutions in 2021 also include an assumed reinsurance arrangement with a regional hospital group entered into during the first quarter of 2021, which resulted in$4.5 million of premium written, comprised of$2.3 million of retroactive premium written and fully earned and$2.2 million of prospective premium written. Furthermore, the increase in premium in 2021 reflected the annual renewal of this arrangement during the third quarter of 2021. See Note 5 of the Notes to Consolidated Financial Statements for further information on this transaction. 84
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(9) Our Small Business Unit is primarily comprised of premium associated with podiatrists, legal professionals, dentists and chiropractors. Our Small Business Unit premium increased in 2021 as compared to 2020 driven by an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses. The increase in renewal pricing in 2021 was primarily the result of an increase in the rate charged for certain renewed policies in select states. (10) We offer extended reporting endorsement or "tail" coverage to insureds who discontinue their claims-made coverage with us, and we also periodically offer tail coverage through stand-alone policies. Tail coverage premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable. The amount of tail coverage premium written can vary significantly from period to period. The decrease in 2021 as compared to 2020 was primarily due to the prior year effect of a large national healthcare account that exercised its contractual option to purchase tail coverage which resulted in$14.3 million of one-time premiums written and fully earned in the second quarter of 2020. This impact was largely offset by$7.8 million of tail premium written and fully earned during the second quarter of 2021 associated with a Custom Physician policy and two large tail policies totaling$2.1 million written and fully earned during the first quarter of 2021. (11) NORCAL Tail Coverages represent premium contributed by NORCAL since the date of acquisition and include endorsement coverages to insureds who discontinue their claims-made coverage and may also periodically include tail coverage offered through stand-alone policies. As detailed in the previous footnote, tail coverage premiums are generally 100% earned in the period written and the amount of tail coverage premium written can vary significantly from period to period. NORCAL Tail Coverages in 2021 included five large tail policies totaling$4.5 million written and fully earned. (12) Our Medical Technology Liability business is marketed throughout theU.S. ; coverage is typically offered on a primary basis, within specified limits, to manufacturers and distributors of medical technology and life sciences products including entities conducting human clinical trials. In addition to the previously listed factors that affect our premium volume, our Medical Technology Liability premium is also impacted by the sales volume of insureds. Our Medical Technology Liability premium increased in 2021 as compared to 2020 due to new business written and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Renewal pricing increases in 2021 are primarily due to changes in the sales volume of certain insureds, including changes in exposure. Retention losses in 2021 are primarily attributable to an increase in competition on terms and pricing, as well as merger activity within the industry.
(13) This component of gross premiums written includes all other product lines
within our Specialty P&C segment.
(14) Certain components of our gross premiums written include alternative market premiums. We currently cede either all or a portion of the alternative market premium, net of reinsurance, to three SPCs of our wholly ownedCayman Islands reinsurance subsidiaries, Inova Re and Eastern Re, which are reported in our Segregated Portfolio Cell Reinsurance segment (see further discussion in the Ceded Premiums Written section that follows). The portion not ceded to the SPCs is retained within our Specialty P&C segment. Year Ended December 31 ($ in millions) 2021 2020
Change
Standard Physician$ 2.0 $ 1.6 $ 0.4 25.0 % Custom Physician - 0.1 (0.1) nm Hospitals and Facilities 0.1 0.2 (0.1) (50.0 %) Senior Care 5.2 5.2 - - % Tail Coverages 0.8 - 0.8 nm Total$ 8.1 $ 7.1 $ 1.0 14.1 % The increase in alternative market gross premiums written in 2021 as compared to 2020 was driven by renewal pricing increases, primarily due to an increase in the rate charged for one program and, to a lesser extent, the impact of tail coverages. We are committed to a rate structure that will allow us to fulfill our obligations to our insureds, while generating competitive long-term returns for our shareholders. Our pricing continues to be based on expected losses as indicated by our historical loss data and available industry loss data. In recent years, this practice has resulted in gradual rate increases and we anticipate further rate increases due to indications of increasing loss severity. Additionally, the pricing of our business includes the effects of filed rates, surcharges and discounts. Renewal pricing also reflects changes in our exposure base, deductibles, 85
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self-insurance retention limits and other policy terms and conditions. See Gross
Premiums Written section for further explanation of changes in renewal pricing.
The change in renewal pricing for our Specialty P&C segment, including by major
component, was as follows:
Year Ended December 31
2021
Specialty P&C segment 8 %
HCPL
Standard Physician(1) 8 %
Specialty(1) 12 %
Total HCPL 9 %
Small Business Unit 6 %
Medical Technology Liability
5 %
(1) Includes policies renewed by NORCAL since the date of acquisition.
New business written by major component on a direct basis was as follows:
Year Ended December 31
(In millions) 2021 2020
HCPL
Standard Physician(1) $ 4.7 $ 2.9
Specialty(1) 28.2 9.0
Total HCPL 32.9 11.9
Small Business Unit 3.9 4.6
Medical Technology Liability 6.5 6.5
Total $ 43.3 $ 23.0
(1) Includes premium contributed by NORCAL since the date of acquisition.
For our Specialty P&C segment, we calculate retention as annualized renewed
premium divided by all annualized premium subject to renewal. Retention is
affected by a number of factors. We may lose insureds to competitors or to
alternative insurance mechanisms such as risk retention groups, captive
arrangements or self-insurance entities (often when physicians join hospitals or
large group practices) or due to pricing or other issues. We may choose not to
renew an insured as a result of our underwriting evaluation. Insureds may also
terminate coverage because they have left the practice of medicine for various
reasons, principally for retirement, death or disability, but also for personal
reasons.
Retention for our Specialty P&C segment, including by major component, was as
follows:
Year Ended December 31
2021 2020
Specialty P&C segment 80 % 79 %
HCPL
Standard Physician(1) 86 % 82 %
Specialty(1) 58 % 65 %
Total HCPL 77 % 76 %
Small Business Unit 91 % 90 %
Medical Technology Liability 90 % 85 %
(1) Includes premium contributed by NORCAL since the date of acquisition. We are currently in the process
of evaluating the NORCAL book of business and implementing ProAssurance's underwriting strategies, which
will likely impact retention in future quarters.
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Ceded Premiums Written
Ceded premiums represent the amounts owed to our reinsurers for their assumption of a portion of our losses. Our HCPL and Medical Technology Liability excess of loss reinsurance arrangements renew annually onOctober 1 . For those excess of loss reinsurance arrangements in effect prior toOctober 1, 2021 , we generally retained the first$2 million in risk insured by us and ceded coverages in excess of this amount. EffectiveOctober 1, 2021 , our HCPL treaty renewed at a lower gross rate and we generally retain from 0% to 5% of the next$24 million of risk for our HCPL coverages in excess of$2 million . Our HCPL excess of loss reinsurance arrangement that renewed onOctober 1, 2021 also incorporated NORCAL policies. Prior toOctober 1, 2021 , NORCAL policies were reinsured under separate reinsurance agreements, primarily excess of loss, which have historically renewed annually onJanuary 1 . For the NORCAL excess of loss reinsurance arrangement that renewed onJanuary 1, 2021 , retention was generally the first$2 million in risk and coverages in excess of this amount are ceded up to$24 million . For our Medical Technology Liability treaty which also renewed effectiveOctober 1, 2021 , we also retain 2.5% of the next$8 million of risk for coverages in excess of$2 million . There were no significant changes in the cost or structure of our Medical Technology Liability treaty upon theOctober 2021 renewal. We pay our reinsurers a ceding premium in exchange for their accepting the risk, and in certain of our excess of loss arrangements, the ultimate amount of which is determined by the loss experience of the business ceded, subject to certain minimum and maximum amounts. Given the length of time that it takes to resolve our claims, many years may elapse before all losses recoverable under a reinsurance arrangement are known. As a part of the process of estimating our loss reserve we also make estimates regarding the amounts recoverable under our reinsurance arrangements. As a result, we may have an adjustment to our estimate of expected losses and associated recoveries for prior year ceded losses under certain loss sensitive reinsurance agreements. Any changes to estimates of premiums ceded related to prior accident years are fully earned in the period the changes in estimates occur.
Ceded premiums written were as follows:
Year Ended
($ in thousands) 2021 2020 Change
Excess of loss reinsurance arrangements (1)
(7.4 %) Other shared risk arrangements (2) 16,112 28,765 (12,653) (44.0 %) Premium ceded to SPCs (3) 7,211 6,118 1,093 17.9 % NORCAL premiums ceded under separate reinsurance agreements since acquisition (4) 2,253 - 2,253 nm Other ceded premiums written 3,100 3,227 (127) (3.9 %) Adjustment to premiums owed under reinsurance agreements, prior accident years, net (5) (3,936) 712 (4,648) (652.8 %) Total ceded premiums written$ 55,362 $ 71,892 $ (16,530) (23.0 %) (1)We generally reinsure risks under our excess of loss reinsurance arrangements pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. Premium due to reinsurers also fluctuates with the volume of written premium subject to cession under the arrangement. In certain of our excess of loss reinsurance arrangements, the premium due to the reinsurer is determined by the loss experience of that business reinsured, subject to certain minimum and maximum amounts. The decrease in ceded premiums written under our excess of loss reinsurance arrangements in 2021 as compared to 2020 primarily reflected the reduced rate on the treaty year effectiveOctober 1, 2020 and, to a lesser extent, a decrease in the overall volume of gross premiums written subject to cession. The decrease in ceded premiums written under our excess of loss reinsurance arrangements in 2021 was partially offset by additional ceded premiums of$1.9 million as a result of incorporating NORCAL policies into our existing HCPL excess of loss reinsurance arrangements with theOctober 1, 2021 renewal (see further discussion in footnote 4 below). (2)We have entered into various shared risk arrangements, including quota share, fronting and captive arrangements, with certain large healthcare systems and other insurance entities. While we cede a large portion of the premium written under these arrangements, they provide us an opportunity to grow net premium through strategic partnerships. These arrangements primarily include ourAscension Health program and, prior to the fourth quarter of 2020, our CAPAssurance program. Our CAPAssurance program was mutually dissolved onOctober 1, 2020 . During the first quarter of 2021, we entered into a new shared risk arrangement with a regional hospital group. The decrease in ceded premiums written under our shared risk arrangements in 2021 as compared to 2020 was primarily due to the aforementioned dissolution of our arrangement with CAPAssurance and, to a lesser extent, a decrease in premium ceded to our Ascension Health Program, somewhat offset by the premium ceded under our new shared risk arrangement, as previously discussed. 87
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(3)As previously discussed, as a part of our alternative market solutions, all or a portion of certain healthcare premium written is ceded to SPCs in our Segregated Portfolio Cell Reinsurance segment under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program. See the Segment Results - Segregated Portfolio Cell Reinsurance section for further discussion on the cession to the SPCs from our Specialty P&C segment. The increase in premiums ceded to SPCs in 2021 as compared to 2020 was driven by renewal pricing increases (see discussion in footnote 14 under the heading "Gross Premiums Written"). (4)NORCAL policies written prior toSeptember 30, 2021 were reinsured under separate reinsurance agreements, primarily excess of loss; however, these policies were incorporated into our existing HCPL excess of loss reinsurance arrangements with theOctober 1, 2021 renewal, as previously discussed. For NORCAL's previous excess of loss agreement, deposit ceded premium, as defined in the contract, was initially estimated and recorded at the inception date of the treaty, generallyJanuary 1 , as an estimate of ceded premiums written for the full contract year based on information provided by brokers and reinsurers. As a result, the majority of ceded premiums for NORCAL's excess of loss reinsurance arrangement was recorded by NORCAL before the acquisition in their first quarter 2021 results and were expensed pro rata throughout the contract year. However, these initial estimates of ceded premiums may be periodically adjusted as new information is received and are fully earned in the period the changes in estimates occur. NORCAL's ceded premiums written since acquisition in 2021 under these reinsurance arrangements related almost entirely to an increase in the estimate of premiums owed in excess of the deposit ceded premium initially recorded by NORCAL prior to acquisition and, to a lesser extent, premium related to cyber liability coverages. EffectiveOctober 1, 2021 , we incorporated NORCAL policies into our existing HCPL excess of loss reinsurance arrangement, as previously discussed. (5)Given the length of time that it takes to resolve our claims, many years may elapse before all losses recoverable under a reinsurance arrangement are known. As a part of the process of estimating our loss reserve we also make estimates regarding the amounts recoverable under our reinsurance arrangements. As previously discussed, the premiums ultimately ceded under certain of our excess of loss reinsurance arrangements are subject to the losses ceded under the arrangements. As part of the review of our reserves for 2021, we decreased our estimate of expected losses and associated recoveries for prior year ceded losses, as well as our estimate of ceded premiums owed to reinsurers. In 2020, we increased our estimate of expected losses and associated recoveries for prior year ceded losses, as well as our estimate of ceded premiums owed to reinsurers due to reaching the maximum level of premium due under certain prior year excess of loss arrangements. Changes to estimates of premiums ceded related to prior accident years are fully earned in the period the changes in estimates occur.
