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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 , we utilized the discrete effective tax rate method for recording income taxes in the period. The discrete method was utilized during the first half of 2022 because the application of the estimated annual effective tax rate method was impractical and did not provide a reliable estimate of the annual effective tax rate. Furthermore, we believed the use of the discrete effective tax rate method for the six months endedJune 30, 2022 was more appropriate than the annual effective tax rate method as minor changes in our estimated ordinary income would have had a significant effect on the estimated annual effective tax rate and would have resulted in sizable variations in the customary relationship between income tax expense (benefit) and pretax accounting income (loss). For the nine months endedSeptember 30, 2022 , we reevaluated our use of the discrete effective tax rate method and concluded that a return to the estimated annual effective tax rate method is appropriate given our revised financial projections and ability to provide a reliable estimate of the annual effective tax rate in the current period. Under the estimated annual effective tax rate method, items which are unusual, infrequent, or that cannot be reliably estimated are considered in the effective tax rate in the period in which the item is included in income and are referred to as discrete items. In calculating our year-to-date income tax expense (benefit), we include the estimated benefit of tax credits for the year-to-date period based on the most recently available information provided by the tax credit partnerships; the actual 44
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amounts of credits provided by the tax credit partnerships may prove to be
different than our estimates. The effect of such a difference is recognized in
the period identified.
For the nine months endedSeptember 30, 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. See further discussion on this method in the Critical Accounting Estimates section under the heading "Estimation of Taxes/Tax Credits" of ourSeptember 30, 2021 report on Form 10-Q. 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 nine months endedSeptember 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 nine months endedSeptember 30, 2022 . We are not aware of any accounting changes not yet adopted as ofSeptember 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. AtSeptember 30, 2022 , we held cash and liquid investments of approximately$86 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 ofNovember 2, 2022 , no borrowings were outstanding under our Revolving Credit Agreement. To date, during 2022, our operating subsidiaries have paid dividends to us of approximately$47 million , which included$6 million that was paid inOctober 2022 . Dividends paid inOctober 2022 have not been included in our cash and liquid investments held outside of our insurance subsidiaries atSeptember 30, 2022 . Excluding the dividends paid inOctober 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). 45
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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 HCPL and Medical Technology Liability treaties renewed October 1, 2022 at a slightly higher rate than the previous treaties; all other material terms were consistent with the expiring treaties. 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. 46
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Excess of Loss Reinsurance Agreements
[[Image Removed: pra-20220930_g1.jpg]]
Healthcare Professional Medical Technology & Life Workers' Compensation -
Liability Sciences Products Traditional
(1) Effective October 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. Effective October 1, 2021 , limits can be reinstated a maximum of four
times.
(2) Prior to
(3) Historically, retention has ranged from 0% 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-20220930_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.
Cash Flows
Cash flows between periods compare as follows:
Nine Months
Ended
(In thousands) 2022 2021 Change
Net cash provided (used) by:
Operating activities $ 6,673 $ 69,363 $ (62,690)
Investing activities (91,749) (25,531) (66,218)
Financing activities (17,154) (56,661) 39,507
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$62.7 million for the nine months endedSeptember 30, 2022 as compared to the nine months endedSeptember 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
Specialty P&C and Corporate segments, partially offset by lower
transaction-related costs associated with our acquisition of NORCAL as
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compared to the prior year period. 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$203.6 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 our 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$46.3 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 nine months ended
individually insignificant components.
We manage our investing cash flows to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations as discussed in this section under the heading "Investing Activities and Related Cash Flows."
Our financing cash flows are primarily comprised of dividend payments. 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 payments during the three months endedSeptember 30, 2022 , due to our expected consolidated loss calculated on a tax basis, or the three and nine months endedSeptember 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$36.1 million as ofSeptember 30, 2022 . These NOL carryforwards are subject to limitation by Internal Revenue Code Section 382 and will begin to expire in 2035. For additional information on the NORCAL acquisition see Note 2 and Note 7 of the Notes to Consolidated Financial Statements in ourDecember 31, 2021 report on Form 10-K. 50
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Table of Contents Investing Activities and Related Cash Flows Our investments atSeptember 30, 2022 andDecember 31, 2021 are comprised as follows: September 30, 2022 December 31, 2021 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Fixed maturities, available-for-sale U.S. Treasury obligations $ 217,951 5 % $ 238,507 5 % U.S. Government-sponsored enterprise obligations 19,893 1 % 20,234 1
%
State and municipal bonds 450,839 10 % 519,196 11 % Corporate debt 1,751,087 40 % 1,898,556 39 % Residential mortgage-backed securities 373,807 8 % 453,941 9 % Commercial mortgage-backed securities 206,625 5 % 245,624 5 % Other asset-backed securities 410,941 9 % 457,664 9 % Total fixed maturities, available-for-sale 3,431,143 78 % 3,833,722 79 % Fixed maturities, trading 43,451 1 % 43,670 1 % Total fixed maturities 3,474,594 79 % 3,877,392 80 % Equity investments(1) 142,254 3 % 214,807 4 % Short-term investments 288,927 7 % 216,987 4 % BOLI 81,239 2 % 81,767 2 % Investment in unconsolidated subsidiaries 305,184 7 % 335,576 7 % Other investments 93,309 2 % 101,794 3 % Total investments$ 4,385,507 100 %$ 4,828,323
100 %
(1) Includes
are not subject to significant equity price risk.
AtSeptember 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: September 30, 2022 December 31, 2021 Carrying % of Total Carrying % of Total ($ in thousands) Value Investment Value Investment Rating* AAA$ 985,835 29 %$ 1,129,136 29 % AA+ 117,622 3 % 130,077 3 % AA 209,514 6 % 254,570 7 % AA- 185,546 5 % 194,661 5 % A+ 260,981 7 % 221,473 6 % A 432,200 13 % 521,598 14 % A- 337,990 10 % 364,147 9 % BBB+ 203,159 6 % 292,984 8 % BBB 308,945 9 % 300,650 8 % BBB- 138,060 4 % 127,982 3 % Below investment grade 241,136 7 % 296,444 8 % Not rated 10,155 1 % - - % Total$ 3,431,143 100 %$ 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 ofSeptember 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$80 million and$150 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. AtSeptember 30, 2022 , our FAL was comprised of fixed maturity securities with a fair value of$29.7 million and cash and cash equivalents of$0.4 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$5.5 million of cash from our FAL balances given Syndicate 6131 ceased underwriting on a quota share basis with Syndicate 1729 beginning with the 2022 underwriting year as well as the settlement of our participation in the results of Syndicate 1729 and Syndicate 6131 for the 2019 underwriting year. Our investment portfolio continues to be primarily composed of high quality fixed income securities with approximately 92% of our fixed maturities being investment grade securities as determined by national rating agencies. The weighted average effective duration of our fixed maturity securities atSeptember 30, 2022 was 3.59 years; the weighted average effective duration of our fixed maturity securities combined with our short-term securities was 3.31 years. The carrying value and unfunded commitments for certain of our investments were as follows: Carrying ValueSeptember 30, 2022
($ in thousands, except expected funding
Unfunded Expected funding
period) 2022 2021 Commitment period in years
Qualified affordable housing project tax
credit partnerships (1) $ 5,037 $ 12,424 $ 267 5
All other investments, primarily investment
fund LPs/LLCs 300,147 323,152 133,643 5
Total $ 305,184 $ 335,576 $ 133,910
(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. At September 30, 2022 , we had investments in 35
separate investment funds with a total carrying value of $300.1 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
We repurchased approximately 139,000 common shares at a cost of approximately$3.3 million , conducted through a 10b5-1 stock repurchase plan inJuly 2022 . We did not repurchase any shares during the nine months endedSeptember 30, 2021 . We did not repurchase any common shares subsequent toSeptember 30, 2022 , and as ofNovember 2, 2022 , our remaining Board authorization was approximately$106.4 million . 52
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Debt
AtSeptember 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. AtSeptember 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$2.1 million in proceeds during the second quarter of 2022. See Note 2 of the Notes to Consolidated Financial Statements of ourDecember 31, 2021 report on Form 10-K for additional information on our interest rate cap agreement. Three of our insurance subsidiaries are members of an FHLB. Through membership, those subsidiaries have access to secured cash advances which can be used for liquidity purposes or other operational needs. In order for us to use FHLB proceeds, regulatory approvals may be required depending on the nature of the transaction. To date, those subsidiaries have not materially utilized their membership for borrowing purposes. 53
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Table of Contents Results of Operations - Three and Nine Months EndedSeptember 30, 2022 Compared to Three and Nine Months EndedSeptember 30, 2021 Selected consolidated financial data for each period is summarized in the table below. Three Months EndedSeptember 30 Nine Months EndedSeptember 30
($ in thousands, except per share
data) 2022 2021 Change 2022 2021 Change
Revenues:
Net premiums written$ 281,989 $ 287,043 $ (5,054) $ 803,055 $ 677,527 $ 125,528 Net premiums earned$ 258,355 $ 272,248 $ (13,893) $ 771,337 $ 698,598 $ 72,739 Net investment result 17,893 34,522 (16,629) 73,080 85,672 (12,592) Net investment gains (losses) (8,262) 530 (8,792) (45,652) 20,212 (65,864) Other income 5,097 2,400 2,697 13,215 6,862 6,353 Total revenues 273,083 309,700 (36,617) 811,980 811,344 636 Expenses: Net losses and loss adjustment expenses 198,073 223,393 (25,320) 585,166 555,030 30,136 Underwriting, policy acquisition and operating expenses 80,679 66,812 13,867 229,788 200,450 29,338 SPCU.S. federal income tax expense 433 431 2 1,424 1,291 133 SPC dividend expense (income) 183 1,320 (1,137) 1,697 5,926 (4,229) Interest expense 5,513 5,814 (301) 14,872 14,203 669 Total expenses 284,881 297,770 (12,889) 832,947 776,900 56,047 Gain on bargain purchase - - - - 74,408 (74,408)
Income (loss) before income taxes (11,798) 11,930 (23,728)
(20,967) 108,852 (129,819) Income tax expense (benefit) (2,673) (270) (2,403) (6,623) (3,132) (3,491) Net income (loss)$ (9,125) $ 12,200 $ (21,325) $ (14,344) $ 111,984 $ (126,328)
Non-GAAP operating income (loss)
$ 21,033 $ 42,452 $ (21,419) Earnings (loss) per share: Basic$ (0.17) $ 0.23 $ (0.40) $ (0.27) $ 2.08 $ (2.35) Diluted$ (0.17) $ 0.23 $ (0.40) $ (0.27) $ 2.07 $ (2.34) Non-GAAP operating income (loss) per share: Basic$ (0.06) $ 0.25 $ (0.31) $ 0.39 $ 0.79 $ (0.40) Diluted$ (0.06) $ 0.25 $ (0.31) $ 0.39 $ 0.79 $ (0.40) Net loss ratio 76.7 % 82.1 % (5.4 pts) 75.9 % 79.4 % (3.5 pts) Underwriting expense ratio 31.2 % 24.5 % 6.7 pts 29.8 % 28.7 % 1.1 pts Combined ratio 107.9 % 106.6 % 1.3 pts 105.7 % 108.1 % (2.4 pts) Operating ratio 98.3 % 99.5 % (1.2 pts) 97.0 % 100.7 % (3.7 pts) Effective tax rate 22.7 % (2.3 %) 25.0 pts 31.6 % (2.9 %) 34.5 pts Return on equity* (3.3 %) 4.0 % (7.3 pts) (1.5 %) 4.2 % (5.7 pts) Non-GAAP operating return on equity* (1.1 %) 4.1 % (5.2 pts) 2.2 % 4.2 % (2.0 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 nine months endedSeptember 30, 2022 as compared to the three and nine months endedSeptember 30, 2021 . See the Segment 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 September 30 Nine Months Ended September
30
($ in thousands) 2022 2021 Change 2022 2021
Change
Net premiums earned Specialty P&C$ 192,762 $ 203,716 $ (10,954) (5.4 %)$ 574,276 $ 487,963 $ 86,313 17.7 % Workers' Compensation Insurance 42,063 42,235 (172) (0.4 %) 124,456 122,872 1,584 1.3 % Segregated Portfolio Cell Reinsurance 17,811 15,344 2,467 16.1 % 53,347 47,500 5,847 12.3 % Lloyd's Syndicates 5,719 10,953 (5,234) (47.8 %) 19,258 40,263 (21,005) (52.2 %)
Consolidated total
(5.1 %)$ 771,337 $ 698,598 $ 72,739 10.4 % For the three and nine months endedSeptember 30, 2022 , consolidated net premiums earned included earned premium from our acquisition of NORCAL of approximately$69.2 million and$221.1 million , respectively, as compared to$82.9 million and$131.4 million during the same respective periods of 2021. The decrease in NORCAL earned premium for the 2022 three-month period was driven by our process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. Excluding NORCAL premiums, our consolidated net premiums earned decreased for the three and nine months endedSeptember 30, 2022 by$0.2 million and$17.0 million , respectively, as compared to the same respective periods of 2021. •The decrease in our Lloyd's Syndicates segment for the three and nine months endedSeptember 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. •For our Specialty P&C segment, excluding NORCAL premiums, net premiums earned increased$2.7 million during the 2022 three-month period and decreased$3.4 million during the 2022 nine-month period as compared to the same respective periods of 2021. The increase in net premiums earned for the 2022 three-month period was primarily attributable to our focus on rate adequacy. 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 during the 2022 nine-month period. The decrease in net premiums earned in our Specialty P&C segment during the 2022 nine-month period 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 2022 three-month period or 2021 three- and nine-month periods. •Net premiums earned in our Segregated Portfolio Cell Reinsurance segment increased for the 2022 three- and nine-month periods driven by tail coverage premiums primarily related to one program in which we do not participate, which resulted in$1.7 million and$4.7 million of one-time premium written and fully earned, respectively. •For ourWorkers' Compensation Insurance segment, net premiums earned remained relatively unchanged for the 2022 three-month period and increased for the 2022 nine-month period due to the prior year effect of a$1.2 million reduction in our EBUB estimate during the first quarter of 2021 and an increase in audit premiums billed to policyholders in 2022. 55
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The following table shows our consolidated net investment result:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net investment income
28.4 %$ 67,132 $ 51,713 $ 15,419 29.8 % Equity in earnings (loss) of unconsolidated subsidiaries* (6,852) 15,244 (22,096) (144.9 %) 5,948 33,959 (28,011) (82.5 %)
Net investment result
(48.2 %)$ 73,080 $ 85,672 $ (12,592) (14.7 %)
*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 nine months endedSeptember 30, 2022 as compared to the same respective periods of 2021 reflected higher average book yields as we continue to reinvest at higher rates as our portfolio matures and, for the 2022 nine-month period the addition of NORCAL's investment portfolio. Furthermore, the increase in net investment income during the 2022 nine-month period 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 nine months endedSeptember 30, 2022 as compared to the same respective periods of 2021 primarily due to the performance of certain LP/LLCs, which are primarily reported to us on a one-quarter lag, and reflected lower market valuations during the first half of 2022, partially offset by lower amortization of tax credit partnership operating losses.
