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PROASSURANCE CORP – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes to those statements which accompany this report. 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," "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 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: Specialty P&C,Workers' Compensation Insurance , Segregated Portfolio Reinsurance, Lloyd's Syndicates and Corporate. Additional information onProAssurance's five operating and reportable segments is included in Note 18 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K and in the Segment Results sections herein that follow.
Critical Accounting Estimates
Our Condensed 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" in ourDecember 31, 2021 report on Form 10-K 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. A detailed discussion of our critical accounting estimates is included in our Critical Accounting Estimates section in Item 7 of ourDecember 31, 2021 report on Form 10-K. 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 •Reinsurance •Valuation of investments and impairment of securities •Goodwill •Income taxes
Estimation of Taxes / Tax Credits
For interim periods, we generally utilize the estimated annual effective tax rate method under which we determine our provision (benefit) for income taxes based on the current estimate of our annual effective tax rate. For the six months endedJune 30, 2022 and 2021, we utilized the discrete effective tax rate method for recording income taxes after the estimated annual effective tax rate method produced an unreliable estimated annual effective tax rate. The discrete method is applied when the application of the estimated annual effective tax rate method is impractical and does not provide a reliable estimate of the annual effective tax rate. We believe the use of the discrete effective tax rate method for the six months endedJune 30, 2022 is more appropriate than the annual effective tax rate method as minor changes in our estimated ordinary income would have a significant effect on the estimated annual effective tax rate and would result in sizable variations in the customary relationship between income tax expense (benefit) and pre-tax accounting income (loss). 43
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Accounting Changes
Beginning in 2022, we revised our process for estimating ULAE as a result of substantially integrating NORCAL into our Specialty P&C segment operations. ULAE are costs that cannot be attributed to processing a specific claim and are allocated to net losses and loss adjustment expenses on the Condensed Consolidated Statement of Income and Comprehensive Income. We have accounted for this change prospectively as a change in accounting estimate. Changes in accounting estimate are reflected prospectively beginning in the period the change in estimate occurs. The change in our estimate of ULAE resulted in an increase to underwriting, policy acquisition and operating expenses with an offsetting decrease to net losses and loss adjustment expenses in our Specialty P&C segment; there was no impact on total expenses or net income (loss) in our Condensed Consolidated Statement of Income and Comprehensive Income for the three and six months endedJune 30, 2022 . See further discussion on this change in estimate in the Segment Results - Specialty Property & Casualty section that follows and in Note 1 of the Notes to Condensed Consolidated Financial Statements. We did not have any other change in accounting estimate or policy that had a material effect on our results of operations or financial position during the six months endedJune 30, 2022 . We are not aware of any accounting changes not yet adopted as ofJune 30, 2022 that could have a material impact on our results of operations, financial position or cash flows.
Liquidity and Capital Resources and Financial Condition
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 (including the acquired wholly owned operating subsidiaries of NORCAL effectiveJanuary 1, 2022 ) 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. AtJune 30, 2022 , we held cash and liquid investments of approximately$55 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 ofAugust 3, 2022 , no borrowings were outstanding under our Revolving Credit Agreement. To date, during 2022, our operating subsidiaries have paid dividends to us of approximately$22 million , which included$21 million that was paid inJuly 2022 . Additionally, we anticipate that our operating subsidiaries will pay dividends of approximately$19 million inAugust 2022 . Dividends paid in July and anticipated to be paid inAugust 2022 have not been included in our cash and liquid investments held outside of our insurance subsidiaries atJune 30, 2022 . Excluding the dividends paid inJuly 2022 and anticipated to be paid inAugust 2022 , our insurance subsidiaries, in the aggregate, are permitted to pay dividends of approximately$108 million over the remainder 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). 44
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Operating Activities and Related Cash Flows
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 discussion in our Liquidity section under the same heading in Item 7 of ourDecember 31, 2021 report on Form 10-K includes additional information regarding our reinsurance agreements. Our HCPL and Medical Technology Liability treaties renew annually onOctober 1 and our Workers' Compensation treaty renews annually onMay 1 . Our traditional workers' compensation treaty renewed May 1, 2022 at a higher rate than the previous treaty; all other material terms were consistent with the expiring treaty. The significant coverages provided by our current excess of loss reinsurance agreements are detailed in the following table. Excess of Loss Reinsurance Agreements [[Image Removed: pra-20220630_g1.jpg]] Healthcare Professional Medical Technology & Life Workers' Compensation - Liability Sciences Products Traditional (1) EffectiveOctober 1, 2020 , one prepaid limit reinstatement of$21M and a second limit reinstatement of up to$21M for the second layer, subject to reinstatement premium, which attaches after the first reinstatement has been completely exhausted. All limit reinstatements thereafter require no additional premium. EffectiveOctober 1, 2021 , limits can be reinstated a maximum of four times.
(2) Prior to
(3) Historically, retention has ranged from 2.5% to 32.5%.
(4) Historically, retention has ranged from
(5) Subject to a limit of
were to exceed this level the Company would retain this excess exposure.
(6) Subject to an AAD where retention is 3.5% of subject earned premium in
annual losses otherwise recoverable in excess of the
occurrence.
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For the workers' compensation business ceded to Inova Re and Eastern Re, each
SPC has in place its own reinsurance arrangements; which are illustrated in the
following table.
Segregated Portfolio Cell Reinsurance
[[Image Removed: pra-20220630_g2.jpg]]
Per Occurrence Coverage Aggregate Coverage
(1) The attachment point is based on a percentage of written premium within
individual cells, ranges from 85% to 94%, and varies by cell.
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Cash Flows
Cash flows between periods compare as follows:
Six Months
Ended
(In thousands) 2022
2021 Change
Net cash provided (used) by:
Operating activities$ (3,671) $ 31,015 $ (34,686) Investing activities (91,113) (70,929) (20,184) Financing activities (13,986) (15,072) 1,086
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$34.7 million for the six months endedJune 30, 2022 as compared to the six months endedJune 30, 2021 was primarily due to:
•An increase in paid losses of
segment primarily due to NORCAL paid losses and the payment of three large
claims totaling
•An increase in cash paid for operating expenses of$59.1 million driven by our Specialty P&C and Corporate segments, partially offset by the effect of transaction-related costs associated with our acquisition of NORCAL in 2021. The increase in cash paid for operating expenses in our Specialty P&C and Corporate segments was driven by an increase in compensation-related costs primarily attributable to an increase in headcount due to the addition of NORCAL employees. Furthermore, the increase in our Specialty P&C segment reflected an increase in commissions paid driven by additional premiums from our acquisition of NORCAL. Additionally, the increase reflected the termination of deferred compensation arrangements assumed in the NORCAL acquisition during the first quarter of 2022 totaling approximately$13.2 million . See further discussion of NORCAL's deferred compensation arrangements in Note 2 to the Notes to Condensed Consolidated Financial Statements. •The effect of a tax refund of approximately$9.0 million which we received inFebruary 2021 and an income tax extension payment of$1.1 million for the 2021 tax year during the second quarter of 2022. See additional discussion on this refund in our Liquidity section under the heading "Taxes" in Item 7 of ourDecember 31, 2021 report on Form 10-K.
The decrease in operating cash flows was partially offset by:
•An increase in net premium receipts of$144.3 million primarily driven by our Specialty P&C segment, partially offset by a decrease in our Lloyd's Syndicates segment. The increase in our Specialty P&C segment was due to additional premiums from our acquisition of NORCAL and the beneficial impacts of our re-underwriting efforts and focus on rate adequacy. The decrease in premium receipts in our Lloyd's Syndicates segment reflected our ceased participation in Syndicate 6131 for the 2022 underwriting year and the impact of our decreased participation in the results of Syndicates 1729 and 6131 for the 2021 underwriting year. •An increase in cash received from investment income of$28.7 million driven by an increase in distributed earnings and redemptions from our portfolio of investments in LPs/LLCs. The increase in the current period also reflected an increase in our investment balances due to the acquisition of NORCAL.
The remaining variance in operating cash flows for the six months ended
2022
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. See
further discussion of our financing activities in this section under the heading
"Financing Activities and Related Cash Flows."
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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. During the second quarter of 2022, we made a nominal safe harbor quarterly estimated tax payment and also made an income tax extension payment of$1.1 million for the 2021 tax year; we did not make any quarterly estimated tax payments or income tax extension payments during the three and six months endedJune 30, 2021 as we expected NOL carryforwards to offset any income taxes due. As a result of the CARES Act that was signed into law onMarch 27, 2020 we were permitted to carryback NOLs generated in tax years 2019 and 2020 for up to five years. See further discussion in the Critical Accounting Estimate section under the heading "U.S. Tax Legislation" and Note 7 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. 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 currently anticipate to receive byDecember 31, 2022 . 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 at the acquisition date ofMay 5, 2021 . 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 were approximately$43.0 million as ofJune 30, 2022 . These NOL carryforwards are subject to limitation by Internal Revenue Code Section 382 and will begin to expire in 2035. For additional information on the NORCAL acquisition see Note 2 and Note 7 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. 48
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Table of Contents Investing Activities and Related Cash Flows Our investments atJune 30, 2022 andDecember 31, 2021 are comprised as follows: June 30, 2022 December 31, 2021 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Fixed maturities, available-for-sale U.S. Treasury obligations$ 221,744 5 % $ 238,507 5 % U.S. Government-sponsored enterprise obligations 17,633 1 % 20,234 1 % State and municipal bonds 473,168 10 % 519,196 11 % Corporate debt 1,790,008 39 % 1,898,556 39 % Residential mortgage-backed securities 385,225 9 % 453,941 9 % Commercial mortgage-backed securities 220,427 5 % 245,624 5 % Other asset-backed securities 423,610 9 % 457,664 9 % Total fixed maturities, available-for-sale 3,531,815 78 % 3,833,722 79 % Fixed maturities, trading 45,274 1 % 43,670 1 % Total fixed maturities 3,577,089 79 % 3,877,392 80 % Equity investments(1) 147,612 3 % 214,807 4 % Short-term investments 326,050 7 % 216,987 4 % BOLI 80,818 2 % 81,767 2 % Investment in unconsolidated subsidiaries 321,912 7 % 335,576 7 % Other investments 95,496 2 % 101,794 3 % Total investments$ 4,548,977 100 %$ 4,828,323 100 %
(1) Includes
are not subject to significant equity price risk.
AtJune 30, 2022 , 99% 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: June 30, 2022 December 31, 2021 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Rating* AAA$ 1,003,906 28 %$ 1,129,136 29 % AA+ 123,992 4 % 130,077 3 % AA 228,063 6 % 254,570 7 % AA- 190,500 5 % 194,661 5 % A+ 223,186 6 % 221,473 6 % A 477,788 14 % 521,598 14 % A- 340,456 10 % 364,147 9 % BBB+ 291,713 8 % 292,984 8 % BBB 251,287 7 % 300,650 8 % BBB- 147,935 4 % 127,982 3 % Below investment grade 244,521 7 % 296,444 8 % Not rated 8,468 1 % - - % Total$ 3,531,815 100 %$ 3,833,722 100 %
*Average of three NRSRO sources, presented as an S&P equivalent. Source: S&P, Copyright ©2022, S&P Global Market Intelligence
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A detailed listing of our investment holdings as ofJune 30, 2022 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. In addition to the interest and dividends we will receive from our investments, we anticipate that between$100 million and$120 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 7 of the Notes to Condensed Consolidated Financial Statements. AtJune 30, 2022 , our FAL was comprised of fixed maturity securities with a fair value of$30.0 million and cash and cash equivalents of$0.3 million deposited with Lloyd's. See further discussion in Note 3 of the Notes to Condensed Consolidated Financial Statements. During the second quarter of 2022, we received a return of approximately$5.5 million of cash from our FAL balances given Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 beginning with the 2022 underwriting year as well as the settlement of our participation in the results of Syndicate 1729 and Syndicate 6131 for the 2019 underwriting year. Our investment portfolio continues to be primarily composed of high quality fixed income securities with approximately 92% of our fixed maturities being investment grade securities as determined by national rating agencies. The weighted average effective duration of our fixed maturity securities atJune 30, 2022 was 3.74 years; the weighted average effective duration of our fixed maturity securities combined with our short-term securities was 3.42 years. The carrying value and unfunded commitments for certain of our investments were as follows: Carrying Value June 30, 2022 ($ in thousands, except expected funding December 31, Unfunded Expected funding period) June 30, 2022 2021 Commitment period in years Qualified affordable housing project tax credit partnerships (1)$ 7,207 $ 12,424 $ 287 5 All other investments, primarily investment fund LPs/LLCs 314,705 323,152 148,451 5 Total$ 321,912 $ 335,576 $ 148,738 (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. 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. AtJune 30, 2022 , we had investments in 35 separate investment funds with a total carrying value of$314.7 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.
Treasury Shares
InJuly 2022 , we repurchased approximately 139,000 common shares at a cost of approximately$3.2 million , conducted through a 10b5-1 stock repurchase plan. As ofAugust 3, 2022 , our remaining Board authorization was approximately$106.4 million . 50
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Debt
AtJune 30, 2022 our debt included$250 million of outstanding unsecured senior notes. The notes bear interest at 5.3% annually and are due inNovember 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 onMay 5, 2021 . 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 are subject to deferral if we do not receive permission from theCalifornia Department of Insurance prior to payment. We received permission from theCalifornia Department of Insurance to pay the first annual interest payment which was paid inApril 2022 . See Note 2 and Note 13 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K 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. AtJune 30, 2022 , there were no outstanding borrowings on our Revolving Credit Agreement; we are in compliance with the financial covenants of the Revolving Credit Agreement.
Additional information regarding our debt is provided in Note 7 of the Notes to
Condensed Consolidated Financial Statements.
We utilized an interest rate cap agreement with a notional amount of$35 million to manage our exposure to increases in LIBOR. Per the interest rate cap agreement, we were entitled to receive cash payments if and when the three-month LIBOR exceeds 2.35%. InApril 2022 , we terminated our interest rate cap agreement that was previously utilized to manage our exposure to increases in LIBOR on Mortgage Loans that were fully repaid in 2021. As a result of the termination, we received$2.1 million in proceeds during the second quarter of 2022. See Note 2 of the Notes to Consolidated Financial Statements of ourDecember 31, 2021 report on Form 10-K for additional information on our interest rate cap agreement. Three of our insurance subsidiaries are members of an FHLB. Through membership, those subsidiaries have access to secured cash advances which can be used for liquidity purposes or other operational needs. In order for us to use FHLB proceeds, regulatory approvals may be required depending on the nature of the transaction. To date, those subsidiaries have not materially utilized their membership for borrowing purposes. 51
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Table of Contents Results of Operations - Three and Six Months EndedJune 30, 2022 Compared to Three and Six Months EndedJune 30, 2021 Selected consolidated financial data for each period is summarized in the table below. Three Months EndedJune 30 Six Months EndedJune 30
($ in thousands, except per share
data) 2022 2021 Change 2022 2021 Change Revenues: Net premiums written$ 210,151 $ 188,214 $ 21,937 $ 521,066 $ 390,484 $ 130,582 Net premiums earned$ 247,271 $ 238,993 $ 8,278 $ 512,982 $ 426,351 $ 86,631 Net investment result 27,124 29,344 (2,220) 55,186 51,149 4,037 Net investment gains (losses) (23,884) 10,833 (34,717) (37,390) 19,682 (57,072) Other income 5,314 2,458 2,856 8,119 4,462 3,657 Total revenues 255,825 281,628 (25,803) 538,897 501,644 37,253 Expenses: Net losses and loss adjustment expenses 177,670 181,852 (4,182) 387,093 331,636 55,457 Underwriting, policy acquisition and operating expenses 77,333 77,188 145 149,109 133,638 15,471 SPCU.S. federal income tax expense 349 504 (155) 991 860 131 SPC dividend expense (income) (854) 2,864 (3,718) 1,513 4,606 (3,093) Interest expense 4,919 5,176 (257) 9,360 8,389 971 Total expenses 259,417 267,584 (8,167) 548,066 479,129 68,937 Gain on bargain purchase - 74,408 (74,408) - 74,408 (74,408)
Income (loss) before income taxes (3,592) 88,452 (92,044)
(9,169) 96,923 (106,092) Income tax expense (benefit) (1,933) (3,598) 1,665 (3,950) (2,862) (1,088) Net income (loss)$ (1,659) $ 92,050 $ (93,709) $ (5,219) $ 99,785 $ (105,004)
Non-GAAP operating income (loss)
$ 24,008 $ 28,688 $ (4,680) Earnings (loss) per share: Basic$ (0.03) $ 1.71 $ (1.74) $ (0.10) $ 1.85 $ (1.95) Diluted$ (0.03) $ 1.70 $ (1.73) $ (0.10) $ 1.85 $ (1.95) Non-GAAP operating income (loss) per share: Basic$ 0.30 $ 0.49 $ (0.19) $ 0.44 $ 0.53 $ (0.09) Diluted$ 0.30 $ 0.49 $ (0.19) $ 0.44 $ 0.53 $ (0.09) Net loss ratio 71.9 % 76.1 % (4.2 pts) 75.5 % 77.8 % (2.3 pts) Underwriting expense ratio 31.3 % 32.3 % (1.0 pts) 29.1 % 31.3 % (2.2 pts) Combined ratio 103.2 % 108.4 % (5.2 pts) 104.6 % 109.1 % (4.5 pts) Operating ratio 94.3 % 101.1 % (6.8 pts) 96.3 % 101.5 % (5.2 pts) Effective tax rate 53.8 % (4.1 %) 57.9 pts 43.1 % (3.0 %) 46.1 pts Return on equity* (0.4 %) 9.0 % (9.4 pts) (0.7 %) 5.0 % (5.7 pts) Non-GAAP operating return on equity* 5.3 % 8.0 % (2.7 pts) 3.7 % 4.3 % (0.6 pts)
*Annualized. See further discussion on this calculation in the Executive Summary of Operations section under the heading "Non-GAAP
Operating ROE."