Ceded Premiums Ratio
As shown in the table below, our ceded premiums ratio was affected in both 2021
and 2020 by revisions to our estimate of premiums owed to reinsurers related to
coverages provided in prior accident years.
Year Ended
2021 2020 Change
Ceded premiums ratio, as reported 8.1 % 13.7 % (5.6 pts)
Less the effect of adjustments in premiums owed under
reinsurance agreements, prior accident years (as previously
discussed)
(0.6 %) 0.1 % (0.7 pts)
Ratio, current accident year 8.7 % 13.6 % (4.9 pts)
The above table reflects ceded premiums written, excluding the effect of prior
year ceded premium adjustments, as a percent of gross premiums written. Our
current accident year ceded premiums ratio for 2021 was impacted by the
inclusion of NORCAL ceded and written premiums since the date of acquisition,
which accounted for 1.7 percentage points of the decrease in the ratio as the
majority of ceded premiums for NORCAL's excess of loss reinsurance arrangements
were recorded before the acquisition, as previously discussed. Excluding the
impact of the NORCAL acquisition, our current accident year ceded premium ratio
for 2021 decreased 3.2 percentage points as compared to 2020. This decrease was
driven by a decrease in premiums ceded under our shared risk arrangements,
partially offset by the effect of a large national healthcare account tail
policy premium written during the second quarter of 2020. See further discussion
on NORCAL ceded premiums and our shared risk arrangements above under the
heading "Ceded Premiums Written."
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Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to our reinsurers for their assumption of a portion of our losses. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. The majority of our policies carry a term of one year; however, some of our Medical Technology Liability policies have a multi-year term and some of our NORCAL Standard Physician policies have a three-month term. In addition, prior to the third quarter of 2020, we wrote certain Standard Physician policies with a twenty-four month term. Tail coverage premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable. Retroactive coverage premiums are 100% earned at the inception of the contract, as all of the associated underlying loss events occurred in the past. Additionally, any ceded premium changes due to changes to estimates of premiums owed under reinsurance agreements for prior accident years are fully earned in the period of change.
Net premiums earned were as follows:
Year Ended December
31
($ in thousands) 2021 2020
Change
Gross premiums earned
Less: Ceded premiums earned 66,403 74,457 (8,054) (10.8 %)
Net premiums earned $ 695,008 $ 477,365 $
217,643 45.6 %
Gross premiums earned in 2021 included additional earned premiums of approximately$226.0 million from our acquisition of NORCAL. Of that amount of earned premium, approximately$155.1 million was associated with NORCAL policies written prior to our acquisition. Excluding premiums associated with the NORCAL acquisition, gross premiums earned decreased$16.4 million in 2021 as compared to 2020 driven by the pro rata effect of a decrease in the volume of written premium during the preceding twelve months, predominantly in our Specialty line of business, due to our re-underwriting efforts and, to a lesser extent, the dissolution of our arrangement with CAPAssurance. The decrease in gross premiums earned in 2021 also reflected premium adjustments related to loss sensitive policies which decreased earned premium by$2.1 million and increased earned premium by$2.9 million in 2020. In addition, the decrease in gross premiums earned during 2021 reflected the prior year effect of a large national healthcare account that exercised its contractual option to purchase tail coverage which resulted in$14.3 million of one-time premiums written and fully earned during the second quarter of 2020 (see previous discussion in footnote 10 under the heading "Gross Premiums Written"). The decrease in gross premiums earned in 2021 was partially offset by tail premium associated with a Custom Physician policy, which resulted in$7.8 million of one-time written and fully earned during the second quarter of 2021 (see previous discussion in footnote 10 under the heading "Gross Premiums Written") and$2.3 million of retroactive premium written and fully earned associated with an assumed reinsurance program (see previous discussion in footnote 8 under the heading "Gross Premiums Written"). Ceded premiums earned during 2021 included additional ceded premium of approximately$11.4 million from our acquisition of NORCAL, which is primarily attributable to subsequent adjustments made to initial deposit ceded premium recorded under NORCAL's excess of loss reinsurance arrangement (see previous discussion in footnote 4 under the heading "Ceded Premiums Written"). Excluding ceded premiums from our NORCAL acquisition, ceded premiums earned decreased$19.5 million in 2021 as compared to 2020 driven by the pro rata effect of a decrease in premium ceded under our shared risk and excess of loss arrangements during the preceding twelve months and, to a lesser extent, the effect of the decrease in our estimate of ceded premiums owed to reinsurers for expected recoveries on prior year ceded losses in 2021 as compared to an increase in our estimate in 2020. 89
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Losses and Loss Adjustment Expenses
The determination of calendar year losses involves the actuarial evaluation of
incurred losses for the current accident year and the actuarial re-evaluation of
incurred losses for prior accident years, including an evaluation of the reserve
amounts required for ECO/XPL losses.
Accident year refers to the accounting period in which the insured event becomes
a liability of the insurer. For claims-made policies, which represent the
majority of the premiums written in our Specialty P&C segment, the insured event
generally becomes a liability when the event is first reported to us. For
occurrence policies, the insured event becomes a liability when the event takes
place. For retroactive coverages, the insured event becomes a liability at
inception of the underlying contract. We believe that measuring losses on an
accident year basis is the best measure of the underlying profitability of the
premiums earned in that period, since it associates policy premiums earned with
the estimate of the losses incurred related to those policy premiums.
The following table summarizes calendar year net loss ratios for our Specialty
P&C segment by separating losses between the current accident year and all prior
accident years. Additionally, the table shows our current accident year net loss
ratios were affected by revisions to our estimate of premiums owed to reinsurers
related to coverages provided in prior accident years. Furthermore, net loss
ratios in the following table include the impact of NORCAL since the date of
acquisition.
Net Loss Ratios (1)
Year Ended December 31
2021 2020 Change
Calendar year net loss ratio 82.8 % 98.5 % (15.7 pts)
Less impact of prior accident years on the net loss ratio (4.7 %) (5.7 %) 1.0 pts
Current accident year net loss ratio 87.5 % 104.2 % (16.7 pts)
Less estimated ratio increase (decrease) attributable to:
Ceded premium adjustments, prior accident years (2)
(0.5 %) 0.2 % (0.7 pts)
Current accident year net loss ratio, excluding the effect of
prior year ceded premium (3)
88.0 % 104.0 % (16.0 pts)
(1)Net losses, as specified, divided by net premiums earned.
(2)During 2021, we decreased our estimates of premiums owed under reinsurance
agreements related to prior accident years which increased net premiums earned
(the denominator of the current accident net loss year ratio). During 2020, we
increased our estimates of premiums owed under reinsurance agreements related to
prior accident years which decreased net premiums earned. See the discussion in
the Premiums section for our Specialty P&C segment under the heading "Ceded
Premiums Written" for additional information.
(3)Our current accident year net loss ratio, excluding the effect of prior year
ceded premium adjustments (as shown in the table above), decreased 16.0
percentage points as compared to 2020. The change in our current accident year
net loss ratio was primarily attributable to the following:
Increase (Decrease) 2021
(In percentage points)
versus 2020
Estimated ratio increase (decrease) attributable to:
Large National Healthcare Account
(9.5 pts) COVID-19 IBNR Reserve (2.2 pts) Premium adjustments on loss sensitive policies 1.0 pts NORCAL Operations 2.0 pts NORCAL Acquisition - Purchase Accounting Adjustment (1.4 pts) All other, net
(5.9 pts)
Decrease in current accident year net loss ratio, excluding the effect of
prior year ceded premium
(16.0 pts)
Excluding the impact of the items specifically identified in the table above,
our current accident year net loss ratio during 2021 improved 5.9 percentage
points driven by decreases to certain loss ratios during the first quarter of
2021 in our Standard Physician and Specialty lines of business as we continue to
recognize the beneficial impacts of our re-underwriting efforts and focus on
rate adequacy. In addition, we observed a reduction in claims frequency that
continued into 2021, some of which is due to our re-underwriting efforts while
some of which we believe is
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associated with the COVID-19 pandemic including the disruption of the court
systems. Given the consistent and prolonged nature of this favorable claims
frequency trend, we further reduced certain loss ratios in our Standard
Physician line of business during the third and fourth quarters of 2021.
Initial loss ratios associated with NORCAL policies were higher than the average for our other books of business in this segment; however, we reduced certain NORCAL loss ratios during the fourth quarter of 2021 due to favorable frequency trends, as previously discussed. The net impact of NORCAL operations resulted in a 2.0 percentage point increase in our current accident year net loss ratio in 2021. We are currently in the process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. Also as a result of our acquisition of NORCAL, our current accident year net loss ratio in 2021 was impacted by amortization of the negative VOBA associated with NORCAL's assumed unearned premium which is recorded as a reduction to current accident year net losses and accounted for a 1.4 percentage point decrease in our current period ratio. See Note 2 of the Notes to Consolidated Financial Statements for additional information on the NORCAL acquisition and the related purchase accounting adjustments. In addition, our current accident year net loss ratio in 2021 was impacted by changes in premium adjustments related to loss sensitive policies which increased the current period ratio as compared to 2020 by 1.0 percentage point (see previous discussion under the heading "Net Premiums Earned"). Our 2020 current accident year net loss ratio was higher due to the effect of a large national healthcare account, net of the impact of related PDR amortization, which accounted for 9.5 percentage points of the decrease in the 2021 ratio as compared to 2020. In addition, our current accident year net loss ratio in 2020 was impacted by a $10 million IBNR reserve we recorded during the second quarter of 2020 for COVID-19 which accounted for 2.2 percentage points of the decrease in the 2021 ratio as compared to 2020. We re-evaluate our previously established reserve each quarter based upon the most recently completed actuarial analysis supplemented by any new analysis, information or trends that have emerged since the date of that study. We also take into account currently available industry trend information. We recognized net favorable prior year accident reserve development of $32.9 million for the year ended December 31, 2021 as compared to $27.5 million for the year ended December 31, 2020. Development recognized during 2021 primarily reflected a lower than anticipated loss emergence, principally related to accident years 2015 through 2020. Development recognized in 2020 principally related to accident years 2014 through 2017. Net favorable prior accident year reserve development recognized in 2021 included a $1.0 million reduction in our IBNR reserve for COVID-19 during the third quarter of 2021 due to the fact that early first notices have not materialized into claims. See additional discussion on the COVID-19 IBNR reserve in the Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses". In addition, net favorable prior accident year reserve development recognized in 2021 included an increase for potential ECO/XPL claims of $1.0 million in 2021 as compared to a reduction in the same reserve of $4.0 million in 2020. Furthermore, favorable development recognized in 2021 included $7.9 million related to the amortization of the purchase accounting fair value adjustment on NORCAL's assumed net reserve and amortization of the negative VOBA associated with NORCAL's DDR reserve which is recorded as a reduction to prior accident year net losses and loss adjustment expenses. We have not recognized any development related to NORCAL's prior accident year reserves since the date of acquisition. A detailed discussion of factors influencing our recognition of loss development is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses." Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the then current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2021 and 2020.