The following table shows our consolidated other income:
Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022
($ in thousands) 2022 2021 Change 2022 2021 Change
Other income $ 5,097 $ 2,400 $ 2,697 112.4 % $ 13,215 $ 6,862 $ 6,353 92.6 %
The increase in consolidated other income for the 2022 three- and nine-month
periods was driven by the effect of foreign currency exchange rate changes of
$2.3 million and $5.4 million , respectively, in our Corporate segment related to
foreign currency denominated loss reserves associated with premium assumed from
an international medical professional liability insured in our Specialty P&C
segment. We mitigate foreign exchange exposure by generally matching the
currency and duration of associated investments to the corresponding loss
reserves. In accordance with GAAP, the impact on the market value of
available-for-sale fixed maturities due to changes in foreign currency exchange
rates is reflected as part of OCI. Conversely, the impact of changes in foreign
currency exchange rates on loss reserves is reflected through net income (loss)
as a component of other income. The effect of exchange rate changes on foreign
currency denominated loss reserves are reported in our Corporate segment to be
consistent with the reporting of the foreign currency denominated invested
assets and associated investment income.
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Expenses
The following table shows our consolidated and segment net loss ratios and net
prior accident year reserve development.
Three Months Ended September 30 Nine Months Ended September 30
($ in millions) 2022 2021 Change 2022 2021 Change
Current accident year net loss ratio
Consolidated ratio 79.5 % 85.2 % (5.7 pts) 80.0 % 83.3 % (3.3 pts)
Specialty P&C 82.9 % 90.0 % (7.1 pts) 84.3 % 89.7 % (5.4 pts)
Workers' Compensation Insurance 71.7 % 77.8 % (6.1 pts) 71.8 % 74.0 % (2.2 pts)
Segregated Portfolio Cell
Reinsurance 67.7 % 67.2 % 0.5 pts 67.5 % 66.3 % 1.2 pts
Lloyd's Syndicates 56.2 % 50.4 % 5.8 pts 37.8 % 54.5 % (16.7 pts)
Calendar year net loss ratio
Consolidated ratio 76.7 % 82.1 % (5.4 pts) 75.9 % 79.4 % (3.5 pts)
Specialty P&C 80.1 % 86.6 % (6.5 pts) 79.6 % 85.6 % (6.0 pts)
Workers' Compensation Insurance 66.9 % 74.3 % (7.4 pts) 66.9 % 69.4 % (2.5 pts)
Segregated Portfolio Cell
Reinsurance 64.0 % 56.7 % 7.3 pts 60.3 % 55.9 % 4.4 pts
Lloyd's Syndicates 72.7 % 62.5 % 10.2 pts 64.2 % 62.7 % 1.5 pts
Favorable (unfavorable) reserve
development, prior accident years
Consolidated $ 7.2 $ 8.6 $ (1.4) $ 31.5 $ 27.2 $ 4.3
Specialty P&C $ 5.5 $ 6.8 $ (1.3) $ 26.8 $ 20.0 $ 6.8
Workers' Compensation Insurance $ 2.0 $ 1.5 $ 0.5 $ 6.0 $ 5.6 $ 0.4
Segregated Portfolio Cell
Reinsurance $ 0.6 $ 1.6 $ (1.0) $ 3.8 $ 4.9 $ (1.1)
Lloyd's Syndicates $ (0.9) $ (1.3) $ 0.4 $ (5.1) $ (3.3) $ (1.8)
The primary drivers of the change in our consolidated current accident year net
loss ratio for the three and nine months ended September 30, 2022 as compared to
the same respective periods of 2021 were as follows:
Increase (Decrease)
2022 versus 2021
Comparative Comparative
three-month nine-month
(In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Operations
(2.3 pts) (0.8 pts) NORCAL Acquisition - Purchase Accounting Amortization 0.9 pts - pts Change in Estimate of ULAE (3.2 pts) (2.4 pts) Ceded Premium Adjustments, Prior Accident Years - pts 0.3 pts SPCs Estimated Aggregate Reinsurance 0.2 pts 0.3 pts All other, net (1.3 pts) (0.7 pts)
Decrease in the consolidated current accident year net loss
ratio
(5.7 pts) (3.3 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 nine months endedSeptember 30, 2022 decreased 1.3 and 0.7 percentage points, respectively, as compared to the same respective periods of 2021 driven by ourWorkers' Compensation Insurance and Specialty P&C segments and, for the 2022 nine-month period, our Lloyd's Syndicates segment. The lower current accident year net loss ratios in ourWorkers' Compensation Insurance segment for the three and nine months endedSeptember 30, 2022 was driven by 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 ratio for the 2021 three-month period was also impacted by an increase in the full-year loss ratio from 72% atJune 30, 2021 to 74% atSeptember 30, 2021 . The improvement in the current accident year net loss ratios in our Specialty P&C segment for the three and nine months endedSeptember 30, 2022 was driven by our reduction 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 57
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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. For our Lloyd's Syndicates segment, the lower current accident year net loss ratio for the 2022 nine-month period 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 period. •Initial expected 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 and further reduced certain expected loss ratios during the third quarter of 2022 due to favorable frequency trends, as previously discussed, leading to a 2.3 and 0.8 percentage point improvement in our consolidated current accident year net loss ratio for the three and nine months endedSeptember 30, 2022 , respectively, as compared to the same periods of 2021. The improvement in our consolidated current accident year net loss ratio for the nine months endedSeptember 30, 2022 as compared to the prior year period also reflected the higher volume of NORCAL premiums in the 2022 nine-month period. •Also as a result of our acquisition of NORCAL, our consolidated current accident year net loss ratios for the nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 2021 were impacted by the purchase accounting amortization of the negative VOBA associated with NORCAL's assumed unearned premium of$4.9 million ,$2.5 million and$4.3 million , respectively, which was recorded as a reduction to current accident year net losses. As ofJune 30, 2022 , the negative VOBA was fully amortized which resulted in a 0.9 percentage point increase in the 2022 three-month period ratio as compared to the prior year period. The purchase accounting amortization did not have an impact on our consolidated current accident year net loss ratio for the nine months endedSeptember 30, 2022 as compared to the prior year period as each respective nine-month period had two quarters of amortization. •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 3.2 and 2.4 percentage point decrease in our consolidated current accident year net loss ratios for the three and nine months endedSeptember 30, 2022 with an offsetting 3.2 and 2.4 percentage point increase, respectively, 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. •During the 2022 nine-month period, we increased our estimate 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 0.3 percentage point increase in our consolidated current period ratio. No such adjustments were made during the 2022 three-month period or 2021 three- and nine-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 nine-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 0.2 and 0.3 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. 58
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In both the 2022 and 2021 three- and nine-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 net prior accident year reserve development:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net favorable reserve
development $ 4,714 $ 5,688 $ (974) (17.1 %) $ 23,219 $ 22,196 $ 1,023 4.6 %
NORCAL Acquisition - Purchase
Accounting Amortization* 2,510 2,900 (390) (13.4 %) 8,309 5,009 3,300 65.9 %
Total net favorable reserve
development $ 7,224 $ 8,588 $
(1,364) (15.9 %)
15.9 %
*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 and$6.0 million during the 2022 three- and nine-month periods, respectively, as compared to$1.0 million in each of the 2021 three- and nine-month periods 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 three months endedSeptember 30, 2022 related to the accident year 2020 and development recognized for the nine months endedSeptember 30, 2022 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 nine months endedSeptember 30, 2022 reflected overall favorable trends in claim closing patterns. •We recognized$0.9 million and$5.1 million of unfavorable prior year development in our Lloyd's Syndicates segment during the three and nine months endedSeptember 30, 2022 , respectively, driven by higher than expected losses and development on certain large claims, primarily catastrophe related losses.
Our consolidated and segment underwriting expense ratios were as follows:
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Underwriting Expense Ratio
Consolidated (1) 31.2 % 24.5 %
6.7 pts 29.8 % 28.7 % 1.1 pts Specialty P&C 26.6 % 17.7 % 8.9 pts 24.8 % 18.7 % 6.1 pts Workers' Compensation Insurance 33.6 % 32.0 % 1.6 pts 32.8 % 31.3 % 1.5 pts Segregated Portfolio Cell Reinsurance 31.4 % 31.0 % 0.4 pts 28.5 % 31.7 % (3.2 pts) Lloyd's Syndicates 32.7 % 35.7 % (3.0 pts) 31.6 % 37.8 % (6.2 pts) Corporate (2) 3.5 % 2.5 % 1.0 pts 3.5 % 2.7 % 0.8 pts (1) Consolidated underwriting expenses include transaction-related costs for the nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 2021 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. We did not incur any transaction-related costs associated with our acquisition of NORCAL for the three months endedSeptember 30, 2022 . 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). 59
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The change in our consolidated underwriting expense ratio for the 2022 three-
and nine-month periods as compared to the same respective periods of 2021 was
primarily attributable to the following:
Increase (Decrease)
2022 versus 2021
Comparative Comparative
(In percentage points) three-month period nine-month period
Estimated ratio increase (decrease) attributable to:
Change in Net Premiums Earned and DPAC amortization
1.1 pts 0.1 pts
NORCAL DPAC Amortization - Prior Period Purchase Accounting Impact 2.1 pts
1.7 pts Change in Estimate of ULAE 3.2 pts 2.4 pts Transaction-related Costs(1) (0.8 pts) (3.1 pts) One-Time Expenses(2) 0.7 pts 0.5 pts All other, net 0.4 pts (0.5 pts) Increase in the underwriting expense ratio 6.7 pts 1.1 pts (1) Represents transaction-related costs associated with our acquisition of NORCAL of$1.9 million for the nine months endedSeptember 30, 2022 as compared to$2.3 million and$23.5 million for the three and nine months endedSeptember 30, 2021 , respectively. We did not incur any transaction-related costs associated with our acquisition of NORCAL for the three months endedSeptember 30, 2022 . 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. (2) Represents one-time expenses of$1.8 million and$3.6 million for the three and nine months endedSeptember 30, 2022 , respectively, mainly comprised of one-time bonuses, accelerated depreciation associated with a decommissioned IT system, employee severance charges and lease exit costs in our Specialty P&C segment. •Excluding the impact of the items specifically identified in the table above, our consolidated underwriting expense ratio for the 2022 three-month period increased by 0.4 percentage points and decreased by 0.5 percentage points for the 2022 nine-month period as compared to the same respective periods of 2021. The increase in our consolidated underwriting expense ratio for the 2022 three-month period was primarily driven by an increase in compensation-related costs, business-related travel and our allowance for credit losses in ourWorkers' Compensation Insurance segment. The decrease in our consolidated underwriting expense ratio for the 2022 nine-month period was primarily 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 nine-month period ratio also reflected the impact of our ceased participation in Syndicate 6131 for the 2022 underwriting year. •As shown in the previous table, our consolidated underwriting expense ratios for both the 2022 three- and nine-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 nine-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 normalized level of amortization associated with NORCAL policies whereas the 2022 nine-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 nine-month periods by 2.1 and 1.7 percentage points, respectively. •As shown in the previous table, the consolidated underwriting expense ratios for the three and nine months endedSeptember 30, 2022 reflected a revision to our process of estimating ULAE which resulted in approximately$8.2 million and$21.8 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 (loss). See additional discussion on this change in ULAE estimate in the Segment Results - Specialty Property and Casualty section that follows. 60
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Gain on Bargain Purchase
As a result of the NORCAL acquisition, we recognized a gain on bargain purchase of$74.4 million during the second quarter of 2021 representing the excess of the fair value of the identifiable assets acquired and liabilities assumed over the purchase consideration. We do not consider this gain in assessing the financial performance of any of our operating or reportable segments and therefore, we excluded it from the Segment Results sections that follow. See further discussion around the gain on bargain purchase recognized from the NORCAL acquisition in Note 2 of the Notes to Consolidated Financial Statements included in ourDecember 31, 2021 report on Form 10-K.
