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TREAN INSURANCE GROUP, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
Edgar Glimpses
The following discussion and analysis of financial condition and results of operations for the three and six months endedJune 30, 2022 is qualified by reference to and should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the related notes included herein and the audited consolidated financial statements and notes included in our 2021 Form 10-K. The discussion and analysis below are based on comparisons between our historical financial data for different periods and include certain forward-looking statements about our business, operations, and financial performance. These forward-looking statements are subject to risks, uncertainties, assumptions, and other factors described in Item 1A - "Risk Factors" in our 2021 Form 10-K. Our actual results may differ materially from those expressed in, or implied by, those forward-looking statements. See "Forward-Looking Statements." All references to "we," "us," "our," "the Company," "Trean ," or similar terms refer toTrean Insurance Group, Inc. and its subsidiaries, unless the context otherwise requires. The information contained in this quarterly report is not a complete description of our business or the risks associated with an investment in our common stock.
The Company defines increases or decreases greater than 200% as "NM" or not
meaningful.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial performance or operating performance. In some cases, you can identify forward-looking statements because they contain words such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "would," "potential," or "continue" or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements are based on management's current expectations and assumptions about future events. These statements are only predictions and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements if the underlying assumptions prove to be incorrect or as a result of risks, uncertainties, and other factors, including the impact of the COVID-19 pandemic on the business and operations of the Company, our program partners and other business relations. Other factors that may cause such differences include the risks described in the Company's filings with theU.S. Securities and Exchange Commission , including the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 . These forward-looking statements speak only as of the date on which they are made. Except as required by applicable securities laws, the Company disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments, changes in assumptions or otherwise. Investors are cautioned not to place undue reliance on the forward-looking statements contained in this press release or in other filings and public statements of the Company. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and assumptions, which in many cases are beyond our control, as described in "Item 1A - Risk Factors" in our 2021 Form 10-K and in this Quarterly Report on Form 10-Q. Our statements reflecting these risks and uncertainties are not exhaustive, and other risks and uncertainties may currently exist or may arise in the future that could have material effects on our business, operations, and financial condition. We cannot assure you that the results, events, and circumstances reflected in the forward looking statements reflected in this Quarterly Report on Form 10-Q and our other public statements and securities filings will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward looking statements. These forward-looking statements speak only as of the date on which such statements are made. We undertake no obligation, and do not intend, to update any forward looking statements after the date of this Quarterly Report on Form 10-Q or to conform such statements to actual results or revised expectations, except as required by applicable securities laws or the rules and regulations of theSecurities and Exchange Commission ("SEC"). 24 -------------------------------------------------------------------------------- Table of Contents Overview We are a provider of products and services to the specialty insurance market. We underwrite specialty casualty insurance products both through ourProgram Partners and also through our Owned MGAs. We also provide ourProgram Partners with a variety of services, including issuing carrier services, claims administration, and reinsurance brokerage, from which we generate recurring fee-based revenues. We have one reportable segment. We provide our insurance products and services to ourProgram Partners and Owned MGAs focused on specialty lines. We target a diversified portfolio of small to medium programs, typically with less than$30 million of premiums, that focus on niche segments of the specialty casualty insurance market and that we believe have strong underwriting track records.
Coronavirus ("COVID-19") Impact
We are monitoring the ongoing COVID-19 pandemic on our business, including how it may impact our premium revenue, loss experience and loss expense, liquidity, and our regulatory capital and surplus, and operations. Significant progress has been made to combat the outbreak of COVID-19; however, the global pandemic, including resulting inflationary pressures, has adversely impacted both the domestic and foreign economies and could still have a materially adverse impact on the Company. Workforce Operations Following the emergence of the COVID-19 pandemic in early 2020, we took a number of actions to protect the health of the public and our employees and to comply with directives and advice of governmental authorities and public health experts. We responded by developing a Preparedness Plan that outlined both corporate-wide and location-specific modifications to working conditions and operations in our offices. We continue to navigate through these challenges with a sharp focus on and goal of safeguarding our employees, helping our customers and managing impacts on our business. Despite the unprecedented environment, our teams are executing at a high level and we are advancing our strategy.
Premium Revenue, Claims and Losses
We have not experienced a material impact to our premium revenue as a result of the COVID-19 pandemic. During the six months endedJune 30, 2022 , compared to the six months endedJune 30, 2021 , gross written premiums increased by 4.1% and gross earned premiums increased by 18.3%, primarily driven by both significant growth in our existing Program Partner business as well as the addition of newProgram Partners . Because a majority of our gross written premiums are related to workers' compensation insurance, revenue trends could be impacted in future periods if the COVID-19 pandemic were to continue or significantly get worse. However, a significant portion of our workers' compensation premiums are pay-as-you-go programs, which reduces our downside risk from future premium audits or refunds.
We also have not experienced a material impact in our reported claims or
incurred losses in the first six months of 2022 as a specific result of the
COVID-19 pandemic.
25 -------------------------------------------------------------------------------- Table of Contents Investment Portfolio With respect to our investment portfolio, we seek to hold a high-quality, diversified portfolio of investments, which are primarily in fixed maturity and available-for-sale investments and as such, our investment portfolio has limited exposure to equity market volatility. For the six months endedJune 30, 2022 , we experienced a decrease of$39,274 in the fair value of our fixed maturities investment portfolio. The decline in the fair value of our fixed maturity investments is primarily attributable to the recent rise in interest rates driven primarily by changing conditions in the financial markets as compared to the comparatively lower rates that prevailed during the initial part of the COVID-19 pandemic in 2020 and 2021, rather than underlying credit risk within our investment portfolio. If there were to be continued equity and debt financial market volatility, which in turn could create mark-to-market investment valuation decreases, we expect there could be additional or increased unrealized losses recorded or realized losses, if sold, in future reporting periods. However, given the conservative nature of our investment portfolio, we expect that any adverse impact on the value of our investment portfolio, as it relates to COVID-19, will be temporary, and we do not expect a long-term negative impact on our financial condition, results of operations or cash flows.
Other Concerns
Adverse events such as changes in the overall public health environment, changing infection patterns and new variants of COVID-19, health-related concerns about working in our offices, restrictions on travel, the potential impact on our business partners and customers, and other matters affecting our general work and business environment could harm our business and delay the implementation of our business strategy. We cannot anticipate all the ways in which the current global health crisis and financial market conditions could adversely impact our business in the future.