Underwriting, Policy Acquisition and Operating Expenses
Our Specialty P&C segment underwriting, policy acquisition and operating
expenses, including NORCAL expenses since the date of acquisition, were
comprised as follows:
Year Ended
December 31
($ in thousands) 2021 2020 Change
DPAC amortization $ 61,662 $ 53,562 $ 8,100 15.1 %
Management fees 3,781 6,136 (2,355) (38.4 %)
Other underwriting and operating expenses 62,266 49,901
12,365 24.8 %
Total $ 127,709 $ 109,599 $ 18,110 16.5 %
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DPAC amortization for 2021 included approximately $9.4 million of DPAC amortization associated with NORCAL policies written subsequent to our acquisition; however, this level of DPAC amortization is approximately $13.4 million lower than would be considered normal for the period of time post-acquisition due to the application of GAAP purchase accounting rules whereby the capitalized policy acquisition costs for policies written prior to the acquisition date were written off through purchase accounting rather than being expensed pro rata over the remaining term of the associated policies (see Note 2 of the Notes to Consolidated Financial Statements for more information). Excluding NORCAL, DPAC amortization decreased for 2021 as compared to 2020 driven by a lower volume of premium written and a decrease in compensation-related expenses driven by a reduction in headcount as a result of the 2020 organizational restructuring. Partially offsetting the decrease in DPAC amortization for 2021 was a decrease in ceding commission income, which is an offset to expense, from certain of our shared risk arrangements. Management fees are charged pursuant to a management agreement by the Corporate segment to the operating subsidiaries within our Specialty P&C segment, excluding the acquired operating subsidiaries of NORCAL, for services provided based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary. Fluctuations in the amount of premium written by each subsidiary can result in corresponding variations in the management fee charged to each subsidiary during a particular period. Due to organizational structure enhancements in our Specialty P&C segment during 2020, the extent to which services are provided by the Corporate segment to the operating subsidiaries within the segment decreased effective January 1, 2021. Accordingly, we reduced the fee charged to the operating subsidiaries in 2021. Other underwriting and operating expenses increased in 2021 primarily due to the addition of approximately $10.0 million of expenses contributed by NORCAL since the date of acquisition and an increase in amortization related to new software placed into service during the second quarter of 2020. In addition, the increase in 2021 reflected higher amounts accrued for performance-related incentive plans due to our improved combined ratio and other performance metrics. These increases in expenses during 2021 were partially offset by lower operating expenses in 2021 resulting from the operational and structural changes implemented over the past two years as well as the effect of $3.4 million of one-time expenses incurred during the prior year. One-time expenses in 2020 were mainly comprised of early retirement benefits granted to certain employees during the third quarter of 2020 as well as expenses associated with the restructuring of our HCPL field office organization, largely during the first half of 2020, consisting of employee severance charges and lease exit costs due to a reduction in physical office locations. The remaining variance in other underwriting and operating expenses for 2021 as compared to 2020 was comprised of individually insignificant components.
Underwriting Expense Ratio (the Expense Ratio)
Our expense ratio for the Specialty P&C segment was as follows:
Year Ended December 31
2021 2020
Change
Underwriting expense ratio 18.4 % 23.0 %
(4.6 pts)
The change in our expense ratio in 2021 as compared to 2020 was primarily
attributable to the following:
Increase (Decrease)
(In percentage points)
2021 versus 2020
Estimated ratio increase (decrease) attributable to:
Change in Net Premiums Earned and DPAC amortization(1)
(0.9 pts) NORCAL Operations (4.2 pts) One-time Expenses (0.8 pts) Large National Healthcare Account Tail Premium(2)
0.7 pts
All other, net 0.6 pts
Decrease in the underwriting expense ratio (4.6 pts)
(1) Excludes premium and DPAC amortization contributed by NORCAL since the date of acquisition (see
Note 2 of the Notes to Consolidated Financial Statements for additional information) as well as $14.3
million of premium in 2020 associated with a large national healthcare account tail policy. In
addition, excludes certain one-time expenses included in DPAC amortization in 2020 of $0.6 million.
(2) See previous discussion under the heading "Gross Premiums Written."
Our underwriting expense ratio for 2021 was impacted by our acquisition of
NORCAL. The additional expenses of NORCAL of $19.3 million for 2021 had only a
nominal effect on the underwriting expense ratio as it was more than offset by
the favorable effect on the ratio of net premiums earned of $214.6 million
contributed by NORCAL which decreased our
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Specialty P&C segment expense ratio for 2021 by 4.2 percentage points. However,
as previously discussed, DPAC amortization associated with NORCAL recorded
during 2021 was lower than would be considered normal due to the application of
GAAP purchase accounting rules. Normalizing this amortization would have
increased our expense ratio for 2021 by an estimated 1.9 percentage points.
Excluding the impact of NORCAL and the remaining items identified in the table
above, our expense ratio for 2021 increased by 0.6 percentage points primarily
due to the impact of an increase in amortization related to new software placed
into service during the second quarter of 2020 and higher amounts accrued for
performance-related incentive plans. These increases in 2021 as compared to 2020
were partially offset by decreased operating expenses resulting from the
operational and structural changes implemented over the past two years, as well
as the aforementioned reduction to the management fee charged by the Corporate
segment.
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Segment Results - Workers' Compensation Insurance
Our Workers' Compensation Insurance segment includes workers' compensation
products provided to employers generally with 1,000 or fewer employees, as
discussed in Note 19 of the Notes to Consolidated Financial Statements. Workers'
compensation products offered include guaranteed cost policies, policyholder
dividend policies, retrospectively-rated policies, deductible policies and
alternative market programs. Alternative market programs include program design,
fronting, claims administration, risk management, SPC rental, asset management
and SPC management services. Alternative market program premiums are 100% ceded
to either the SPCs within our Segregated Portfolio Cell Reinsurance segment or,
to a limited extent, an unaffiliated captive insurer for one program. Our
Workers' Compensation Insurance segment results reflect pre-tax underwriting
profit or loss from these workers' compensation products, exclusive of
investment results, which are included in our Corporate segment. Segment results
included the following:
Year Ended December 31
($ in thousands) 2021 2020 Change
Net premiums written $ 161,865 $ 164,871 $ (3,006) (1.8 %)
Net premiums earned $ 164,600 $ 171,772 $ (7,172) (4.2 %)
Other income 2,211 2,216 (5) (0.2 %)
Net losses and loss adjustment expenses (114,704) (111,552)
(3,152) 2.8 % Underwriting, policy acquisition and operating expenses (52,418) (56,449) 4,031 (7.1 %) Segment results $ (311) $ 5,987 $ (6,298) (105.2 %) Net loss ratio 69.7% 64.9% 4.8 pts Underwriting expense ratio 31.8% 32.9% (1.1 pts) Premiums Written Our workers' compensation premium volume is driven by five primary factors: (1) the amount of new business written, (2) retention of our existing book of business, (3) premium rates charged on our renewal book of business, (4) changes in payroll exposure and (5) audit premium.
Gross, ceded and net premiums written were as follows:
Year Ended December
31
($ in thousands) 2021 2020
Change
Gross premiums written $ 240,546 $ 246,791 $ (6,245) (2.5 %)
Less: Ceded premiums written 78,681 81,920 (3,239) (4.0 %)
Net premiums written $ 161,865 $ 164,871 $ (3,006) (1.8 %)
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Gross Premiums Written
Gross premiums written by product were as follows:
Year Ended
December 31
($ in thousands) 2021 2020 Change
Traditional business:
Guaranteed cost $ 138,756 $ 145,546 $ (6,790) (4.7 %)
Policyholder dividend 21,468 20,464 1,004 4.9 %
Deductible 4,613 4,581 32 0.7 %
Retrospective(1) 2,741 909 1,832 201.5 %
Other 6,357 7,094 (737) (10.4 %)
Alternative market business(2) 67,821 69,487 (1,666) (2.4 %)
Change in EBUB estimate (1,210) (1,290) 80 (6.2 %)
Total $ 240,546 $ 246,791 $ (6,245) (2.5 %)
(1) The change in retrospectively-rated policies included an adjustment that
decreased premium by $1.1 million and $2.5 million during the years ended
December 31, 2021 and 2020, respectively.
(2) A majority of alternative market premiums are ceded to SPCs in our
Segregated Portfolio Cell Reinsurance segment. See further discussion on
alternative market gross premiums written in our Segment Operating Results -
Segregated Portfolio Cell Reinsurance section under the heading "Gross Premiums
Written" that follows.
Gross premiums written decreased during the year ended December 31, 2021 as
compared to 2020, reflecting a decrease in audit premium and new business,
partially offset by improvement in both renewal retention and renewal rate
changes. Policy audits processed during 2021 resulted in audit premium returned
to policyholders totaling $0.8 million as compared to audit premium billed to
policyholders of $0.6 million during 2020. We reduced our EBUB estimate by $1.2
million in 2021 as compared to $1.3 million in 2020. The decrease in audit
premium processed as well as the reduction of our EBUB estimate in 2021
primarily reflected the impact of COVID-19 on actual and expected final payroll
audits for policies written prior to the onset of the pandemic in 2020. Renewal
retention was 87% in 2021 as compared to 84% for 2020. The 2020 renewal
retention was impacted by the reduction in premium funding for a large
alternative market program. Renewal rate decreased 2% in 2021 as compared to 4%
in 2020. New business written decreased $6.3 million during 2021 as compared to
2020, reflecting the competitive workers' compensation market conditions and a
decrease in new business submissions in 2021, which were 18% lower than 2020.
We retained 23 of the 24 workers' compensation alternative market programs up
for renewal during the year ended December 31, 2021. During the fourth quarter
of 2021, we placed one program into run-off due to continued unfavorable
underwriting results. The program had gross written premium of $1.8 million for
the year ended December 31, 2021.
New business, audit premium, renewal retention and renewal price changes for our
traditional business and the alternative market business are shown in the table
below:
Year Ended December 31
2021 2020
Alternative
Traditional Market Segment Traditional Alternative Market Segment
($ in millions) Business Business Results Business Business Results
New business $ 17.8 $ 3.3 $ 21.1 $ 23.7 $ 3.7 $ 27.4
Audit premium (excluding EBUB) $ (1.9) $ 1.1 $ (0.8)
$ 0.7 $ (0.1) $ 0.6 Retention rate (1) 86 % 89 % 87 % 84 % 84 % 84 % Change in renewal pricing (2) (1 %) (4 %) (2 %) (4 %) (4 %) (4 %)
(1) We calculate our workers' compensation retention rate as annualized expiring renewed premium divided by all annualized expiring
premium subject to renewal. Our retention rate can be impacted by various factors, including price or other competitive issues, insureds
being acquired, or a decision not to renew based on our underwriting evaluation.