In all tables that follow, the abbreviation "nm" indicates that the information or the percentage change is not meaningful.
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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 three and six months ended
compared to the three and six months ended
Results sections that follow for additional information regarding each segment's
results.
Revenues
The following table shows our consolidated and segment net premiums earned:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net premiums earned
Specialty P&C $ 183,547 $ 168,635 $ 14,912 8.8 % $ 381,514 $ 284,249 $ 97,265 34.2 %
Workers' Compensation
Insurance 41,709 40,626 1,083 2.7 % 82,393 80,636 1,757 2.2 %
Segregated Portfolio
Cell Reinsurance 16,222 16,272 (50) (0.3 %) 35,536 32,156 3,380 10.5 %
Lloyd's Syndicates 5,793 13,460 (7,667) (57.0 %) 13,539 29,310 (15,771) (53.8 %)
Consolidated total $ 247,271 $ 238,993 $ 8,278 3.5 % $ 512,982 $ 426,351 $ 86,631 20.3 %
For the three and six months ended June 30, 2022 , consolidated net premiums
earned included earned premium from our acquisition of NORCAL of approximately
$71.0 million and $151.9 million , respectively, as compared to $48.5 million
during both the three and six months ended June 30, 2021 . Excluding NORCAL
premiums, our consolidated net premiums earned decreased for the three and six
months ended June 30, 2022 by $14.3 million and $16.8 million , respectively, as
compared to the same respective periods of 2021 driven by a decrease in net
premiums earned in our Lloyd's Syndicates and Specialty P&C segments, partially
offset by an increase in net premiums earned in our Workers' Compensation
Insurance segment. The decrease in our Lloyd's Syndicates segment for the three
and six months ended June 30, 2022 was due to our decreased participation in the
results of Syndicate 1729 and Syndicate 6131 for the 2021 underwriting year and,
to a lesser extent, our ceased participation in Syndicate 6131 for the 2022
underwriting year. In the second quarter of 2021, we wrote a tail policy which
resulted in $7.8 million of one-time premium written and fully earned at that
time. The non-recurrence of this one-time transaction was the largest impact to
the decline in earned premium for our legacy Specialty P&C business. The
decrease in net premiums earned in our Specialty P&C segment also reflected the
effect of an adjustment made during the second quarter of 2022 to ceded premiums
owed under reinsurance agreements related to prior accident year losses; no such
adjustments were made during the same respective period of 2021. For our
Workers' Compensation Insurance segment, the increase in net premiums earned
during the 2022 three- and six-month periods reflected an increase in audit
premiums billed to policyholders and, for the 2022 six-month period, the prior
year effect of a $1.2 million reduction in our EBUB estimate during the first
quarter of 2021. Net premiums earned in our Segregated Portfolio Cell
Reinsurance segment remained relatively unchanged for the 2022 three-month
period and increased for the 2022 six-month period driven by tail coverage
premiums primarily related to one program in which we do not participate, which
resulted in $3.0 million of one-time premium written and fully earned during the
first quarter of 2022.
The following table shows our consolidated net investment result:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net investment income $ 21,944 $ 17,417 $ 4,527 26.0 % $ 42,387 $ 32,434 $ 9,953 30.7 %
Equity in earnings (loss)
of unconsolidated
subsidiaries* 5,180 11,927 (6,747) (56.6 %) 12,799 18,715 (5,916) (31.6 %)
Net investment result $ 27,124 $ 29,344 $ (2,220) (7.6 %) $ 55,186 $ 51,149 $ 4,037 7.9 %
*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.
The increase in our consolidated net investment income for the three and six
months ended June 30, 2022 as compared to the same respective periods of 2021
was driven by the addition of NORCAL's investment portfolio and also reflected
higher average book yields as we continue to reinvest at higher rates as our
portfolio matures. Furthermore, the increase in net investment income during the
2022 three- and six-month periods reflected the prior year impact of capital
planning in anticipation of closing the NORCAL acquisition. Equity in earnings
of unconsolidated subsidiaries decreased for the three and six months ended
June 30, 2022 as compared to the same respective periods of 2021 driven by lower
reported earnings from a
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few LP investments, which are primarily reported to us on a one-quarter lag and reflected market volatility during the first quarter of 2022, partially offset by lower amortization of tax credit partnership operating losses.
The following table shows our consolidated other income:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Other income $ 5,314 $ 2,458 $ 2,856 116.2 % $ 8,119 $ 4,462 $ 3,657 82.0 %
The increase in consolidated other income for the 2022 three- and six-month
periods was driven by the effect of foreign currency exchange rate changes of
$2.7 million and $3.1 million , respectively, in our Corporate segment related to
foreign currency denominated loss reserves associated with premium assumed from
an international medical professional liability insured in our Specialty P&C
segment. We mitigate foreign exchange exposure by generally matching the
currency and duration of associated investments to the corresponding loss
reserves. In accordance with GAAP, the impact on the market value of available
for sale fixed maturities due to changes in foreign currency exchange rates is
reflected as part of OCI. Conversely, the impact of changes in foreign currency
exchange rates on loss reserves is reflected through net income as a component
of other income. The effect of exchange rate changes on foreign currency
denominated loss reserves are reported in our Corporate segment to be consistent
with the reporting of the foreign currency denominated invested assets and
associated investment income.
Expenses
The following table shows our consolidated and segment net loss ratios and net
prior accident year reserve development.
Three Months Ended June 30 Six Months Ended June 30
($ in millions) 2022 2021 Change 2022 2021 Change
Current accident year net loss ratio
Consolidated ratio 79.5 % 81.9 % (2.4 pts) 80.2 % 82.2 % (2.0 pts)
Specialty P&C 84.1 % 89.4 % (5.3 pts) 85.0 % 89.6 % (4.6 pts)
Workers' Compensation Insurance 71.8 % 73.0 % (1.2 pts) 71.8 % 72.0 % (0.2 pts)
Segregated Portfolio Cell
Reinsurance 70.7 % 62.9 % 7.8 pts 67.3 % 65.8 % 1.5 pts
Lloyd's Syndicates 14.1 % 37.2 % (23.1 pts) 29.9 % 56.1 % (26.2 pts)
Calendar year net loss ratio
Consolidated ratio 71.9 % 76.1 % (4.2 pts) 75.5 % 77.8 % (2.3 pts)
Specialty P&C 74.6 % 83.1 % (8.5 pts) 79.4 % 84.9 % (5.5 pts)
Workers' Compensation Insurance 67.0 % 68.3 % (1.3 pts) 66.9 % 66.9 % - pts
Segregated Portfolio Cell
Reinsurance 57.2 % 51.9 % 5.3 pts 58.4 % 55.6 % 2.8 pts
Lloyd's Syndicates 59.5 % 40.4 % 19.1 pts 60.7 % 62.8 % (2.1 pts)
Favorable (unfavorable) reserve
development, prior accident years
Consolidated $ 19.0 $ 13.8 $ 5.2 $ 24.3 $ 18.6 $ 5.7
Specialty P&C $ 17.4 $ 10.5 $ 6.9 $ 21.3 $ 13.2 $ 8.1
Workers' Compensation Insurance $ 2.0 $ 1.9 $ 0.1 $ 4.0 $ 4.1 $ (0.1)
Segregated Portfolio Cell
Reinsurance $ 2.2 $ 1.8 $ 0.4 $ 3.2 $ 3.3 $ (0.1)
Lloyd's Syndicates $ (2.6) $ (0.4) $ (2.2) $ (4.2) $ (2.0) $ (2.2)
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The primary drivers of the change in our consolidated current accident year net loss ratio for the three and six months endedJune 30, 2022 as compared to the same respective periods of 2021 were as follows: Increase (Decrease) 2022 versus 2021 Comparative Comparative three-month six-month (In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Operations
(1.6 pts) 0.2 pts NORCAL Acquisition - Purchase Accounting Amortization (0.2 pts) (0.5 pts) Change in Estimate of ULAE (2.6 pts) (2.6 pts) Custom Physician Tail Policy 0.6 pts 0.3 pts Ceded Premium Adjustments, Prior Accident Years 1.0 pts 0.5 pts SPCs Estimated Aggregate Reinsurance 0.5 pts 0.4 pts All other, net (0.1 pts) (0.3 pts)
Decrease in the consolidated current accident year net loss
ratio
(2.4 pts) (2.0 pts) •Excluding the impact of the items specifically identified in the table above, our consolidated current accident year net loss ratios for the three and six months endedJune 30, 2022 decreased 0.1 and 0.3 percentage points, respectively, as compared to the same respective periods of 2021 driven by our Specialty P&C, Lloyd'sSyndicates and Workers' Compensation Insurance segments. The improvement in the current accident year net loss ratios in our Specialty P&C segment for the three and six months endedJune 30, 2022 was driven by a decrease to certain expected loss ratios in our Standard Physician line of business primarily reflecting the improvement in pricing and terms that we have obtained in our estimate of expected losses, which we began recognizing in the second half of 2021, somewhat offset by changes in the mix of business. For our Lloyd's Syndicates segment, the lower current accident year net loss ratios for the 2022 three- and six-month periods were driven by decreases to certain loss estimates during the first quarter of 2022, partially offset by lower reinsurance recoveries as a proportion of gross losses as compared to the prior year periods. The improvement in the current accident year net loss ratios in ourWorkers' Compensation Insurance segment for the three and six months endedJune 30, 2022 primarily reflected an improvement in loss frequency and severity trends, partially offset by the continuation of intense price competition and the resulting renewal rate decreases. •As shown in the previous table, initial loss ratios associated with NORCAL policies are higher than the average for the other books of business in our Specialty P&C segment; however, we reduced certain expected NORCAL loss ratios during the fourth quarter of 2021 due to favorable frequency trends which resulted in a 1.6 percentage point decrease in our consolidated current accident year net loss ratio for the three months endedJune 30, 2022 as compared to the prior year quarter. For the six months endedJune 30, 2022 , the impact of NORCAL's higher initial loss ratios also resulted in a 0.2 percentage point increase in our consolidated current accident year net loss ratio as compared to the same respective prior year period due to a higher volume of NORCAL premium in the current year. Also as a result of our acquisition of NORCAL, our consolidated current accident year net loss ratios were impacted by the 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 0.2 and 0.5 percentage point decrease, respectively, in our current period ratios as compared to the prior year. As ofJune 30, 2022 , the negative VOBA associated with NORCAL's assumed unearned premium has been fully amortized. •Beginning in 2022, we revised our process of estimating ULAE in our Specialty P&C segment as a result of substantially integrating NORCAL into our operations, which accounted for a 2.6 percentage point decrease in our consolidated current accident year net loss ratios for the three and six months endedJune 30, 2022 with an offsetting 2.6 percentage point increase in our consolidated expense ratios for the same current periods with no impact to our consolidated combined ratios, total expenses or net income. See additional information on this change in ULAE estimate in the Segment Results - Specialty Property and Casualty section that follows. •Our consolidated current accident year net loss ratios for the 2021 three- and six-month periods were also impacted by a large Custom Physician tail policy written and fully earned in our Specialty P&C segment during the second quarter of 2021 ($7.8 million of net premiums earned with a lower loss ratio than the Specialty P&C segment's average initial loss ratio), which accounted for a decrease of 0.6 and 0.3 percentage points, respectively, to the prior year ratios. 55
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•During the 2022 three- and six-month periods, we increased our estimates of
premiums owed under swing rated reinsurance agreements related to prior accident
years in our Specialty P&C segment which decreased net premium earned (the
denominator of the current accident year net loss ratio) and accounted for a 1.0
and 0.5 percentage point increase, respectively, in our consolidated current
period ratios. No such adjustments were made during the 2021 three- and
six-month periods. See the Segment Results - Specialty Property and Casualty
section that follows under the heading "Ceded Premiums Written" for additional
information.
•Furthermore, our consolidated current accident year net loss ratios for the
2022 three- and six-month periods reflected the effects of a decrease in our
estimate of aggregate reinsurance under the workers' compensation programs in
our Segregated Portfolio Cell Reinsurance segment, which accounted for an
increase of 0.5 and 0.4 percentage points, respectively, in the current period
ratios as compared to the prior year periods. The decrease in the estimated
aggregate reinsurance reflected an improvement in expected ultimate program year
losses in certain programs.
In both the 2022 and 2021 three- and six-month periods, our consolidated
calendar year net loss ratios were lower than our consolidated current accident
year net loss ratios due to the recognition of net favorable prior year reserve
development, as shown in the previous table. The following table shows our
consolidated current net prior accident year reserve development:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net favorable reserve
development $ 16,074 $ 11,658 $ 4,416 37.9 % $ 18,505 $ 16,507 $ 1,998 12.1 %
NORCAL Acquisition - Purchase
Accounting Amortization* 2,900 2,109 791 37.5 % 5,799 2,109 3,690 175.0 %
Total net favorable reserve
development $ 18,974 $ 13,767 $ 5,207 37.8 % $ 24,304 $ 18,616 $ 5,688 30.6 %
*See Note 2 of the Notes to Consolidated Financial Statements in our
amortization of the NORCAL acquisition purchase accounting adjustments.