Significant Components of Results of Operations
Gross written premiums: Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for general and administrative expenses (including policy acquisition costs), reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
•addition and retention of
•new business submissions to our
•binding of new business submissions into policies;
•renewals of existing policies; and
•average size and premium rate of bound policies.
Gross earned premiums: Gross earned premiums are the earned portion of gross written premiums. We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Ceded earned premiums: Ceded earned premiums are the amount of gross earned premiums ceded to reinsurers. We enter into reinsurance contracts to limit our maximum losses and diversify our exposure and provide statutory surplus relief. The volume of our ceded earned premiums is affected by the level of our gross earned premiums and any decision we make to increase or decrease limits, retention levels, and co-participations. Net earned premiums: Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is earned and ceded to third-party reinsurers, including ourProgram Partners and professional reinsurers, under our reinsurance agreements. Net investment income: We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed maturities, including other equity investments and short-term investments. Our net investment income includes interest income on our invested assets, income on funds held investments as well as unrealized gains and losses on our equity portfolio. 26 -------------------------------------------------------------------------------- Table of Contents Net realized gains/losses: Net realized gains/losses are a function of the difference between the amount received by us on the sale of a security and the security's recorded value as well as any "other-than-temporary impairments" relating to fixed maturity investments recognized in earnings. Other revenue: Other revenue includes brokerage, third-party administrative, management, consulting, and other fee-based revenues, which are commonly based on written premiums. Loss and loss adjustment expenses (LAE): Losses and LAE are net of reinsurance and include claims paid, estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending, and servicing claims. In general, our losses and LAE are affected by:
•frequency of claims associated with the particular types of insurance contacts
that we write;
•trends in the average size of losses incurred on a particular type of business;
•mix of business written by us;
•changes in the legal or regulatory environment related to the business we
write;
•trends in legal defense costs;
•wage inflation; and
•inflation in medical costs.
Losses and LAE are based on an actuarial analysis of the estimated losses,
including losses incurred during the period and changes in estimates from prior
periods. Losses and LAE may be paid out over a period of years.
General and administrative expenses: General and administrative expenses include net commissions, insurance-related expenses, and general and administrative operating expenses. Net commissions consist of policy acquisition costs and other underwriting expenses, net of ceding commissions. Policy acquisition costs are principally comprised of the commissions we pay our brokers and program managers. Policy acquisition costs that are directly related to the successful acquisition or reinsurance of those policies are deferred. All policy acquisition costs are charged to expense in proportion to premium earned over the policy life. We receive ceding commissions on business ceded under our reinsurance contracts. Insurance-related expenses largely consist of state premium taxes. General and administrative operating expenses include employee salaries and benefits, corporate business insurance costs, technology costs, office rent, and professional services fees such as legal, accounting, audit, tax, and actuarial services. Intangible asset amortization: Intangible asset amortization consists of expenses incurred related to the amortization of intangible assets recorded as a result of business acquisitions and consists of trade names, customer lists and relationships, and non-compete agreements.
Noncash stock compensation: Noncash stock compensation includes expenses related
to the fair value and issuance of restricted stock units (time, market and
performance-based) and stock options.
Gains on embedded derivatives: Gains (losses) on embedded derivatives consist of the change in fair value of derivatives, the effect of net investment income on funds held investments, and the effect of realized gains and loss on funds held investments. Interest expense: Interest expense consists primarily of interest paid on our term loan facility (See "Financial Condition, Liquidity and capital resources - Debt and Credit Agreements").
Other income: Other income consists primarily of sublease revenue and other
miscellaneous income items.
Equity earnings in affiliates, net of tax: Equity earnings in affiliates, net of
tax includes the Company's share of earnings from equity method investments.
27 -------------------------------------------------------------------------------- Table of Contents Key Metrics
We discuss certain key financial and operating metrics, described below, which
provide useful information about our business and the operational factors
underlying our financial performance.
Underwriting income is a non-GAAP financial measure defined as income before taxes excluding net investment income, investment revaluation gains, net realized gains or losses, intangible asset amortization, noncash stock compensation, gains and losses on embedded derivatives, interest expense, other revenue, and other income and expenses. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of underwriting income to income before taxes in accordance with GAAP. Adjusted net income is a non-GAAP financial measure defined as net income excluding the impact of certain items, including noncash intangible asset amortization and stock compensation, noncash changes in fair value of embedded derivatives, other expenses, and gains or losses that we believe do not reflect our core operating performance, which items may have a disproportionate effect in a given period, affecting comparability of our results across periods. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of adjusted net income to net income in accordance with GAAP.
Loss ratio, expressed as a percentage, is the ratio of losses and LAE to net
earned premiums.
Expense ratio, expressed as a percentage, is the ratio of general and
administrative expenses to net earned premiums.
Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% generally indicates an underwriting profit. A combined ratio over 100% generally indicates an underwriting loss.
Return on equity is net income expressed on an annualized basis as a percentage
of average beginning and ending stockholders' equity during the period.
Adjusted return on equity is a non-GAAP financial measure defined as adjusted net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of adjusted return on equity to return on equity in accordance with GAAP.
Tangible stockholders' equity is defined as stockholders' equity less goodwill
and other intangible assets.
Return on tangible equity is a non-GAAP financial measure defined as net income
expressed on an annualized basis as a percentage of average beginning and ending
tangible stockholders' equity during the period. See "Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of return on tangible equity to return
on equity in accordance with GAAP.
Adjusted return on tangible equity is a non-GAAP financial measure defined as
adjusted net income expressed on an annualized basis as a percentage of average
beginning and ending tangible stockholders' equity during the period. See
"Reconciliation of Non-GAAP Financial Measures" for a reconciliation of adjusted
return on tangible equity to return on tangible equity in accordance with GAAP.
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Results of Operations
Consolidated Results of Operations for the Three Months Ended
Compared to
The following table summarizes our results of operations for the three months
ended
Three Months Ended June 30,
(in thousands, except for percentages) 2022 2021 Change Percentage Change (1)
Revenues
Gross written premiums$ 154,189 $ 156,551 $ (2,362) (1.5)% Decrease (increase) in gross unearned premiums 2,953 (17,927) 20,880 (116.5)% Gross earned premiums 157,142 138,624 18,518 13.4% Ceded earned premiums (91,132) (90,681) (451) 0.5% Net earned premiums 66,010 47,943 18,067 37.7% Net investment income (391) 2,103 (2,494) (118.6)% Net realized gains 1,349 10 1,339 NM Other revenue 1,804 1,229 575 46.8% Total revenue 68,772 51,285 17,487 34.1% Expenses Losses and loss adjustment expenses 40,887 29,725 11,162 37.6% General and administrative expenses 21,679 15,267 6,412 42.0% Other expenses 268 845 (577) (68.3)% Intangible asset amortization 1,500 1,413 87 6.2% Noncash stock compensation 403 419 (16) (3.8)% Interest expense 467 425 42 9.9% Total expenses 65,204 48,094 17,110 35.6% Gains (losses) on embedded derivatives 3,356 (686) 4,042 NM Other income 24 35 (11) (31.4)% Income before taxes 6,948 2,540 4,408 173.5% Income tax expense 1,457 414 1,043 NM Net income$ 5,491 $ 2,126 $ 3,365 158.3%
(1) The Company defines increases or decreases greater than 200% as "NM" or not meaningful.