(2) The pricing of our business includes an assessment of the underlying policy exposure and market conditions. We continue to base our
pricing on expected losses, as indicated by our historical loss data.
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Ceded Premiums Written
Ceded premiums written were as follows:
Year
Ended December 31
($ in thousands) 2021 2020 Change
Premiums ceded to SPCs $ 64,639 $ 66,725 $ (2,086) (3.1 %)
Premiums ceded to external reinsurers 12,768 12,795 (27) (0.2 %)
Premiums ceded to unaffiliated captive
insurer 3,182 2,762 420 15.2 %
Change in return premium estimate under
external reinsurance (605) (39) (566) 1,451.3 %
Estimated revenue share under external
reinsurance (1,303) (323) (980) 303.4 %
Total ceded premiums written $ 78,681 $ 81,920 $ (3,239) (4.0 %)
Premiums ceded to SPCs represent alternative market business that is ceded under
100% quota share agreements to the SPCs in our Segregated Portfolio Cell
Reinsurance segment. Premiums ceded to unaffiliated captive insurer represent
alternative market business for one program that is ceded under a 100% quota
share reinsurance agreement. Alternative market premiums written decreased in
2021, which resulted in lower premium ceded to SPCs. See further discussion on
alternative market gross premiums written in our Segment Operating Results -
Segregated Portfolio Cell Reinsurance section under the heading "Gross Premiums
Written" that follows.
Under our external reinsurance agreement for traditional business, we retain the
first $0.5 million in risk insured by us and cede losses in excess of this
amount on each loss occurrence under our primary external reinsurance treaty,
subject to an AAD equal to 3.5% of ceded earned premium for the treaty year
effective May 1, 2021. Per our reinsurance agreements, we cede premiums related
to our traditional business on an earned premium basis. The decrease in premiums
ceded to external reinsurers during the year ended December 31, 2021 primarily
reflected lower earned premium, partially offset by an increase in reinsurance
rates effective May 1, 2021.
Changes in the return premium estimate reflected adjustments to our estimate of
expected future recovery of ceded premium based on the underlying loss
experience of our reinsurance contracts that include a provision for return
premium. We increased our estimate of return premium by $0.6 million for the
year ended December 31, 2021 as compared to a nominal amount in 2020. The change
in estimated return premium for the year ended December 31, 2021 primarily
reflected favorable prior year loss development on previously reported reinsured
claims.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
Year Ended December 31
2021 2020 Change
Ceded premiums ratio, as reported 32.4 % 32.8 % (0.4 pts)
Less the effect of:
Premiums ceded to SPCs (100%) 24.6 % 24.6 % - pts
Retrospective premium adjustments - % 0.1 % (0.1 pts)
Premiums ceded to unaffiliated captive insurers (100%) 1.7 % 1.4 % 0.3 pts
Change in EBUB 0.1 % 0.1 % - pts
Change in return premium estimate under external
reinsurance (0.4 %) - % (0.4 pts)
Estimated revenue share (0.7 %) (0.2 %) (0.5 pts)
Assumed premiums earned (not ceded to external
reinsurers) (0.2 %) (0.3 %) 0.1 pts
Ceded premiums ratio (related to external reinsurance),
less the effects of above
7.3 % 7.1 % 0.2 pts
The above table reflects traditional ceded premiums earned as a percent of
traditional gross premiums earned. As discussed above, we cede premiums in our
traditional business to external reinsurers on an earned premium basis. The
increase in the ceded premiums ratio in 2021 as compared to 2020 primarily
reflected the increase in reinsurance rates.
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Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to SPCs in our Segregated Portfolio Cell Reinsurance segment, external reinsurers (including changes related to the return premium and revenue share estimates) and the unaffiliated captive insurer. Because premiums are earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Our workers' compensation policies are twelve month term policies, and premiums are earned on a pro rata basis over the policy period. Net premiums earned also include premium adjustments related to the audit of our insureds' payrolls, changes in our EBUB estimate and premium adjustments related to retrospectively-rated policies. Payroll audits are conducted subsequent to the end of the policy period and any related premium adjustments processed are recorded as fully earned in the current period. In addition, we record an estimate for EBUB and evaluate the estimate on a quarterly basis.
Net premiums earned were as follows:
Year Ended December
31
($ in thousands) 2021 2020
Change
Gross premiums earned $ 243,665 $ 255,484 $ (11,819) (4.6 %)
Less: Ceded premiums earned 79,065 83,712 (4,647) (5.6 %)
Net premiums earned $ 164,600 $ 171,772 $
(7,172) (4.2 %)
The decrease in net premiums earned during the year ended December 31, 2021 as compared to 2020 primarily reflected the pro rata effect of a reduction in net premiums written during the preceding twelve months and the impact of audit premium returned to policyholders. The decrease in net premiums earned during the year ended December 31, 2021 was partially offset by a decrease in negative premium adjustments under retrospectively-rated policies and a decrease in ceded earned premium, which reflected the increased revenue share and return premium estimates.
Losses and Loss Adjustment Expenses
We estimate our current accident year loss and loss adjustment expenses by
developing actual reported losses using historical loss development factors,
adjusted to reflect current and expected trends based on various internal
analyses and supplemental information. The following table summarizes calendar
year net loss ratios by separating losses between the current accident year and
all prior accident years. Calendar year and current accident year net loss
ratios by component were as follows:
Year Ended December 31
2021 2020 Change
Calendar year net loss ratio 69.7 % 64.9 % 4.8 pts
Less impact of prior accident years on the net loss
ratio
(4.3 %) (4.1 %) (0.2 pts)
Current accident year net loss ratio 74.0 % 69.0 % 5.0 pts
The current accident year loss ratio increased in 2021 as compared to 2020,
reflecting workers returning to full employment in 2021 after the lifting of
pandemic-related restrictions and the labor shortage. We experienced an increase
in reported claim activity in 2021, including an increase in severity-related
claim activity. The increase in reported claim activity is attributable to
workers being out of "work shape" as they returned to employment in 2021 as well
as the lack of training, alternative work arrangements and employee fatigue due
to the labor shortage. The current accident year loss ratio in 2021 was also
impacted by the continuation of intense price competition and the resulting
renewal rate decreases as well as the reduction in net premiums earned related
to negative audit premium, as previously discussed.
Calendar year incurred losses (excluding IBNR) in excess of our per occurrence
reinsurance retention, before consideration of the AAD (see previous discussion
under the heading "Ceded Premiums Written"), increased $11.3 million in 2021 as
compared to 2020. Current accident year ceded incurred losses totaled $6.9
million in 2021 as compared to $2.8 million in 2020. We retained calendar year
incurred losses in excess of our per occurrence retention totaling $6.6 million
for the year ended December 31, 2021 which reflected losses within the AAD.
We recognized net favorable prior year development related to our previously
established reserve of $7.1 million for the year ended December 31, 2021 as
compared to $7.0 million for 2020. The net favorable prior year reserve
development for the years ended December 31, 2021 and 2020 reflected overall
favorable trends in claim closing patterns. Net favorable development for the
year ended December 31, 2021 primarily related to accident years 2012 through
2017. Net favorable development for the year ended December 31, 2020 primarily
related to accident years 2014 through 2017.
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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses include the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers' compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by our Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern byProAssurance . The management fee is based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary.
Our Workers' Compensation Insurance segment underwriting, policy acquisition and
operating expenses were comprised as follows:
Year Ended
December 31
($ in thousands) 2021 2020 Change
DPAC amortization $ 29,092 $ 31,547 $ (2,455) (7.8 %)
Management fees 1,804 1,861 (57) (3.1 %)
Other underwriting and operating expenses 34,359 37,642
(3,283) (8.7 %)
Policyholder dividend expense 1,155 1,051
104 9.9 %
SPC ceding commission offset (13,992) (15,652) 1,660 (10.6 %) Total $ 52,418 $ 56,449 $ (4,031) (7.1 %)
The decrease in DPAC amortization for the year ended December 31, 2021 as
compared to 2020 primarily reflected the decrease in net premiums earned.
The decrease in other underwriting and operating expenses for the year ended December 31, 2021 as compared to 2020 primarily reflected a decrease in compensation-related costs driven by a reduction in headcount as a result of the third quarter of 2020 restructuring and a reduction in our allowance for expected credit losses, partially offset by an increase in expenses related to our policy administration and claim system implementation project. Additionally, the decrease in other underwriting and operating expenses in 2021 as compared to 2020 reflected the prior year effect of one-time costs of $0.9 million primarily comprised of employee severance costs associated with the 2020 restructuring. As previously discussed, alternative market premiums written by our Workers' Compensation Insurance segment unit are 100% ceded, less a ceding commission, to either the SPCs in our Segregated Portfolio Cell Reinsurance segment or, to a limited extent, an unaffiliated captive insurer. The ceding commission charged to the SPCs consists of an amount for fronting fees, cell rental fees, commissions, premium taxes and risk management fees. The fronting fees, commissions, premium taxes and risk management fees are recorded as an offset to underwriting, policy acquisition and operating expenses. Cell rental fees are recorded as a component of other income and claims administration fees are recorded as ceded ULAE. The decrease in SPC ceding commissions earned for the year ended December 31, 2021 as compared to 2020, primarily reflected the decrease in alternative market ceded earned premium.
Underwriting Expense Ratio (the Expense Ratio)
The underwriting expense ratio included the impact of the following:
Year Ended December 31
2021 2020 Change
Underwriting expense ratio, as reported 31.8 % 32.9 % (1.1 pts)
Less estimated ratio increase (decrease) attributable to:
Impact of ceding commissions received from SPCs
3.3 % 3.2 % 0.1 pts Retrospective premium adjustment 0.1 % 0.3 % (0.2 pts) Impact of audit premium 0.4 % 0.1 % 0.3 pts Change in return premium estimate under external reinsurance (0.1 %) - % (0.1 pts) Estimated revenue share (0.2 %) - % (0.2 pts) Underwriting expense ratio, less listed effects 28.3 % 29.3 % (1.0 pts)
Excluding the items noted in the table above, the expense ratio decreased for
the year ended December 31, 2021, primarily reflecting the reduction in
compensation-related costs and the allowance for credit losses noted above,
partially offset by the decrease in net premiums earned.
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Table of Contents Segment Results - Segregated Portfolio Cell Reinsurance The Segregated Portfolio Cell Reinsurance segment includes the results (underwriting profit or loss, plus investment results, net ofU.S. federal income taxes) of SPCs at Inova Re and Eastern Re, our Cayman Islands SPC operations, as discussed in Note 19 of the Notes to Consolidated Financial Statements. SPCs are segregated pools of assets and liabilities that provide an insurance facility for a defined set of risks. Assets of each SPC are solely for the benefit of that individual cell and each SPC is solely responsible for the liabilities of that individual cell. Assets of one SPC are statutorily protected from the creditors of the others. Each SPC is owned, fully or in part, by an individual company, agency, group or association and the results of the SPCs are attributable to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest ranges from a low of 20% to a high of 85%. SPC results attributable to external cell participants are reported as an SPC dividend (expense) income in our Segregated Portfolio Cell Reinsurance segment. In addition, our Segregated Portfolio Cell Reinsurance segment includes the investment results of the SPCs as the investments are solely for the benefit of the cell participants and investment results attributable to external cell participants are reflected in the SPC dividend (expense) income. As of December 31, 2021, there were 27 (4 inactive) SPCs. The SPCs assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from our Workers' Compensation Insurance and Specialty P&C segments. As of December 31, 2021, there were two SPCs that assumed both workers' compensation insurance and healthcare professional liability insurance and one SPC that assumed only healthcare professional liability insurance.