Taxes
Our provision for income taxes and effective tax rates for the nine months ended
Nine Months Ended
($ in thousands) 2022 2021
Change
Income (loss) before income taxes
Less: Income tax expense (benefit) (6,623) (3,132) (3,491) (111.5 %)
Net income (loss) $ (14,344) $ 111,984 $ (126,328) (112.8 %)
Effective tax rate 31.6% (2.9%) 34.5 pts
We recognized an income tax benefit of $6.6 million and $3.1 million during the
nine months ended September 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 nine-month period as compared to consolidated
pre-tax income recognized in the 2021 nine-month period. Furthermore, the
comparability of our effective tax rates is impacted by our use of the estimated
annual effective tax rate method for the 2022 nine-month period versus our use
of the discrete effective tax rate method for the 2021 nine-month period (see
further discussion on these methods in the Critical Accounting Estimates section
under the heading "Estimation of Taxes/Tax Credits").
Our effective tax rates for both the 2022 and 2021 nine-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
nine-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."
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 nine months ended
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Combined ratio 107.9 % 106.6 % 1.3 pts 105.7 % 108.1 % (2.4 pts)
Less: investment income ratio 9.6 % 7.1 % 2.5 pts 8.7 % 7.4 % 1.3 pts
Operating ratio 98.3 % 99.5 % (1.2 pts) 97.0 % 100.7 % (3.7 pts)
Combined ratio, excluding
transaction-related costs* 107.9 % 105.8 % 2.1 pts 105.5 % 104.8 % 0.7 pts
*Our consolidated combined ratios for the 2022 nine-month period includes $1.9 million of transaction-related costs included in consolidated operating
expenses associated with our acquisition of NORCAL as compared to $2.3 million and $23.5 million for the 2021 three- and nine-month periods,
respectively. We did not incur any transaction-related costs associated with our acquisition of NORCAL for the three months ended September 30, 2022 .
Given these costs do not reflect normal operating expenses, we have excluded their impact from our calculation of the consolidated combined ratio. See
previous discussion under the heading "Expenses."
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The primary drivers of the change in our operating ratios were as follows:
Increase (Decrease)
2022 versus 2021
Comparative Comparative
three-month nine-month
(In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Acquisition - Purchase Accounting Amortization 1.0 pts (0.3 pts) Investment Results (2.5 pts) (1.3 pts) Transaction-related Costs (0.8 pts) (3.1 pts)
NORCAL DPAC Amortization - Prior Period Purchase Accounting
Impact
2.1 pts 1.7 pts
All other, net (1.0 pts) (0.7 pts)
Decrease in the operating ratio (1.2 pts) (3.7 pts)
Excluding the impact of the items specifically identified in the table above,
our operating ratio for the 2022 three and nine months ended decreased by 1.0
and 0.7 percentage points, respectively, as compared to the same respective
periods of 2021. The decrease in our operating ratios for the 2022 three- and
nine-month periods were primarily due to a lower net loss ratio in our Specialty
P&C segment driven by a decrease to certain expected NORCAL loss ratios during
the fourth quarter of 2021 and further reduced certain expected loss ratios
during the third quarter of 2022 due to favorable frequency trends. Furthermore,
the improvement in the Specialty P&C segment's net loss ratio for the 2022
three- and nine-month periods reflected a decrease to certain expected loss
ratios in our Standard Physician line of business, which we began recognizing in
the second half of 2021, somewhat offset by changes in the mix of business. 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 Nine Months Ended
September 30 September 30
(In thousands, except per share data) 2022 2021 2022 2021
Net income (loss) $ (9,125) $ 12,200 $ (14,344) $ 111,984
Items excluded in the calculation of Non-GAAP operating
income (loss):
Net investment (gains) losses 8,262 (530) 45,652 (20,212)
Net investment gains (losses) attributable to SPCs
which no profit/loss is retained (1)
(562) 143 (3,362) 2,208 Transaction-related costs (2) - 2,327 1,862 23,535 Guaranty fund assessments (recoupments) 4 53 130 186 Gain on bargain purchase (3) - - - (74,408) Pre-tax effect of exclusions 7,704 1,993 44,282 (68,691) Tax effect, at 21% (4) (1,555) (427) (8,905) (841) After-tax effect of exclusions 6,149 1,566 35,377 (69,532) Non-GAAP operating income (loss)$ (2,976) $ 13,766 $ 21,033 $ 42,452 Per diluted common share: Net income (loss)$ (0.17) $ 0.23 $ (0.27) $ 2.07 Effect of exclusions 0.11 0.02 0.66 (1.28)
Non-GAAP operating income (loss) per diluted common
share
$ (0.06) $ 0.25 $ 0.39 $ 0.79 (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 estimated annual effective tax rate method for the nine months endedSeptember 30, 2022 , while we utilized the discrete effective tax rate method for the nine months endedSeptember 30, 2021 . For the 2022 periods our effective tax rate was applied to these items in calculating net income (loss), excluding net investment gains (losses) and related adjustments. For the 2021 periods, our statutory tax rate was applied to these items in calculating net income (loss), excluding the 2021 gain on bargain purchase. See further discussion on these methods in the Critical Accounting Estimates section under the heading "Estimation of Taxes/Tax Credits". 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. 63
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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 nine months endedSeptember 30, 2022 and 2021: Three Months Ended Nine Months Ended September 30 September 30 2022 2021 Change 2022 2021 Change ROE(1) (3.3 %) 4.0 % (7.3 pts) (1.5 %) 4.2 % (5.7 pts) Pre-tax effect of items excluded in the calculation of Non-GAAP operating ROE 2.8 % 0.2 % 2.6 pts 4.7 % 0.1 % 4.6 pts Tax effect, at 21%(2) (0.6 %) (0.1 %) (0.5 pts) (1.0 %) (0.1 %) (0.9 pts) Non-GAAP operating ROE (1.1 %) 4.1 % (5.2 pts) 2.2 % 4.2 % (2.0 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 nine months endedSeptember 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 nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 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 nine-month periods associated with our acquisition of NORCAL, which decreased our Non-GAAP operating ROE by 0.5 points for the 2022 three-month period and increased 0.6 percentage points for the 2022 nine-month period 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 nine-month periods decreased by 4.7 and 2.6 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 nine-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 nine-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. 64
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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(1) 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 nine months
ended September 30, 2022 attributable to:
Dividends declared (0.15)
Net income (loss) (0.27)
Other(2) 0.01
Non-GAAP Adjusted Book Value Per Share at September 30, 2022 25.75
Add: AOCI Per Share(1) (6.00)
Book Value Per Share at September 30, 2022 $ 19.75
(1) Primarily the impact of accumulated unrealized investment gains (losses) on our
available-for-sale fixed maturity investments. See Note 8 of the Notes to Condensed Consolidated
Financial Statements for additional information.
(2) Includes the impact of share-based compensation and shares repurchased conducted through a 10b5-1
stock repurchase plan.
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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 nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 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. We did not incur any transaction-related costs associated with our acquisition of NORCAL for the three months endedSeptember 30, 2022 . Segment results included the following: Three Months Ended September 30 Nine Months Ended September 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Net premiums written $ 216,131$ 218,636 $ (2,505) (1.1 %) $ 600,984$ 467,383 $ 133,601 28.6 % Net premiums earned $ 192,762$ 203,716 $ (10,954) (5.4 %) $ 574,276$ 487,963 $ 86,313 17.7 % Other income 832 860 (28) (3.3 %) 3,755 2,800 955 34.1 % Net losses and loss adjustment expenses (154,361) (176,490) 22,129 (12.5 %) (457,320) (417,890) (39,430) 9.4 % Underwriting, policy acquisition and operating expenses (51,295) (36,147) (15,148) 41.9 % (142,252) (91,369) (50,883) 55.7 % Segment results$ (12,062) $ (8,061) $ (4,001) (49.6 %)$ (21,541) $ (18,496) $ (3,045) (16.5 %) Net loss ratio 80.1% 86.6% (6.5 pts) 79.6% 85.6% (6.0 pts) Underwriting expense ratio 26.6% 17.7% 8.9 pts 24.8% 18.7% 6.1 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 nine months endedSeptember 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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums written $ 238,043 $ 235,091 $ 2,952 1.3 % $ 663,476 $ 515,414 $ 148,062 28.7 %
Less: Ceded premiums
written 21,912 16,455 5,457 33.2 % 62,492 48,031 14,461 30.1 %
Net premiums written $ 216,131 $ 218,636 $ (2,505) (1.1 %) $ 600,984 $ 467,383 $ 133,601 28.6 %
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Gross Premiums Written
Gross premiums written by component were as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Professional Liability
HCPL
Standard Physician(1)(12) $ 66,586 $ 65,531 $ 1,055 1.6 % $ 162,928 $ 167,882 $ (4,954) (3.0 %)
NORCAL Standard Physician(2) 54,340 55,235 (895) (1.6 %) 199,898 71,575 128,323 179.3 %
Total Standard Physician 120,926 120,766 160 0.1 % 362,826 239,457 123,369 51.5 %
Specialty
Custom Physician(3)(12) 10,074 13,222 (3,148) (23.8 %) 29,930 35,814 (5,884) (16.4 %) NORCAL Custom Physician(4) 4,858 6,700 (1,842) (27.5 %) 20,895 7,905 12,990 164.3 % Hospitals and Facilities(5)(12) 18,408 12,802 5,606 43.8 % 43,574 39,553 4,021 10.2 % NORCAL Hospitals and Facilities(6) 2,554 3,999 (1,445) (36.1 %) 11,022 6,386 4,636 72.6 % Senior Care(7)(12) 811 573 238 41.5 % 5,481 6,333 (852) (13.5 %) Reinsurance assumed(8) 16,850 14,612 2,238 15.3 % 34,739 29,139 5,600 19.2 % Total Specialty 53,555 51,908 1,647 3.2 % 145,641 125,130 20,511 16.4 % Total HCPL 174,481 172,674 1,807 1.0 % 508,467 364,587 143,880 39.5 % Small Business Unit(9) 38,983 38,718 265 0.7 % 84,484 84,662 (178) (0.2 %) Tail Coverages(10)(12) 8,667 5,210 3,457 66.4 % 24,026 26,666 (2,640) (9.9 %) NORCAL Tail Coverages(10) 3,446 6,544 (3,098) (47.3 %) 15,011 8,994 6,017 66.9 % Total Professional Liability 225,577 223,146 2,431 1.1 % 631,988 484,909 147,079 30.3 % Medical Technology Liability(11) 12,167 11,709 458 3.9 % 30,780 29,887 893 3.0 % Other 299 236 63 26.7 % 708 618 90 14.6 % Total Gross Premiums Written$ 238,043 $ 235,091 $ 2,952 1.3 %$ 663,476 $ 515,414 $ 148,062 28.7 % (1) Standard Physician premium, exclusive of NORCAL, increased for the 2022 three-month period and decreased for the 2022 nine-month period as compared to the same respective periods of 2021. The increase in premium for the 2022 three-month period as compared to the same period of 2021 was driven by an increase in renewal pricing and new business written, partially offset by retention losses. The decrease in premium for the 2022 nine-month period as compared to the same period of 2021 was driven by retention losses and, to a lesser extent, the shifting of certain policies totaling$4.2 million from our Standard Physician line to our Custom Physician line of business during the second quarter of 2022. Partially offsetting these factors during the 2022 nine-month period was an increase in renewal pricing and new business written. Renewal pricing increases during the 2022 three- and nine-month periods reflect the rising loss cost environment and new business written reflects the competitive market conditions. Retention losses during the 2022 three- and nine-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. 67