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The table below shows the total premiums earned on a gross and net basis for the
respective three-month periods:
Three Months Ended June 30,
(in thousands, except for percentages) 2022 2021
Key metrics:
Underwriting income(1) $ 3,444 $ 2,951
Adjusted net income(1) $ 5,546 $ 4,316
Loss ratio 61.9 % 62.0 %
Expense ratio 32.8 % 31.8 %
Combined ratio 94.7 % 93.8 %
Return on equity 5.3 % 2.0 %
Adjusted return on equity(1) 5.4 % 4.2 %
Return on tangible equity(1) 11.0 % 4.2 %
Adjusted return on tangible equity(1) 11.1 % 8.6 %
(1) This metric represents a non-GAAP financial measure. See 'Reconciliation of Non-GAAP Financial
Measures' for a reconciliation of this metric to the applicable GAAP metric.
Three Months Ended June 30,
(in thousands, except for
percentages) 2022 2021 Change Percentage Change
Revenues
Gross written premiums $ 154,189 $ 156,551 $ (2,362) (1.5)%
Increase in gross unearned premiums 2,953 (17,927) 20,880 (116.5)%
Gross earned premiums 157,142 138,624 18,518 13.4%
Ceded earned premiums (91,132) (90,681) (451) 0.5%
Net earned premiums $ 66,010 $ 47,943 $ 18,067 37.7%
Gross written premiums: Gross written premiums decreased $2,362 , or (1.5)%, to
$154,189 for the three month ended June 30, 2022 , compared to $156,551 for the
three months ended June 30, 2021 . The decrease was primarily driven by the
Company's continued focus on maintaining underwriting discipline in an unusually
competitive environment and a more
gradual increase of current year premium from new program partners added in 2021
and 2022 than originally estimated.
Workers' compensation represented 58.8% of our gross written premiums for the
three months ended June 30, 2022 , compared to 60.0% for the three months ended
June 30, 2021 . For the three months ended June 30, 2022 , gross written premiums
for workers' compensation decreased by $3,240 , or 3.4%, compared to the same
period in 2021, reflecting the intentional decrease in California business that
resulted from the Company's measures undertaken to exit certain unfavorable
risks in 2021 in keeping with our overall strategy to prioritize underwriting
discipline, coupled with a recent highly competitive market.
All other non-workers' compensation liability represented 41.2% of our gross
written premiums for the three month ended June 30, 2022 , compared to 40.0% for
the three months ended June 30, 2021 . For the three months ended June 30, 2022 ,
gross written premiums for all other non-workers' compensation liability
increased $878 , or 1.4%, compared to the same period in 2021. The increase is
due primarily to growth in our accident & health, commercial auto and commercial
lines, a result of continued line of business diversification.
Gross earned premiums: Gross earned premiums increased $18,518 , or 13.4%, to
$157,142 for the three months ended June 30, 2022 , compared to $138,624 for the
three months ended June 30, 2021 . The increase in gross earned premiums reflects
the increase in gross unearned premiums of $20,880 net of a decrease in gross
written premiums of $2,362 . Gross earned premiums as a percentage of gross
written premiums increased to 101.9% for the three months ended June 30, 2022 ,
compared to 88.5% for the three months ended June 30, 2021 .
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Ceded earned premiums: Ceded earned premiums increased $451 , or 0.5%, to $91,132
for the three months ended June 30, 2022 , compared to $90,681 for the three
months ended June 30, 2021 . The increase in ceded earned premiums is primarily
driven by the growth in gross earned premiums as described above, partially
offset by an increase in our retention. Ceded earned premiums as a percentage of
gross earned premiums decreased to 58.0% for the three months ended June 30,
2022 , compared to 65.4% for the three months ended June 30, 2021 , reflecting the
Company's strategic decision to retain more gross written premiums.
Net earned premiums: Net earned premiums increased $18,067 , or 37.7%, to $66,010
for the three months ended June 30, 2022 , compared to $47,943 for the three
months ended June 30, 2021 . The increase is primarily due to the growth in gross
earned premiums as described above and the Company's strategic decision to
retain more gross written premiums.
Net investment income (loss): Net investment income decreased $2,494 , or 118.6%,
to a loss of $391 for the three months ended June 30, 2022 , compared to $2,103
for the three months ended June 30, 2021 . The decrease reflects unrealized
losses on equity securities of $3,441 , partially offset by interest income.
During the first quarter of 2022, we purchased high-yield equity securities,
which we believe will improve the yield on our portfolio.
Net realized gains: Net realized gains were $1,349 for the three months ended
June 30, 2022 , compared to $10 for the three months ended June 30, 2021 . The
increase was primarily due to earn-out proceeds received of $1,400 related to
the Company's sale of TRI in 2021.
Other revenue: Other revenue increased
months ended
revenue of
Losses and loss adjustment expenses: Losses and LAE increased$11,162 , or 37.6%, to$40,887 for the three months endedJune 30, 2022 , compared to$29,725 for the three months endedJune 30, 2021 . The increase is primarily attributable to the growth in earned premiums and increased retention during the three months endedJune 30, 2022 . This resulted in a loss ratio of 61.9% for the three months endedJune 30, 2022 compared to 62.0% for the three months endedJune 30, 2021 . General and administrative expenses: General and administrative expenses increased$6,412 , or 42.0%, to$21,679 for the three months endedJune 30, 2022 , compared to$15,267 for the three months endedJune 30, 2021 . The expense ratio was 32.8% for the three months endedJune 30, 2022 , compared to 31.8% for the three months endedJune 30, 2021 . 31 -------------------------------------------------------------------------------- Table of Contents The table below shows the components of general and administrative expenses for the respective three-month periods: Three Months Ended June 30, 2022 2021 Change Direct commissions$ 29,133 $ 27,602 $ 1,531 Ceding commissions (26,628) (29,684) 3,056 Net commissions 2,505 (2,082) 4,587 Insurance-related expenses 5,889 5,149 740 General and administrative operating expenses 13,285 12,200 1,085 Total general and administrative expenses$ 21,679
General and administrative expenses - % of gross written premiums 8.6 % 7.8 % Retention rate (1) 42.0 % 34.6 % Direct commission rate (2) 18.5 % 19.9 % Ceding commission rate (3) 29.2 % 32.7 %
(1) Net earned premium as a percentage of gross earned premiums.