Segment results reflects our share of the underwriting and investment results of
the SPCs in which we participate, and included the following:
Year Ended
December 31
($ in thousands) 2021 2020 Change
Net premiums written $
63,042 $ 64,159 $ (1,117) (1.7 %)
Net premiums earned $ 63,688 $ 66,352 $ (2,664) (4.0 %) Net investment income 814 1,084 (270) (24.9 %) Net investment gains (losses) 4,080 3,085 995 32.3 % Other income 3 205 (202) (98.5 %) Net losses and loss adjustment expenses (32,569) (29,605) (2,964) 10.0 % Underwriting, policy acquisition and operating expenses (21,635) (20,709) (926) 4.5 % SPC U.S. federal income tax expense (1) (1,947) (1,746) (201) 11.5 % SPC net results 12,434 18,666 (6,232) (33.4 %) SPC dividend (expense) income (2) (10,050) (14,304) 4,254 (29.7 %) Segment results (3) $
2,384 $ 4,362 $ (1,978) (45.3 %)
Net loss ratio 51.1% 44.6% 6.5 pts Underwriting expense ratio 34.0% 31.2% 2.8 pts (1) Represents the provision forU.S. federal income taxes for SPCs at Inova Re, which have elected to be taxed as aU.S. corporation under Section 953(d) of the Internal Revenue Code.U.S. federal income taxes are included in the total SPC net results and are paid by the individual SPCs. (2) Represents the net (profit) loss attributable to external cell participants. (3) Represents our share of the net profit (loss) of the SPCs in which we participate. 99
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Premiums Written
Premiums in our Segregated Portfolio Cell Reinsurance segment are assumed from either our Workers' Compensation Insurance or Specialty P&C segments. Premium volume is driven by five primary factors: (1) the amount of new business written, (2) retention of the existing book of business, (3) premium rates charged on the renewal book of business and, for workers' compensation business, (4) changes in payroll exposure and (5) audit premium.
Gross, ceded and net premiums written were as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Gross premiums written $ 71,850 $ 72,843 $ (993) (1.4 %)
Less: Ceded premiums written 8,808 8,684 124 1.4 %
Net premiums written $ 63,042 $ 64,159 $ (1,117) (1.7 %)
Gross Premiums Written
Gross premiums written reflected reinsurance premiums assumed by component as
follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Workers' compensation $ 64,639 $ 66,725 $
(2,086) (3.1 %)
Healthcare professional liability 7,211 6,118 1,093 17.9 %
Gross Premiums Written $ 71,850 $ 72,843 $
(993) (1.4 %)
Gross premiums written for the years ended December 31, 2021 and 2020 were primarily comprised of workers' compensation coverages assumed from our Workers' Compensation Insurance segment. Workers' compensation gross premiums written decreased during the year ended December 31, 2021 as compared to 2020, which primarily reflected the competitive workers' compensation market conditions and the resulting renewal rate decreases of 4%, partially offset by an improvement in renewal retention. The renewal retention rate during 2020 includes the impact of a reduction in premium funding for a large workers' compensation program. We do not participate in this program; therefore, the reduction in premium funding had no effect on the segment results for the year ended December 31, 2021. The increase in healthcare professional liability gross premiums written in 2021 as compared to 2020 primarily reflected higher renewal pricing and exposure increases in two programs. We retained 22 of the 23 workers' compensation alternative market programs up for renewal for the year ended December 31, 2021. During the fourth quarter, we placed one program into run-off due to continued unfavorable underwriting results. The program had gross written premium of $1.8 million for the year ended December 31, 2021. We retained 100% of the 3 healthcare professional liability programs up for renewal during 2021.
New business, audit premium, retention and renewal price changes for the assumed
workers' compensation premium is shown in the table below:
Year Ended December 31
($ in millions) 2021 2020
New business $ 3.3 $ 3.7
Audit premium (including EBUB) $ 1.1 $ (0.1)
Retention rate (1) 89 % 84 %
Change in renewal pricing (2) (4 %) (4 %)
(1) We calculate our workers' compensation retention rate as annualized expiring renewed premium
divided by all annualized expiring premium subject to renewal. Our retention rate can be impacted by
various factors, including price or other competitive issues, insureds being acquired, or a decision
not to renew based on our underwriting evaluation.
(2) The pricing of our business includes an assessment of the underlying policy exposure and market
conditions. We continue to base our pricing on expected losses, as indicated by our historical loss
data.
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Ceded Premiums Written
Ceded premiums written were as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Ceded premiums written $ 8,808 $ 8,684 $ 124 1.4 %
For the workers' compensation business, each SPC has in place its own external
reinsurance arrangements. The healthcare professional liability business is
assumed net of reinsurance from our Specialty P&C segment; therefore, there are
no ceded premiums related to the healthcare professional liability business
reflected in the table above. The risk retention for each loss occurrence for
the workers' compensation business ranges from $0.3 million to $0.4 million
based on the program, with limits up to $119.7 million. In addition, each
program has aggregate reinsurance coverage between $1.1 million and $2.1 million
on a program year basis. Per the SPC external reinsurance agreements, premiums
are ceded on a written premium basis. The change in ceded premiums written in
2021 as compared to 2020 primarily reflected the impact of rate increases under
the external reinsurance contract, partially offset by the decrease in workers'
compensation gross premiums written. External reinsurance rates vary based on
the alternative market program.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
Year Ended December 31
2021 2020 Change
Ceded premiums ratio 13.6 % 13.0 % 0.6 pts
The above table reflects ceded premiums as a percent of gross premiums written
for the workers' compensation business only; healthcare professional liability
business is assumed net of reinsurance, as discussed above. The ceded premiums
ratio reflects the weighted average reinsurance rates of all SPC programs. The
increase in the ceded premiums ratio for the year ended December 31, 2021
reflects an increase in reinsurance rates.
Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that the SPCs cede to external reinsurers. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Policies ceded to the SPCs are twelve month term policies and premiums are earned on a pro rata basis over the policy period. Net premiums earned also include premium adjustments related to the audit of workers' compensation insureds' payrolls. Payroll audits are conducted subsequent to the end of the policy period and any related adjustments processed are recorded as fully earned in the current period.
Gross, ceded and net premiums earned were as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Gross premiums earned $ 72,359 $ 75,112 $ (2,753) (3.7 %)
Less: Ceded premiums earned 8,671 8,760 (89) (1.0 %)
Net premiums earned $ 63,688 $ 66,352 $ (2,664) (4.0 %)
The decrease in net premiums earned during the year ended December 31, 2021
primarily reflected the pro rata effect of a reduction in net premiums written
during the preceding twelve months.
Net Investment Income and Net Investment Gains (Losses)
Net investment income for the years ended December 31, 2021 and 2020 was
primarily attributable to interest earned on available-for-sale fixed maturity
investments, which primarily include investment-grade corporate debt securities.
We recognized $4.1 million and $3.1 million of net investment gains for the
years ended December 31, 2021 and 2020, respectively, which primarily reflected
an increase in the fair value of our equity portfolio.
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Losses and Loss Adjustment Expenses
The following table summarizes the calendar year net loss ratios by separating losses between the current accident year and all prior accident years. The current accident year net loss ratio reflects the aggregate loss ratio for all programs. Loss reserves are estimated for each program on a quarterly basis. Due to the size of some of the programs, quarterly loss results can create volatility in the current accident year net loss ratio from period to period.
Calendar year and current accident year net loss ratios for the years ended
December 31, 2021 and 2020 were as follows:
Year Ended December 31
2021 2020 Change
Calendar year net loss ratio 51.1 % 44.6 % 6.5 pts
Less impact of prior accident years on the
net loss ratio (16.0 %) (25.0 %) 9.0 pts
Current accident year net loss ratio 67.1 % 69.6 % (2.5 pts)
The current accident year net loss ratio decreased in 2021 as compared to 2020,
primarily reflecting favorable trends in the prior accident year claim results
and their impact on our analysis of the current accident year loss estimate. The
decrease was partially offset by the continuation of intense price competition
and the resulting renewal rate decreases in the workers' compensation business
as well as the impact of higher claim activity related to workers returning to
full employment in 2021 after the lifting of pandemic-related restrictions and
the labor shortage.
Calendar year incurred losses (excluding IBNR) ceded to our external reinsurers
increased $5.2 million for the year ended December 31, 2021 as compared to 2020.
Current accident year ceded incurred losses (excluding IBNR) increased $2.3
million for the year ended December 31, 2021 as compared to 2020.
We recognized net favorable prior year reserve development of $10.2 million and
$16.5 million for the years ended December 31, 2021 and 2020, respectively.
Net favorable prior year reserve development in the workers' compensation business totaled $7.6 million in 2021 as compared to $12.1 million in 2020. The 2021 net favorable prior year reserve development related primarily to accident year 2015 and accident years 2018 through 2020. The 2020 net favorable development related primarily to accident years 2018 and 2019. Net favorable prior year reserve development in the healthcare professional liability business totaled $2.5 million in 2021 as compared to $4.4 million in 2020. The 2021 net favorable prior year reserve development related primarily to accident years 2018 through 2020, while the 2020 net favorable prior year reserve development related primarily to accident years 2017 through 2019.
Underwriting, Policy Acquisition and Operating Expenses
Our Segregated Portfolio Cell Reinsurance segment underwriting, policy
acquisition and operating expenses were comprised as follows:
Year Ended
December 31
($ in thousands) 2021 2020
Change
DPAC amortization $ 18,730 $ 19,636
$ (906) (4.6 %)
Policyholder dividend expense 508 72
436 605.6 %
Other underwriting and operating expenses 2,397 1,001
1,396 139.5 %
Total $ 21,635 $ 20,709 $ 926 4.5 %
DPAC amortization primarily represents ceding commissions, which vary by program
and are paid to our Workers' Compensation Insurance and Specialty P&C segments
for premiums assumed. Ceding commissions include an amount for fronting fees,
commissions, premium taxes and risk management fees, which are reported as an
offset to underwriting, policy acquisition and operating expenses within our
Workers' Compensation Insurance and Specialty P&C segments. In addition, ceding
commissions paid to our Workers' Compensation Insurance segment include cell
rental fees which are recorded as other income and claims administration fees
which are recorded as ceded ULAE within our Workers' Compensation Insurance
segment.
Other underwriting and operating expenses primarily include bank fees,
professional fees and changes in the allowance for expected credit losses. The
increase in other underwriting and operating expenses for the year ended
December 31, 2021 as
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compared to 2020 primarily reflected the change in our allowance for expected credit losses related to one program in which we do not participate, partially offset by a decrease in professional fees. The increase in policyholder dividend expense for the year ended December 31, 2021 as compared to 2020, related primarily to one SPC program, in which we do not participate.
Underwriting Expense Ratio (the Expense Ratio)
The underwriting expense ratio included the impact of the following:
Year Ended December 31
2021 2020 Change
Underwriting expense ratio, as reported 34.0 % 31.2 % 2.8 pts
Less: impact of audit premium on expense ratio (0.5 %) 0.1 % (0.6 pts)
Underwriting expense ratio, excluding the effect of
audit premium
34.5 % 31.1 % 3.4 pts Excluding the effect of audit premium, the underwriting expense ratio increased for the year ended December 31, 2021. The increase primarily reflected the change in the allowance for expected credit losses and policyholder dividend expense, as discussed above, as well as the decrease in net premiums earned.