•We reduced our prior accident year IBNR reserve for COVID-19 by$3.0 million during the second quarter of 2022 as early first notices of potential claims related to anticipated COVID losses have not turned into claims. See additional discussion on the COVID-19 IBNR reserve in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses" in ourDecember 31, 2021 report on Form 10-K. •Development recognized in our Specialty P&C segment during the 2022 three- and six-month periods principally related to accident years 2018 through 2021. We have not recognized any development related to NORCAL's prior accident year reserves since the date of acquisition onMay 5, 2021 . •For ourWorkers' Compensation Insurance and Segregated Portfolio Cell Reinsurance segments, the net favorable development recognized during the three and six months endedJune 30, 2022 reflected overall favorable trends in claim closing patterns. •We recognized$2.6 million and$4.2 million of unfavorable prior year development in our Lloyd's Syndicates segment during the three and six months endedJune 30, 2022 , respectively, driven by higher than expected losses and development on certain large claims, primarily catastrophe related losses. 56
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Our consolidated and segment underwriting expense ratios were as follows:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Underwriting Expense Ratio
Consolidated (1) 31.3 % 32.3 %
(1.0 pts) 29.1 % 31.3 % (2.2 pts)
Specialty P&C 26.2 % 17.1 % 9.1 pts 23.8 % 19.4 % 4.4 pts
Workers' Compensation Insurance 32.8 % 31.3 % 1.5 pts 32.4 % 31.0 % 1.4 pts
Segregated Portfolio Cell
Reinsurance 32.3 % 32.5 % (0.2 pts) 27.0 % 32.1 % (5.1 pts)
Lloyd's Syndicates 26.0 % 35.1 % (9.1 pts) 31.2 % 38.6 % (7.4 pts)
Corporate (2) 3.6 % 2.5 % 1.1 pts 3.5 % 2.9 % 0.6 pts
(1) Consolidated underwriting expenses include 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 11 of the Notes to Condensed
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 2022 three-
and six-month periods as compared to the same respective periods of 2021 was
primarily attributable to the following:
Increase (Decrease)
2022 versus 2021
Comparative Comparative six-month
(In percentage points) three-month period period
Estimated ratio increase (decrease) attributable to:
Change in Net Premiums Earned and DPAC amortization(1)
(0.1 pts) (0.5 pts)
NORCAL DPAC Amortization - Prior Period Purchase Accounting
Impact
2.6 pts 1.5 pts Change in Estimate of ULAE 2.6 pts 2.6 pts Tail Premium(2) 1.1 pts 0.3 pts Transaction-related Costs(3) (8.2 pts) (4.6 pts) All other, net 1.0 pts (1.5 pts) Decrease in the underwriting expense ratio (1.0 pts) (2.2 pts) (1) Excludes tail premium. (2) Represents the effect of the change in premium earned from tail policies as there is typically minimal deferred acquisition costs associated with tail premium (see further discussion in the Segment Results - Specialty Property and Casualty and Segregated Portfolio Cell Reinsurance sections that follow). (3) Represents transaction-related costs associated with our acquisition of NORCAL of$0.7 million and$1.9 million for the three and six months endedJune 30, 2022 , respectively, as compared to$20.3 million and$21.2 million for the same respective periods of 2021. While these costs are included in our consolidated results, they are not allocated to an individual segment as we do not consider these costs in assessing the financial performance of any of our operating or reportable segments. See Note 11 of the Notes to Condensed Consolidated Financial Statements for a reconciliation of our segment results to our consolidated results. •Excluding the impact of the items specifically identified in the table above, our consolidated underwriting expense ratio for the three and six months endedJune 30, 2022 increased by 1.0 percentage points and decreased by 1.5 percentage points, respectively, as compared to the same respective prior year periods. The increase in our consolidated underwriting expense ratio for the 2022 three-month period was primarily driven by an increase in operating expenses due to higher professional fees and higher amounts accrued for performance-related incentive plans due to our improved combined ratio and other performance metrics in our Specialty P&C segment. Furthermore, our consolidated underwriting expense ratio for the 2022 three-month period reflected an increase in compensation-related costs, business-related travel and marketing in ourWorkers' Compensation Insurance segment. The decrease in our consolidated underwriting expense ratio for the 2022 six-month period was driven by lower operating expenses due to the benefits from prior organizational restructurings and proactive expense management as well as expense synergies recognized from the NORCAL acquisition in our Specialty P&C segment. The decrease in the 2022 six-month period ratio also reflected the change in our allowance for expected credit losses in our Segregated Portfolio Cell Reinsurance segment related to the collection of customer accounts that were previously written off. 57
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•As shown in the previous table, our consolidated underwriting expense ratios for both the 2022 three- and six-month periods are higher as compared to the same respective periods of 2021 reflecting the impact of lower DPAC amortization than would have otherwise been recognized associated with NORCAL policies during each of the 2021 three- and six-month periods due to the application of GAAP purchase accounting rules in 2021. Under these purchase accounting rules, the capitalized policy acquisition costs for NORCAL policies written prior to the acquisition date were written off through purchase accounting onMay 5, 2021 rather than being expensed pro rata over the remaining term of the associated policies (see Note 2 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K for more information). DPAC amortization in our Specialty P&C segment for the 2022 three-month period included a more normalized level of amortization associated with NORCAL policies whereas the 2022 six-month period was approximately$1.0 million lower than would have otherwise been recognized. Normalizing the prior year amortization would have increased our consolidated underwriting expense ratios for the 2021 three- and six-month periods by 2.6 and 1.5 percentage points, respectively. •As shown in the previous table, the consolidated underwriting expense ratios for the three and six months endedJune 30, 2022 reflected a revision to our process of estimating ULAE which resulted in approximately$6.3 million and$13.6 million , respectively, of expenses remaining in operating expenses instead of being allocated to net losses and loss adjustment expenses. As a result, this change in ULAE estimate had offsetting impacts to our consolidated loss and expense ratios during the same periods with no impact to our consolidated combined ratio, total expenses or net income. See additional discussion on this change in ULAE estimate in the Segment Results - Specialty Property and Casualty section that follows. Gain on Bargain Purchase As a result of the NORCAL acquisition, we recognized a gain on bargain purchase of$74.4 million during the second quarter of 2021 representing the excess of the fair value of the identifiable assets acquired and liabilities assumed over the purchase consideration. We do not consider this gain in assessing the financial performance of any of our operating or reportable segments and therefore, we excluded it from the Segment Results sections that follow. See further discussion around the gain on bargain purchase recognized from the NORCAL acquisition in Note 2 of the Notes to Consolidated Financial Statements included in ourDecember 31, 2021 report on Form 10-K.
Taxes
Our provision for income taxes and effective tax rates for the six months ended
Six Months Ended
($ in thousands) 2022 2021
Change
Income (loss) before income taxes
Less: Income tax expense (benefit) (3,950) (2,862) (1,088) (38.0 %)
Net income (loss) $ (5,219) $ 99,785 $
(105,004) (105.2 %)
Effective tax rate 43.1% (3.0%)
46.1 pts
We recognized an income tax benefit of$3.9 million and$2.9 million during the six months endedJune 30, 2022 and 2021, respectively; however, the comparability of our effective tax rates is impacted by the consolidated pre-tax loss recognized during the 2022 six-month period as compared to consolidated pre-tax income recognized in the 2021 six-month period. Our effective tax rates for both the 2022 and 2021 six-month periods were different from the statutory federal income tax rate of 21% due to the benefit recognized from the tax credits transferred to us from our tax credit partnership investments. Additionally, our effective tax rate for the 2021 six-month period was different from the statutory federal income tax rate of 21% due to the non-taxable$74.4 million gain on bargain purchase related to the NORCAL acquisition, as previously discussed. See further discussion of other notable items impacting our effective tax rate in the Segment Operating Results - Corporate section that follows under the heading "Taxes." 58
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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 three and six months ended
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Combined ratio 103.2 % 108.4 % (5.2 pts) 104.6 % 109.1 % (4.5 pts)
Less: investment income ratio 8.9 % 7.3 % 1.6 pts 8.3 % 7.6 % 0.7 pts
Operating ratio 94.3 % 101.1 % (6.8 pts) 96.3 % 101.5 % (5.2 pts)
Combined ratio, excluding
transaction-related costs* 102.9 % 99.9 % 3.0 pts 104.3 % 104.2 % 0.1 pts
*Our consolidated combined ratios for the 2022 three- and six-month periods includes
transaction-related costs included in consolidated operating expenses associated with our acquisition of NORCAL as compared to
our calculation of the consolidated combined ratio. See previous discussion under the heading "Expenses."
The primary drivers of the change in our operating ratios were as follows:
Increase (Decrease)
2022 versus 2021
Comparative Comparative
three-month six-month
(In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Acquisition - Purchase Accounting Amortization (0.5 pts) (1.2 pts) Investment Results (1.6 pts) (0.7 pts) Transaction-related Costs (8.2 pts) (4.6 pts)
NORCAL DPAC Amortization - Prior Period Purchase Accounting
Impact
2.6 pts 1.5 pts
All other, net 0.9 pts (0.2 pts)
Decrease in the operating ratio (6.8 pts) (5.2 pts)
Excluding the impact of the items specifically identified in the table above,
our operating ratio for the 2022 three-month period increased by 0.9 percentage
points and remained essentially unchanged for the 2022 six-month period as
compared to the same respective periods of 2021. The increase in our operating
ratio for the 2022 three-month period was primarily due to a higher net loss
ratio in our Segregated Portfolio Cell Reinsurance segment driven by the change
in aggregate reinsurance recoveries, partially offset by an improvement in our
net loss ratio in our Specialty P&C segment driven by a decrease to certain loss
ratios in our Standard Physician line of business, which we began recognizing in
the second half of 2021. See previous discussion in this section under the
heading "Expenses" and further discussion in our Segment Operating Results
sections that follow.
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Non-GAAP Financial Measures
Non-GAAP Operating Income (Loss)
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):
Three Months Ended Six Months Ended
June 30 June 30
(In thousands, except per share data) 2022 2021 2022 2021
Net income (loss) $ (1,659) $ 92,050 $ (5,219) $ 99,785
Items excluded in the calculation of Non-GAAP operating
income (loss):
Net investment (gains) losses 23,884 (10,833) 37,390 (19,682)
Net investment gains (losses) attributable to SPCs
which no profit/loss is retained (1)
(2,198) 1,275 (2,800) 2,065 Transaction-related costs (2) 685 20,282 1,862 21,208 Guaranty fund assessments (recoupments) 113 130 125 133 Gain on bargain purchase (3) - (74,408) - (74,408) Pre-tax effect of exclusions 22,484 (63,554) 36,577 (70,684) Tax effect, at 21% (4) (4,497) (1,894) (7,350) (413) After-tax effect of exclusions 17,987 (65,448) 29,227 (71,097) Non-GAAP operating income (loss)$ 16,328 $ 26,602 $ 24,008 $ 28,688 Per diluted common share: Net income (loss)$ (0.03) $ 1.70 $ (0.10) $ 1.85 Effect of exclusions 0.33 (1.21) 0.54 (1.32)
Non-GAAP operating income (loss) per diluted common
share
$ 0.30 $ 0.49 $ 0.44 $ 0.53 (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 annual expected statutory tax rate associated with the taxable or tax deductible items listed above. We utilized the discrete effective tax rate method for the three and six months endedJune 30, 2022 and 2021. Our statutory tax rate was applied to these items in calculating net income (loss), excluding the 2021 gain on bargain purchase and net realized gains (losses) and related adjustments. Net investment gains (losses) in our Corporate segment are treated as discrete items and are tax effected at the annual expected statutory tax rate (21%) in the period they are included in our consolidated tax provision and net income (loss). 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. 60
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Non-GAAP Operating ROE
Non-GAAP operating ROE is a financial measure that is calculated as annualized Non-GAAP operating income (loss) for the period divided by the average of beginning and ending total GAAP shareholders' equity. As previously discussed, in calculating Non-GAAP operating income (loss), we have excluded the effects of certain items that do not reflect normal results. Non-GAAP operating ROE measures the overall after-tax profitability of our insurance operations and shows how efficiently capital is being used; however, it should be considered in conjunction with ROE computed in accordance with GAAP. The following table is a reconciliation of ROE to Non-GAAP operating ROE for the three and six months endedJune 30, 2022 and 2021: Three Months Ended Six Months Ended June 30 June 30 2022 2021 Change 2022 2021 Change ROE(1) (0.4 %) 9.0 % (9.4 pts) (0.7 %) 5.0 % (5.7 pts) Pre-tax effect of items excluded in the calculation of Non-GAAP operating ROE 7.2 % (0.4 %) 7.6 pts 5.5 % (0.6 %) 6.1 pts Tax effect, at 21%(2) (1.5 %) (0.6 %) (0.9 pts) (1.1 %) (0.1 %) (1.0 pts) Non-GAAP operating ROE 5.3 % 8.0 % (2.7 pts) 3.7 % 4.3 % (0.6 pts) (1) The$74.4 million gain on bargain purchase recognized during the second quarter of 2021 was excluded in our calculation of ROE for the three and six months endedJune 30, 2021 consistent with our treatment of gains on bargain purchases from previous acquisitions. Further, transaction-related costs associated with our acquisition of NORCAL were not annualized in our quarterly calculation of ROE for the three and six months endedJune 30, 2022 and 2021 as these costs are considered non-recurring in nature. (2) The 21% rate is the annual expected statutory tax rate associated with the taxable or tax deductible items. See further discussion in footnote 4 in this section under the heading "Non-GAAP Operating Income." Non-GAAP operating ROE was impacted by the amortization of purchase accounting adjustments during the 2022 and 2021 three- and six-month periods associated with our acquisition of NORCAL, which increased our Non-GAAP operating ROE by 0.6 and 1.1 percentage points for the 2022 three- and six-month periods, respectively, as compared to the same respective periods of 2021. See Note 2 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K for additional information on the NORCAL acquisition and the related purchase accounting adjustments. Excluding the purchase accounting amortization, Non-GAAP operating ROE for the 2022 three- and six-month periods decreased by 3.3 and 1.7 percentage points, respectively, largely due to a lower amount of prior year DPAC amortization associated with NORCAL policies than would have otherwise been recognized during the 2021 three- and six-month periods due to the application of GAAP purchase accounting rules (see previous discussion under the heading "Expenses"). Furthermore, the decrease in ROE for the 2022 three- and six-month periods reflected a decrease in our investment results from our portfolio of investments in LPs/LLCs and unfavorable prior year development in our Lloyd's Syndicates segment. See previous discussion in this section under the heading "Revenues" and further discussion in our Segment Operating Results sections that follow. 61
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Non-GAAP Adjusted Book Value per Share
Book value per share is calculated as total GAAP shareholders' equity divided by the total number of common shares outstanding at the balance sheet date. This ratio measures the net worth of the Company to shareholders on a per share basis. Non-GAAP adjusted book value per share is a Non-GAAP measure widely used within the insurance sector and is calculated as shareholders' equity, excluding AOCI, divided by the total number of common shares outstanding at the balance sheet date. This Non-GAAP calculation measures the net worth of the Company to shareholders on a per share basis excluding AOCI to eliminate the temporary and potentially significant effects of fluctuations in interest rates on our fixed income portfolio; however, it should be considered in conjunction with book value per share computed in accordance with GAAP. The increase in interest rates during 2022 lead to significant unrealized holding losses on our available-for-sale fixed maturity investments resulting in volatility in AOCI. See Note 8 of the Notes to Condensed Consolidated Financial Statements for additional information.