(2) Direct commissions as a percentage of gross earned premiums.
(3) Ceding commissions as a percentage of ceded earned premiums.
Direct commissions increased$1,531 primarily due to an increase in gross earned premiums. Ceding commissions decreased$3,056 primarily due to an increase in retention, partially offset by an increase in ceded earned premiums reflecting the increase in gross earned premiums. Insurance-related expenses increased$740 primarily as a result of an increase in gross earned premiums. General and administrative operating expenses increased$1,085 . The increase in general and administrative operating expense is primarily the result of an increase in salaries and benefits of$1,074 which related primarily to a general increase in workforce. Intangible asset amortization: Intangible asset amortization increased$87 to$1,500 for the three months endedJune 30, 2022 , compared to$1,413 for the three months endedJune 30, 2021 . The increase is driven by the addition of intangible assets acquired in the acquisition of WIC in the third quarter of 2021. Noncash stock compensation: Noncash stock compensation was$403 for the three months endedJune 30, 2022 , compared with$419 for the three months endedJune 30, 2021 . Expenses incurred during both periods relate to the fair value of restricted stock units and stock options granted under the Company's 2020 Omnibus Plan recognized over the requisite service periods. Gains (losses) on embedded derivatives: The table below shows the components of gains (losses) on embedded derivatives for the respective three-month periods: Three Months Ended
2022 2021 Change
Change in fair value of embedded derivatives $ 4,140 $
(167)$ 4,307 Effect of net investment income on funds held investments (774) (519) (255) Effect of realized gains on funds held investments (10) - (10)
Total gains (losses) on embedded derivatives $ 3,356 $
(686)
Gains on embedded derivatives increased$4,042 to$3,356 for the three months endedJune 30, 2022 , compared to a loss of$686 for the three months endedJune 30, 2021 . The gain reflected an increase in the fair value of embedded derivatives of$4,307 , the effect of investment income on funds held investments of$(255) and the effect of realized losses on funds held 32 -------------------------------------------------------------------------------- Table of Contents investments of$10 . The increase in fair value of the embedded derivatives resulted primarily from the increase in interest rates between periods, which has reduced the fair value of the underlying funds held under reinsurance agreements. Income tax expense: Income tax expense was$1,457 for the three months endedJune 30, 2022 , which resulted in an effective tax rate of 21.0%. The effective tax rate equaled the statutory rate of 21% since the impact of state taxes were offset by the impact of tax-exempt municipal income on the Company's investments. For the three months endedJune 30, 2021 , income tax expense was$414 , which resulted in an effective tax rate of 16.3%. The decrease in the effective tax rate from the statutory rate of 21% is due primarily to the impact of tax exempt municipal income on the Company's investments.
Owned MGAs and Program Partner Premiums:
The following table shows the total premiums earned on a gross and net basis for
Three Months Ended June 30, 2022
Owned MGAs Program Partner Total
Gross written premiums $ 59,839 $ 94,350 $ 154,189
Increase in gross unearned premiums 900 2,053 2,953
Gross earned premiums 60,739 96,403 157,142
Ceded earned premiums (21,938) (69,194) (91,132)
Net earned premiums $ 38,801 $ 27,209 $ 66,010
We utilize both quota share and catastrophe excess of loss ("XOL") contracts in
our reinsurance strategy for our Owned MGAs and Program Partners . For the three
months ended June 30, 2022 , the Company retained 63.9% of gross earned premiums
for Owned MGAs, compared to 28.2% for Program Partners .
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Consolidated Results of Operations for the Six Months Ended
Compared to
The following table summarizes our results of operations for the six months
ended
Six Months Ended June 30, Percentage Change
(in thousands, except for percentages) 2022 2021 Change (1)
Revenues
Gross written premiums$ 315,592 $ 303,281 $ 12,311 4.1 % Increase in gross unearned premiums 89 (36,358) 36,447 (100.2) % Gross earned premiums 315,681 266,923 48,758 18.3 % Ceded earned premiums (185,494) (177,846) (7,648) 4.3 % Net earned premiums 130,187 89,077 41,110 46.2 % Net investment income 2,185 4,375 (2,190) (50.1) % Net realized gains 302 23 279 NM Other revenue 5,005 5,884 (879) (14.9) % Total revenue 137,679 99,359 38,320 38.6 % Expenses Losses and loss adjustment expenses 80,080 54,606 25,474 46.7 % General and administrative expenses 39,979 27,158 12,821 47.2 % Intangible asset amortization 2,999 2,827 172 6.1 % Noncash stock compensation 559 630 (71) (11.3) % Interest expense 875 852 23 2.7 % Total expenses 124,760 86,918 37,842 43.5 % Gains (losses) on embedded derivatives 9,592 1,990 7,602 NM Other income 47 156 (109) (69.9) % Income before taxes 22,558 14,587 7,971 54.6 % Income tax expense 4,727 3,019 1,708 56.6 % Net income$ 17,831 $ 11,568 $ 6,263 54.1 %
(1) The Company defines increases or decreases greater than 200% as "NM" or not meaningful.
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The table below shows the total premiums earned on a gross and net basis for the
respective six-month periods:
Six Months Ended June 30,
(in thousands, except for percentages) 2022 2021
Key metrics:
Underwriting income(1) $ 10,128 $ 7,313
Adjusted net income(1) $ 13,850 $ 12,425
Loss ratio 61.5 % 61.3 %
Expense ratio 30.7 % 30.5 %
Combined ratio 92.2 % 91.8 %
Return on equity 8.6 % 5.6 %
Adjusted return on equity(1) 6.7 % 6.0 %
Return on tangible equity(1) 17.6 % 11.6 %
Adjusted return on tangible equity(1) 13.7 % 12.5 %
(1) This metric represents a non-GAAP financial measure. See 'Reconciliation of Non-GAAP Financial
Measures' for a reconciliation of this metric to the applicable GAAP metric.