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(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 decreased for the 2022 three-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. NORCAL Standard Physician premium increased during the 2022 nine-month period as compared to the same period of 2021 driven by four months of additional premium for the 2022 nine-month period as compared to the same period of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, NORCAL Standard Physician premium increased during the 2022 nine-month period as compared to the same period of 2021 due to an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses. Retention losses for the 2022 three- and nine-month periods were primarily attributable to price competition and, for the 2022 nine-month period, the process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. (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. Exclusive of NORCAL, the decrease in Custom Physician premium during the 2022 three- and nine-month periods as compared to the same respective periods of 2021 reflected net timing differences of$5.2 million and$6.0 million , respectively, primarily related to the current year renewal of a few policies. The decrease in Custom Physician premium during the 2022 three- and nine-month periods also reflected 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 nine-month period reflected the shifting of certain policies totaling$4.2 million from our Standard Physician line of business. Renewal pricing increases for the 2022 three- and nine-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 nine-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 6.8 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. The decrease in NORCAL Custom Physician premium for the 2022 three-month period as compared to the same period of 2021 was driven by retention losses, including the loss of a$2.2 million policy during the third quarter of 2022 due to price competition, partially offset by an increase in renewal pricing and, to a lesser extent, new business written. NORCAL Custom Physician premium increased during the 2022 nine-month period as compared to the same period of 2021 driven by four months of additional premium for the 2022 nine-month period as compared to the same period of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, the increase in NORCAL Custom Physician premium during the 2022 nine-month period reflected an increase in renewal pricing and, to a lesser extent, new business written, partially offset by retention losses. Retention losses during the 2022 nine-month period reflect the loss of a$2.2 million policy during the second quarter of 2022 due to price competition as well as our evaluation of the NORCAL book of business and implementingProAssurance's underwriting strategies. (5) Hospitals and Facilities premium, exclusive of NORCAL, (which includes hospitals, surgery centers and miscellaneous medical facilities) increased for the 2022 three- and nine-month periods as compared to the same respective periods of 2021 driven by new business written, primarily miscellaneous medical facilities, and an increase in renewal pricing, partially offset by retention losses. The increase in Hospitals and Facilities premium during the 2022 three-month period also reflected net timing differences of$6.4 million , primarily related to the current year renewal of five policies; a majority of these policies renewed in the third quarter of 2022 as compared to the first and second quarters of 2021. Retention losses in the 2022 nine-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 nine-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. The decrease in NORCAL Hospitals and Facilities premium for the 2022 three-month period as compared to the same period of 2021 was driven by retention losses, partially offset by new business written and, to a lesser extent, an increase in renewal pricing. NORCAL Hospitals and Facilities premium increased during the 2022 nine-month period as compared to the same period of 2021 driven four months of additional premium for the 2022 nine-month period as compared to the same period of 2021 due to the timing of our acquisition of NORCAL onMay 5, 2021 . In addition, the increase in NORCAL Hospitals and Facilities premium during the 2022 nine-month period 2021 was driven by new business written and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Retention losses for the 2022 nine-month period are largely attributable to the process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies. 68
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(7) Senior Care premium includes facilities specializing in long term residential care primarily for the elderly ranging from independent living through skilled nursing. Our Senior Care premium remained relatively unchanged for the 2022 three-month period and decreased for the 2022 nine-month period as compared to the same respective periods of 2021. The decrease in Senior Care premium for the 2022 nine-month period was 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 nine-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. (8) We offer custom alternative risk solutions including assumed reinsurance. The increase in premium during the 2022 three- and nine-month periods reflected 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. In addition, the increase for the 2022 three- and nine-month periods reflected an assumed reinsurance arrangement with a regional hospital group entered into during the third quarter of 2022 totaling$1.3 million . The increase in premium during the 2022 nine-month period as compared to the same period of 2021 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 nine-month periods as compared to the same respective periods of 2021. The increase in renewal pricing during the 2022 three- and nine-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, excluding NORCAL, during the 2022 nine-month period as compared to the same period of 2021 was primarily due to the prior year effect of$7.8 million of tail premium written and fully earned during the second quarter of 2021 associated with a large Custom Physician policy. (11) Our Medical Technology Liability business is marketed throughout theU.S. ; coverage is typically offered on a primary basis, within specified limits, to manufacturers and distributors of medical technology and life sciences products including entities conducting human clinical trials. In addition to the previously listed factors that affect our premium volume, our Medical Technology Liability premium is also impacted by the sales volume of insureds. Our Medical Technology Liability premium increased during the 2022 three- and nine-month periods as compared to the same respective periods of 2021 driven by new business written and, to a lesser extent, an increase in renewal pricing, partially offset by retention losses. Renewal pricing increases during the 2022 three- and nine-month periods are primarily due to changes in the sales volume and changes in exposure of certain insureds. Retention losses during the 2022 three- and nine-month periods are primarily attributable to insureds no longer needing coverage, an increase in competition on terms and pricing, as well as merger activity within the industry. 69
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(12) Certain components of our gross premiums written include alternative market premiums. We currently cede either all or a portion of the alternative market premium, net of reinsurance, to three SPCs of our wholly ownedCayman Islands reinsurance subsidiaries, Inova Re and Eastern Re, which are reported in our Segregated Portfolio Cell Reinsurance segment (see further discussion in the Ceded Premiums Written section that follows). The portion not ceded to the SPCs is retained within our Specialty P&C segment. Three Months Ended September 30 Nine Months Ended September 30 ($ in millions) 2022 2021 Change 2022 2021 Change Standard Physician $ - $ - $ - nm $ -$ 2.0 $ (2.0) nm Custom Physician - - - nm 2.0 - 2.0 nm Hospitals and Facilities 0.1 0.1 - - % 0.1 0.1 - - % Senior Care 0.3 0.6 (0.3) (50.0 %) 4.2 5.2 (1.0) (19.2 %) Tail Coverages 1.7 - 1.7 nm 4.7 0.7 4.0 571.4 % Total$ 2.1 $ 0.7 $ 1.4 200.0 %$ 11.0 $ 8.0 $ 3.0 37.5 % Alternative market gross premiums written increased during the 2022 three- and nine-month periods as compared to the same respective periods of 2021 driven by an increase in tail coverage premium, primarily related to one program. Additionally, alternative market gross premiums during the 2022 nine-month period reflected a$2.0 million expiring Standard Physician policy in one program renewed as a Custom Physician policy during the second quarter of 2022. 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 Nine Months Ended September 30 September 30 2022 2022 Specialty P&C segment 8 % 7 % HCPL Standard Physician 9 % 7 % Specialty 7 % 10 % Total HCPL 9 % 8 % Small Business Unit 7 % 6 % Medical Technology Liability 3 % 3 %
New business written by major component on a direct basis was as follows:
Three Months Ended Nine Months Ended
September 30 September 30
(In millions) 2022 2021 2022 2021
HCPL
Standard Physician $ 4.0 $ 2.3 $ 7.8 $ 3.9
Specialty 5.4 6.4 13.4 18.8
Total HCPL 9.4 8.7 21.2 22.7
Small Business Unit 1.4 1.3 3.0 3.1
Medical Technology Liability 1.3 1.2 3.9 4.7
Total $ 12.1 $ 11.2 $ 28.1 $ 30.5
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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 Nine Months Ended
September 30 September 30
2022 2021 2022 2021
Specialty P&C segment 87 % 84 % 84 % 83 %
HCPL
Standard Physician 89 % 85 % 87 % 86 %
Specialty 74 % 69 % 69 % 66 %
Total HCPL 85 % 81 % 82 % 80 %
Small Business Unit 91 % 91 % 91 % 91 %
Medical Technology Liability 92 % 90 % 91 % 89 %
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 on October 1 . Through our current
excess of loss reinsurance arrangements which renewed effective October 1, 2022 ,
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.
There were no significant changes in the cost or structure of our HCPL treaty
upon the October 2022 renewal. Our HCPL excess of loss reinsurance arrangement
that renewed on October 1, 2021 renewed at a lower gross rate and prospectively
incorporated NORCAL policies. Prior to October 1, 2021 , NORCAL policies were
reinsured under separate reinsurance agreements, primarily excess of loss, which
have historically renewed annually on January 1 . For the NORCAL excess of loss
reinsurance arrangement that renewed on January 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 effective October 1, 2022 , we do not retain any of the next $8 million
of risk for coverages in excess of $2 million .
Ceded premiums written were as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Excess of loss reinsurance arrangements
(1) $ 11,138 $ 7,062 $
4,076 57.7 %
Other shared risk arrangements (2)
7,413 6,387 1,026 16.1 % 15,955 14,318 1,637 11.4 % Premium ceded to SPCs (3) 1,921 443 1,478 333.6 % 10,201 7,046 3,155 44.8 % NORCAL premiums ceded since acquisition(4) - 1,691 (1,691) nm - 1,758 (1,758) nm Other ceded premiums written(5) 1,440 872 568 65.1 % 4,881 2,466 2,415 97.9 % Adjustment to premiums owed under reinsurance agreements, prior accident years, net(6) - - - nm 3,000 - 3,000 nm Total ceded premiums written$ 21,912 $ 16,455 $ 5,457 33.2 %$ 62,492 $ 48,031 $ 14,461 30.1 % (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 nine-month periods as compared to the same respective periods of 2021 was driven by additional ceded premiums of$3.5 million and$9.6 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 was relatively unchanged for the 2022 three-month period and 71
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decreased by approximately$3.6 million during the 2022 nine-month period as compared to the same respective periods of 2021. The decrease during the 2022 nine-month period was 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 nine-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- and nine-month periods increased as compared to the same respective periods of 2021 driven by the impact of tail coverages, primarily related to one program (see discussion in footnote 12 under the heading "Gross Premiums Written"). (4) NORCAL policies written prior toSeptember 30, 2021 were reinsured under separate reinsurance agreements, primarily excess of loss; however, these policies were incorporated into our existing HCPL excess of loss reinsurance arrangements with theOctober 1, 2021 renewal, as previously discussed. For NORCAL's previous excess of loss agreement, deposit ceded premium, as defined in the contract, was initially estimated and recorded at the inception date of the treaty, generallyJanuary 1 , as an estimate of ceded premiums written for the full contract year based on information provided by brokers and reinsurers. As a result, the majority of ceded premiums for NORCAL's excess of loss reinsurance arrangement was recorded by NORCAL before the acquisition in their first quarter 2021 results and were expensed pro rata throughout the contract year. However, these initial estimates of ceded premiums may be periodically adjusted as new information is received and are fully earned in the period the changes in estimates occur. NORCAL's ceded premiums written for the 2021 three- and nine-month periods related almost entirely to an increase in the estimate of premiums owed in excess of the deposit ceded premium initially recorded by NORCAL prior to acquisition and, to a lesser extent, premium related to cyber liability coverages. EffectiveOctober 1, 2021 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 nine-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 nine-month period 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 the 2022 three-month period and both the 2021 three- and nine-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. Changes to estimates of premiums ceded related to prior accident years are fully earned in the period the changes in estimates occur. 72
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Ceded Premiums Ratio
As shown in the table below, our ceded premiums ratio was affected during the
2022 nine-month period 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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Ceded premiums ratio 9.2 % 7.0 % 2.2 pts 9.4 % 9.3 % 0.1 pts
Less the effect of adjustments in
premiums owed under reinsurance
agreements, prior accident years (as
previously discussed) - % - % - pts 0.5 % - % 0.5 pts
Ratio, current accident year 9.2 % 7.0 % 2.2 pts 8.9 % 9.3 % (0.4 pts)
The above table reflects ceded premiums written, excluding the effect of prior
year ceded premium adjustments, as previously discussed, as a percent of gross
premiums written. Our ceded premiums ratio for the 2022 three-month period
increased as compared to the same period of 2021 driven by an increase in
premiums ceded under our excess of loss arrangements as a result of NORCAL being
incorporated into our existing HCPL treaty. The decrease in our ceded premiums
ratios for the 2022 nine-month period as compared to the same period of 2021 was
driven by the reduced rate on our excess of loss reinsurance arrangements for
the treaty year effective October 1, 2021 and 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 nine-month period as compared to the
same period of 2021 was partially offset by an increase in premiums ceded to
SPCs. See additional discussion above under the heading "Ceded Premiums
Written."