The following table is a reconciliation of our book value per share to Non-GAAP
adjusted book value per share at
Book Value Per Share
Book Value Per Share at December 31, 2021 $ 26.46
Less: AOCI Per Share 0.30
Non-GAAP Adjusted Book Value Per Share at December 31, 2021 26.16
Increase (decrease) to Adjusted Book Value Per Share during the six
months ended June 30, 2022 attributable to:
Dividends declared (0.10)
Net income (loss) (0.10)
Non-GAAP Adjusted Book Value Per Share at June 30, 2022 $ 25.96
Add: AOCI Per Share (4.33)
Book Value Per Share at June 30, 2022 $ 21.63
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Table of Contents Segment Results - Specialty Property & Casualty Our Specialty P&C segment focuses on professional liability insurance and medical technology liability insurance as discussed in Note 18 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. 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 in ourDecember 31, 2021 report on Form 10-K provides additional information regarding this acquisition). Segment results reflected pre-tax underwriting profit or loss from these insurance lines and included the amortization of certain purchase accounting adjustments. Segment results for the three and six months endedJune 30, 2022 and 2021 exclude transaction-related costs associated with our acquisition of NORCAL as we do not consider these costs in assessing the financial performance of the segment. Segment results included the following: Three Months Ended June 30 Six Months Ended June 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Net premiums written $ 150,015$ 127,434 $ 22,581 17.7 % $ 384,853$ 248,747 $ 136,106 54.7 % Net premiums earned $ 183,547$ 168,635 $ 14,912 8.8 % $ 381,514$ 284,249 $ 97,265 34.2 % Other income 1,903 1,471 432 29.4 % 2,924 1,939 985 50.8 % Net losses and loss adjustment expenses (137,002) (140,214) 3,212 (2.3 %) (302,960) (241,400) (61,560) 25.5 % Underwriting, policy acquisition and operating expenses (48,077) (28,877) (19,200) 66.5 % (90,958) (55,223) (35,735) 64.7 % Segment results $ 371 $ 1,015$ (644) (63.4 %) $ (9,480)$ (10,435) $ 955 9.2 % Net loss ratio 74.6% 83.1% (8.5 pts) 79.4% 84.9% (5.5 pts) Underwriting expense ratio 26.2% 17.1% 9.1 pts 23.8% 19.4% 4.4 pts Premiums Written Changes in our premium volume within our Specialty P&C segment are generally driven by three primary factors: (1) the amount of new business written, (2) our retention of existing business and (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. In addition, premium volume may periodically be affected by shifts in the timing of renewals between periods. For the three and six months endedJune 30, 2022 , our premium volume was primarily affected by our acquisition of NORCAL. The medical 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, therefore, are 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 capacity. The medical professional liability market has been particularly affected by these cycles. Underwriting cycles are driven, among other reasons, by excess capacity available to compete for the business. Changes in the frequency and severity of losses may also 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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021
Change
Gross premiums written
18.1 %$ 425,433 $ 280,323 $ 145,110 51.8 % Less: Ceded premiums written 17,745 14,601 3,144 21.5 % 40,580 31,576 9,004 28.5 % Net premiums written$ 150,015 $ 127,434 $ 22,581 17.7 %$ 384,853 $ 248,747 $ 136,106 54.7 % 63
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Gross Premiums Written
Gross premiums written by component were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Professional Liability
HCPL
Standard Physician(1)(12) $ 43,689 $ 49,734 $ (6,045) (12.2 %) $ 96,342 $ 102,351 $ (6,009) (5.9 %)
NORCAL Standard Physician(2) 39,082 16,340 22,742 139.2 % 145,558 16,340 129,218 790.8 %
Total Standard Physician 82,771 66,074 16,697 25.3 % 241,900 118,691 123,209 103.8 %
Specialty
Custom Physician(3) 12,449 6,755 5,694 84.3 % 19,856 22,592 (2,736) (12.1 %) NORCAL Custom Physician(4) 4,399 1,205 3,194 265.1 % 16,037 1,205 14,832 1,230.9 % Hospitals and Facilities(5) 10,969 10,410 559 5.4 % 25,166 26,751 (1,585) (5.9 %) NORCAL Hospitals and Facilities(6) 5,401 2,387 3,014 126.3 % 8,468 2,387 6,081 254.8 % Senior Care(7)(12) 177 719 (542) (75.4 %) 4,670 5,760 (1,090) (18.9 %) Reinsurance assumed(8) 8,128 4,090 4,038 98.7 % 17,889 14,527 3,362 23.1 % Total Specialty 41,523 25,566 15,957 62.4 % 92,086 73,222 18,864 25.8 % Total HCPL 124,294 91,640 32,654 35.6 % 333,986 191,913 142,073 74.0 % Small Business Unit(9) 22,982 23,178 (196) (0.8 %) 45,501 45,944 (443) (1.0 %) Tail Coverages(10)(12) 5,521 13,318 (7,797) (58.5 %) 15,359 21,456 (6,097) (28.4 %) NORCAL Tail Coverages(10) 3,832 2,450 1,382 56.4 % 11,565 2,450 9,115 372.0 % Total Professional Liability 156,629 130,586 26,043 19.9 % 406,411 261,763 144,648 55.3 % Medical Technology Liability(11) 10,913 11,194 (281) (2.5 %) 18,613 18,178 435 2.4 % Other 218 255 (37) (14.5 %) 409 382 27 7.1 %
Total Gross Premiums Written
18.1 %$ 425,433 $ 280,323 $ 145,110 51.8 % (1) Standard Physician premium, exclusive of NORCAL, decreased for the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by retention losses and, to a lesser extent, the shifting of certain policies totaling$2.7 million and$4.2 million , respectively, from our Standard Physician line to our Custom Physician line of business. Partially offsetting these factors during the 2022 three- and six-month periods was an increase in renewal pricing and new business written. Renewal pricing increases during the 2022 three- and six-month periods reflect the rising loss cost environment and new business written reflects the competitive market conditions. Retention losses during the 2022 three- and six-month periods generally reflect our underwriting strategy 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. Our underwriting and strategic planning process includes a continual evaluation of venues, specialties and other areas to improve our underwriting results. Retention losses during the 2022 six-month period also reflected the loss of a$2.0 million policy that chose to utilize self-insurance as well as the loss of a$1.0 million policy due to price competition. (2) NORCAL Standard Physician premium represents premium contributed by NORCAL since the date of acquisition and is comprised of twelve month term policies and, to a lesser extent, three month term policies. NORCAL Standard Physician premium increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by one month of additional premium for the 2022 three-month period and four months of additional premium for the 2022 six-month period as compared to the same respective periods of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, NORCAL Standard Physician premium increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 due to an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses. In addition, retention for the 2022 three- and six-month periods reflects the process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. 64
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(3) Custom Physician premium includes large physician groups, multi-state physician groups and non-standard physicians and is written primarily on an excess and surplus lines basis. The increase in Custom Physician premium during the 2022 three-month period as compared to the same period of 2021 was driven by an increase in renewal pricing, and, to a lesser extent, new business written, partially offset by retention losses, including the loss of a$1.7 million policy due to the consolidation of an insured with a larger entity which is not insured by us. Custom Physician premium decreased for the 2022 six-month period as compared to the same period of 2021 driven by retention losses, partially offset by an increase in renewal pricing and, to a lesser extent, new business written. Additionally, Custom Physician premium during the 2022 three- and six-month periods reflected the shifting of certain policies totaling$2.7 million and$4.2 million , respectively, to our Custom Physician line from our Standard Physician line of business. Renewal pricing increases for the 2022 three- and six-month periods reflect pricing actions taken in response to a rising loss cost environment and new business written reflects the competitive market conditions. The retention rate in our Custom Physician book for the 2022 six-month period reflects the impact of the loss of two large policies totaling$9.0 million due to the willingness of competitors to offer pricing and terms that did not meet our underwriting criteria during the first quarter of 2022, which resulted in a decrease to our Specialty retention rate of 9.6 percentage points. (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 increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by one month of additional premium for the 2022 three-month period and four months of additional premium for the 2022 six-month period as compared to the same respective periods of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, NORCAL Custom Physician premium increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by new business written, partially offset by retention losses. Retention losses during the 2022 three- and six-month periods reflect the loss of a$2.2 million policy due to price competition as well as our continued evaluation of the NORCAL book of business and implementingProAssurance's underwriting strategies. (5) Hospitals and Facilities premium (which includes hospitals, surgery centers and miscellaneous medical facilities) was relatively unchanged for the 2022 three-month period and decreased for the 2022 six-month period as compared to the same respective periods of 2021. The decrease in Hospitals and Facilities premium for the 2022 six-month period was driven by retention losses and, to a lesser extent, net timing differences of$3.9 million . The decrease in Hospitals and Facilities premium for the 2022 six-month period was partially offset by new business written, primarily miscellaneous medical facilities and, to a lesser extent, an increase in renewal pricing. Retention losses in the 2022 six-month period were largely attributable to the loss of a$1.4 million policy due to the insured entering into a captive arrangement and our non-renewal of a$1.2 million policy during the first quarter of 2022 due to our focus on underwriting discipline. Renewal pricing increases for the 2022 three- and six-month periods reflect rate increases and contract modifications that we believe are appropriate given the current loss environment and new business written reflects the competitive market conditions. (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 increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by one month of additional premium for the 2022 three-month period and four months of additional premium for the 2022 six-month period as compared to the same respective periods of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, NORCAL Hospitals and Facilities premium increased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses. Retention losses for 2022 three- and six-month periods are largely attributable to the continued process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. (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 decreased for the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by retention losses, partially offset by new business written and, to a lesser extent, an increase in renewal pricing. The lower premium retention for the 2022 six-month period was primarily due to a large account renewing with a meaningful reduction in exposure driven by a reduction in the number of owned facilities. 65
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(8) We offer custom alternative risk solutions including assumed reinsurance. The increase in premium during the 2022 three- and six-month periods was driven by an increase in premiums assumed on a quota share basis through a strategic partnership in place since 2016 with an international medical professional liability insurer. In 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. The increase in premium during the 2022 six-month period was partially offset by the impact of 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 (see Note 5 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K). (9) Our Small Business Unit is comprised of premium associated with podiatrists, legal professionals, dentists and chiropractors. Our Small Business Unit premium remained relatively unchanged during the 2022 three- and six-month periods as compared to the same respective periods of 2021 as retention losses were almost entirely offset by an increase in renewal pricing and, to a lesser extent, new business written. The increase in renewal pricing during the 2022 three- and six-month periods 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 Tail Coverages during the 2022 three- and six-month periods as compared to the same respective periods of 2021 was primarily due to the prior year effect of$7.8 million of tail premium written and fully earned during the second quarter of 2021 associated with a large Custom Physician policy. (11) 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 remained relatively unchanged during the 2022 three-month period and increased during the 2022 six-month period as compared to the same respective periods of 2021. The increase in our Medical Technology Liability Premium during the 2022 six-month period was driven by new business written and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Renewal pricing increases during the 2022 six-month period are primarily due to changes in the sales volume of certain insureds partially offset by renewal pricing decreases during the 2022 three-month period due to changes in exposure of certain insureds. Retention losses during the 2022 three- and six-month periods are primarily attributable to insureds no longer needing coverage, an increase in competition on terms and pricing, as well as merger activity within the industry. (12) 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. Three Months Ended June 30 Six Months Ended June 30 ($ in millions) 2022 2021 Change 2022 2021 Change Standard Physician $ -$ 2.0 $ (2.0) nm $ -$ 2.0 $ (2.0) nm Custom Physician 2.0 - 2.0 nm 2.0 - 2.0 nm Senior Care - 0.4 (0.4) nm 3.9 4.6 (0.7) (15.2 %) Tail Coverages - 0.4 (0.4) nm 3.0 0.7 2.3 328.6 % Total$ 2.0 $ 2.8 $ (0.8) (28.6 %)$ 8.9 $ 7.3 $ 1.6 21.9 % Alternative market gross premiums written decreased during the 2022 three-month period and increased during the 2022 six-month period as compared to the same respective periods of 2021. The decrease during the 2022 three-month period was driven by timing differences related to the prior year renewal of certain policies. The increase during the 2022 six-month period was driven by an increase in tail coverage premium, primarily related to one program. Additionally, a$2.0 million expiring Standard Physician policy in one program renewed as a Custom Physician policy during the second quarter of 2022. 66
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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 rate increases and we anticipate
further rate increases due to indications of increasing projected loss severity.
Additionally, the pricing of our business includes the effects of filed rates,
surcharges and discounts. Renewal pricing can also reflect changes in our
exposure base, deductibles, self-insurance retention limits and other policy
terms and conditions. See further explanation of changes in renewal pricing
above under the heading "Gross Premiums Written".
The change in renewal pricing for our Specialty P&C segment, including by major
component, was as follows:
Three Months Ended Six Months Ended
June 30 June 30
2022 2022
Specialty P&C segment 6 % 8 %
HCPL
Standard Physician 8 % 7 %
Specialty 7 % 12 %
Total HCPL 7 % 8 %
Small Business Unit 5 % 4 %
Medical Technology Liability (1 %) 3 %
New business written by major component on a direct basis was as follows:
Three Months Ended Six Months Ended
June 30 June 30
(In millions) 2022 2021 2022 2021
HCPL
Standard Physician $ 2.0 $ 1.0 $ 3.8 $ 1.6
Specialty 4.3 3.7 8.0 12.4
Total HCPL 6.3 4.7 11.8 14.0
Small Business Unit 0.6 0.8 1.6 1.8
Medical Technology Liability 0.9 1.7 2.6 3.5
Total $ 7.8 $ 7.2 $ 16.0 $ 19.3
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:
Three Months Ended Six Months Ended
June 30 June 30
2022 2021 2022 2021
Specialty P&C segment 84 % 86 % 82 % 81 %
HCPL
Standard Physician(1) 86 % 88 % 86 % 87 %
Specialty 72 % 72 % 67 % 62 %
Total HCPL 81 % 84 % 81 % 78 %
Small Business Unit 92 % 91 % 91 % 91 %
Medical Technology Liability 95 % 89 % 90 % 88 %
(1) See Gross Premiums Written section above for further explanation of retention decline in 2022.
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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 . Through our current excess of loss reinsurance arrangements, we generally retain the first$2 million in risk insured by us and cede coverages in excess of this amount. For our HCPL coverages in excess of$2 million , we generally retain from 0% to 5% of the next$24 million of risk. Our HCPL excess of loss reinsurance arrangement that renewed onOctober 1, 2021 renewed at a lower gross rate and prospectively 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 were 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$2 million . There were no significant changes in the cost or structure of our Medical Technology Liability treaty upon theOctober 2021 renewal.
Ceded premiums written were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Excess of loss reinsurance arrangements
(1) $ 7,821 $ 7,703 $ 118
1.5 %
Other shared risk arrangements (2)
4,206 3,968 238 6.0 % 8,542 7,931 611 7.7 % Premium ceded to SPCs (3) 1,399 2,134 (735) (34.4 %) 8,280 6,603 1,677 25.4 % NORCAL premiums ceded since acquisition(4) - 67 (67) nm - 67 (67) nm Other ceded premiums written(5) 1,319 729 590 80.9 % 3,441 1,594 1,847 115.9 % Adjustment to premiums owed under reinsurance agreements, prior accident years, net(6) 3,000 - 3,000 nm 3,000 - 3,000 nm Total ceded premiums written$ 17,745 $ 14,601 $ 3,144
21.5 %
(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. Premium due to reinsurers is based on a rate factor applied to gross premiums written subject to cession under the arrangement. The increase in ceded premiums written under our excess of loss reinsurance arrangements during the 2022 three- and six-month periods as compared to the same respective periods of 2021 was driven by additional ceded premiums of$1.7 million and$6.1 million , respectively, as a result of incorporating NORCAL policies into our existing HCPL excess of loss reinsurance arrangements with theOctober 1, 2021 renewal, as previously discussed. Excluding NORCAL, ceded premiums written under our excess of loss reinsurance arrangements decreased by approximately$1.6 million and$4.2 million during the 2022 three- and six-month periods, respectively, primarily due to a decrease in the overall volume of gross premiums written subject to cession and, to a lesser extent, the higher retention and reduced rate on the treaty year effectiveOctober 1, 2021 . (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. The increase in ceded premiums written under our shared risk arrangements during the 2022 three- and six-month periods as compared to the same respective periods of 2021 was primarily due to an increase in premium ceded to our Ascension Health Program. (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. Premiums ceded to SPCs during the 2022 three-month period decreased as compared to the same period of 2021 driven by timing differences related to the prior year renewal of certain policies. The increase in premiums ceded to SPCs during the 2022 six-month period as compared to the same period of 2021 was driven by the impact of tail coverages, primarily related to one program (see discussion in footnote 12 under the heading "Gross Premiums Written"). 68
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(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 for the 2021 three- and six-month periods primarily reflected cyber liability coverages. EffectiveOctober 1, 2021 andJanuary 2022 , we prospectively incorporated NORCAL policies into our existing HCPL excess of loss reinsurance and cyber liability arrangements, respectively. (5) The increase in other ceded premiums written during the 2022 three- and six-month periods as compared to the same respective periods of 2021 was primarily driven by the incorporation of NORCAL's cyber liability coverages into our existing HCPL cyber liability arrangement with theJanuary 1, 2022 renewal, as previously discussed. (6) 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 the 2022 three- and six-month periods, 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 the overall change in expected loss recoveries attributable to one large claim during the second quarter of 2022. We do not believe this isolated claim indicates a change in overall loss trends for us or the industry. As part of the review of our reserves during both the 2021 three- and six-month periods, we concluded that our estimate of expected losses and associated recoveries for prior year ceded losses was reasonable; therefore, we did not adjust our estimate of ceded premiums owed to reinsurers during the 2021 three- and six-month periods. 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 ratios were affected during the 2022 three- and six-month periods by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years. The ceded premiums ratio was as follows: Three Months Ended June 30 Six Months Ended June 30 2022 2021 Change 2022 2021 Change Ceded premiums ratio 10.6 % 10.3 % 0.3 pts 9.5 % 11.3 % (1.8 pts) Less the effect of adjustments in premiums owed under reinsurance agreements, prior accident years (as previously discussed) 1.8 % - % 1.8 pts 0.7 % - % 0.7 pts Ratio, current accident year 8.8 % 10.3 % (1.5 pts) 8.8 % 11.3 % (2.5 pts) The above table reflects ceded premiums written, excluding the effect of prior year ceded premium adjustments, as a percent of gross premiums written. The decrease in our ceded premiums ratios for the 2022 three- and six-month periods as compared to the same respective periods of 2021 was driven by the reduced rate on our excess of loss reinsurance arrangements for the treaty year effectiveOctober 1, 2021 and, for the 2022 six-month period, the impact of the addition of the NORCAL gross written premium base during the first quarter of 2022. The decrease in our ceded premiums ratio for the 2022 six-month period as compared to the same period of 2021 was partially offset by an increase in premiums ceded to SPCs. See additional discussion on NORCAL ceded premiums and premiums ceded to SPCs above under the heading "Ceded Premiums Written." 69
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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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 201,855 $ 186,474 $ 15,381 8.2 % $ 414,134 $ 318,534 $ 95,600 30.0 %
Less: Ceded premiums earned 18,308 17,839 469 2.6 % 32,620 34,285 (1,665) (4.9 %)
Net premiums earned $ 183,547 $ 168,635 $ 14,912 8.8 % $ 381,514 $ 284,249 $ 97,265 34.2 %
Gross premiums earned included earned premium from our acquisition of NORCAL of
approximately $73.4 million and $153.1 million during the 2022 three- and
six-month periods, respectively, as compared to $50.7 million during both of the
2021 three- and six-month periods. Excluding NORCAL premiums, gross premiums
earned during the 2022 three- and six-month periods decreased $7.3 million and
$6.8 million , respectively, as compared to the same respective periods of 2021
driven by tail premium associated with a Custom Physician policy, which resulted
in $7.8 million of one-time written and fully earned during the prior year
period (see previous discussion in footnote 10 under the heading "Gross Premiums
Written"), partially offset by the beneficial impacts of our re-underwriting
efforts and focus on rate adequacy.