Six Months Ended June 30,
(in thousands, except for
percentages) 2022 2021 Change Percentage Change
Revenues
Gross written premiums $ 315,592 $ 303,281 $ 12,311 4.1 %
Increase in gross unearned premiums 89 (36,358) 36,447 (100.2) %
Gross earned premiums 315,681 266,923 48,758 18.3 %
Ceded earned premiums (185,494) (177,846) (7,648) 4.3 %
Net earned premiums $ 130,187 $ 89,077 $ 41,110 46.2 %
Gross written premiums: Gross written premiums increased $12,311 , or 4.1%, to
$315,592 for the six months ended June 30, 2022 , compared to $303,281 for the
six months ended June 30, 2021 . The increase is primarily attributable to the
growth in our existing Program Partner business and the following changes in
gross written premiums by line of business:
Workers' compensation represented 60.0% of our gross written premiums for the
six months ended June 30, 2022 , compared to 63.7% for the six months ended June
30, 2021 . For the six months ended June 30, 2022 , gross written premiums for
workers' compensation decreased by $3,833 , or 2.0%, compared to the same period
in 2021, reflecting the intentional decrease in California business that
resulted from the Company's measures undertaken to reduce certain unfavorable
risks in 2021 in keeping with our overall strategy to prioritize underwriting
discipline, coupled with a recent highly competitive market.
All other non-workers' compensation liability represented 40.0% of our gross
written premiums for the six months ended June 30, 2022 , compared to 36.3% for
the six months ended June 30, 2021 . For the six months ended June 30, 2022 ,
gross written premiums for all other non-workers' compensation liability
increased $16,144 , or 14.7%, compared to the same period in 2021. The increase
is due primarily to growth in our accident & health, commercial auto,
commercial, and auto physical damage lines, which is a result of continued line
of business diversification.
Gross earned premiums: Gross earned premiums increased $48,758 , or 18.3%, to
$315,681 for the six months ended June 30, 2022 , compared to $266,923 for the
six months ended June 30, 2021 . The increase in gross earned premiums reflects
the increase in gross written premiums of $12,311 and an increase in gross
unearned premiums of $36,447 . Gross earned premiums as a percentage of gross
written premiums increased to 100.0% for the six months ended June 30, 2022 ,
compared to 88.0% for the six months ended June 30, 2021 .
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Ceded earned premiums: Ceded earned premiums increased $7,648 , or 4.3%, to
$185,494 for the six months ended June 30, 2022 , compared to $177,846 for the
six months ended June 30, 2021 . The increase in ceded earned premiums is
primarily driven by the growth in gross earned premiums as described above,
partially offset by an increase in our retention. Ceded earned premiums as a
percentage of gross earned premiums decreased to 58.8% for the six months ended
June 30, 2022 , compared to 66.6% for the six months ended June 30, 2021 ,
reflecting the Company's strategic decision to retain more gross written
premiums.
Net earned premiums: Net earned premiums increased $41,110 , or 46.2%, to
$130,187 for the six months ended June 30, 2022 , compared to $89,077 for the six
months ended June 30, 2021 . The increase is primarily due to the growth in gross
earned premiums as described above and the Company's strategic decision to
retain more gross written premiums.
Net investment income: Net investment income decreased $2,190 , or 50.1%, to
$2,185 for the six months ended June 30, 2022 , compared to $4,375 for the six
months ended June 30, 2021 . The decrease reflects unrealized losses of $3,441 on
equity securities, partially offset by higher interest income. During the first
quarter of 2022, we purchased high-yield securities, which we believe will
improve the yield on our portfolio.
Net realized gains: Net realized gains were $302 for the six months ended June
30, 2022 , compared to net realized gains of $23 for the six months ended June
30, 2021 . Net realized gains for the six months ended June 30, 2022 includes
earn-out proceeds received of $1,400 related to the Company's sale of TRI in
2021. The net realized gain was offset by our repositioning strategy to sell our
lower-yielding assets and purchase higher-yielding investments, prior to
anticipated interest rate increases. This turnover in our portfolio resulted in
realized losses of $1,022 . We believe the payback period on the realized losses
will be 12 months or less.
Other revenue: Other revenue decreased $879 , or 14.9%, to $5,005 for the six
months ended June 30, 2022 , compared to $5,884 for the six months ended June 30,
2021 . The decrease is largely driven by a reduction in brokerage revenue of $410
due to lower placement fees reflecting the Company's increase in retention year
over year. In addition, managing general agent fees, third-party administrator
fees, consulting and other fee-based revenue were all lower during the period.
Losses and loss adjustment expenses: Losses and LAE increased $25,474 , or 46.7%,
to $80,080 for the six months ended June 30, 2022 , compared to $54,606 for the
six months ended June 30, 2021 . The increase is primarily attributable to the
growth in earned premiums and increased retention during the six months ended
June 30, 2022 . This resulted in a loss ratio of 61.5% for the six months ended
June 30, 2022 , compared to 61.3% for the six months ended June 30, 2021 .
General and administrative expenses: General and administrative expenses
increased $12,821 , or 47.2%, to $39,979 for the six months ended June 30, 2022 ,
compared to $27,158 for the six months ended June 30, 2021 . The expense ratio
was 30.7% for the six months ended June 30, 2022 , compared to 30.5% for the six
months ended June 30, 2021 .
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The table below shows the components of general and administrative expenses for
the respective six-month periods:
Six Months Ended June 30,
2022 2021 Change
Direct commissions $ 57,041 $ 50,710 $ 6,331
Ceding commissions (53,625) (57,892) 4,267
Net commissions 3,416 (7,182) 10,598
Insurance-related expenses 11,660 9,425 2,235
General and administrative operating expenses 24,903 24,915 (12)
Total general and administrative expenses $ 39,979
General and administrative expenses - % of gross written premiums 7.9 % 8.2 % Retention rate (1) 41.2 % 33.4 % Direct commission rate (2) 18.1 % 19.0 % Ceding commission rate (3) 28.9 % 32.6 %
(1) Net earned premium as a percentage of gross earned premiums.
(2) Direct commissions as a percentage of gross earned premiums.
(3) Ceding commissions as a percentage of ceded earned premiums.
Direct commissions increased$6,331 primarily due to an increase in gross earned premiums. Ceding commissions decreased$4,267 primarily due to an increase in retention, partially offset by an increase in ceded earned premiums reflecting the increase in gross earned premiums. Insurance-related expenses increased$2,235 primarily as a result of an increase in gross earned premiums. General and administrative operating expenses decreased$12 . The decrease in general and administrative operating expense is primarily the result of an increase in salaries and benefits of$1,242 , which related primarily to a general increase in workforce, partially offset by a decrease in professional fees of$955 and depreciation expense of$157 . Intangible asset amortization: Intangible asset amortization increased$172 to$2,999 for the six months endedJune 30, 2022 , compared to$2,827 for the six months endedJune 30, 2021 . The increase is primarily driven by the addition of intangible assets acquired in the acquisition of WIC in the third quarter of 2021.