SPC
The SPCs at Inova Re have made a 953(d) election under theU.S. Internal Revenue Code and are subject toU.S. federal income tax.U.S. federal income taxes incurred totaled $1.9 million and $1.7 million for the years ended December 31, 2021 and 2020, respectively.U.S. federal income taxes are included in the total SPC net results and are paid by the individual SPCs. 103
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Segment Results - Lloyd's Syndicates
Our Lloyd's Syndicates segment includes the results from our participation in certain Syndicates atLloyd's of London . In addition to our participation in Syndicate results, we have investments in and other obligations to our Lloyd's Syndicates consisting of a Syndicate Credit Agreement and FAL requirements. For the 2021 underwriting year, our FAL was comprised of investment securities and cash and cash equivalents deposited with Lloyd's which at December 31, 2021 had a fair value of approximately $37.8 million, as discussed in Note 4 of the Notes to Consolidated Financial Statements. During the second and fourth quarters of 2021, we received a return of approximately $24.5 million and $8.0 million, respectively, of cash from our FAL balances given the reduction in our participation in the results of Syndicate 1729, to 5% from 29%, and Syndicate 6131, to 50% from 100%, for the 2021 underwriting year. Further, during the fourth quarter of 2021, we received a return of approximately $26.6 million of cash from our FAL balances given Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's business is retained within Syndicate 1729 beginning with the 2022 underwriting year.
We normally report results from our involvement in Lloyd's Syndicates on a
quarter lag, except when information is available that is material to the
current period. Furthermore, the investment results associated with our FAL
investments and certain
concurrently as that information is available on an earlier time frame.
Lloyd's Syndicate 1729. We provide capital to Syndicate 1729, which covers a range of property and casualty insurance and reinsurance lines in both theU.S. and international markets. The remaining capital for Syndicate 1729 is provided by unrelated third parties, including private names and other corporate members. As previously discussed, we decreased our participation in the results of Syndicate 1729 for the 2021 underwriting year to 5% to support and grow our core insurance operations. Due to the quarter lag, this reduced participation was not reflected in our results until the second quarter of 2021. Syndicate 1729 had a maximum underwriting capacity of £185 million (approximately $250 million based on December 31, 2021 exchange rates) for the 2021 underwriting year, of which £9 million (approximately $13 million based on December 31, 2021 exchange rates) was our allocated underwriting capacity. For the 2022 underwriting year, our participation in the results of Syndicate 1729 remains unchanged at 5%. Syndicate 1729's maximum underwriting capacity for the 2022 underwriting year is £210 million (approximately $284 million at December 31, 2021), of which £11 million (approximately $15 million at December 31, 2021) is our allocated underwriting capacity. Lloyd's Syndicate 6131. Prior to January 1, 2022, we provided capital to an SPA, Syndicate 6131, which focused on contingency and specialty property business. Effective July 1, 2020, Syndicate 6131 entered into a six-month quota share reinsurance agreement with an unaffiliated insurer. Under this agreement, Syndicate 6131 ceded essentially half of the premium assumed from Syndicate 1729 to the unaffiliated insurer; the agreement was non-renewed on January 1, 2021 and we decreased our participation in the results of Syndicate 6131 to 50% from 100% for the 2021 underwriting year, as previously discussed. Due to the quarter lag, this reduced participation was not reflected in our results until the second quarter of 2021. Syndicate 6131 had a maximum underwriting capacity for the 2021 underwriting year of £20 million (approximately $27 million based on December 31, 2021 exchange rates), of which £10 million (approximately $14 million based on December 31, 2021 exchange rates) was our allocated underwriting capacity. Effective January 1, 2022, Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's business is retained within Syndicate 1729 beginning with the 2022 underwriting year, as previously discussed. Premium from our participation in the results of Syndicate 6131 from open underwriting years prior to 2022 will continue to earn out pro rata over the entire policy period of the underlying business. 104
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In addition to the results of our participation in Lloyd's Syndicates, as
discussed above, our Lloyd's Syndicates segment also includes 100% of the
results of our wholly owned subsidiaries that support our operations at Lloyd's.
For the years ended December 31, 2021 and 2020, the results of our Lloyd's
Syndicates segment were as follows:
Year
Ended December 31
($ in thousands) 2021 2020 Change
Net premiums written $ 31,667 $ 67,652 $ (35,985) (53.2 %)
Net premiums earned $ 48,372 $ 77,226 $ (28,854) (37.4 %)
Net investment income 1,961 4,128 (2,167) (52.5 %)
Net investment gains (losses) 249 988 (739) (74.8 %)
Other income 912 51 861 1,688.2 %
Net losses and loss adjustment expenses (29,812) (50,216) 20,404 (40.6 %)
Underwriting, policy acquisition and operating
expenses (17,957) (30,136) 12,179 (40.4 %)
Income tax benefit (expense) - 29 (29) nm
Segment results $ 3,725 $ 2,070 $ 1,655 80.0 %
Net loss ratio 61.6 % 65.0 % (3.4 pts)
Underwriting expense ratio 37.1 % 39.0 % (1.9 pts)
Premiums Written
Changes in premium volume within our Lloyd's Syndicates segment are driven by
five primary factors: (1) changes in our participation in the Syndicates, (2)
the amount of new business and the channels in which the business is written,
(3) the retention of existing business, (4) the premium charged for business
that is renewed, which is affected by rates charged and by the amount and type
of coverage an insured chooses to purchase and (5) the timing of premium written
through multi-period policies.
Gross, ceded and net premiums written were as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Gross premiums written $ 37,969 $ 84,718 $ (46,749) (55.2 %)
Less: Ceded premiums written 6,302 17,066 (10,764) (63.1 %)
Net premiums written
$ 31,667 $ 67,652 $ (35,985) (53.2 %) Gross Premiums Written Gross premiums written in 2021 consisted of specialty property coverages (31% of total gross premiums written), property insurance coverages (27%), casualty coverages (26%), contingency coverages (9%), catastrophe reinsurance coverages (5%) and property reinsurance coverages (2%). The decrease in gross premiums written in 2021 as compared to 2020 was primarily driven by our decreased participation in the results of Syndicates 1729 and 6131, partially offset by volume increases on renewal business and renewal pricing increases, primarily on property insurance and casualty coverages and new business written, primarily on specialty property and property insurance coverages.
Ceded Premiums Written
Syndicate 1729 utilizes reinsurance to provide the capacity to write larger
limits of liability on individual risks, to provide protection against
catastrophic loss and to provide protection against losses in excess of policy
limits. As previously discussed, for the second half of 2020 Syndicate 6131
utilized external quota share reinsurance to manage the net loss exposure on the
specialty property and contingency coverages it assumed from Syndicate 1729 by
ceding essentially half of the premium assumed to an unaffiliated insurer; this
agreement was non-renewed on January 1, 2021. Due to the quarter lag, the effect
of this six-month reinsurance arrangement began to be reflected in our results
in the fourth quarter of 2020. Ceded premiums written decreased for the year
ended December 31, 2021 as compared to 2020 primarily driven by our decreased
participation in the results of Syndicates 1729 and 6131 and, to a lesser
extent, the impact of an increase in estimated reinsurance reinstatement
premiums of $1.2 million during the fourth quarter of 2020 triggered by certain
property and catastrophe related losses exceeding specified levels in the
reinsurance agreement.
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Net Premiums Earned
Net premiums earned consist of gross premiums earned less the portion of earned premiums that the Syndicates cede to reinsurers for their assumption of a portion of losses. Premiums written through open-market channels are generally earned pro rata over the entire policy period, which is predominantly twelve months, whereas premiums written through delegated underwriting authority arrangements are generally earned over the policy period plus twelve months. Therefore, net premiums earned is affected by shifts in the mix of policies written between the open-market and delegated underwriting authority arrangements. Additionally, net premiums earned consists of a mix of policies earned from different open underwriting years. As previously discussed, we participate to a varying degree in each open underwriting year which may cause fluctuations in premiums earned. Furthermore, fluctuations in premiums earned tend to lag those of premiums written. Premiums for certain policies and assumed reinsurance contracts are reported subsequent to the coverage period and/or may be subject to adjustment based on loss experience. These premium adjustments are earned when reported, which can result in further fluctuation in earned premium.
Gross, ceded and net premiums earned were as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Gross premiums earned $ 60,590 $ 98,990 $ (38,400) (38.8 %)
Less: Ceded premiums earned 12,218 21,764 (9,546) (43.9 %)
Net premiums earned $ 48,372 $ 77,226 $ (28,854) (37.4 %)
The decrease in net premiums earned for the year ended December 31, 2021 as
compared to 2020 was driven by our decreased participation in Syndicates 1729
and 6131, partially offset by the effect of the aforementioned reinstatement
premiums earned of $1.2 million during the fourth quarter of 2020.
Net Losses and Loss Adjustment Expenses
Losses for the year were primarily recorded using the loss assumptions by risk category incorporated into the business plans submitted to Lloyd's for Syndicate 1729 and Syndicate 6131 with consideration given to loss experience incurred to date. The assumptions used in each business plan were consistent with loss results reflected in Lloyd's historical data for similar risks. The loss ratios may fluctuate due to the mix of earned premium and the timing of earned premium adjustments (see discussion in this section under the heading "Net Premiums Earned"). Premium and exposure for some of Syndicate 1729's insurance policies and reinsurance contracts are initially estimated and subsequently adjusted over an extended period of time as underlying premium reports are received from cedents and insureds. When reports are received, the premium, exposure and corresponding loss estimates are revised accordingly. Changes in loss estimates due to premium or exposure fluctuations are incurred in the accident year in which the premium is earned.
The following table summarizes calendar year net loss ratios by separating
losses between the current accident year and all prior accident years. Net loss
ratios for the period were as follows:
Year Ended December 31
2021 2020 Change
Calendar year net loss ratio 61.6 % 65.0 % (3.4 pts)
Less impact of prior accident years on the net
loss ratio 9.7 % 0.8 % 8.9 pts
Current accident year net loss ratio 51.9 % 64.2 % (12.3 pts)
For the year ended December 31, 2021, the current accident year net loss ratio
decreased 12.3 percentage points as compared to 2020. The decrease in the
current accident year net loss ratio was primarily driven by higher reinsurance
recoveries as a proportion of gross losses as compared to the prior year period,
partially offset by certain catastrophe related losses.
We recognized $4.7 million and $0.6 million of unfavorable prior year
development for the years ended December 31, 2021 and 2020, respectively. The
unfavorable prior year development for the year ended December 31, 2021 was
driven by higher than expected losses and development on certain large claims,
primarily catastrophe related losses.
We have exposures to potential COVID-19 claims through our participation in
Syndicates 1729 and 6131. During 2021, we recognized losses related to COVID-19
of approximately $1.6 million, net of reinsurance, as compared to $3.6 million
during 2020, primarily in Syndicate 6131's contingency and Syndicate 1729's
casualty books of business. See previous discussion in Part I, Item 1 under the
heading "Insurance Regulatory Matters- COVID-19."
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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses decreased by $12.2
million for the year ended December 31, 2021 as compared to 2020 and reflected
our decreased participation in Syndicate 1729 and Syndicate 6131.