Ceded premiums earned during the 2022 three- and six-month periods reflected an
adjustment made during the second quarter of 2022 to ceded premiums owed under
swing rated reinsurance agreements related to prior accident year losses; no
such adjustments were made during the same respective periods of 2021 (see
previous discussion in footnote 6 under the heading "Ceded Premiums Written").
After removing the effect of the prior accident year ceded premium adjustment,
ceded premiums earned decreased $2.5 million and $4.7 million during the 2022
three- and six-month periods, respectively, as compared to the same periods of
2021. The remaining decrease during the 2022 three- and six-month periods was
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.
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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.
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 and the
policy that is in effect at that time responds to the claim. For occurrence
policies, the insured event becomes a liability when the event takes place even
though the claim may be reported to us at a later date. 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. The net loss ratios for our Specialty P&C segment were as
follows:
Net Loss Ratios (1)
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 74.6% 83.1% (8.5 pts) 79.4 % 84.9 % (5.5
pts)
Less impact of prior accident years on the net loss ratio (9.5%) (6.3%) (3.2 pts) (5.6 %) (4.7 %) (0.9
pts)
Current accident year net loss ratio(2) 84.1% 89.4% (5.3 pts) 85.0 % 89.6 % (4.6 pts)
(1)Net losses, as specified, divided by net premiums earned.
(2)For the three and six months endedJune 30, 2022 , our current accident year net loss ratio (as shown in the table above), improved 5.3 and 4.6 percentage points, respectively, as compared to the same respective periods of 2021. The change in our current accident year net loss ratio in each period was primarily attributable to the following: Increase (Decrease) 2022 versus 2021 Comparative Comparative three-month six-month (In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Operations
(2.4 pts) (1.3 pts) NORCAL Acquisition - Purchase Accounting Amortization (0.3 pts) (0.7 pts) Change in Estimate of ULAE (3.5 pts) (3.6 pts) Custom Physician Tail Policy 1.2 pts 0.7 pts Ceded Premium Adjustments, Prior Accident Years 1.4 pts 0.7 pts All other, net (1.7 pts) (0.4 pts) Decrease in current accident year net loss ratio (5.3 pts) (4.6 pts) •Excluding the impact of the items specifically identified in the table above, our current accident year net loss ratios for the three and six months endedJune 30, 2022 improved 1.7 and 0.4 percentage points, respectively, as compared to the same respective periods of 2021 driven by a decrease to certain expected loss ratios in our Standard Physician line of business primarily reflecting the improvement in pricing and terms that we have obtained in our estimate of expected losses, which we began recognizing in the second half of 2021, somewhat offset by changes in the mix of business. Furthermore, we continue to observe a reduction in claims frequency that started to emerge in 2020, some of which is due to our re-underwriting efforts and 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 reduced certain expected loss ratios in our Standard Physician line of business during the third and fourth quarters of 2021. We continue to remain cautious in recognizing the full impact of these favorable trends in our current 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. 71
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•Initial expected loss ratios associated with NORCAL policies are higher than the average for our other books of business in this segment; however, we reduced certain expected NORCAL loss ratios during the fourth quarter of 2021 due to favorable frequency trends, as previously discussed, leading to a 2.4 percentage point improvement in our segment current accident year net loss ratio for the current quarter as compared to the prior year quarter. NORCAL policies resulted in a 1.3 percentage point improvement in our segment current accident year net loss ratios for the six months endedJune 30, 2022 as compared to the prior year period given the higher volume of NORCAL premium in the 2022 six-month period. We continue 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 ratios for the three and six months endedJune 30, 2022 and 2021 were impacted by the 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 0.3 and 0.7 percentage point decrease, respectively, in our current period ratios. As ofJune 30, 2022 , the negative VOBA associated with NORCAL's assumed unearned premium has been fully amortized.
•Beginning in 2022, we revised our process of estimating ULAE as a result of
substantially integrating NORCAL into our Specialty P&C segment operations,
which accounted for a 3.5 and 3.6 percentage point decrease in our current
accident year net loss ratios for the 2022 three- and six-month periods,
respectively, with an offsetting 3.5 and 3.6 percentage point increase,
respectively, in our current period expense ratios with no impact to our
combined ratios or segment results during the three and six months ended
following section under the heading "Underwriting, Policy Acquisition and
Operating Expenses").
•Our current accident year net loss ratios for the 2021 three- and six-month periods were impacted by a large Custom Physician tail policy ($7.8 million of net premiums earned recorded with a lower loss ratio than the segment's average initial loss ratio), which accounted for a 1.2 and 0.7 percentage point decrease, respectively, in the prior period ratios. •During the 2022 three- and six-month periods, we increased our estimate of premiums owed under reinsurance agreements related to prior accident years which decreased net premium earned (the denominator of the current accident year net loss ratio) in the second quarter of 2022 and accounted for a 1.4 and 0.7 percentage point increase, respectively, in our current period ratios. No such adjustments were made during the 2021 three- and six-month periods. See the previous discussion under the heading "Ceded Premiums Written" for additional information. We re-evaluate our previously established reserve each quarter based upon the most recently completed actuarial analysis supplemented by any new analysis, information or trends that have emerged since the date of that study. We also take into account currently available industry trend information.
The following table shows our net prior accident year reserve development:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net favorable reserve
development $ 14,499 $ 8,400 $ 6,099 72.6 % $ 15,500 $ 11,074 $ 4,426 40.0 %
NORCAL Acquisition - Purchase
Accounting Amortization* 2,900 2,109 791 37.5 % 5,799 2,109 3,690 175.0 %
Total net favorable reserve
development $ 17,399 $ 10,509 $ 6,890 65.6 % $ 21,299 $ 13,183 $ 8,116 61.6 %
*See Note 2 of the Notes to Consolidated Financial Statements in our
amortization of the NORCAL acquisition purchase accounting adjustments.
•Development recognized during the three and six months endedJune 30, 2022 principally related to accident years 2018 through 2020. Development recognized during the three and six months endedJune 30, 2021 principally related to accident years 2017 through 2020. We have not recognized any development related to NORCAL's prior accident year reserves since the date of acquisition onMay 5, 2021 based on our comparison of expected loss emergence to actual loss emergence. •We reduced our prior accident year IBNR reserve for COVID-19 by$3.0 million during the second quarter of 2022 as early first notices of potential claims related to anticipated COVID losses have not turned into claims. See additional discussion on the COVID-19 IBNR reserve in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses" in ourDecember 31, 2021 report on Form 10-K. •Net favorable development recognized during the six months endedJune 30, 2022 included an increase of$4.0 million in our reserve for potential ECO/XPL claims, as compared to a reduction in this same reserve of$1.6 million and$1.4 million during the three and six months endedJune 30, 2021 , respectively. 72
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A detailed discussion of factors influencing our recognition of loss development is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses" in ourDecember 31, 2021 report on Form 10-K. Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the then current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2022 and 2021.
Underwriting, Policy Acquisition and Operating Expenses
Our Specialty P&C segment underwriting, policy acquisition and operating
expenses were comprised as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 24,236 $ 13,785 $ 10,451 75.8 % $ 45,978 $ 26,181 $ 19,797 75.6 %
Management fees 995 856 139 16.2 % 2,397 1,856 541 29.1 %
Other underwriting and
operating expenses 22,846 14,236 8,610 60.5 % 42,583 27,186 15,397 56.6 %
Total $ 48,077 $ 28,877 $ 19,200 66.5 % $ 90,958 $ 55,223 $ 35,735 64.7 %
DPAC amortization for the 2022 three- and six-month periods increased due to a
higher amount of premium written driven by our 2021 acquisition of NORCAL. Due
to the NORCAL acquisition and application of GAAP purchase accounting rules, the
level of DPAC amortization in each of the 2021 three- and six-month periods was
approximately $6.3 million lower than would have otherwise been recognized.
Under these purchase accounting rules, the capitalized policy acquisition costs
for policies written prior to the acquisition date were written off through
purchase accounting on May 5, 2021 rather than being expensed pro rata over the
remaining term of the associated policies (see Note 2 of the Notes to
Consolidated Financial Statements in our December 31, 2021 report on Form 10-K
for more information). DPAC amortization for the 2022 three-month period
included a more normalized level of amortization associated with NORCAL policies
whereas the 2022 six-month period was approximately $1.0 million lower than
would have otherwise been recognized. The remaining increase in DPAC
amortization for the 2022 three- and six-month periods as compared to the same
respective periods of 2021 reflected an increase in agency commissions due to a
higher volume of commissionable premium driven by NORCAL as well as an increase
in brokerage expenses due to our increased participation with an international
medical professional liability insurer in our Specialty line of business (see
discussion under the heading "Gross Premiums Written").
Management fees are charged pursuant to a management agreement by the Corporate
segment to the operating subsidiaries within our Specialty P&C segment 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 continued organizational structure enhancements in our Specialty
P&C segment during 2021 as well as operational alignments as a result of the
integration of NORCAL, the extent to which services are provided exclusively by
the Corporate segment to the operating subsidiaries within the segment decreased
further effective January 1, 2022 . Accordingly, we reduced the fee charged to
the operating subsidiaries in 2022. Also effective January 1, 2022 , the
management agreement included the wholly owned operating subsidiaries of NORCAL
contributing to $0.2 million and $0.8 million of additional management fees in
the 2022 three- and six-month periods, respectively.
Other underwriting and operating expenses increased during the 2022 three- and
six-month periods primarily due to a revision to our process of estimating ULAE
which resulted in approximately $6.3 million and $13.6 million , respectively, of
expenses remaining in operating expenses instead of being allocated to net
losses and loss adjustment expenses. As a result, this change in ULAE estimate
had offsetting impacts to our loss and expense ratios during the 2022 three- and
six-month periods with no impact to our combined ratio or segment results. See
additional discussion on this change in ULAE estimate in the previous section
under the heading "Losses and Loss Adjustment Expenses." Excluding the impact of
the change in ULAE, other underwriting and operating expenses increased due to
an increase in professional fees and, to a lesser extent, higher amounts accrued
for performance-related incentive plans due to our improved combined ratio and
other performance metrics. The increase in professional fees for the 2022 three-
and six-month periods was primarily attributable to an increase in IT consulting
fees and additional external audit fees in 2022 due to the inclusion of NORCAL.
The increase in other underwriting and operating expenses for the 2022 six-month
period also reflected one-time expenses of $1.6 million incurred during the
first quarter of 2022 mainly comprised of one-time bonuses, employee severance
charges and lease exit costs.
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Underwriting Expense Ratio (the Expense Ratio)
Our expense ratio for the Specialty P&C segment was as follows:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio 26.2 % 17.1 % 9.1 pts 23.8 % 19.4 % 4.4 pts
The change in our expense ratio for the 2022 three- and six-month periods as
compared to the same respective periods of 2021 was primarily attributable to
the following:
Increase (Decrease)
2022 versus 2021
Comparative three-month Comparative six-month
(In percentage points) period period
Estimated ratio increase (decrease) attributable to:
Increase in Net Premiums Earned and DPAC amortization(1)
1.1 pts 0.6 pts NORCAL DPAC Amortization - Prior Period Purchase Accounting Impact 3.8 pts 2.2 pts Change in Estimate of ULAE 3.5 pts 3.6 pts Tail Premium(2) 0.7 pts - pts All other, net - pts (2.0 pts) Increase in the underwriting expense ratio 9.1 pts 4.4 pts
(1) Excludes tail premium.
(2) Represents the effect of the change in premium earned from tail policies as there is typically minimal expense associated
with tail premium (see discussion under the heading "Gross Premiums Written").
The higher expense ratios for both the 2022 three- and six-month periods as
compared to the same respective periods of 2021 reflect the impact of lower DPAC
amortization than would have otherwise been recognized during each of the 2021
three- and six-month periods due to the application of GAAP purchase accounting
rules in 2021 and change in estimate of ULAE, as previously discussed. As shown
in the previous table, normalizing the prior year DPAC amortization would have
increased our expense ratios for the 2021 three- and six-month periods by 3.8
and 2.2 percentage points, respectively. The increase in the expense ratio from
the increase in DPAC amortization in relation to net premiums earned for the
2022 three- and six-month periods of 1.1 and 0.6 percentage points,
respectively, primarily reflects an increase in agency commissions due to a
higher volume of commissionable premium driven by NORCAL. The change in other
operating expenses decreased our expense ratio for the 2022 six-month period by
2.0 percentage points primarily due to the benefits from prior organizational
restructurings and proactive expense management as well as expense synergies
recognized from the NORCAL acquisition, partially offset by an increase in
professional fees and, to a lesser extent, higher amounts accrued for
performance-related incentive plans, as previously discussed.
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Table of Contents Segment Results -Workers' Compensation Insurance OurWorkers' Compensation Insurance segment includes workers' compensation products provided to employers generally with 1,000 or fewer employees, as discussed in Note 18 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. Workers' compensation products offered include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market programs. Alternative market programs include services related to 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. OurWorkers' 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: Three Months Ended June 30 Six Months Ended June 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Net premiums written$ 42,558 $ 40,784 $ 1,774
4.3 %
Net premiums earned$ 41,709 $ 40,626 $ 1,083
2.7 %
Other income
517 900 (383)
(42.6 %) 1,199 1,293 (94) (7.3 %)
Net losses and loss adjustment
expenses
(27,947) (27,751) (196) 0.7 % (55,158) (53,958) (1,200) 2.2 % Underwriting, policy acquisition and operating expenses (13,669) (12,712) (957)
7.5 % (26,669) (24,998) (1,671) 6.7 %
Segment results
$ 610 $ 1,063 $ (453)
(42.6 %)
Net loss ratio 67.0% 68.3% (1.3 pts) 66.9% 66.9% - pts
Underwriting expense ratio 32.8% 31.3% 1.5 pts
32.4% 31.0% 1.4 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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums written
%
Less: Ceded premiums written 21,076 17,061 4,015 23.5
% 47,928 42,505 5,423 12.8 % Net premiums written$ 42,558 $ 40,784 $ 1,774 4.3 %$ 87,824 $ 87,668 $ 156 0.2 % 75
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Gross Premiums Written
Gross premiums written by product were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Traditional business:
Guaranteed cost $ 35,719 $ 32,865 $ 2,854 8.7 % $ 71,222 $ 71,061 $ 161 0.2 %
Policyholder dividend 5,530 6,740 (1,210) (18.0 %) 13,392 14,260 (868) (6.1 %)
Deductible 468 386 82 21.2 % 2,588 2,439 149 6.1 %
Retrospective(1) 2,430 2,205 225 10.2 % 3,076 2,660 416 15.6 %
Other 2,111 1,706 405 23.7 % 3,726 3,306 420 12.7 %
Alternative market business(2) 17,376 13,943 3,433 24.6 % 41,748 37,657 4,091 10.9 %
Change in EBUB estimate - - - nm - (1,210) 1,210 nm
Total $ 63,634 $ 57,845 $ 5,789 10.0 % $ 135,752 $ 130,173 $ 5,579 4.3 %
(1) The change in retrospectively-rated policies included an adjustment that
decreased premium by $0.6 million and $0.7 million for the three and six months
ended June 30, 2022 , respectively, as compared to $0.3 million and $0.4 million
for the same respective periods of 2021.