Noncash stock compensation: Noncash stock compensation was
months ended
2021
restricted stock units and stock options granted under the Company's 2020
Omnibus Plan recognized over the requisite service periods.
Gains on embedded derivatives:
The table below shows the components of gains (losses) on embedded derivatives
for the respective six-month periods:
Six Months
Ended
2022 2021 Change
Change in fair value of embedded derivatives $ 11,036 $ 3,189 $ 7,847
Effect of net investment income on funds held
investments (1,442) (1,199) (243)
Effect of realized gains on funds held
investments (2) - (2)
Total gains on embedded derivatives $ 9,592 $
1,990
Gains on embedded derivatives increased$7,602 to$9,592 for the six months endedJune 30, 2022 , compared to$1,990 for the six months endedJune 30, 2021 . The gain reflected an increase in the fair value of embedded derivatives of$7,847 , the effect of investment income on funds held investments of$243 and the effect of realized losses on funds held investments of 37 -------------------------------------------------------------------------------- Table of Contents$2 . The increase in fair value of the embedded derivatives resulted primarily from an increase in interest rates between periods, which has reduced the value of the underlying funds held under reinsurance agreements. Income tax expense: Income tax expense was$4,727 for the six months endedJune 30, 2022 , which resulted in an effective tax rate of 21.0%. The effective tax rate equaled the statutory rate of 21% since the impact of state taxes were offset by the impact of tax-exempt municipal income on the Company's investments. For the six months endedJune 30, 2021 , income tax expense was$3,019 , which resulted in an effective tax rate of 20.7%. The decrease in the effective tax rate from the statutory rate of 21% is due primarily to the impact of tax-exempt municipal income on the Company's investments.
Owned MGAs and Program Partner Premiums:
The following table shows the total premiums earned on a gross and net basis for
Six Months Ended June 30, 2022
Owned MGAs Program Partner Total
Gross written premiums $ 128,483 $ 187,109 $ 315,592
Increase in gross unearned premiums (4,359) 4,448 89
Gross earned premiums 124,124 191,557 315,681
Ceded earned premiums (47,327) (138,167) (185,494)
Net earned premiums $ 76,797 $ 53,390 $ 130,187
We utilize both quota share and XOL contracts in our reinsurance strategy for
our Owned MGAs and Program Partners . Direct commissions for Program Partners
include third-party agent commissions and MGA service fees, while Owned MGA
direct commissions include only third-party agent commissions. For the six
months ended June 30, 2022 , the Company retained 61.9% of gross earned premiums
for Owned MGAs compared to 27.9% for Program Partners .
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Reconciliation of Non-GAAP Financial Measures
Underwriting income
We define underwriting income as income before taxes excluding net investment
income, investment revaluation gains, net realized gains or losses, intangible
asset amortization, noncash stock compensation, gains and losses on embedded
derivatives, interest expense, other revenue, and other income and expenses.
Underwriting income represents the pre-tax profitability of our underwriting
operations and allows us to evaluate our underwriting performance without regard
to investment income, intangible asset amortization, noncash stock compensation,
interest expense, other revenue, and other income and expenses. We use this
metric because we believe it gives our management and other users of our
financial information useful insight into our underwriting business performance
by adjusting for these expenses and sources of income. Underwriting income
should not be viewed as a substitute for net income calculated in accordance
with GAAP, and other companies may define underwriting income differently.
Three Months Ended June 30,
(in thousands, except percentages) 2022 2021
Net income $ 5,491 $ 2,126
Income tax expense 1,457 414
Income before taxes 6,948 2,540
Other revenue (1,804) (1,229)
Gains (losses) on embedded derivatives (3,356) 686
Net investment income 391 (2,103)
Net realized gains (1,349) (10)
Other expenses 268 845
Interest expense 467 425
Intangible asset amortization 1,500 1,413
Noncash stock compensation 403 419
Other income (24) (35)
Underwriting income $ 3,444 $ 2,951
Six Months Ended June 30,
(in thousands, except percentages) 2022 2021
Net income $ 17,831 $ 11,568
Income tax expense 4,727 3,019
Income before taxes 22,558 14,587
Other revenue (5,005) (5,884)
Gains (losses) on embedded derivatives (9,592) (1,990)
Net investment income (2,185) (4,375)
Net realized gains (302) (23)
Other expenses 268 845
Interest expense 875 852
Intangible asset amortization 2,999 2,827
Noncash stock compensation 559 630
Other income (47) (156)
Underwriting income $ 10,128 $ 7,313
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Adjusted net income
We define adjusted net income as net income excluding the impact of certain
items, including noncash intangible asset amortization and stock compensation,
noncash changes in fair value of embedded derivatives, other expenses and gains
or losses that we believe do not reflect our core operating performance, which
items may have a disproportionate effect in a given period, affecting
comparability of our results across periods. We calculate the tax impact only on
adjustments that would be included in calculating our income tax expense using
an expected effective tax rate for the applicable years. We use adjusted net
income as an internal performance measure in the management of our operations
because we believe it gives our management and other users of our financial
information useful insight into our results of operations and our underlying
business performance by eliminating the effects of these items. Adjusted net
income should not be viewed as a substitute for net income calculated in
accordance with GAAP, and other companies may define adjusted net income
differently.
Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except percentages) 2022 2021 2022 2021
Net income $ 5,491 $ 2,126 $ 17,831 $ 11,568
Intangible asset amortization 1,500 1,413 2,999 2,827
Noncash stock compensation 403 419 559 630
Change in fair value of embedded
derivative (4,140) 167 (11,036) (3,189)
Unrealized losses on equity
securities 3,441 - 3,441 -
Realized gain on sale of investment (1,400) - (1,400) -
Other expenses 268 845 268 845
Total adjustments 72 2,844 (5,169) 1,113
Tax impact of adjustments (17) (654) 1,188 (256)
Adjusted net income $ 5,546 $ 4,316 $ 13,850 $ 12,425
Adjusted return on equity
We define adjusted return on equity as adjusted net income expressed on an
annualized basis as a percentage of average beginning and ending stockholders'
equity during the period. We use adjusted return on equity as an internal
performance measure in the management of our operations because we believe it
gives our management and other users of our financial information useful insight
into our results of operations and our underlying business performance by
adjusting for items that we believe do not reflect our core operating
performance and that may diminish comparability across periods. Adjusted return
on equity should not be viewed as a substitute for return on equity calculated
in accordance with GAAP, and other companies may define adjusted return on
equity differently.
Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except
percentages) 2022 2021 2022 2021
Adjusted return on equity
calculation:
Numerator: adjusted net income $ 5,546 $ 4,316 $ 13,850 $ 12,425
Denominator: average equity 413,258 415,159 416,014 413,725
Adjusted return on equity 5.4 % 4.2 % 6.7 % 6.0 %
Return on equity 5.3 % 2.0 % 8.6 % 5.6 %
Return on tangible equity and adjusted return on tangible equity
We define tangible stockholders' equity as stockholders' equity less goodwill
and other intangible assets. We define return on tangible equity as net income
expressed on an annualized basis as a percentage of average beginning and ending
tangible stockholders' equity during the period. We define adjusted return on
tangible equity as adjusted net income expressed on an annualized basis as a
percentage of average beginning and ending tangible stockholders' equity during
the period. We regularly evaluate acquisition opportunities and have
historically made acquisitions that affect stockholders' equity. We use return
on tangible equity and adjusted return on tangible equity as internal
performance measures in the management of our
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operations because we believe they give our management and other users of our
financial information useful insight into our results of operations and our
underlying business performance by adjusting for the effects of acquisitions on
our stockholders' equity and, in the case of adjusted return on tangible equity,
by adjusting for the items that we believe do not reflect our core operating
performance and that may diminish comparability across periods. Return on
tangible equity and adjusted return on tangible equity should not be viewed as a
substitute for return on equity or return on tangible equity, respectively,
calculated in accordance with GAAP, and other companies may define return on
tangible equity and adjusted return on tangible equity differently.
Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except percentages) 2022 2021 2022 2021
Return on tangible equity calculation:
Numerator: net income $ 5,491 $ 2,126 $ 17,831 $ 11,568
Denominator:
Average stockholders' equity 413,258 415,159 416,014 413,725
Less: average goodwill and other
intangible assets 213,213 213,836 213,962 214,543
Average tangible stockholders' equity 200,045 201,323 202,052 199,182
Return on tangible equity 11.0 % 4.2 % 17.6 % 11.6 %
Return on equity 5.3 % 2.0 % 8.6 % 5.6 %
Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except percentages) 2022 2021 2022 2021
Adjusted return on tangible equity
calculation:
Numerator: adjusted net income $ 5,546 $ 4,316 $ 13,850 $ 12,425
Denominator: average tangible equity 200,045 201,323 202,052 199,182
Adjusted return on tangible equity 11.1 % 8.6 % 13.7 % 12.5 %
Return on equity 5.3 % 2.0 % 8.6 % 5.6 %
Financial Condition, Liquidity and Capital Resources
Sources and Uses of Funds
We are organized as a holding company with our operations conducted through our subsidiaries, including our wholly owned insurance subsidiaries: Benchmark, which is domiciled inKansas and commercially domiciled inCalifornia ; ALIC, which is domiciled inUtah ; 7710, which is domiciled inSouth Carolina ; and BSIC, which is domiciled inArkansas . Accordingly, the holding company may receive cash through: (i) loans from banks; (ii) draws on a revolving loan agreement; (iii) issuance of equity and debt securities; (iv) corporate service fees from our operating subsidiaries; (v) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions; and (vi) dividends from our non-insurance subsidiaries and, subject to certain limitations discussed below, dividends from our insurance subsidiaries. We also may use the proceeds from these sources to contribute funds to the insurance subsidiaries in order to support premium growth, reduce our reliance on reinsurance, pay taxes, and for other general business purposes.
State insurance laws restrict the ability of insurance companies to declare
stockholder dividends without prior regulatory approval. State insurance
regulators require insurance companies to maintain specified levels of statutory
capital and surplus.
UnderKansas andCalifornia law, dividends payable from Benchmark without the prior approval of the applicable insurance commissioner must not exceed the greater of (i) 10% of Benchmark's surplus as shown on the last statutory financial statement on file with theKansas Insurance Department and theCalifornia Department of Insurance , respectively; or (ii) 100% of net income during the applicable twelve-month period (not including realized gains). Dividends shall not include pro rata distributions of any class of Benchmark's own securities. UnderUtah law, dividends payable from ALIC without the prior approval of the applicable insurance commissioner must not exceed the lesser of: (i) 10% of ALIC's surplus as shown on the last statutory financial statement on file with theUtah 41 -------------------------------------------------------------------------------- Table of ContentsInsurance Department ; or (ii) 100% of net income during the applicable twelve- month period (not including realized gains). Dividends shall not include pro rata distributions of any class of ALIC's own securities. UnderSouth Carolina law, dividends payable from 7710 without the prior approval of the applicable insurance commissioner are limited to the following during the preceding twelve months: (a) when paid from other than earned surplus must not exceed the lesser of: (i) 10% of 7710's surplus as regards policyholders as shown in 7710's most recent annual statement; or (ii) the net income, not including net realized gains or losses as shown in 7710's most recent annual statement; or (b) when paid from earned surplus must not exceed the greater of: (i) 10% of 7710's surplus as regards policyholders as shown in 7710Insurance Company's most recent annual statement; or (ii) the net income, not including net realized gains or losses as shown in 7710's most recent annual statement. Dividends shall not include pro rata distributions of any class of 7710's own securities. UnderArkansas law, dividends payable from BSIC without the prior approval of the applicable insurance commissioner must not exceed the lesser of (i) 10% of BSIC's surplus as shown on the last statutory financial statement on file with theArkansas Insurance Department ; or (ii) 100% of net income during the applicable twelve- month period (not including realized gains). Dividends shall not include pro rata distributions of any class of BSIC's own securities. The maximum amount of dividends the insurance subsidiaries can pay us during 2022 without regulatory approval is approximately$21,000 . Insurance regulators have broad powers to ensure that statutory surplus remains at adequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. In the future, state insurance regulatory authorities that have jurisdiction over the payment of dividends by the insurance subsidiaries may adopt statutory provisions more restrictive than those currently in effect. Our insurance subsidiaries are also required by state law to maintain a minimum level of policyholders' surplus.Kansas ,Utah ,Arkansas , andSouth Carolina utilize a risk-based capital requirement as promulgated by theNational Association of Insurance Commissioners . Such requirements are designed to identify the various business risks (e.g., investment risk, underwriting profitability risk, etc.) of insurance companies and their subsidiaries. As ofJune 30, 2022 andDecember 31, 2021 , the total adjusted capital of our insurance subsidiaries was in excess of their respective prescribed risk-based capital requirements.