For the year ended December 31, 2021, the underwriting expense ratio decreased by 1.9 percentage points as compared to 2020 which primarily reflected the impact of our reduced participation in Syndicate 1729 and Syndicate 6131. Operating expenses incurred during 2021 primarily were related to the 2021 underwriting year for which our participation is 5% and 50% in Syndicate 1729 and Syndicate 6131, respectively, whereas the net premiums earned during the same period also includes premium from other open underwriting years in which we participate at a higher degree.
Investments
Syndicate 1729's fixed maturity portfolio includes certain debt securities classified as trading securities. Investment results associated with these fixed maturity trading securities are reported on the same quarter lag. The decrease in net investment income in 2021 as compared to 2020 was primarily attributable to lower average investment balances and lower yields, primarily from investment-grade corporate debt securities. The lower average investment balance in 2021 was driven by the return of approximately $32.3 million of cash and cash equivalents from our FAL balances during the third quarter of 2020 given the reduction in our participation in the results of Syndicate 1729 to 29% from 61% for the 2020 underwriting year. In addition, we received a return of approximately $24.5 million and $8.0 million of cash from our FAL balances during the second and fourth quarters of 2021, respectively, given the additional reduction in our participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021 underwriting year, as previously discussed. Further, during the fourth quarter of 2021, we received a return of approximately $26.6 million of cash from our FAL balances given the decision to incorporate Syndicate 6131's business into Syndicate 1729 for the 2022 underwriting year, as previously discussed. Our lower FAL balances will continue to impact the segment's net investment income in future periods.
Taxes
The results of this segment are subject to
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Segment Results - Corporate
Our Corporate segment includes our investment operations, including the investment operations of NORCAL since the date of acquisition and excludes those reported in our Segregated Portfolio Cell Reinsurance and Lloyd's Syndicates segments as discussed in Note 18 of the Notes to Consolidated Financial Statements. In addition, this segment includes corporate expenses, interest expense,U.S. income taxes and non-premium revenues generated outside of our insurance entities. Segment results for the year ended December 31, 2021 exclude transaction-related costs and the associated income tax benefit related to the NORCAL acquisition as we do not consider these items in assessing the financial performance of the segment (Note 2 of the Notes to Consolidated Financial Statements provides additional information regarding this acquisition). Segment results for our Corporate segment were net earnings of $91.2 million and $71.4 million for the years ended December 31, 2021 and 2020, respectively, and included the following:
Year Ended December 31
($ in thousands) 2021 2020 Change
Net investment income $ 67,747 $ 66,786 $ 961 1.4 %
Equity in earnings (loss) of unconsolidated
subsidiaries $ 48,974 $ (11,921) $ 60,895 510.8 %
Net investment gains (losses) $ 19,981 $ 11,605 $ 8,376 72.2 %
Other income $ 5,531 $ 2,531 $ 3,000 118.5 %
Operating expense $ 26,641 $ 23,429 $ 3,212 13.7 %
Interest expense $ 19,719 $ 15,503 $ 4,216 27.2 %
Income tax expense (benefit) $ 4,651 $ (41,300) $ 45,951 111.3 %
Net Investment Income, Equity in Earnings (Loss) of Unconsolidated Subsidiaries,
Net Investment Gains (Losses)
Net Investment Income
Net investment income is primarily derived from the income earned by our fixed maturity securities and also includes dividend income from equity securities, income from our short-term and cash equivalent investments, earnings from other investments and increases in the cash surrender value of BOLI contracts, net of investment fees and expenses. Net investment income in 2021 also includes income earned, net of investment fees and expenses, since the date of acquisition from investments acquired from NORCAL .
Net investment income by investment category was as follows:
Year Ended
December 31
($ in thousands) 2021 2020 Change
Fixed maturities $ 71,451 $ 64,338 $ 7,113 11.1 %
Equities 2,539 4,369 (1,830) (41.9 %)
Short-term investments, including Other 1,860 2,209 (349) (15.8 %)
BOLI 2,699 2,023 676 33.4 %
Investment fees and expenses (10,802) (6,153)
(4,649) 75.6 %
Net investment income $ 67,747 $ 66,786 $ 961 1.4 %
Fixed Maturities
Income from our fixed maturities increased in 2021 as compared to 2020 driven by
higher average investment balances primarily attributable to the addition of
fixed maturity securities valued at $1.1 billion to our portfolio on May 5, 2021
as a result of the NORCAL acquisition (see Note 2 of the Notes to Consolidated
Financial Statements for additional information). The increase in income from
our fixed maturities in 2021 was partially offset by lower yields from our
corporate debt securities and the impact of capital planning in anticipation of
closing the NORCAL acquisition. As a result of the NORCAL acquisition, average
investment balances were approximately 51% higher for 2021 as compared to 2020;
excluding the impact of the acquisition, average investment balances were
approximately 10% higher.
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Average yields for our fixed maturity portfolio were as follows:
Year Ended December 31
2021 2020
Average income yield 2.3% 3.1%
Average tax equivalent income yield 2.3% 3.1%
Yields on fixed maturity securities decreased in 2021 as compared to 2020. The
decrease in 2021 was primarily driven by the application of GAAP purchase
accounting rules whereby all NORCAL fixed maturity securities acquired were
valued at fair value on the date of acquisition resulting in lower average
yields on those securities as compared to the average yields on our other
securities.
Equities
Income from our equity portfolio decreased in 2021 as compared to 2020 due to a decrease in our allocation to this asset category during the first half of 2021 and, to a lesser extent, the reallocation in our mix of securities within this asset category.
Short-term Investments and Other Investments
Short-term investments, which have a maturity at purchase of one year or less are carried at fair value, which approximates their cost basis, and are primarily composed of investments inU.S. treasury obligations, commercial paper and money market funds. Income from our short-term and other investments decreased during 2021 primarily attributable to lower yields given the actions taken by theFederal Reserve to aggressively reduce interest rates in response to COVID-19, partially offset by income contributed by investments acquired from NORCAL. BOLI We hold BOLI policies that are carried at the current cash surrender value of the policies, which includes the BOLI policies acquired from NORCAL. All insured individuals were members ofProAssurance or NORCAL management at the time the policies were acquired. Income from our BOLI policies increased in 2021 as compared to 2020 primarily attributable to the addition of BOLI policies valued at $10 million to our portfolio on May 5, 2021 as a result of the NORCAL acquisition.
Investment Fees and Expenses
Investment fees and expenses increased in 2021 as compared to 2020 driven by additional costs associated with our investments acquired from NORCAL since the date of acquisition.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries was comprised as
follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
All other investments, primarily investment fund
LPs/LLCs $ 64,031 $ 7,855 $ 56,176 715.2 %
Tax credit partnerships (15,057) (19,776) 4,719 (23.9 %)
Equity in earnings (loss) of unconsolidated
subsidiaries $ 48,974 $ (11,921) $ 60,895 510.8 %
We hold interests in certain LPs/LLCs that generate earnings from trading
portfolios, secured debt, debt securities, multi-strategy funds and private
equity investments. The performance of the LPs/LLCs is affected by the
volatility of equity and credit markets. For our investments in LPs/LLCs, we
record our allocable portion of the partnership operating income or loss as the
results of the LPs/LLCs become available, typically following the end of a
reporting period. The increase in our investment results from our portfolio of
investments in LPs/LLCs for 2021 as compared to 2020 was due to higher earnings
from several LPs/LLCs and the prior year effect of the volatility in global
financial markets related to COVID-19. Our investment results from our portfolio
of investments in LPs/LLCs in 2021 included additional earnings of approximately
$1.4 million from acquired interests in four LPs as a result of the NORCAL
acquisition; given the results of our investments in LPs/LLCs are often reported
to us on a one quarter lag, the earnings from these investments were not
reflected in our results until the third quarter of 2021.
Our tax credit partnership investments are designed to generate returns in the
form of tax credits and tax-deductible project operating losses and are
comprised of qualified affordable housing project tax credit partnerships and a
historic tax credit partnership. We account for our tax credit partnership
investments under the equity method and record our allocable portion of the
operating losses of the underlying properties based on estimates provided by the
partnerships. For our qualified affordable housing project tax credit
partnerships, we adjust our estimates of our allocable portion of operating
losses
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periodically as actual operating results of the underlying properties become
available. The primary benefits of tax credits and tax-deductible operating
losses from the historic tax credit partnerships are earned in a short period
with potential for additional cash flows extending over several years. The
results from our tax credit partnership investments for the year ended
December 31, 2021 reflected lower partnership operating losses as compared to
2020. In addition, based on results received, we increased our estimate of
operating losses by $1.9 million and $4.3 million for the years ended
December 31, 2021 and 2020, respectively.
The tax benefits received from our tax credit partnerships, which are not
reflected in our investment results, reduced our tax expense in 2021 and 2020 as
follows:
Year Ended December 31
(In millions) 2021 2020
Tax credits recognized during the period $ 13.2 $ 17.9
Tax benefit of tax credit partnership operating losses $ 3.2
$ 4.2
The tax credits generated from our tax credit partnership investments of $13.2
million for 2021 were deferred for use in future periods due to the utilization
of NOLs available to us following our acquisition of NORCAL. For the year ended
December 31, 2020, due to our consolidated pre-tax loss, the tax credits
generated from our tax credit partnership investments of $17.9 million were
deferred to be utilized in future periods. For the year ended December 31, 2021,
we utilized approximately $2.0 million of tax credits carried forward from 2019
and, as of December 31, 2021, we had approximately $46.7 million of available
tax credit carryforwards generated from our investments in tax credit
partnerships which we expect to utilize in future years. See further discussion
in Note 7 of the Notes to Consolidated Financial Statements.
Tax credits provided by the underlying projects of our historic tax credit
partnership are typically available in the tax year in which the project is put
into active service, whereas the tax credits provided by qualified affordable
housing project tax credit partnerships are provided over approximately a ten
year period.
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Non-GAAP Financial Measure - Tax Equivalent Investment Result
We believe that to fully understand our investment returns it is important to
consider the current tax benefits associated with certain investments as the tax
benefit received represents a portion of the return provided by our tax-exempt
bonds, BOLI, common and preferred stocks, and tax credit partnership investments
(collectively, our tax-preferred investments). We impute a pro forma
tax-equivalent result by estimating the amount of fully-taxable income needed to
achieve the same after-tax result as is currently provided by our tax-preferred
investments. We believe this better reflects the economics behind our decision
to invest in certain asset classes that are either taxed at lower rates and/or
result in reductions to our current federal income tax expense. Our pro forma
tax-equivalent investment result is shown in the table that follows as well as a
reconciliation of our GAAP net investment result to our tax equivalent result.
Year
Ended December 31
(In thousands) 2021 2020
GAAP net investment result:
Net investment income $ 67,747 $ 66,786
Equity in earnings (loss) of unconsolidated subsidiaries 48,974 (11,921)
GAAP net investment result $ 116,721
$ 54,865
Pro forma tax-equivalent investment result $ 120,450
$ 56,088
Reconciliation of pro forma and GAAP tax-equivalent
investment result:
GAAP net investment result
$ 116,721 $ 54,865
Taxable equivalent adjustments, calculated using the 21%
federal statutory tax rate
State and municipal bonds 522 595
BOLI 717 538
Dividends received 12 90
Tax credit partnerships* 2,478 -
Pro forma tax-equivalent investment result $ 120,450 $ 56,088
* Due to the realized NOL for the years ended December 31, 2021 and December 31, 2020, the tax
credits recognized from our tax credit partnership investments, during each of those respective
years, were deferred to be utilized in future periods, however during the year ended December 31,
2021, we utilized a portion of the tax credits carried forward from the 2019 tax year.