(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 increased during the three and six months ended June 30,
2022 as compared to the same respective periods of 2021 primarily driven by an
increase in audit premium and renewal business and, for the 2022 six-month
period, the prior year impact of the reduction of our EBUB estimate, partially
offset by a decrease in new business. Policy audits processed during the 2022
three- and six-month periods resulted in audit premium billed to policyholders
totaling $3.0 million and $4.7 million , respectively, as compared to audit
premium returned to policyholders of $1.0 million and $1.8 million for the same
respective periods in 2021. We did not adjust our EBUB estimate for the 2022
three- and six-month periods or the 2021 three-month period; however, we reduced
our EBUB estimate by $1.2 million for the 2021 six-month period. The increase in
renewal business reflects payroll exposure increases related to labor market
strengthening and wage inflation and strong renewal retention, partially offset
by renewal rate decreases. Renewal retention was 87% and 87% for the 2022 three-
and six-month periods, respectively, as compared to 85% and 88% for the same
respective periods of 2021. Renewal rates decreased 5% and 4% during the 2022
three- and six-month periods, respectively, as compared to 3% during each of the
same respective periods of 2021. New business written decreased $2.3 million and
$4.3 million during the 2022 three- and six-month periods, respectively, as
compared to the same respective periods of 2021, reflecting the competitive
workers' compensation market conditions and a reduction in new business
submissions during the 2022 three- and six-month periods.
We retained 100% of the fifteen (six in the second quarter) workers'
compensation alternative market programs that were up for renewal during the six
months ended
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New business, audit premium, renewal retention and renewal price changes for our
traditional business and the alternative market business are shown in the table
below:
Three Months Ended June 30
2022 2021
Alternative
Traditional Market Segment Traditional Alternative Segment
($ in millions) Business Business Results Business Market Business Results
New business $ 3.6 $ 0.9 $ 4.5 $ 6.1 $ 0.7 $ 6.8
Audit premium (excluding EBUB)
$ (1.2) $ 0.2 $ (1.0) Retention rate (1) 88 % 83 % 87 % 85 % 83 % 85 % Change in renewal pricing (2) (5 %) (5 %) (5 %) (3 %) (5 %) (3 %) Six Months Ended June 30 2022 2021 Alternative Traditional Market Segment Traditional Alternative Segment ($ in millions) Business Business Results Business Market Business Results New business$ 7.1 $ 2.1 $ 9.2$ 12.0 $ 1.5 $ 13.5
Audit premium (excluding EBUB)
$ (2.2) $ 0.4 $ (1.8) Retention rate (1) 87 % 89 % 87 % 87 % 89 % 88 % Change in renewal pricing (2) (4 %) (4 %) (4 %) (2 %) (5 %) (3 %)
(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.
Ceded Premiums Written
Ceded premiums written were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Premiums ceded to SPCs $ 15,235 $ 13,926 $ 1,309 9.4 % $ 36,723 $ 34,608 $ 2,115 6.1 %
Premiums ceded to external
reinsurers 3,632 3,211 421 13.1 % 6,787 6,186 601 9.7 %
Premiums ceded to
unaffiliated captive
insurers 2,141 17 2,124 12,494.1 % 5,025 3,049 1,976 64.8 %
Change in return premium
estimate under external
reinsurance 225 (21) 246 1,171.4 % 254 (495) 749 151.3 %
Estimated revenue share
under external reinsurance (157) (72) (85) 118.1 % (861) (843) (18) 2.1 %
Total ceded premiums
written $ 21,076 $ 17,061 $ 4,015 23.5 % $ 47,928 $ 42,505 $ 5,423 12.8 %
Premiums ceded to SPCs represent alternative market business that is ceded under
100% quota share reinsurance agreements to the SPCs in our Segregated Portfolio
Cell Reinsurance segment. Premiums ceded to unaffiliated captive insurers
represent alternative market business for two programs that are ceded under a
100% quota share reinsurance agreements. Alternative market premiums written
increased for the 2022 three- and six-month periods as compared to the same
respective periods of 2021, which resulted in higher premiums 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. The increase in premiums ceded to
unaffiliated captive insurers during the 2022 three- and six-month periods as
compared to the same respective periods of 2021 was driven by a new program that
was effective June 1, 2022 . The policies in the new program were previously
written in our traditional book of business; therefore, the premium ceded to the
unaffiliated captive resulted in a decrease in net premiums written for the
Workers' Compensation Insurance segment.
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Under our external reinsurance treaty 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, subject to an AAD, equal to 3.5% of subject earned premium for the treaty year effectiveMay 1, 2022 . Premiums ceded under our traditional reinsurance treaty are based on premiums earned during the treaty period. The increase in premiums ceded to external reinsurers during the 2022 three- and six-month periods primarily reflected an increase in reinsurance rates. 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 treaties that include a provision for return premium. As shown in the table above, we decreased our estimate of return premium by$0.2 million and$0.3 million during the 2022 three- and six-month periods, respectively, as compared to an increase by a nominal amount and$0.5 million during the same respective periods in 2021. Changes in the estimated return premium primarily reflect adjustments to loss estimates on previously reported reinsured claims. We are party to a revenue sharing agreement with our reinsurance broker under which we participate in the broker's revenue earned under our reinsurance treaties based on the volume of premium ceded. We estimate the amount of revenue we expect to receive under this agreement as premiums are recognized and ceded to the reinsurers. Ceded Premiums Ratio
Ceded premiums ratio was as follows:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Ceded premiums ratio, as reported 34.3 % 33.1 % 1.2 pts 33.8 % 32.4 % 1.4 pts
Less the effect of:
Premiums ceded to SPCs (100%) 24.5 % 24.5 % - pts 26.2 % 25.1 % 1.1 pts
Retrospective premium adjustments 0.1 % - % 0.1 pts 0.1 % - % 0.1 pts
Premiums ceded to unaffiliated
captive insurers (100%) 1.7 % 1.6 % 0.1 pts 0.7 % 1.7 % (1.0 pts)
Change in EBUB - % - % - pts - % 0.1 % (0.1 pts)
Change in return premium estimate
under external reinsurance 0.5 % - % 0.5 pts 0.3 % (0.6 %) 0.9 pts
Estimated revenue share (0.3 %) (0.2 %) (0.1 pts) (1.0 %) (1.0 %) - pts
Assumed premiums earned (not ceded to
external reinsurers) (0.3 %) (0.3 %) - pts (0.3 %) (0.3 %) - pts
Ceded premiums ratio (related to
external reinsurance), less the
effects of above 8.1 % 7.5 % 0.6 pts 7.8 % 7.4 % 0.4 pts
The above table reflects traditional ceded premiums earned as a percent of
traditional gross premiums earned. As discussed above, premiums ceded under our
traditional reinsurance treaty are based on premiums earned during the treaty
period. The increase in the ceded premiums ratio for the three and six months
ended June 30, 2022 as compared to the same respective periods of 2021 primarily
reflected an 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 insurers. Because premiums are generally 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 carry an estimate for EBUB and evaluate the estimate on a quarterly basis.
Net premiums earned were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 63,521 $ 60,710 $ 2,811 4.6 % $ 124,555 $ 119,342 $ 5,213 4.4 %
Less: Ceded premiums earned 21,812 20,084 1,728 8.6 % 42,162 38,706 3,456 8.9 %
Net premiums earned $ 41,709 $ 40,626 $ 1,083 2.7 % $ 82,393 $ 80,636 $ 1,757 2.2 %
Net premiums earned increased during the three and six months ended June 30,
2022 as compared to the same respective periods of 2021 primarily reflecting an
increase in audit premium and, for the six months ended June 30, 2022 , the prior
year reduction to EBUB, partially offset by the pro rata effect of lower net
premiums written during the preceding twelve months and higher reinsurance
costs.
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:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 67.0 % 68.3 % (1.3 pts) 66.9 % 66.9 % - pts
Less impact of prior accident
years on the net loss ratio (4.8 %) (4.7 %) (0.1 pts) (4.9 %) (5.1 %) 0.2 pts
Current accident year net loss
ratio 71.8 % 73.0 % (1.2 pts) 71.8 % 72.0 % (0.2 pts)
The decrease in the current accident year net loss ratio during the three and
six months ended June 30, 2022 as compared to the same respective periods of
2021 primarily reflected an improvement in loss frequency and severity trends,
partially offset by the continuation of intense price competition and the
resulting renewal rate decreases. The current accident year net loss ratios for
the 2021 three- and six-month periods reflected higher claim activity as workers
returned to employment with the easing of pandemic-related restrictions. The
current accident year net loss ratio for the 2021 three-month period was also
impacted by an increase in the full-year loss ratio from 71% in the first
quarter to 72% in the second quarter of 2021.
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"), decreased $3.5 million and $1.8
million for the three and six months ended June 30, 2022 , respectively, as
compared to the same respective periods of 2021. We retained losses in excess of
our per occurrence retention totaling $1.0 million and $2.0 million during the
2022 three- and six-month periods, respectively, as compared to $1.5 million and
$2.7 million for the same respective periods of 2021 which reflected losses
within the AAD. There were no current accident year reported losses ceded to
reinsurers during the three and six months ended June 30, 2022 or 2021, as all
losses were within the AAD.
We recognized net favorable prior year development of $2.0 million and $4.0
million for the three and six months ended June 30, 2022 , respectively, as
compared to $1.9 million and $4.1 million for the same respective periods of
2021. The net favorable prior year reserve development for the three and six
months ended June 30, 2022 and 2021 reflected overall favorable trends in claim
closing patterns. Net favorable development for the 2022 and 2021 three- and
six-month periods was primarily related to accident years 2017 and prior.
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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses include the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers' compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by our Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern byProAssurance . The management fee is based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary.
Our
operating expenses were comprised as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 7,531 $ 7,249 $ 282 3.9 % $ 14,592 $ 13,990 $ 602 4.3 %
Management fees 477 434 43 9.9 % 1,018 976 42 4.3 %
Other underwriting and
operating expenses 9,105 8,343 762 9.1 % 17,972 16,594 1,378 8.3 %
Policyholder dividend
expense 284 233 51 21.9 % 493 502 (9) (1.8 %)
SPC ceding commission
offset (3,728) (3,547) (181) 5.1 % (7,406) (7,064) (342) 4.8 %
Total $ 13,669 $ 12,712 $ 957 7.5 % $ 26,669 $ 24,998 $ 1,671 6.7 %
The increase in DPAC amortization for the three and six months ended June 30,
2022 as compared to the same respective periods in 2021 primarily reflected the
increase in gross premiums earned.
The increase in other underwriting and operating expenses for the three and six
months ended June 30, 2022 as compared to the same respective periods of 2021
primarily reflected an increase in costs related to compensation,
business-related travel, marketing and, for the 2022 six-month period, lease
exit costs. Marketing costs included advertising and website-related activities
that were planned for 2022. Business-related travel has increased as a result of
the easing of pandemic-related restrictions. During the first quarter of 2022,
we recognized one-time lease exit costs of $0.2 million due to the early
termination of an office lease; however, as a result, we anticipate annual
expense savings of approximately $0.1 million .
As previously discussed, alternative market premiums written by our Workers'
Compensation Insurance segment are 100% ceded, less a ceding commission, to
either the SPCs in our Segregated Portfolio Cell Reinsurance segment or, to a
limited extent, the unaffiliated captive insurers. 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 increase in SPC ceding commissions earned for the
three and six months ended June 30, 2022 as compared to the same respective
periods of 2021, primarily reflected the increase in alternative market ceded
earned premium.
Underwriting Expense Ratio (the Expense Ratio)
The underwriting expense ratio included the impact of the following:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio, as reported 32.8 % 31.3 % 1.5 pts 32.4 % 31.0 % 1.4 pts
Less estimated ratio increase (decrease)
attributable to:
Impact of ceding commissions received
from SPCs 3.7 % 3.1 % 0.6 pts 3.6 % 3.0 % 0.6 pts
Retrospective premium adjustment 0.3 % 0.1 % 0.2 pts 0.2 % 0.1 % 0.1 pts
Impact of audit premium (0.9 %) 0.6 % (1.5 pts) (0.5 %) 0.8 % (1.3 pts)
Change in return premium estimate under
external reinsurance 0.1 % - % 0.1 pts 0.1 % (0.1 %) 0.2 pts
Estimated revenue share (0.1 %) - % (0.1 pts) (0.2 %) (0.2 %) - pts
Underwriting expense ratio, less listed
effects 29.7 % 27.5 % 2.2 pts 29.2 % 27.4 % 1.8 pts
Excluding the items noted in the table above, the expense ratio increased for
the three and six months ended June 30, 2022 , primarily reflecting the increase
in other underwriting and operating expenses, as previously discussed.
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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 18 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. 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 ofJune 30, 2022 , there were 27 (4 inactive) SPCs. 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. As ofJune 30, 2022 , 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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net premiums written $ 14,515 $ 14,208 $ 307 2.2 % $ 39,732 $ 36,396 $ 3,336 9.2 %
Net premiums earned $ 16,222 $ 16,272 $ (50)
(0.3 %)
Net investment income
211 206 5 2.4 % 323 427 (104) (24.4 %) Net investment gains (losses) (2,782) 1,580 (4,362)
(276.1 %) (3,493) 2,568 (6,061) (236.0 %)
Other income
1 1 - - % 1 2 (1) (50.0 %) Net losses and loss adjustment expenses (9,272) (8,443) (829)
9.8 % (20,763) (17,867) (2,896) 16.2 %
Underwriting, policy acquisition and
operating expenses
(5,237) (5,293) 56
(1.1 %) (9,605) (10,320) 715 (6.9 %)
SPC
(1)
(349) (504) 155 (30.8 %) (991) (860) (131) 15.2 % SPC net results (1,206) 3,819 (5,025)
(131.6 %) 1,008 6,106 (5,098) (83.5 %)
SPC dividend (expense) income (2)
854 (2,864) 3,718
(129.8 %) (1,513) (4,606) 3,093 (67.2 %)
Segment results (3)
$ (352) $ 955 $ (1,307)
(136.9 %)
Net loss ratio 57.2% 51.9% 5.3 pts 58.4% 55.6% 2.8 pts Underwriting expense ratio 32.3% 32.5% (0.2 pts) 27.0% 32.1% (5.1 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) and OCI of the SPCs in which we participate. 81
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Premiums Written
Premiums in our Segregated Portfolio Cell Reinsurance segment are assumed from either ourWorkers' 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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums written $ 16,634 $ 16,060 $ 574 3.6 % $ 45,003 $ 41,211 $ 3,792 9.2 %
Less: Ceded premiums written 2,119 1,852 267 14.4 % 5,271 4,815 456 9.5 %
Net premiums written $ 14,515 $ 14,208 $ 307 2.2 % $ 39,732 $ 36,396 $ 3,336 9.2 %
Gross Premiums Written
Gross premiums written reflected reinsurance premiums assumed by component as
follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Workers' compensation $ 15,235 $ 13,926 $ 1,309 9.4 % $ 36,723 $ 34,608 $ 2,115 6.1 %
Healthcare professional
liability 1,399 2,134 (735) (34.4 %) 8,280 6,603 1,677 25.4 %
Gross Premiums Written $ 16,634 $ 16,060 $ 574 3.6 % $ 45,003 $ 41,211 $ 3,792 9.2 %
Gross premiums written for the three and six months ended June 30, 2022 and 2021
were primarily comprised of workers' compensation coverages assumed from our
Workers' Compensation Insurance segment. Workers' compensation gross premiums
written increased during the three and six months ended June 30, 2022 as
compared to the same respective periods of 2021 driven by higher audit premium
and new business, partially offset by renewal rate decreases of 5% and 4%,
respectively. Healthcare professional liability gross premiums written decreased
during the three months ended June 30, 2022 and increased during the six months
ended June 30, 2022 as compared to the same respective periods of 2021. The
decrease during the three months ended June 30, 2022 primarily reflects the
impact of non-renewed policies. The increase during the six months ended
June 30, 2022 was driven by the effect of tail coverage premium primarily
related to one program in which we do not participate, which resulted in $3.0
million of one-time premium written and fully earned during the first quarter of
2022. We retained 100% of the fourteen (six in the second quarter) workers'
compensation programs and two (one in the second quarter) healthcare
professional liability programs up for renewal during the six months ended
June 30, 2022 .