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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 211,782 $ 221,956 $ (10,174) (4.6 %) $ 625,916 $ 540,489 $ 85,427 15.8 %
Less: Ceded premiums earned 19,020 18,240 780 4.3 % 51,640 52,526 (886) (1.7 %)
Net premiums earned $ 192,762 $ 203,716 $ (10,954) (5.4 %) $ 574,276 $ 487,963 $ 86,313 17.7 %
Gross premiums earned included earned premium from our acquisition of NORCAL of
approximately $72.9 million and $226.0 million during the 2022 three- and
nine-month periods, respectively, as compared to $88.1 million and $138.8
million during the same respective periods of 2021. Excluding NORCAL premiums,
gross premiums earned increased $5.1 million during the 2022 three-month period
and decreased $1.7 million during the 2022 nine-month period as compared to the
same respective periods of 2021. The increase for the 2022 three-month period
was driven by our focus on rate adequacy. The decrease for the 2022 nine-month
period was 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").
Ceded premiums earned increased $0.8 million during the 2022 three-month period
and decreased $0.9 million during the 2022 nine-month period as compared to the
same respective periods of 2021. The increase in ceded premiums earned during
the 2022 three-month period was primarily attributable to the pro rata effect of
an increase in premium ceded under our excess of loss arrangements during the
preceding twelve months, partially offset by the effect of subsequent prior year
adjustment made to initial deposit ceded premium recorded under NORCAL's excess
of loss reinsurance arrangement (see previous discussion in footnote 4 under the
heading "Ceded Premiums Written"). The decrease in ceded premiums earned during
the 2022 nine-month period was driven by a decrease in premium ceded under our
shared risk arrangements during the preceding twelve months,
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partially offset by 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 2022 three-month period or the 2021 three- and nine-month periods (see previous discussion in footnote 6 under the heading "Ceded Premiums Written").
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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 80.1% 86.6% (6.5 pts) 79.6 % 85.6 % (6.0
pts)
Less impact of prior accident years on the net loss ratio (2.8%) (3.4%) 0.6 pts (4.7 %) (4.1 %) (0.6
pts)
Current accident year net loss ratio(2) 82.9% 90.0% (7.1 pts) 84.3 % 89.7 % (5.4 pts)
(1)Net losses, as specified, divided by net premiums earned.
(2)For the three and nine months endedSeptember 30, 2022 , our current accident year net loss ratio (as shown in the table above), improved 7.1 and 5.4 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 nine-month (In percentage points) periods periods
Estimated ratio increase (decrease) attributable to:
NORCAL Operations
(2.2 pts) (1.6 pts) NORCAL Acquisition - Purchase Accounting Amortization 1.2 pts - pts Change in Estimate of ULAE (4.3 pts) (3.8 pts) Ceded Premium Adjustments, Prior Accident Years - pts 0.4 pts All other, net (1.8 pts) (0.4 pts) Decrease in current accident year net loss ratio (7.1 pts) (5.4 pts) •Excluding the impact of the items specifically identified in the table above, our current accident year net loss ratios for the three and nine months endedSeptember 30, 2022 improved 1.8 and 0.4 percentage points, respectively, as compared to the same respective periods of 2021 driven by our reduction 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. 74
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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 and further reduced certain expected loss ratios during the third quarter of 2022 due to favorable frequency trends, as previously discussed, leading to a 2.2 and 1.6 percentage point improvement in our segment current accident year net loss ratios for the three and nine months endedSeptember 30, 2022 , respectively. The improvement in our segment current accident year net loss ratio for the nine months endedSeptember 30, 2022 as compared to the prior year period also reflected the higher volume of NORCAL premium in the 2022 nine-month period. Furthermore, we completed the process of evaluating the NORCAL book of business and implementingProAssurance's underwriting strategies during the second quarter of 2022. •Also as a result of our acquisition of NORCAL, our current accident year net loss ratios for the nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 2021 were impacted by the purchase accounting amortization of the negative VOBA associated with NORCAL's assumed unearned premium of$4.9 million ,$2.5 million and$4.3 million , respectively, which is recorded as a reduction to current accident year net losses. As ofJune 30, 2022 , the negative VOBA was fully amortized which resulted in a 1.2 percentage point increase in the 2022 three-month period ratio as compared to the prior year period. The purchase accounting amortization did not have an impact on our current accident year net loss ratio for the nine months endedSeptember 30, 2022 as compared to the prior year period as each respective nine-month period had two quarters of amortization. •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 4.3 and 3.8 percentage point decrease in our current accident year net loss ratios for the 2022 three- and nine-month periods, respectively, with an offsetting 4.3 and 3.8 percentage point increase, respectively, in our current period expense ratios with no impact to our combined ratios or segment results during the three and nine months endedSeptember 30, 2022 , respectively (see discussion on our expense ratios in the following section under the heading "Underwriting, Policy Acquisition and Operating Expenses"). •During the 2022 nine-month period, 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 0.4 percentage point increase in our current period ratio. No such adjustments were made during the 2022 three-month period or 2021 three- and nine-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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net favorable reserve
development $ 3,000 $ 3,900 $ (900) (23.1 %) $ 18,500 $ 14,975 $ 3,525 23.5 %
NORCAL Acquisition -
Purchase Accounting
Amortization* 2,510 2,900 (390) (13.4 %) 8,309 5,009 3,300 65.9 %
Total net favorable reserve
development $ 5,510 $ 6,800 $ (1,290)
(19.0 %)
34.2 %
*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 months endedSeptember 30, 2022 related to the accident year 2020 and development recognized for the nine months endedSeptember 30, 2022 principally related to accident years 2018 through 2021. Development recognized during the three and nine months endedSeptember 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 and$6.0 million during the 2022 three- and nine-month periods, respectively, as compared to$1.0 million in each of 2021 three- and nine-month periods 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. 75
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•Net favorable development recognized during the nine months endedSeptember 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$0.4 million for the three months endedSeptember 30, 2021 and an increase of$1.0 million for the nine months endedSeptember 30, 2021 . A detailed discussion of factors influencing our recognition of loss development is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses" in ourDecember 31, 2021 report on Form 10-K. Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the then current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2022 and 2021.
Underwriting, Policy Acquisition and Operating Expenses
Our Specialty P&C segment underwriting, policy acquisition and operating
expenses were comprised as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 24,357 $ 16,145 $
8,212 50.9 %$ 70,335 $ 42,328 $ 28,007 66.2 % Management fees 1,410 1,159 251 21.7 % 3,806 3,015 791 26.2 % Other underwriting and operating expenses 25,528 18,843 6,685 35.5 % 68,111 46,026 22,085 48.0 % Total$ 51,295 $ 36,147 $ 15,148 41.9 %$ 142,252 $ 91,369 $ 50,883 55.7 % DPAC amortization for the 2022 three- and nine-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 the 2021 three- and nine-month periods was approximately$5.5 million and$11.8 million lower, respectively, 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 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 for the 2022 three-month period included a normalized level of amortization associated with NORCAL policies whereas the 2022 nine-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 nine-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, an increase in compensation-related expenses driven by an increase in headcount due to the addition of NORCAL employees 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 effectiveJanuary 1, 2022 . Accordingly, we reduced the fee charged to the operating subsidiaries in 2022. Also effectiveJanuary 1, 2022 , the management agreement included the wholly owned operating subsidiaries of NORCAL contributing to$0.3 million and$1.1 million of additional management fees in the 2022 three- and nine-month periods, respectively. 76
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Other underwriting and operating expenses increased during the 2022 three- and nine-month periods primarily due to a revision to our process of estimating ULAE which resulted in approximately$8.2 million and$21.8 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 nine-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 decreased for the 2022 three-month period and increased for the 2022 nine-month period as compared to the same respective periods of 2021. The decrease for the 2022 three-month period was 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 certain one-time expenses of$1.8 million mainly comprised of one-time bonuses, accelerated depreciation associated with a decommissioned IT system, employee severance charges and lease exit costs. The increase for the 2022 nine-month period was primarily attributable to an increase in professional fees, higher amounts accrued for performance-related incentive plans due to our improved combined ratio and other performance metrics as well as certain one-time expenses of$3.6 million mainly comprised of one-time bonuses, accelerated depreciation associated with a decommissioned IT system, employee severance charges and lease exit costs. The increase in professional fees for the 2022 nine-month period was primarily attributable to an increase in IT consulting fees and higher external audit fees due to the timing of prior year invoices.
Underwriting Expense Ratio (the Expense Ratio)
Our expense ratio for the Specialty P&C segment was as follows:
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio 26.6 % 17.7 % 8.9 pts 24.8 % 18.7 % 6.1 pts
The change in our expense ratio for the 2022 three- and nine-month periods as
compared to the same respective periods of 2021 was primarily attributable to
the following:
Increase (Decrease)
2022 versus 2021
Comparative Comparative
(In percentage points) three-month period nine-month period
Estimated ratio increase (decrease) attributable to:
Change in Net Premiums Earned and DPAC amortization
2.0 pts 1.2 pts
NORCAL DPAC Amortization - Prior Period Purchase Accounting
Impact
2.7 pts 2.4 pts
Change in Estimate of ULAE 4.3 pts 3.8 pts
One-Time Expenses 0.9 pts 0.6 pts
All other, net (1.0 pts) (1.9 pts)
Increase in the underwriting expense ratio 8.9 pts 6.1 pts
The change in other operating expenses decreased our expense ratios for the 2022
three- and nine-month periods by 1.0 and 1.9 percentage points, respectively,
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. Further, the higher expense ratios for both the 2022
three- and nine-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 nine-month periods due to the
application of GAAP purchase accounting rules in 2021, change in estimate of
ULAE and the impact of one-time expenses, 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 nine-month periods by 2.7
and 2.4 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 nine-month periods of 2.0 and 1.2 percentage points,
respectively, primarily reflects an increase in agency commissions due to a
higher volume of commissionable premium driven by NORCAL.
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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, unaffiliated captive insurers for two programs. 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 September 30 Nine Months Ended September 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Net premiums written$ 43,973 $ 46,702 $ (2,729) (5.8 %)$ 131,796 $ 134,370 $ (2,574) (1.9 %) Net premiums earned$ 42,063 $ 42,235 $ (172) (0.4 %)$ 124,456 $ 122,872 $ 1,584 1.3 % Other income 554 437 117 26.8 % 1,753 1,730 23 1.3 % Net losses and loss adjustment expenses (28,148) (31,364) 3,216 (10.3 %) (83,306) (85,323) 2,017 (2.4 %) Underwriting, policy acquisition and operating expenses (14,146) (13,521) (625) 4.6 % (40,816) (38,519) (2,297) 6.0 % Segment results$ 323 $ (2,213) $ 2,536 (114.6 %)$ 2,087 $ 760 $ 1,327 174.6 % Net loss ratio 66.9% 74.3% (7.4 pts) 66.9% 69.4% (2.5 pts) Underwriting expense ratio 33.6% 32.0% 1.6 pts 32.8% 31.3% 1.5 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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums written $ 63,543 $ 64,594 $ (1,051) (1.6 %) $ 199,295 $ 194,767 $ 4,528 2.3 %
Less: Ceded premiums written 19,570 17,892 1,678 9.4 % 67,499 60,397 7,102 11.8 %
Net premiums written $ 43,973 $ 46,702 $ (2,729) (5.8 %) $ 131,796 $ 134,370 $ (2,574) (1.9 %)
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Gross Premiums Written
Gross premiums written by product were as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Traditional business:
Guaranteed cost $ 38,823 $ 42,368 $ (3,545) (8.4 %) $ 110,045 $ 113,429 $ (3,384) (3.0 %)
Policyholder dividend 3,961 3,560 401 11.3 % 17,353 17,820 (467) (2.6 %)
Deductible 1,516 1,641 (125) (7.6 %) 4,104 4,080 24 0.6 %
Retrospective(1) 893 448 445 99.3 % 3,969 3,107 862 27.7 %
Other 1,942 1,742 200 11.5 % 5,668 5,049 619 12.3 %
Change in EBUB Estimate 450 - 450 nm 450 (1,210) 1,660 (137.2 %)
Total traditional business 47,585 49,759 (2,174) (4.4 %) 141,589 142,275 (686) (0.5 %)
Alternative market business(2) 15,958 14,835 1,123 7.6 % 57,706 52,492 5,214 9.9 %
Total $ 63,543 $ 64,594 $ (1,051) (1.6 %) $ 199,295 $ 194,767 $ 4,528 2.3 %
(1) The change in retrospectively-rated policies included an adjustment that
decreased premium by $0.2 million and $0.9 million for the three and nine months
ended September 30, 2022 , respectively, as compared to $0.1 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 decreased during the three months ended September 30,
2022 as compared to the same period of 2021 primarily reflecting retention
losses, renewal rate decreases and lower new business, partially offset by
higher audit premium and increased payroll exposure. Renewal premium was
impacted by the loss of a large traditional account with expiring premium of
$3.8 million , which accounted for a 5.5 percentage point decline in the renewal
retention rate for the current period. Renewal retention was 80% and 88% for the
2022 and 2021 three-month periods, respectively. Renewal rate decreases and new
business results reflected the continuation of competitive workers' compensation
market conditions. Renewal rates declined 5% for the 2022 three-month period as
compared to no change for the same period in 2021. New business decreased $0.4
million from 2021 to 2022. Policy audits processed during the 2022 three-month
period resulted in audit premium billed to policyholders totaling $4.1 million
as compared to audit premium returned to policyholders totaling $0.2 million for
the same respective period in 2021.