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Net Investment Gains (Losses)
The following table provides detailed information regarding our net investment
gains (losses).
Year Ended December 31
(In thousands) 2021 2020 Total impairment losses Corporate debt $ - $ (1,745)
Portion of impairment losses recognized in other comprehensive income
before taxes:
Corporate debt
- 237 Net impairment losses recognized in earnings - (1,508) Gross realized gains, available-for-sale fixed maturities 13,047 13,436 Gross realized (losses), available-for-sale fixed maturities (1,133) (2,499) Net realized gains (losses), equity investments 5,394 12,965 Net realized gains (losses), other investments 8,660 3,883 Change in unrealized holding gains (losses), equity investments (4,697) (18,926)
Change in unrealized holding gains (losses), convertible securities,
carried at fair value as a part of other investments
(1,701) 3,850
Other 411 404
Net investment gains (losses) $ 19,981 $ 11,605
We did not recognize any credit-related impairment losses in earnings or
non-credit impairment losses in OCI for the year ended December 31, 2021. For
the year ended December 31, 2020, we recognized $1.5 million of credit-related
impairment losses in earnings and a nominal amount of non-credit impairment
losses in OCI. The credit-related impairment losses recognized in 2020 primarily
related to corporate bonds in the energy and consumer sectors. Additionally,
2020 included credit-related impairment losses related to four corporate bonds
in various sectors, which were sold during 2020. The non-credit impairment
losses recognized during 2020 related to three corporate bonds in the energy and
consumer sectors.
We recognized $20.0 million of net investment gains for the year ended
December 31, 2021 which include approximately $1.9 million of net investment
gains related to investments acquired from NORCAL. Net investment gains in 2021
were driven by realized gains on the sale of certain available-for-sale fixed
maturities and other investments, partially offset by unrealized holding losses
resulting from decreases in the fair value on our equity portfolio. We
recognized $11.6 million of net investment gains for the year ended December 31,
2020, driven primarily by realized gains on the sale of certain
available-for-sale fixed maturities and equity investments, partially offset by
unrealized holding losses resulting from decreases in the fair value on our
equity portfolio due to the volatility in the global financial markets related
to COVID-19.
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Operating Expenses
Corporate segment operating expenses were comprised as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Operating expenses $ 36,007 $ 37,562 $ (1,555) (4.1 %)
Management fee offset (9,366) (14,133) 4,767 (33.7 %)
Total $ 26,641 $ 23,429 $ 3,212 13.7 %
Operating expenses decreased during the year ended December 31, 2021 as compared
to 2020 primarily due to a decrease in professional fees and, to a lesser
extent, the prior year effect of $0.5 million of one-time expenses incurred in
2020, partially offset by an increase in compensation-related costs. The
decrease in professional fees in 2021 was driven by a decrease in corporate
legal expenses. One-time expenses in 2020 were primarily comprised of employee
severance and early retirement benefits granted to certain employees. The
increase in compensation-related costs during 2021 was driven by higher amounts
accrued for performance-related incentive plans due to our improved performance
metrics and, to a lesser extent, an increase in share-based compensation
expenses attributable to the effect of an increase in the value of projected
awards in 2021 based upon the improvement of the associated performance metrics.
Operating subsidiaries within our Specialty P&C segment (excluding the acquired
operating subsidiaries of NORCAL) and our Workers' Compensation Insurance
segment are charged a management fee by the Corporate segment for services
provided to these subsidiaries. The management fee is based on the extent to
which services are provided to the subsidiary and the amount of premium written
by the subsidiary. Under the arrangement, the expenses associated with such
services are reported as expenses of the Corporate segment, and the management
fees charged are reported as an offset to Corporate operating expenses.
Fluctuations in the amount of premium written by each subsidiary can result in
corresponding variations in the management fee charged to each subsidiary during
a particular period. Due to organizational structure enhancements in our
Specialty P&C segment during 2020, the extent to which services are provided by
the Corporate segment to the operating subsidiaries within that segment
decreased effective January 1, 2021. Accordingly, we reduced the fee charged to
the operating subsidiaries within the Specialty P&C segment during 2021. There
were no changes to the extent to which services are provided by the Corporate
segment to the operating subsidiaries within our Workers' Compensation Insurance
segment in 2021.
Interest Expense
Consolidated interest expense for the years ended December 31, 2021 and 2020 was
comprised as follows:
Year Ended December 31
($ in thousands) 2021 2020 Change
Senior Notes due 2023 $ 13,429 $ 13,429 $ - - %
Contribution Certificates (including accretion)* 5,046 - 5,046 nm
Revolving Credit Agreement (including fees and
amortization) 1,120 831 289 34.8 %
Mortgage Loans (including amortization) 444 812 (368) (45.3 %)
(Gain)/loss on interest rate cap (320) 431 (751) (174.2 %)
Interest expense $ 19,719 $ 15,503 $ 4,216 27.2 %
*Includes accretion of approximately $1.2 million for the year ended December 31, 2021 which is recorded as an increase
to interest expense as a result of the difference between the recorded acquisition date fair value and the principal
balance of the Contribution Certificates associated with our acquisition of NORCAL.
Consolidated interest expense increased during 2021 as compared to 2020 driven by the addition of interest expense on the Contribution Certificates associated with our acquisition of NORCAL (See Note 2 and Note 13 of the Notes to Consolidated Financial Statements) and, to a lesser extent, an increase in the borrowings on our Revolving Credit Agreement. During the third quarter of 2021, we repaid the balance outstanding on the Revolving Credit Agreement of $15.0 million and there were no outstanding borrowings on this agreement during 2020; interest expense on the Revolving Credit Agreement in both 2021 and 2020 primarily reflected unused commitment fees. The increase in consolidated interest expense for 2021 was partially offset by lower interest expense on our Mortgage Loans. In 2021, we repaid the balance outstanding on our Mortgage Loans of $35.3 million; interest expense on the Mortgage Loans during the current period included the write-off of the related unamortized debt issuance costs which were nominal in amount. In addition, consolidated interest expense during 2021 was impacted by the change in the fair value of our interest rate cap.
See further discussion of our interest rate cap agreement in Note 3 and further
discussion on our outstanding debt in Note 13 of the Notes to Consolidated
Financial Statements.
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Taxes
Tax expense allocated to our Corporate segment includesU.S. tax only, which would includeU.S. tax expense incurred from our corporate membership inLloyd's of London . TheU.K. tax expense incurred by theU.K. based subsidiaries of our Lloyd's Syndicates segment is allocated to that segment. The SPCs at Inova Re, one of ourCayman Islands reinsurance subsidiaries, have each made a 953(d) election under theU.S. Internal Revenue Code and are subject toU.S. federal income tax; therefore, tax expense allocated to our Corporate segment also includes tax expense incurred from any SPC at Inova Re in which we have a participation interest of 80% or greater as those SPCs are required to be included in our consolidated tax return. Consolidated tax expense (benefit) reflects the tax expense (benefit) of both segments and the tax impact of items excluded from segment reporting, as shown in the table below: Year Ended December 31 (In thousands) 2021 2020 Corporate segment income tax expense (benefit) $ 4,651 $ (41,300) Lloyd's Syndicates segment income tax expense (benefit) - (29) Income tax expense (benefit) - transaction-related costs* (2,168) - Consolidated income tax expense (benefit) $ 2,483 $ (41,329) *Represents the income tax benefit associated with the transaction-related costs related to our acquisition of NORCAL that are not included in a segment as we do not consider these costs in assessing the financial performance of any of our operating or reportable segments. See Note 18 of the Notes to Consolidated Financial Statements for a reconciliation of our segment results to our consolidated results. Listed below are the primary factors affecting our consolidated effective tax rate for the years ended December 31, 2021 and 2020. The comparability of each factor's impact on our effective tax rate is affected by the consolidated pre-tax income recognized during 2021 as compared to the consolidated pre-tax loss recognized during 2020. Factors that have the same directional impact on income tax expense (benefit) in each period have an opposite impact on our effective tax rate due to the effective tax rate being calculated based upon a pre-tax income during the year ended December 31, 2021 versus the pre-tax loss during the year ended December 31, 2020. These factors include the following: Year Ended December 31 2021 2020 Income tax Income tax (benefit) ($ in thousands) (benefit) expense Rate Impact expense Rate Impact Computed "expected" tax expense (benefit) at statutory rate $ 30,787 21.0 % $ (45,582) 21.0 % Tax-exempt income (1) (1,298) (0.9 %) (976) 0.4 % Tax credits (13,160) (9.0 %) (17,876) 8.2 % Non-U.S. operating results (1,322) (0.9 %) (1,307) 0.6 %
Tax deficiency (excess tax benefit) on share-based
compensation
286 0.2 % 457 (0.2 %) Tax rate differential on loss carryback - - % (7,758) 3.6 % Goodwill impairment (2) - - % 31,413 (14.5 %) Non-taxable gain on bargain purchase (3) (15,626) (10.7 %) - - % Provision-to-return and other differences 3,574 2.4 % 1,217 (0.5 %) Change in uncertain tax positions (1,909) (1.3 %) (1,674) 0.8 % State income taxes 460 0.3 % (561) 0.3 % Other 691 0.6 % 1,318 (0.7 %) Total income tax expense (benefit) $ 2,483 1.7 % $ (41,329) 19.0 %
(1) Includes tax-exempt interest, dividends received deduction and change in
cash surrender value of BOLI.
(2) Represents the tax impact of the impairment of non-deductible goodwill in relation to the Specialty P&C reporting unit during the third quarter of 2020 (see further discussion on the impairment charge in the Critical Accounting Estimates section under the heading "Goodwill / Intangibles" and in Note 8 of the Notes to Consolidated Financial Statements). (3) Represents the tax impact of the non-taxable gain on bargain purchase as a result of our acquisition of NORCAL on May 5, 2021. See further discussion on the gain on bargain purchase in Note 2 of the Notes to Consolidated Financial Statements. 114
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Our effective tax rates for 2021 and 2020, as shown in the table above, differed
from the statutory federal income tax rate of 21% in each respective year. The
most significant item impacting our effective tax rate for 2021 was the gain on
bargain purchase of $74.4 million related to the NORCAL acquisition, all of
which was non-taxable. See further discussion on the gain on bargain purchase in
Note 2 of the Notes to Consolidated Financial Statements. Additionally, our
effective tax rates for both 2021 and 2020 include the benefit recognized from
the tax credits transferred to us from our tax credit partnership investments.
Tax credits recognized for the year ended December 31, 2021 were $13.2 million
as compared to $17.9 million in 2020. While projected tax credits for 2021 are
less than 2020, they continue to have a significant impact on the effective tax
rate for 2021. For 2020, our effective tax rate was also affected by the
additional statutory tax rate differential of 14% on the carryback of our 2020
and 2019 NOLs to the 2015 and 2014 tax years, respectively, as a result of
changes made by the CARES Act to the NOL provisions of the tax law. Furthermore,
our pre-tax loss in 2020 included a $161.1 million goodwill impairment
recognized in relation to the Specialty P&C reporting unit during the third
quarter of 2020. Of the $161.1 million goodwill impairment, $149.6 million was
non-deductible for which no tax benefit was recognized, while the remaining
$11.5 million was deductible for which a 21% tax benefit was recognized on the
related income tax amortization. Consequently, the total impact of the goodwill
impairment on the effective tax rate in 2020 was approximately 14.5%. See
further discussion on this goodwill impairment in Notes 1 and 8 of the Notes to
Consolidated Financial Statements.
115
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