New business, audit premium, retention and renewal price changes for the assumed
workers' compensation premium is shown in the table below:
Three Months Ended June 30 Six Months Ended June 30
($ in millions) 2022 2021 2022 2021
New business $ 0.9 $ 0.7 $ 2.1 $ 1.5
Audit premium $ 1.2 $ 0.2 $ 2.8 $ 0.4
Retention rate (1) 83 % 83 % 89 % 89 %
Change in renewal pricing (2) (5 %) (5 %) (4 %) (5 %)
(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:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Ceded premiums written $ 2,119 $ 1,852 $ 267
14.4 %
For the workers' compensation business, each SPC has in place its own external reinsurance coverage. 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. Premiums ceded under our SPC reinsurance treaty are based on premiums written during the treaty period. The change in ceded premiums written during the three and six months endedJune 30, 2022 as compared to the same respective periods of 2021 primarily reflected the increase in workers' compensation gross premiums written and the impact of rate increases under the external reinsurance treaty. External reinsurance rates vary based on the alternative market program.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Ceded premiums ratio 13.9% 13.3% 0.6 pts 14.4% 13.9% 0.5 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 three and six months ended June 30,
2022 as compared to the same respective periods of 2021 primarily reflected 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 are recorded as fully earned in the current period.
Gross, ceded and net premiums earned were as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 18,596 $ 18,427 $ 169
0.9 %
Less: Ceded premiums earned
2,374 2,155 219 10.2 % 4,724 4,238 486 11.5 % Net premiums earned$ 16,222 $ 16,272 $ (50) (0.3 %)$ 35,536 $ 32,156 $ 3,380 10.5 % Net premiums earned remained relatively unchanged during the three months endedJune 30, 2022 as compared to the same period of 2021. The increase in net premiums earned during the six months endedJune 30, 2022 primarily reflected the aforementioned effect of$3.0 million of tail premium fully written and earned during the first quarter of 2022 and the increase in audit premium billed to policyholders, partially offset by the pro rata effect of a reduction in net premiums written during the preceding twelve months. 83
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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 and associated reinsurance are estimated for each program on a quarterly basis. Each SPC has in place its own reinsurance agreement, and the attachment point of aggregate reinsurance coverage varies by program. Due to the size of some of the programs, quarterly loss results, including changes in estimated aggregate reinsurance, 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 three and six
months ended
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 57.2 % 51.9 % 5.3 pts 58.4 % 55.6 % 2.8 pts
Less impact of prior accident
years on the net loss ratio (13.5 %) (11.0 %) (2.5 pts) (8.9 %) (10.2 %) 1.3 pts
Current accident year net loss
ratio 70.7 % 62.9 % 7.8 pts 67.3 % 65.8 % 1.5 pts
Less estimated ratio increase
(decrease) attributable to:
Change in estimated aggregate
reinsurance 2.4 % (5.2 %) 7.6 pts 1.7 % (3.4 %) 5.1 pts
Current accident year net loss
ratio, excluding the effect of
the change in estimated aggregate
reinsurance 68.3 % 68.1 % 0.2 pts 65.6 % 69.2 % (3.6 pts)
During the 2022 three- and six-month periods, we decreased our estimate of
aggregate reinsurance which increased our current accident year net loss ratios
as compared to the same respective periods of 2021. The decrease in the
estimated aggregate reinsurance reflected an improvement in expected ultimate
program year losses in certain programs. See additional information regarding
the SPC's aggregate reinsurance agreements in our Liquidity section under the
heading "Operating Activities and Related Cash Flows."
The current accident year net loss ratio, excluding the effect of changes in
estimated aggregate reinsurance, was relatively unchanged for the 2022
three-month period and decreased 3.6 percentage points for the 2022 six-month
period, as compared to the same respective periods of 2021. The improvement in
the current accident year net loss ratio for the 2022 six-month period primarily
reflects favorable trends in prior accident year workers' compensation claim
results and their impact on our analysis of the current year loss estimate,
partially offset by the continuation of intense price competition and the
resulting renewal rate decreases in the workers' compensation business.
Calendar year incurred losses (excluding IBNR) ceded to our external reinsurers
increased $7.1 million and $2.4 million for the three and six months ended
June 30, 2022 , respectively, as compared to the same respective periods of 2021.
Current accident year ceded incurred losses (excluding IBNR) increased $6.2
million and $4.1 million for the 2022 three- and six-month periods,
respectively, as compared to the same respective periods of 2021. The increase
in both the calendar year and current accident year ceded incurred losses is
driven by two large 2022 accident year loss occurrences.
We recognized net favorable prior year reserve development of $2.2 million and
$3.2 million for the three and six months ended June 30, 2022 , respectively, as
compared to $1.8 million and $3.3 million for the same respective periods of
2021. The net favorable prior year reserve development for the three and six
months ended June 30, 2022 related entirely to workers' compensation business,
which reflected overall favorable trends in claim closing patterns primarily in
accident years 2019 and 2020. The net favorable prior year reserve development
for the three and six months ended June 30, 2021 also related entirely to the
workers' compensation business which primarily reflected overall favorable claim
trends in claim closing patterns in accident years 2018 and 2019.
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Underwriting, Policy Acquisition and Operating Expenses
Our Segregated Portfolio Cell Reinsurance segment underwriting, policy
acquisition and operating expenses were comprised as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 4,859 $ 4,769 $ 90 1.9 % $ 10,152 $ 9,405 $ 747 7.9 %
Policyholder dividend
expense 13 111 (98) (88.3 %) 79 284 (205) (72.2 %)
Other underwriting and
operating expenses 365 413 (48) (11.6 %) (626) 631 (1,257) (199.2 %)
Total $ 5,237 $ 5,293 $ (56) (1.1 %) $ 9,605 $ 10,320 $ (715) (6.9 %)
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. Other
underwriting and operating expenses remained relatively unchanged for the 2022
three-month period as compared to the same period of 2021. The decrease in other
underwriting and operating expenses for the six months ended June 30, 2022 as
compared to the same period of 2021 primarily reflected the change in our
allowance for expected credit losses related to the collection of customer
accounts that were previously written off.
The decrease in policyholder dividend expense for the three and six months ended
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:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio, as
reported 32.3% 32.5% (0.2 pts) 27.0% 32.1% (5.1 pts)
Less: impact of audit premium on
expense ratio (2.6%) (0.4%) (2.2 pts) (2.2%) (0.3%) (1.9 pts)
Underwriting expense ratio,
excluding the effect of audit
premium 34.9% 32.9% 2.0 pts 29.2% 32.4% (3.2 pts)
Excluding the effect of audit premium, the underwriting expense ratio increased
for the 2022 three-month period and decreased for the 2022 six-month period as
compared the same respective periods of 2021. The increase in the underwriting
expense ratio for the 2022 three-month period primarily reflected an increase in
the average ceding commissions incurred and an increase in ceded premiums earned
resulting from higher reinsurance costs. The decrease in the underwriting
expense ratio for the 2022 six-month period primarily reflected the change in
the allowance for expected credit losses and policyholder dividend expense, as
discussed above.
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Segment Results - Lloyd's Syndicates
Our Lloyd's Syndicates segment includes the results from our participation in Syndicate 1729 and Syndicate 6131 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 2022 underwriting year, our FAL was comprised of investment securities and cash and cash equivalents deposited with Lloyd's which atJune 30, 2022 had a fair value of approximately$30.3 million , as discussed in Note 3 of the Notes to Condensed Consolidated Financial Statements. During the second quarter of 2022, we received a return of approximately$5.5 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. The return of FAL during the second quarter of 2022 also related to the settlement of our participation in the results of Syndicate 1729 and Syndicate 6131 for the 2019 underwriting year. The discussion in our Segment Operating Results under the same heading in Item 7 of ourDecember 31, 2021 report on Form 10-K includes additional information regarding our participation.
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.
Our participation in the results of Syndicate 1729 for the 2022 underwriting year remains unchanged from the 2021 underwriting year at 5%. EffectiveJanuary 1, 2022 , Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 as Syndicate 6131's applicable business is retained within Syndicate 1729 beginning with the 2022 year of account. The results from our participation in 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. Due to the quarter lag, our ceased participation in Syndicate 6131 was not reflected in our results until the second quarter of 2022. 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 three and six months endedJune 30, 2022 and 2021, the results of our Lloyd's Syndicates segment were as follows: Three Months Ended June 30 Six Months Ended June 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Gross premiums written$ 4,081 $ 8,629 $ (4,548) (52.7 %)$ 9,897 $ 22,732 $ (12,835) (56.5 %) Less: Ceded premiums written 1,018 2,841 (1,823) (64.2 %) 1,240 5,059 (3,819) (75.5 %) Net premiums written$ 3,063 $ 5,788 $ (2,725) (47.1 %)$ 8,657 $ 17,673 $ (9,016) (51.0 %) Net premiums earned$ 5,793 $ 13,460 $ (7,667) (57.0 %)$ 13,539 $ 29,310 $ (15,771) (53.8 %) Net investment income 143 518 (375) (72.4 %) 355 1,246 (891) (71.5 %)
Net investment gains (losses) (485) 89 (574) (644.9 %)
(884) (26) (858) 3,300.0 % Other income 129 361 (232) (64.3 %) 263 582 (319) (54.8 %) Net losses and loss adjustment expenses (3,449) (5,444) 1,995 (36.6 %) (8,212) (18,411) 10,199 (55.4 %) Underwriting, policy acquisition and operating expenses (1,508) (4,721) 3,213 (68.1 %) (4,218) (11,311) 7,093 (62.7 %) Segment results$ 623 $ 4,263 $ (3,640) (85.4 %)$ 843 $ 1,390 $ (547) (39.4 %) Net loss ratio 59.5% 40.4% 19.1 pts 60.7% 62.8% (2.1 pts) Underwriting expense ratio 26.0% 35.1% (9.1 pts) 31.2% 38.6% (7.4 pts) 86
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Premiums
Net premiums written decreased during the 2022 three- and six-month periods as compared to the same respective periods of 2021 driven by our ceased participation in Syndicate 6131 for the 2022 underwriting year and, for the 2022 six-month period, the impact of our decreased participation in the results of Syndicates 1729 and 6131 for the 2021 underwriting year. The decrease in net premiums written for the 2022 three- and six-month periods was partially offset by volume increases on renewal business and renewal pricing increases, primarily on casualty and property insurance coverages, as well as new business written, primarily on specialty and property insurance coverages. Net premiums earned decreased$7.7 million and$15.8 million during the 2022 three- and six-month periods, respectively, as compared to the same respective periods of 2021 primarily attributable to the pro rata effect of a reduction in net premiums written during the preceding twelve months.
Net Losses and Loss Adjustment Expenses
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:
Net Loss Ratios
Three Months Ended June 30 Six Months Ended June 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 59.5 % 40.4 % 19.1 pts 60.7 % 62.8 % (2.1
pts)
Less: impact of prior accident years on the net loss ratio 45.4 % 3.2 % 42.2 pts 30.8 % 6.7 % 24.1
pts
Current accident year net loss ratio 14.1 % 37.2 % (23.1 pts) 29.9 % 56.1 % (26.2
pts)
The decrease in the current accident year net loss ratio for the three and six months endedJune 30, 2022 as compared to the same respective periods of 2021 was driven by decreases to certain loss estimates during the first quarter of 2022, partially offset by lower reinsurance recoveries as a proportion of gross losses as compared to the prior year periods. We recognized$2.6 million and$4.2 million of unfavorable prior year development during the three and six months endedJune 30, 2022 as compared to$0.4 million and$2.0 million for the same respective periods of 2021. The unfavorable prior year development for the three and six months endedJune 30, 2022 was driven by higher than expected losses and development on certain large claims, primarily catastrophe related losses.
Underwriting, Policy Acquisition and Operating Expenses
For the 2022 three- and six-month periods, the underwriting expense ratio
decreased by 9.1 and 7.4 percentage points, respectively, as compared to the
same respective periods of 2021 which primarily reflected the impact of our
ceased participation in Syndicate 6131 for the 2022 underwriting year. Syndicate
6131 incurred nominal operating expenses during the current period whereas the
net premiums earned during the same period also includes premium from open
underwriting years prior to 2022. The decrease in the underwriting expense ratio
for the 2022 six-month period also reflected the impact of our reduced
participation in the results of Syndicate 1729 and Syndicate 6131 for the 2021
underwriting year.
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Segment Results - Corporate
Our Corporate segment includes our investment operations 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 ourDecember 31, 2021 report on Form 10-K. 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 three and six months endedJune 30, 2022 and 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 (for additional information on the NORCAL acquisition see Note 2 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K). Segment results for our Corporate segment was a net loss of$2.4 million for the three months endedJune 30, 2022 and net earnings of$3.6 million for the six months endedJune 30, 2022 as compared to net earnings of$26.8 million and$47.1 million for the three and six months endedJune 30, 2021 , respectively, and included the following: Three Months Ended June 30 Six Months Ended June 30 ($ in thousands) 2022 2021 Change 2022 2021 Change
Net investment income
Equity in earnings (loss) of
unconsolidated subsidiaries
Net investment gains (losses)
Other income
$ 3,626 $ 351 $ 3,275 933.0 %$ 5,691 $ 2,245 $ 3,446 153.5 % Operating expense$ 9,019 $ 5,929 $ 3,090 52.1 %$ 17,756 $ 12,177 $ 5,579 45.8 % Interest expense$ 4,919 $ 5,176 $ (257)
(5.0 %)
Income tax expense (benefit)
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 changes in the cash surrender value of BOLI contracts, net of investment fees and expenses.
Net investment income (loss) by investment category was as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Fixed maturities $ 21,600 $ 17,351 $ 4,249 24.5 % $ 42,700 $ 32,076 $ 10,624 33.1 %
Equities 967 448 519 115.8 % 1,668 1,142 526 46.1 %
Short-term investments,
including Other 700 681 19 2.8 % 1,104 879 225 25.6 %
BOLI 261 685 (424) (61.9 %) 214 1,129 (915) (81.0 %)
Investment fees and expenses (1,938) (2,472) 534 (21.6 %) (3,977) (4,465) 488 (10.9 %)
Net investment income $ 21,590 $ 16,693 $ 4,897 29.3 % $ 41,709 $ 30,761 $ 10,948 35.6 %
Fixed Maturities
Income from our fixed maturities increased during the 2022 three- and six-month
periods as compared to the same respective periods of 2021 driven by higher
average investment balances primarily attributable to the addition of fixed
maturity securities valued at $1.1 billion to our portfolio on May 5, 2021 as a
result of the NORCAL acquisition (see Note 2 of the Notes to Consolidated
Financial Statements in ProAssurance's December 31, 2021 report on Form 10-K for
additional information). In addition, the increase in income from our fixed
maturities during the 2022 three- and six-month periods reflected higher average
book yields as we continue to reinvest at higher rates as our portfolio matures.
As a result of the NORCAL acquisition, average investment balances over a
twelve-month period were approximately 17% and 34% higher for the 2022 three-
and six-month periods, respectively, as compared to the same respective periods
of 2021; excluding the impact of the acquisition, average investment balances
were approximately 2% and 4% higher, respectively.
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Average yields for our fixed maturity portfolio were as follows:
Three Months Ended June 30 Six Months Ended June 30
2022 2021 2022 2021
Average income yield 2.3% 2.2% 2.3% 2.0%
Average tax equivalent income yield 2.3% 2.2% 2.3% 2.0%
Equities
Income from our equity portfolio increased during the 2022 three- and six-month
periods as compared to the same respective periods of 2021 which reflected
changes in the mix of equities owned.