Gross premiums written increased during the nine months ended September 30, 2022
as compared to the same period of 2021, primarily reflecting higher audit
premium and changes in the carried EBUB estimate, partially offset by lower
renewal and new business premium. Policy audits processed during the 2022
nine-month period resulted in audit premium billed to policyholders totaling
$8.9 million as compared to audit premium returned to policyholders totaling
$2.0 million for the same period in 2021. Additionally, the carried EBUB
estimate was increased $0.5 million during the 2022 nine-month period as
compared to a reduction of $1.2 million for the same period in 2021.
We retained 100% of the eighteen (three in the third quarter) workers'
compensation alternative market programs that were up for renewal during the
nine months ended
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New business, audit premium, renewal retention and renewal price changes for our
traditional business and the alternative market business are shown in the table
below:
Three Months Ended
2022 2021
Alternative
Traditional Market Segment Traditional Alternative Market Segment
($ in millions) Business Business Results Business Business Results
New business $ 3.1 $ 0.8 $ 3.9 $ 3.5 $ 0.8 $ 4.3
Audit premium (excluding EBUB)
$ (0.1) $ (0.1) $ (0.2) Retention rate (1) 77 % 86 % 80 % 87 % 93 % 88 % Change in renewal pricing (2) (5 %) (4 %) (5 %) 1 % (2 %) - % Nine Months Ended September 30 2022 2021 Alternative Traditional Market Segment Traditional Alternative Market Segment ($ in millions) Business Business Results Business Business Results New business$ 10.2 $ 2.9 $ 13.1 $ 15.5 $ 2.3 $ 17.8
Audit premium (excluding EBUB)
$ (2.3) $ 0.3 $ (2.0) Retention rate (1) 84 % 88 % 85 % 87 % 90 % 88 % Change in renewal pricing (2) (5 %) (4 %) (4 %) (1 %) (4 %) (2 %)
(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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Premiums ceded to SPCs(1)
7.8 %$ 52,681 $ 49,409 $ 3,272 6.6 % Premiums ceded to external reinsurers(2) 3,720 3,290 430 13.1 % 10,508 9,476 1,032 10.9 % Premiums ceded to unaffiliated captive insurers(1) - 34 (34) (100.0 %) 5,025 3,083 1,942 63.0 % Change in return premium estimate under external reinsurance (3) (46) (55) 9 16.4 % 208 (550) 758 137.8 % Estimated revenue share under external reinsurance (4) (62) (178) 116 (65.2 %) (923) (1,021) 98 (9.6 %) Total ceded premiums written$ 19,570 $ 17,892 $ 1,678 9.4 %$ 67,499 $ 60,397 $ 7,102 11.8 % (1) Represents 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 100% quota share reinsurance agreements. 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. (2) 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. (3) Changes in the return premium estimate reflect 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. (4) 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 written increased during the three and nine months endedSeptember 30, 2022 as compared to the same respective periods of 2021, primarily reflecting higher alternative market premiums ceded to the Segregated Portfolio Cell Reinsurance Segment and, for the 2022 nine-month period, unaffiliated captive insurers, and an increase in reinsurance rates under our external reinsurance treaty. The increase in premiums ceded to unaffiliated captive insurers during the 2022 nine-month period as compared to the same period of 2021 was driven by a new program that was effectiveJune 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 insurer resulted in a decrease in net premiums written for theWorkers' Compensation Insurance segment.
Ceded Premiums Ratio
Ceded premiums ratio was as follows:
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Ceded premiums ratio, as reported 34.2 % 31.8 % 2.4 pts 34.0 % 32.2 % 1.8 pts
Less the effect of:
Premiums ceded to SPCs (100%) 23.9 % 23.4 % 0.5 pts 24.7 % 24.6 %
0.1 pts
Premiums ceded to unaffiliated captive insurers (100%) 2.5 % 1.6 % 0.9 pts 2.0 % 1.7 % 0.3 pts Estimated revenue share (0.1 %) (0.4 %) 0.3 pts (0.7 %) (0.8 %) 0.1 pts Assumed premiums earned (not ceded to external reinsurers) (0.3 %) (0.3 %) - pts (0.3 %) (0.2 %) (0.1 pts) Ceded premiums ratio (related to external reinsurance), less the effects of above 8.2 % 7.5 % 0.7 pts 8.3 % 6.9 % 1.4 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 nine months endedSeptember 30, 2022 as compared to the same respective periods of 2021 primarily reflected the increase in reinsurance rates. 81
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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 and changes in our estimates related to EBUB 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. We evaluate our estimates related to EBUB and retrospectively-rated premium adjustments on a quarterly basis with any adjustments being included in written and earned premium in the current period.
Net premiums earned were as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 63,963 $ 61,964 $ 1,999 3.2 % $ 188,518 $ 181,306 $ 7,212 4.0 %
Less: Ceded premiums earned 21,900 19,729 2,171 11.0 % 64,062 58,434 5,628 9.6 %
Net premiums earned $ 42,063 $ 42,235 $ (172) (0.4 %) $ 124,456 $ 122,872 $ 1,584 1.3 %
Net premiums earned remained relatively unchanged for the three months ended
September 30, 2022 and increased during the nine months ended September 30, 2022
as compared to the same respective periods of 2021. The increase in net premiums
earned for the 2022 nine-month period primarily reflected the change in the
carried EBUB estimate, which increased $0.5 million during the 2022 nine-month
period as compared to a reduction of $1.2 million for the same period in 2021.
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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 66.9 % 74.3 % (7.4 pts) 66.9 % 69.4 % (2.5 pts)
Less impact of prior accident
years on the net loss ratio (4.8 %) (3.5 %) (1.3 pts) (4.9 %) (4.6 %) (0.3 pts)
Current accident year net loss
ratio 71.7 % 77.8 % (6.1 pts) 71.8 % 74.0 % (2.2 pts)
The decrease in the current accident year net loss ratio during the three and
nine months ended September 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 nine-month periods reflected higher claim activity as
workers returned to employment with the easing of pandemic-related restrictions
in our operating territories, including the impact of labor shortages on the
existing workforce. 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 72% at June 30, 2021 to 74% at September 30, 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 $1.9 million and $3.7
million for the three and nine months ended September 30, 2022 , respectively, as
compared to the same respective periods of 2021. We retained losses in excess of
our per occurrence retention totaling $1.5 million and $3.5 million during the
2022 three- and nine-month periods, respectively, as compared to $1.4 million
and $4.2 million for the same respective periods of 2021 which reflected losses
within the AAD.
We recognized net favorable prior year development of $2.0 million and $6.0
million for the three and nine months ended September 30, 2022 , respectively, as
compared to $1.5 million and $5.6 million for the same respective periods of
2021. The net favorable prior year reserve development for the three and nine
months ended September 30, 2022 and 2021 reflected overall favorable trends in
claim closing patterns. Net favorable development for the 2022 and 2021 three-
and nine-month periods was primarily related to accident years 2017 and prior.
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Underwriting, Policy Acquisition and Operating Expenses
Underwriting, policy acquisition and operating expenses include the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers' compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by our Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern byProAssurance . The management fee is based on the extent to which services are provided to the subsidiary and the amount of premium written by the subsidiary.
Our
operating expenses were comprised as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 7,513 $ 7,464 $ 49 0.7 % $ 22,105 $ 21,454 $ 651 3.0 %
Management fees 477 485 (8) (1.6 %) 1,495 1,461 34 2.3 %
Other underwriting and
operating expenses 9,635 8,611 1,024 11.9 % 27,609 25,205 2,404 9.5 %
Policyholder dividend
expense 216 329 (113) (34.3 %) 708 831 (123) (14.8 %)
SPC ceding commission
offset (3,695) (3,368) (327) 9.7 % (11,101) (10,432) (669) 6.4 %
Total $ 14,146 $ 13,521 $ 625 4.6 % $ 40,816 $ 38,519 $ 2,297 6.0 %
The increase in DPAC amortization for the three and nine months ended
reflected the increase in gross premiums earned.
The increase in other underwriting and operating expenses for the three and nine months endedSeptember 30, 2022 as compared to the same respective periods of 2021 primarily reflected an increase in costs related to compensation, business-related travel and our allowance for credit losses. Additionally, for the 2022 nine-month period, we incurred planned higher marketing costs related to advertising and website-related activities. The increase in compensation-related costs primarily reflected a higher headcount. The increase in travel-related costs reflected the easing of pandemic-related restrictions and the return to more normal business activity. As previously discussed, alternative market premiums written by ourWorkers' 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, claims administration fees 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 nine months endedSeptember 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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio, as reported 33.6 % 32.0 % 1.6 pts 32.8 % 31.3 % 1.5 pts
Less estimated ratio increase (decrease)
attributable to:
Impact of ceding commissions received
from SPCs 4.1 % 3.3 % 0.8 pts 3.7 % 3.1 % 0.6 pts
Impact of audit premium (1.8 %) 0.1 % (1.9 pts) (0.9 %) 0.6 % (1.5 pts)
Underwriting expense ratio, less listed
effects 31.3 % 28.6 % 2.7 pts 30.0 % 27.6 % 2.4 pts
Excluding the items noted in the table above, the expense ratio increased for
the three and nine months ended September 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 ofSeptember 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 ofSeptember 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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Net premiums written $ 15,672 $ 13,260 $ 2,412 18.2 % $ 55,404 $ 49,656 $ 5,748 11.6 %
Net premiums earned $ 17,811 $ 15,344 $ 2,467 16.1 % $ 53,347 $ 47,500 $ 5,847 12.3 %
Net investment income 294 193 101 52.3 % 617 620 (3) (0.5 %)
Net investment gains (losses) (732) 204 (936) (458.8 %) (4,225) 2,772 (6,997) (252.4 %)
Other income 1 - 1 nm 2 2 - - %
Net losses and loss adjustment
expenses (11,407) (8,693) (2,714) 31.2 % (32,170) (26,560) (5,610) 21.1 %
Underwriting, policy acquisition and
operating expenses (5,599) (4,758) (841) 17.7 % (15,203) (15,078) (125) 0.8 %
SPC U.S. federal income tax expense
(1) (433) (431) (2) 0.5 % (1,424) (1,291) (133) 10.3 %
SPC net results (65) 1,859 (1,924) (103.5 %) 944 7,965 (7,021) (88.1 %)
SPC dividend (expense) income (2) (183) (1,320) 1,137 (86.1 %) (1,697) (5,926) 4,229 (71.4 %)
Segment results (3) $ (248) $ 539 $ (787) (146.0 %) $ (753) $ 2,039 $ (2,792) (136.9 %)
Net loss ratio 64.0% 56.7% 7.3 pts 60.3% 55.9% 4.4 pts
Underwriting expense ratio 31.4% 31.0% 0.4 pts 28.5% 31.7% (3.2 pts)
(1) Represents the provision for U.S. federal income taxes for SPCs at Inova Re, which have elected to be taxed as a U.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.
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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 September 30 Nine Months Ended
($ in thousands) 2022 2021 Change 2022 2021
Change
Gross premiums written
17.3 %$ 62,882 $ 56,455 $ 6,427 11.4 % Less: Ceded premiums written 2,207 1,984 223 11.2 % 7,478 6,799 679 10.0 % Net premiums written$ 15,672 $ 13,260 $ 2,412 18.2 %$ 55,404 $ 49,656 $ 5,748 11.6 %
Gross Premiums Written
Gross premiums written reflected reinsurance premiums assumed by component as
follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Workers' compensation $ 15,958 $ 14,801 $ 1,157 7.8 % $ 52,681 $ 49,409 $ 3,272 6.6 %
Healthcare professional
liability 1,921 443 1,478 333.6 % 10,201 7,046 3,155 44.8 %
Gross Premiums Written $ 17,879 $ 15,244 $ 2,635 17.3 % $ 62,882 $ 56,455 $ 6,427 11.4 %
Gross premiums written for the three and nine months ended September 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 2022 three- and nine-month periods as
compared to the same respective periods of 2021 driven by higher audit premium
and new business, partially offset by renewal rate decreases of 4% in each
respective period. Healthcare professional liability gross premiums written
increased during the 2022 three- and nine-month periods as compared to the same
respective periods of 2021, primarily reflecting the impact of tail coverage
premium primarily related to one program in which we do not participate. See
further discussion in our Segment Results - Specialty Property & Casualty
section under the heading "Premiums Written." We retained 100% of the seventeen
(three in the third quarter) workers' compensation programs and two (none in the
third quarter) healthcare professional liability programs up for renewal during
the nine months ended September 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 September 30 Nine Months Ended September 30
($ in millions) 2022 2021 2022 2021
New business $ 0.8 $ 0.8 $ 2.9 $ 2.3
Audit premium $ 1.2 $ (0.1) $ 4.0 $ 0.3
Retention rate (1) 86 % 93 % 88 % 90 %
Change in renewal pricing (2) (4 %) (2 %) (4 %) (4 %)
(1) We calculate our workers' compensation retention rate as annualized expiring renewed premium divided by all annualized
expiring premium subject to renewal. Our retention rate can be impacted by various factors, including price or other
competitive issues, insureds being acquired, or a decision not to renew based on our underwriting evaluation.
(2) The pricing of our business includes an assessment of the underlying policy exposure and market conditions. We continue
to base our pricing on expected losses, as indicated by our historical loss data.
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Ceded Premiums Written
Ceded premiums written were as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Ceded premiums written $ 2,207 $ 1,984 $ 223 11.2 % $ 7,478 $ 6,799 $ 679 10.0 %
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 nine months ended September 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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Ceded premiums ratio 13.8% 13.4% 0.4 pts 14.2% 13.8% 0.4 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 nine months ended
September 30, 2022 as compared to the same respective periods of 2021 primarily
reflected the 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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Gross premiums earned $ 20,195 $ 17,495 $
2,700 15.4 %
Less: Ceded premiums earned
2,384 2,151 233 10.8 % 7,108 6,390 718 11.2 % Net premiums earned$ 17,811 $ 15,344 $ 2,467 16.1 %$ 53,347 $ 47,500 $ 5,847 12.3 % Net premiums earned increased during the three and nine months endedSeptember 30, 2022 as compared to the same period of 2021. The increase in net premiums earned primarily reflected the aforementioned impact of healthcare professional liability tail premium written and fully earned and the increase in workers' compensation audit premium billed to policyholders. 86
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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 nine
months ended
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 64.0 % 56.7 % 7.3 pts 60.3 % 55.9 % 4.4 pts
Less impact of prior accident
years on the net loss ratio (3.7 %) (10.5 %) 6.8 pts (7.2 %) (10.4 %) 3.2 pts
Current accident year net loss
ratio 67.7 % 67.2 % 0.5 pts 67.5 % 66.3 % 1.2 pts
Less estimated ratio increase
(decrease) attributable to:
Change in estimated aggregate
reinsurance 1.3 % (2.4 %) 3.7 pts 1.6 % (3.1 %) 4.7 pts
Current accident year net loss
ratio, excluding the effect of
the change in estimated aggregate
reinsurance 66.4 % 69.6 % (3.2 pts) 65.9 % 69.4 % (3.5 pts)
During the 2022 three- and nine-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, decreased in both the 2022 three and nine-month
periods, reflecting a lower workers' compensation current accident year net loss
ratio, partially offset by a higher healthcare professional liability current
accident year net loss ratio. The improvement in the workers' compensation
current accident year net loss ratio for the 2022 three- and nine-month periods
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. The
increase in the healthcare professional liability current accident year loss
ratio for the 2022 three- and nine-month periods primarily reflected an increase
in expected claim frequency related to one program in which we do not
participate.
Calendar year incurred losses (excluding IBNR) ceded to our external reinsurers
increased $0.5 million and $2.8 million for the three and nine months ended
September 30, 2022 , respectively, as compared to the same respective periods of
2021. Current accident year ceded incurred losses (excluding IBNR) decreased
$0.9 million and increased $4.9 million for the 2022 three- and nine-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 $0.6 million and
$3.8 million for the three and nine months ended September 30, 2022 ,
respectively, as compared to $1.6 million and $4.9 million for the same
respective periods of 2021. The development for the 2022 three- and nine-month
periods includes net favorable development of $1.3 million and $4.6 million in
the workers' compensation business, partially offset by net unfavorable
development of $0.7 million in each period in the healthcare professional
liability business. The net favorable development in the workers' compensation
business reflected overall favorable trends in claim closing patterns primarily
in accident years 2016 through 2020. The net unfavorable development in the
healthcare professional liability business primarily reflected higher than
expected claim frequency in one program in which we do not participate. The net
favorable prior year reserve development for the three and nine months ended
September 30, 2021 also related entirely to the workers' compensation business
which primarily reflected overall favorable claim trends in claim closing
patterns in accident years 2018 and 2019.
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Underwriting, Policy Acquisition and Operating Expenses
Our Segregated Portfolio Cell Reinsurance segment underwriting, policy
acquisition and operating expenses were comprised as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
DPAC amortization $ 5,067 $ 4,526 $ 541 12.0 % $ 15,219 $ 13,930 $ 1,289 9.3 %
Policyholder dividend
expense 57 64 (7) (10.9 %) 135 348 (213) (61.2 %)
Other underwriting and
operating expenses 475 168 307 182.7 % (151) 800 (951) (118.9 %)
Total $ 5,599 $ 4,758 $ 841 17.7 % $ 15,203 $ 15,078 $ 125 0.8 %
DPAC amortization primarily represents ceding commissions, which vary by program
and are paid to our Workers' Compensation Insurance and Specialty P&C segments
for premiums assumed. Ceding commissions include an amount for fronting fees,
commissions, premium taxes and risk management fees, which are reported as an
offset to underwriting, policy acquisition and operating expenses within our
Workers' Compensation Insurance and Specialty P&C segments. In addition, ceding
commissions paid to our Workers' Compensation Insurance segment include cell
rental fees which are recorded as other income and claims administration fees
which are recorded as ceded ULAE within our Workers' Compensation Insurance
segment.
Other underwriting and operating expenses primarily include bank fees,
professional fees and changes in the allowance for expected credit losses. The
increase in other underwriting and operating expenses for the 2022 three-month
period as compared to the same period in 2021 primarily reflects changes in the
allowance for credit losses. Other underwriting and operating expenses for the
2022 nine-month period reflects a decrease 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 2022 nine-month period as
compared to the same period of 2021 primarily reflects changes in estimated
dividends for 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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Underwriting expense ratio, as
reported 31.4% 31.0% 0.4 pts 28.5% 31.7% (3.2 pts)
Less: impact of audit premium on
expense ratio (2.2%) 0.2% (2.4 pts) (2.2%) (0.1%) (2.1 pts)
Underwriting expense ratio,
excluding the effect of audit
premium 33.6% 30.8% 2.8 pts 30.7% 31.8% (1.1 pts)
Excluding the effect of audit premium, the underwriting expense ratio increased
for the 2022 three-month period and decreased for the 2022 nine-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 nine-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 atSeptember 30, 2022 had a fair value of approximately$30.1 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 nine months endedSeptember 30, 2022 and 2021, the results of our Lloyd's Syndicates segment were as follows: Three Months Ended September 30 Nine Months Ended September 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Gross premiums written$ 6,844 $ 8,970 $ (2,126) (23.7 %)$ 16,741 $ 31,702 $ (14,961) (47.2 %) Less: Ceded premiums written 631 525 106 20.2 % 1,870 5,584 (3,714) (66.5 %) Net premiums written$ 6,213 $ 8,445 $ (2,232) (26.4 %)$ 14,871 $ 26,118 $ (11,247) (43.1 %) Net premiums earned$ 5,719 $ 10,953 $ (5,234) (47.8 %)$ 19,258 $ 40,263 $ (21,005) (52.2 %) Net investment income 98 431 (333) (77.3 %) 453 1,677 (1,224) (73.0 %) Net investment gains (losses) (131) 35 (166) (474.3 %) (1,015) 9 (1,024) (11,377.8 %) Other income 168 283 (115) (40.6 %) 430 864 (434) (50.2 %) Net losses and loss adjustment expenses (4,157) (6,846) 2,689 (39.3 %) (12,370) (25,257) 12,887 (51.0
%)
Underwriting, policy acquisition and operating expenses (1,871) (3,909) 2,038 (52.1 %) (6,087) (15,219) 9,132 (60.0 %) Segment results$ (174) $ 947 $ (1,121) (118.4 %)$ 669 $ 2,337 $ (1,668) (71.4 %) Net loss ratio 72.7% 62.5% 10.2 pts 64.2% 62.7% 1.5 pts Underwriting expense ratio 32.7% 35.7% (3.0 pts) 31.6% 37.8% (6.2 pts) 89
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Premiums
Net premiums written decreased during the 2022 three- and nine-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 nine-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 nine-month periods was partially offset by volume increases on renewal business and renewal pricing increases, primarily on property insurance and property reinsurance coverages, as well as new business written, primarily on property insurance and casualty coverages. Net premiums earned decreased$5.2 million and$21.0 million during the 2022 three- and nine-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 September 30 Nine Months Ended September 30
2022 2021 Change 2022 2021 Change
Calendar year net loss ratio 72.7 % 62.5 % 10.2 pts 64.2 % 62.7 % 1.5
pts
Less: impact of prior accident years on the net loss ratio 16.5 % 12.1 % 4.4 pts 26.4 % 8.2 % 18.2
pts
Current accident year net loss ratio 56.2 % 50.4 % 5.8 pts 37.8 % 54.5 % (16.7
pts)
The current accident year net loss ratio increased during the three months endedSeptember 30, 2022 as compared to the same period of 2021 driven by lower reinsurance recoveries as a proportion of gross losses as compared to the prior year period and, to a lesser extent, certain catastrophe-related losses. The decrease in the current accident year net loss ratio for the nine months endedSeptember 30, 2022 as compared to the same period 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 period, as previously discussed. We recognized$0.9 million and$5.1 million of unfavorable prior year development during the three and nine months endedSeptember 30, 2022 , respectively, as compared to$1.3 million and$3.3 million for the same respective periods of 2021. The unfavorable prior year development for the three and nine months endedSeptember 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 nine-month periods, the underwriting expense ratio
decreased by 3.0 and 6.2 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 nine-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 nine months endedSeptember 30, 2022 and the three and nine months endedSeptember 30, 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. We did not incur any transaction-related costs associated with our acquisition of NORCAL for the three months endedSeptember 30, 2022 . 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 were net earnings of$3.0 million and$6.7 million for the three and nine months endedSeptember 30, 2022 , respectively, as compared to$22.8 million and$70.0 million for the same respective periods of 2021 and included the following: Three Months Ended September 30 Nine Months Ended September 30 ($ in thousands) 2022 2021 Change 2022 2021 Change Net investment income$ 24,353 $ 18,654 $ 5,699
30.6 %
Equity in earnings (loss) of
unconsolidated subsidiaries
(144.9 %)
Net investment gains (losses)
(2,642.6 %)$ (40,412) $ 17,431 $ (57,843) (331.8 %) Other income$ 4,695 $ 1,542 $ 3,153 204.5 %$ 10,386 $ 3,786 $ 6,600 174.3 % Operating expense$ 8,921 $ 6,872 $ 2,049 29.8 %$ 26,679 $ 19,050 $ 7,629 40.0 % Interest expense$ 5,513 $ 5,814 $ (301)
(5.2 %)
Income tax expense (benefit)
(1,320.5 %)
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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Fixed maturities $ 23,315 $ 19,447 $ 3,868 19.9 % $ 66,015 $ 51,523 $ 14,492 28.1 %
Equities 846 648 198 30.6 % 2,514 1,790 724 40.4 %
Short-term investments,
including Other 1,756 561 1,195 213.0 % 2,860 1,440 1,420 98.6 %
BOLI 421 623 (202) (32.4 %) 635 1,752 (1,117) (63.8 %)
Investment fees and expenses (1,985) (2,625) 640 (24.4 %) (5,962) (7,089) 1,127 (15.9 %)
Net investment income $ 24,353 $ 18,654 $ 5,699 30.6 % $ 66,062 $ 49,416 $ 16,646 33.7 %
Fixed Maturities
Income from our fixed maturities increased during the 2022 three- and nine-month
periods as compared to the same respective periods of 2021 driven by higher
average book yields as we continue to reinvest at higher rates as our portfolio
matures. In addition, the increase in income from our fixed maturities during
the 2022 nine-month period reflected 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). As a result of the NORCAL acquisition, average investment balances
over a twelve-month period were approximately 3% and 23% higher for the 2022
three- and nine-month periods, respectively, as compared to the same respective
periods of 2021; excluding the impact of the acquisition, average investment
balances were approximately 1% lower and 2% higher, respectively.
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Average yields for our fixed maturity portfolio were as follows:
Three Months Ended September 30 Nine Months Ended September 30
2022 2021 2022 2021
Average income yield 2.5% 2.2% 2.4% 2.2%
Average tax equivalent income yield 2.5% 2.2% 2.4% 2.2%
Equities
Income from our equity portfolio increased during the 2022 three- and nine-month
periods as compared to the same respective periods of 2021 which reflected
changes in the mix of equities owned.