BOLI
We hold BOLI policies that are carried at the current cash surrender value of the policies, which includes the BOLI policies acquired from NORCAL. All insured individuals were members ofProAssurance or NORCAL management at the time the policies were acquired. Income from our BOLI policies decreased in 2022 three- and six-month periods as compared to the same respective periods of 2021 primarily attributable to a decrease in the cash surrender value of policies acquired from NORCAL.
Equity in Earnings (Loss) of Unconsolidated Subsidiaries
Equity in earnings (loss) of unconsolidated subsidiaries was comprised as
follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
All other investments,
primarily investment fund
LPs/LLCs $ 7,028 $ 16,680 $ (9,652) (57.9 %) $ 17,035 $ 26,654 $ (9,619) (36.1 %)
Tax credit partnerships (1,848) (4,753) 2,905 (61.1 %) (4,236) (7,939) 3,703 (46.6 %)
Equity in earnings (loss) of
unconsolidated subsidiaries $ 5,180 $ 11,927 $ (6,747) (56.6 %) $ 12,799 $ 18,715 $ (5,916) (31.6 %)
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. Our investment results from our portfolio of investments in
LPs/LLCs for the 2022 three- and six-month periods as compared to the same
respective periods of 2021 decreased primarily due to lower earnings from a few
LP/LLCs and reflected market volatility during the first quarter of 2022.
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 periodically as actual operating results of the underlying properties
become available. The primary benefit of credits and losses from our historic
tax credit partnership 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 three and six months ended June 30, 2022
reflected lower partnership operating losses as compared to the same respective
periods of 2021, partially offset by an increase in our estimate of operating
losses by $0.6 million in the three and six months ended June 30, 2022 as
compared to $1.5 million in the three and six months ended June 30, 2021 .
The tax benefits received from our tax credit partnerships, which are not
reflected in our investment results, reduced our tax expense in 2022 and 2021 as
follows:
Three Months Ended June 30 Six Months Ended June 30
(In millions) 2022 2021 2022 2021
Tax credits recognized during the period $ 1.2 $ 3.4 $ 2.4 $ 6.8
Tax benefit of tax credit partnership
operating losses $ 0.4 $ 1.0 $ 0.9 $ 1.7
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The tax credits generated from our tax credit partnership investments of$1.2 million and$2.4 million for the three and six months endedJune 30, 2022 , respectively, were deferred for use in future periods due to our expected consolidated loss calculated on a tax basis. For the three and six months endedJune 30, 2021 the tax credits generated from our tax credit partnership investments of$3.4 million and$6.8 million , respectively, were deferred to be utilized in future periods. Not included in the table above is$2.0 million of tax credits recaptured from the 2019 tax year during the six months endedJune 30, 2022 due to the carryback of our estimated NOL for the six months endedJune 30, 2022 to the 2021 tax year. The recaptured tax credits were earned in 2019 but not utilized until 2021 due to NOL's generated in both 2019 and 2020. As ofJune 30, 2022 , we had approximately$51.1 million of available tax credit carryforwards generated from our investments in tax credit partnerships which we expect to utilize in future periods. 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.
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.
Three Months Ended June 30 Six Months Ended June 30
(In thousands) 2022 2021 2022 2021
GAAP net investment result:
Net investment income $ 21,590 $ 16,693 $ 41,709 $ 30,761
Equity in earnings (loss) of unconsolidated
subsidiaries 5,180 11,927 12,799 18,715
GAAP net investment result $ 26,770 $ 28,620 $ 54,508 $ 49,476
Pro forma tax-equivalent investment result
Reconciliation of pro forma and GAAP tax-equivalent investment result: GAAP net investment result$ 26,770 $ 28,620 $ 54,508 $ 49,476 Taxable equivalent adjustments, calculated using the 21% federal statutory tax rate State and municipal bonds 134 103 267 218 BOLI 69 182 57 300 Dividends received - 26 - 28 Tax credit partnerships* - (1,792) (2,478) -
Pro forma tax-equivalent investment result
$ 52,354 $ 50,022 *Due to our expected consolidated loss calculated on a tax basis for the three and six months endedJune 30, 2022 , the tax credits recognized from our tax credit partnership investments were deferred to be utilized in future periods; however, during the six months endedJune 30, 2022 , we recaptured a portion of tax credits earned in 2019, that were utilized in 2021, as a result of our expected carry back of our 2022 NOL to the 2021 tax year, resulting in a current tax expense related to tax credit partnerships. We earned tax credits totaling$3.4 million and$6.8 million from our tax credit partnership investments during the three and six months endedJune 30, 2021 , respectively. As of the second quarter of 2021, all of these tax credits were deferred for use in future periods due to the utilization of NOLs available to us following our acquisition of NORCAL. 90
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Net Investment Gains (Losses)
The following table provides detailed information regarding our net investment
gains (losses).
Three Months Ended June 30 Six Months Ended June 30
(In thousands) 2022 2021 2022 2021
Total impairment losses Corporate debt $ (972) $ - $ (972) $ - Portion of impairment losses recognized in other comprehensive income before taxes: Corporate debt 419 - 419 - Net impairment losses recognized in earnings (553) - (553) - Gross realized gains, available-for-sale fixed maturities 256 5,434 1,361 9,596 Gross realized (losses), available-for-sale fixed maturities (884) (315) (1,978) (502) Net realized gains (losses), equity investments (5,235) 1,119 (5,928) 5,275 Net realized gains (losses), other investments (760) 1,297 (110) 4,493
Change in unrealized holding gains (losses), equity
investments
(3,095) 1,230 (13,347) (2,558)
Change in unrealized holding gains (losses), convertible
securities, carried at fair value as a part of other
investments
(10,583) 529 (13,058) 339 Other 237 (130) 600 497 Net investment gains (losses)$ (20,617)
For the three and six months endedJune 30, 2022 , we recognized credit-related impairment losses in earnings of$0.6 million and non-credit impairment losses in OCI of$0.4 million . The credit-related and non-credit impairment losses recognized during the three and six months endedJune 30, 2022 related to a corporate bond in the consumer sector. We did not recognize any credit-related impairment losses in earnings or non-credit impairment losses in OCI during the three and six months endedJune 30, 2021 . We recognized$20.6 million and$33.0 million of net investment losses during the 2022 three- and six-month periods, respectively, driven by unrealized holding losses resulting from changes in the fair value of our convertible securities and equity investments and, to a lesser extent, realized losses from the sale of equity investments during the period. During the 2021 three- and six-month periods, we recognized$9.2 million and$17.1 million of net investment gains, respectively, driven primarily by realized gains on the sale of certain available-for-sale fixed maturities and equity investments.
Other Income
Other income was$3.6 million and$5.7 million for the 2022 three- and six-month periods, respectively, as compared to$0.4 million and$2.2 million during the same respective periods of 2021. The increase in other income for the 2022 three- and six-month periods was driven by the effect of foreign currency exchange rate changes of$2.7 million and$3.1 million , respectively, related to foreign currency denominated loss reserves associated with premium assumed from an international medical professional liability insured in our Specialty P&C segment. We mitigate foreign exchange exposure by generally matching the currency and duration of associated investments to the corresponding loss reserves. In accordance with GAAP, the impact on the market value of available for sale fixed maturities due to changes in foreign currency exchange rates is reflected as part of OCI. Conversely, the impact of changes in foreign currency exchange rates on loss reserves is reflected through net income as a component of other income. The effect of exchange rate changes on foreign currency denominated loss reserves are reported in our Corporate segment to be consistent with the reporting of the foreign currency denominated invested assets and associated investment income. 91
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Operating Expenses
Corporate segment operating expenses were comprised as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Operating expenses $ 10,474 $ 8,075 $ 2,399 29.7 % $ 21,154 $ 16,866 $ 4,288 25.4 %
Management fee offset (1,455) (2,146) 691 (32.2 %) (3,398) (4,689) 1,291 (27.5 %)
Total $ 9,019 $ 5,929 $ 3,090 52.1 % $ 17,756 $ 12,177 $ 5,579 45.8 %
Operating expenses increased $2.4 million and $4.3 million during the 2022
three- and six-month periods, respectively, as compared to the same respective
periods of 2021 primarily due to an increase in compensation-related costs,
professional fees and, for the 2022 six-month period, share-based compensation
expenses. The increase in compensation-related costs during the 2022 three- and
six-month periods was driven by an increase in segment headcount due to the
addition of Corporate NORCAL employees. Subsequent to acquisition on May 5,
2021 , compensation-related costs of all NORCAL employees were reported in our
Specialty P&C segment. Beginning in 2022, compensation-related costs for
Corporate NORCAL employees are reported in our Corporate segment. In addition,
the increase in compensation-related costs also reflected higher amounts accrued
for performance-related incentive plans due to our improved performance metrics.
The increase in share-based compensation expense in the 2022 six-month period
was attributable to the effect of the incorporation of certain NORCAL employees
into our share-based compensation plans beginning in 2022.
Operating subsidiaries within our Specialty P&C segment 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 continued organizational structure
enhancements in our Specialty P&C segment during 2021 as well as operational
alignments as a result of the integration of NORCAL, the extent to which
services are provided exclusively by the Corporate segment to the operating
subsidiaries within the Specialty P&C segment decreased further effective
January 1, 2022 . Accordingly, we reduced the fee charged to the operating
subsidiaries within the Specialty P&C segment during the first quarter of 2022.
Also effective January 1, 2022 , the management agreement included the wholly
owned operating subsidiaries of NORCAL contributing to $0.2 million and $0.8
million of additional management fees during the 2022 three- and six-month
periods, respectively. There were no changes to the extent to which services are
provided exclusively by the Corporate segment to the operating subsidiaries
within our Workers' Compensation Insurance segment in 2022.
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Interest Expense
Consolidated interest expense for the three and six months ended
and 2021 was comprised as follows:
Three Months Ended June 30 Six Months Ended June 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Senior Notes due 2023 $ 3,357 $ 3,357 $ - - % $ 6,714 $ 6,714 $ - - %
Contribution Certificates
(including accretion)(1) 1,679 1,128 551 48.8 % 3,532 1,128 2,404 213.1 %
Revolving Credit Agreement
(including fees and
amortization)(2) 273 291 (18) (6.2 %) 519 506 13 2.6 %
Mortgage Loans (including
amortization) - 217 (217) nm - 365 (365) nm
(Gain)/loss on interest rate
cap (390) 183 (573) 313.1 % (1,405) (324) (1,081) (333.6 %)
Interest expense $ 4,919 $ 5,176 $ (257) (5.0 %) $ 9,360 $ 8,389 $ 971 11.6 %
(1) Includes accretion of approximately $0.4 million and $0.9 million for the three and six months ended June 30, 2022 , respectively, as compared to approximately $0.2
million in each period of 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.
(2) There were no outstanding borrowings on our Revolving Credit Agreement during the three and six months ended June 30, 2022 ; interest expense primarily reflected
unused commitment fees. The 2021 three- and six-month periods reflected an increase in weighted average outstanding borrowings which were $9.2 million and $4.6
million , respectively.
Consolidated interest expense remained relatively unchanged for the 2022
three-month period and increased for the 2022 six-month period as compared to
the same respective periods of 2021. The increase in consolidated interest
expense for the 2022 six-month period was driven by the Contribution
Certificates associated with our acquisition of NORCAL on May 5, 2021 (see Note
2 of the Notes to Consolidated Financial Statements in our December 31, 2021
report on Form 10-K), partially offset by the change in fair value of our
interest rate cap which was terminated during the second quarter of 2022. See
further discussion of our interest rate cap agreement and outstanding debt in
Note 2 and Note 7 of the Notes to Condensed Consolidated Financial Statements,
respectively, and further discussion of our Contribution Certificates in Note 13
of the Notes to Consolidated Financial Statements in our December 31, 2021
report on Form 10-K.
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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 . AnyU.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: Three Months Ended Six Months Ended June 30 June 30 (In thousands) 2022 2021 2022 2021 Corporate segment income tax expense (benefit)$ (1,789)
Income tax expense (benefit) - transaction-related
costs*
(144) (3,818) (391) (4,013) Consolidated income tax expense (benefit)$ (1,933) $ (3,598) $ (3,950) $ (2,862) *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 11 of the Notes to Condensed 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 rates for the three and six months endedJune 30, 2022 and 2021. The comparability of each factor's impact on our effective tax rate is affected by the consolidated pre-tax loss recognized during the three and six months endedJune 30, 2022 as compared to the consolidated pre-tax income recognized during the same respective periods of 2021. Factors that have the same directional impact on income tax expense 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 loss during the three and six months endedJune 30, 2022 versus the pre-tax income during the same respective periods of 2021. These factors include the following: Three Months Ended June 30 2022 2021 Income tax Income tax (benefit) (benefit) ($ in thousands) expense Rate Impact expense Rate Impact Computed "expected" tax expense (benefit) at statutory rate $ (754) 21.0 % $ 18,575 21.0 % Tax-exempt income (1) (381) 10.6 % (291) (0.3 %) Tax credits (1,198) 33.4 % (3,380) (3.8 %) Non-U.S. operating results (131) 3.7 % (895) (1.1 %) Tax deficiency (excess tax benefit) on share-based compensation 1 - % (17) - % Change in uncertain tax positions 19 (0.5 %) 91 0.1 % Estimated annual tax rate differential (2) - - % (2,087) (2.4 %) Non-taxable gain on bargain purchase (3) - - % (15,626) (17.7 %) Other 511 (14.4 %) 32 0.1 % Total income tax expense (benefit) $ (1,933) 53.8 % $ (3,598) (4.1 %) 94
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Six Months Ended June 30
2022 2021
Income tax Income tax
(benefit) (benefit)
($ in thousands) expense Rate Impact expense Rate Impact
Computed "expected" tax expense (benefit) at
statutory rate $ (1,925) 21.0 % $ 20,354 21.0 %
Tax-exempt income (1) (476) 5.2 % (477) (0.5 %)
Tax credits (2,403) 26.2 % (6,754) (7.0 %)
Non-U.S. operating results (177) 2.0 % (292) (0.3 %)
Tax deficiency (excess tax benefit) on
share-based compensation 341 (3.7 %) 280 0.3 %
Change in uncertain tax positions 40 (0.4 %) - - %
Non-taxable gain on bargain purchase (3) - - % (15,626) (16.1 %)
Other 650 (7.2 %) (347) (0.4 %)
Total income tax expense (benefit) $ (3,950) 43.1 % $ (2,862) (3.0 %)
(1) Includes tax-exempt interest, dividends received deduction and change in
cash surrender value of BOLI.
(2) During the second quarter of 2021, we reversed the estimated annual tax rate
differential recorded for the three months ended March 31, 2021 as we utilized
the discrete effective tax rate method for the six months ended June 30, 2021;
therefore, there is no tax rate differential for the six-months ended June 30,
2021 (see further discussion on this method in the Critical Accounting Estimates
section under the heading "Estimation of Taxes/Tax Credits").
(3) Represents the tax impact of the 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
included in our December 31, 2021 report on Form 10-K.
For the three and six months ended June 30, 2022 and 2021 we utilized the
discrete effective tax rate method for recording the provision (benefit) for
income taxes which treats the income tax expense (benefit) for the period as if
it were the income tax expense (benefit) for the full year and determines the
income tax expense (benefit) on that basis (see further discussion on this
method in the Critical Accounting Estimates section under the heading
"Estimation of Taxes/Tax Credits"). Our effective tax rates for both the 2022
and 2021 three- and six-month periods were different from the statutory federal
income tax rate of 21% due to the benefit recognized from the tax credits
transferred to us from our tax credit partnership investments. We recognized tax
credits of $1.2 million and $2.4 million during the three and six months ended
June 30, 2022, respectively, as compared to $3.4 million and $6.8 million for
the same respective periods of 2021. While projected tax credits for 2022 are
less than 2021, they continue to have a significant impact on the effective tax
rate for the 2022 three- and six-month periods. Additionally, our effective tax
rates for the 2021 three- and six-month periods were different from the
statutory federal income tax rate of 21% due to the gain on bargain purchase of
$74.4 million related to the NORCAL acquisition, all of which was non-taxable.
There were no other individually significant items impacting our effective tax
rates for the 2022 and 2021 three- and six-month periods.
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