Short-term Investments and Other Investments
Short-term investments, which have a maturity at purchase of one year or less are carried at fair value, which approximates their cost basis, and are primarily composed of investments inU.S. treasury obligations, commercial paper and money market funds. Income from our short-term and other investments increased during the 2022 three- and nine-month periods as compared to the same respective periods of 2021 primarily due to higher yields given the increase in interest rates. 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 nine-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 September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
All other investments,
primarily investment fund
LPs/LLCs $ (4,688) $ 18,835 $ (23,523) (124.9 %) $ 12,347 $ 45,489 $ (33,142) (72.9 %)
Tax credit partnerships (2,164) (3,591) 1,427 (39.7 %) (6,399) (11,530) 5,131 (44.5 %)
Equity in earnings (loss) of
unconsolidated subsidiaries $ (6,852) $ 15,244 $ (22,096) (144.9 %) $ 5,948 $ 33,959 $ (28,011) (82.5 %)
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 nine-month periods as compared to the same
respective periods of 2021 decreased primarily due to the performance of certain
LP/LLCs which reflected lower market valuations during the first half 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 nine months ended September 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 $0.4 million and $1.0 million in the three and nine months
ended September 30, 2022 , respectively, as compared to $0.2 million and $1.7
million for the same respective periods of 2021.
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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 September 30 Nine Months Ended September 30
(In millions) 2022 2021 2022 2021
Tax credits recognized during the period
$ 3.6$ 9.9 Tax benefit of tax credit partnership operating losses$ 0.5 $ 0.8 $ 1.3$ 2.4 The tax credits generated from our tax credit partnership investments of$1.2 million and$3.6 million for the three and nine months endedSeptember 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 nine months endedSeptember 30, 2021 the tax credits generated from our tax credit partnership investments of$3.1 million and$9.9 million , respectively, were deferred to be utilized in future periods. Not included in the table above is$2.7 million of tax credits recaptured from the 2019 tax year during the nine months endedSeptember 30, 2022 due to the carryback of our estimated NOL for the nine months endedSeptember 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 ofSeptember 30, 2022 , we had approximately$52.3 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 September
30 Nine Months Ended September 30
(In thousands) 2022 2021 2022 2021
GAAP net investment result:
Net investment income $ 24,353 $ 18,654 $ 66,062 $ 49,416
Equity in earnings (loss) of unconsolidated
subsidiaries (6,852) 15,244 5,948 33,959
GAAP net investment result $ 17,501 $ 33,898
Pro forma tax-equivalent investment result
Reconciliation of pro forma and GAAP tax-equivalent investment result: GAAP net investment result$ 17,501 $ 33,898 $ 72,010 $ 83,375 Taxable equivalent adjustments, calculated using the 21% federal statutory tax rate State and municipal bonds 125 160 392 378 BOLI 112 166 169 466 Dividends received - (3) - 25 Tax credit partnerships* (991) - (3,469) -
Pro forma tax-equivalent investment result
$ 69,102 $ 84,244 *Due to our expected consolidated loss calculated on a tax basis for the three and nine months endedSeptember 30, 2022 , the tax credits recognized from our tax credit partnership investments totaling$1.2 million and$3.6 million , respectively, were deferred to be utilized in future periods; however, during the nine months endedSeptember 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$3.1 million and$9.9 million from our tax credit partnership investments during the three and nine months endedSeptember 30, 2021 , respectively. As of the third 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. 93
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Net Investment Gains (Losses)
The following table provides detailed information regarding our net investment
gains (losses).
Three Months Ended September 30 Nine Months Ended September 30
(In thousands) 2022 2021 2022 2021
Total impairment losses Corporate debt $ - $ -$ (972) $ - Portion of impairment losses recognized in other comprehensive income before taxes: Corporate debt - - 419 - Net impairment losses recognized in earnings - - (553) - Gross realized gains, available-for-sale fixed maturities 142 2,066 1,503 11,663 Gross realized (losses), available-for-sale fixed maturities (54) (254) (2,032) (756) Net realized gains (losses), equity investments - (1) (5,928) 5,274 Net realized gains (losses), other investments 209 1,699 99 6,192
Change in unrealized holding gains (losses), equity
investments
(5,925) (699) (19,272) (3,257)
Change in unrealized holding gains (losses), convertible
securities, carried at fair value as a part of other
investments
(1,441) (2,456) (14,499) (2,117) Other (330) (64) 270 432 Net investment gains (losses)$ (7,399)
We did not recognize any credit-related impairment losses in earnings or non-credit impairment losses in OCI during the three months endedSeptember 30, 2022 or the three and nine months endedSeptember 30, 2021 . For the nine months endedSeptember 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 nine months endedSeptember 30, 2022 related to a corporate bond in the consumer sector. We recognized$7.4 million and$40.4 million of net investment losses during the 2022 three- and nine-month periods, respectively, driven by unrealized holding losses resulting from changes in the fair value of our convertible securities and equity investments and, for the 2022 nine-month period, realized losses from the sale of equity investments. During the 2021 three- and nine-month periods, we recognized$0.3 million and$17.4 million of net investment gains, respectively, driven by realized gains on the sale of certain available-for-sale fixed maturities and other investments.
Other Income
Other income was$4.7 million and$10.4 million for the 2022 three- and nine-month periods, respectively, as compared to$1.5 million and$3.8 million during the same respective periods of 2021. The increase in other income for the 2022 three- and nine-month periods was driven by the effect of foreign currency exchange rate changes of$2.3 million and$5.4 million , respectively, related to foreign currency denominated loss reserves associated with premium assumed from an international medical professional liability insured in our Specialty P&C segment. We mitigate foreign exchange exposure by generally matching the currency and duration of associated investments to the corresponding loss reserves. In accordance with GAAP, the impact on the market value of available-for-sale fixed maturities due to changes in foreign currency exchange rates is reflected as part of OCI. Conversely, the impact of changes in foreign currency exchange rates on loss reserves is reflected through net income (loss) as a component of other income. The effect of exchange rate changes on foreign currency denominated loss reserves are reported in our Corporate segment to be consistent with the reporting of the foreign currency denominated invested assets and associated investment income. 94
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Operating Expenses
Corporate segment operating expenses were comprised as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021 Change
Operating expenses $ 10,806 $ 9,675 $ 1,131 11.7 % $ 31,963 $ 26,542 $ 5,421 20.4 %
Management fee offset (1,885) (2,803) 918 (32.8 %) (5,284) (7,492) 2,208 (29.5 %)
Total $ 8,921 $ 6,872 $ 2,049 29.8 % $ 26,679 $ 19,050 $ 7,629 40.0 %
Operating expenses increased for the 2022 three- and nine-month periods by $1.1
million and $5.4 million , respectively, as compared to the same respective
periods of 2021 primarily due to an increase in professional fees, share-based
compensation expenses and, for the 2022 nine-month period, compensation-related
costs. The increase in professional fees for the 2022 three- and nine-month
periods was primarily driven by an increase in consulting fees and, to a lesser
extent, an increase in recruiting and employee placement fees as a result of
filling open positions across the organization. Prior to 2022, recruiting and
employee placement fees were allocated to the operating segments. The increase
in share-based compensation expense in the 2022 three- and nine-month periods
was attributable to the effect of the incorporation of certain NORCAL employees
into our share-based compensation plans beginning in 2022. The increase in
compensation-related costs during the 2022 nine-month period 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.
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 $0.3 million and $1.1
million of additional management fees during the 2022 three- and nine-month
periods, respectively. There were no changes to the extent to which services are
provided exclusively by the Corporate segment to the operating subsidiaries
within our Workers' Compensation Insurance segment in 2022.
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Interest Expense
Consolidated interest expense for the three and nine months ended September 30,
2022 and 2021 was comprised as follows:
Three Months Ended September 30 Nine Months Ended September 30
($ in thousands) 2022 2021 Change 2022 2021
Change
Senior Notes due 2023 $ 3,357 $ 3,357 $ -
- % $ 10,071 $ 10,071 $ - - %
Contribution Certificates
(including accretion)(1) 1,906 1,962 (56) (2.9 %) 5,438 3,090 2,348 76.0 %
Revolving Credit Agreement
(including fees and
amortization)(2) 250 364 (114) (31.3 %) 768 870 (102) (11.7 %)
Mortgage Loans (including
amortization) - 79 (79) nm - 444 (444) nm
(Gain)/loss on interest rate
cap - 52 (52) nm (1,405) (272) (1,133) (416.5 %)
Interest expense $ 5,513 $ 5,814 $ (301) (5.2 %) $ 14,872 $ 14,203 $ 669 4.7 %
(1) Includes accretion of approximately $0.4 million and $1.3 million for the three and nine months ended September 30, 2022, respectively, as compared to approximately
$0.6 million and $0.8 million in the same respective periods 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 nine months ended September 30, 2022. During the third quarter of 2021,
we repaid the balance outstanding on the Revolving Credit Agreement of $15.0 million. Interest expense in both the 2022 and 2021 three- and nine-month periods primarily
reflected unused commitment fees.
Consolidated interest expense remained relatively unchanged for the 2022
three-month period and increased for the 2022 nine-month period as compared to
the same respective periods of 2021. The increase in consolidated interest
expense for the 2022 nine-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 Nine Months Ended September 30 September 30 (In thousands) 2022 2021 2022 2021 Corporate segment income tax expense (benefit) $ (2,673)
$ 219 $ (6,232) $ 1,369
Income tax expense (benefit) - transaction-related
costs*
- (489) (391) (4,501)
Consolidated income tax expense (benefit) $ (2,673) $ (270) $ (6,623) $ (3,132)
*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 nine months ended September 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 nine months ended
September 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 nine months ended September 30, 2022
versus the pre-tax income during the same respective periods of 2021. These
factors include the following:
Three Months Ended September 30
2022 2021
Income tax
Income tax (benefit)
($ in thousands) (benefit) expense Rate Impact expense Rate Impact
Computed "expected" tax expense (benefit) at
statutory rate $ (2,478) 21.0 % $ 2,505 21.0 %
Tax-exempt income (1) (291) 2.5 % (418) (3.5 %)
Tax credits (1,201) 10.2 % (3,126) (26.2 %)
Non-U.S. operating results 37 (0.2 %) (199) (1.7 %)
Estimated annual tax rate differential (2) 1,933 (16.4 %) - - %
Other (673) 5.6 % 968 8.1 %
Total income tax expense (benefit) $ (2,673) 22.7 % $ (270) (2.3 %)
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Nine Months Ended September 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 $ (4,403) 21.0 % $ 22,859 21.0 %
Tax-exempt income (1) (767) 3.7 % (895) (0.8 %)
Tax credits (3,604) 17.2 % (9,880) (9.1 %)
Non-U.S. operating results (140) 0.8 % (491) (0.4 %)
Estimated annual tax rate differential (2) 1,933 (9.2 %) - - %
Non-taxable gain on bargain purchase (3) - - % (15,626) (14.4 %)
Other 358 (1.9 %) 901 0.8 %
Total income tax expense (benefit) $ (6,623) 31.6 % $ (3,132) (2.9 %)
(1) Includes tax-exempt interest, dividends received deduction and change in
cash surrender value of BOLI.
(2) Represents the tax rate differential between our actual effective tax rate
for the three and nine months ended September 30, 2022 and our projected annual
effective tax rate as of September 30, 2022 as calculated under the estimated
annual effective tax rate method. There was no tax rate differential recorded
for the three and nine months ended September 30, 2021 as we utilized the
discrete effective tax rate method at September 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 nine months ended September 30, 2022, the provision (benefit)
for income taxes and the effective tax rate are determined utilizing the
estimated annual effective tax rate method which is based upon our current
estimate of our annual effective tax rate at the end of each quarterly reporting
period (the projected annual effective tax rate) plus the impact of certain
discrete items that are not included in the projected annual effective tax rate.
For the three and nine months ended September 30, 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 the methods utilized
to compute interim taxes 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 nine-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 $3.6 million during the three and
nine months ended September 30, 2022, respectively, as compared to $3.1 million
and $9.9 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 nine-month periods.
Additionally, our effective tax rate for the 2021 nine-month period was
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 nine-month
periods.
Our effective tax rate for the 2022 nine-month period, as shown in the table
above, differed from our projected annual effective tax rate of 9.6% due to
certain discrete items. These discrete items increased our effective tax rate by
22.0% for the 2022 nine-month period mainly due to the treatment of net
investment losses. When we utilize the estimated annual effective tax rate
method, net investment gains or losses are treated as discrete items and
reflected in the effective tax rate in the period in which they are included in
income. This treatment of net investment losses of $40.4 million for the nine
months ended September 30, 2022 in our Corporate segment accounted for an
increase of 21.9% in the effective tax rate. The remaining discrete items that
affected our effective tax rate for the 2022 nine-month period were comprised of
individually insignificant components.
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