As of
Management believes that we have sufficient liquidity available to meet our
operating cash needs and obligations and committed capital expenditures for the
next twelve months.
Cash Flows
Our most significant source of cash is from premiums received from insureds, net
of the related commission amount for the policies. Our most significant cash
outflow is for claims that arise when a policyholder incurs an insured loss.
Because the payment of claims occurs after the receipt of the premium, often
years later, we invest the cash in various investment securities that generally
earn interest and dividends. The table below summarizes our net cash flows.
Six Months
Ended
2022 2021
Cash, cash equivalents and restricted cash provided by
(used in):
Operating activities $ 40,075 $ 22,820
Investing activities (68,212) (65,599)
Financing activities (832) (625)
Net increase (decrease) in cash, cash equivalents and
restricted cash $ (28,969) $ (43,404)
Operating Activities: Net cash provided by operating activities for the six
months ended June 30, 2022 was $40,075 , compared to $22,820 for the same period
in 2021. Net cash provided by operating activities includes net income as
adjusted for depreciation and amortization, stock compensation, unrealized gains
and losses on embedded derivatives, net realized gains and losses on
investments, unrealized gains and losses on equity securities, bond amortization
and accretion, the change
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in deferred income taxes, and amortization of deferred financing costs. Net cash
provided by operating activities for the six months ended June 30, 2022
primarily reflects increased unpaid loss and loss adjustment expenses of
$33,366 , decreased prepaid reinsurance premiums of $13,952 , increased funds held
under reinsurance agreements of $11,963 , partially offset by increases in
premiums and other receivables of $11,902 , an increase in reinsurance
recoverables of $11,560 , a decrease in accounts payable and accrued expenses of
$5,616 , and an increase in other assets of $5,101 . Unpaid loss and loss
adjustment expenses increased primarily due to an increase in gross written
premiums and an increase in our retention. The decrease in prepaid reinsurance
premiums was the result of increased retention, partially offset by the increase
in ceded premiums. Funds held under reinsurance agreements increased due a
reduction in the derivatives, partially offset by an increase in ceded premiums.
The increases in premiums and other receivables and reinsurance recoverables
were primarily a result of an increase in gross written premiums during the
period. The decrease in accounts payable and accrued expenses is due to
reductions in the accrued bonus, accrued 401(k) match and accrued premium taxes
paid in the first quarter of 2022. Other assets increased as a result of
increases in our deferred acquisition costs and contract asset balances.
Net cash provided by operating activities for the six months ended June 30, 2021
reflects increases in unpaid loss and loss adjustment expenses of $44,742 ,
unearned premiums of $36,401 and funds held under reinsurance agreements of
$3,080 ; partially offset by increases in premiums and other receivables of
$22,714 , reinsurance recoverables of $18,730 , prepaid reinsurance premiums of
$13,033 , other assets of $6,623 and decreases in reinsurance premiums payable of
$5,388 , accounts payable and accrued expenses of $4,011 and income taxes payable
of $3,791 . Unpaid loss and loss adjustment expenses and unearned premiums
increased primarily due to an increase in gross written premiums. The increases
in premiums and other receivables and reinsurance recoverables were primarily a
result of an increase in gross written premiums during the period. Other assets
increased as a result of increases in our deferred acquisition costs and
contract asset balances. Funds held under reinsurance agreements decreased due
to an arbitration settlement in the fourth quarter of 2020, resulting in the
non-cash transfer of certain investments held as collateral. Excluding non-cash
transfers, funds held under reinsurance agreements increased as a result of an
increase in gross written premium. Net cash provided by operating activities for
the six months ended June 30, 2020 reflects distributions received from equity
method investments and incremental cash received for operating assets and
liabilities.
Investing Activities: Net cash used in investing activities for the six months
ended June 30, 2022 was $68,212 , compared to net cash used in investing
activities of $65,599 for the same period in 2021. Net cash used in investing
activities for the six months ended June 30, 2022 includes $67,873 net cash used
in the purchase and sale of investments and $339 in capital expenditures. Net
cash provided by investing activities for the six months ended June 30, 2021
includes $65,758 net cash used in the purchase and sale of investments, $73 in
capital expenditures, and $232 in cash received for the sale of equity method
investments.
Financing Activities: Net cash used in financing activities for the six months
ended June 30, 2022 was $832 , compared to net cash used in financing activities
of $625 for the same period in 2021. Net cash used in financing activities for
the six months ended June 30, 2022 and 2021 primarily includes the principal
payments made on the Company's debt.
Debt and Credit Agreements
First Horizon Credit Agreement
OnJuly 16, 2020 , the Company entered into an Amended and Restated Credit Agreement withFirst Horizon Bank , which, among other things, extended the Company's credit facility for a period of five years throughMay 26, 2025 and increased its term loan facility by$11,707 , resulting in a total term loan debt amount of$33,000 and a revolving credit facility of$2,000 . Borrowings under the facility are secured by substantially all of the assets of the Company other thanBenchmark Holding Company and its subsidiaries. The loan has a variable interest rate of 3-month LIBOR plus 4.50%, which was 5.51% as ofJune 30, 2022 and 4.64% as ofDecember 31, 2021 (under the 2018 First Horizon Credit Agreement). The outstanding principal balance of the loan is to be repaid in quarterly installments that escalate from approximately$206 to$825 untilMarch 2025 . All equity securities of the subsidiaries of the Company (other thanBenchmark Holding Company and its subsidiaries) have been pledged as collateral.
Reinsurance
We cede a portion of the risk we accept on our balance sheet to third-party
reinsurers through a variety of reinsurance arrangements. We manage these
arrangements to align risks with our
retention relative to our financial objectives, balance sheet size and ratings
requirements, as well as to limit our maximum loss resulting from a
43 -------------------------------------------------------------------------------- Table of Contents single program or a single event. We utilize both quota share and XOL reinsurance as tools in our overall risk management strategy to achieve these goals, usually in conjunction with each other. Quota share reinsurance involves the proportional sharing of premiums and losses of each defined program. We utilize quota share reinsurance for several purposes, including (i) to cede risk toProgram Partners , which allows us to share economics and align incentives, and (ii) to cede risk to third-party reinsurers in order to manage our net written premiums appropriately based on our financial objectives, capital base,A.M. Best financial strength rating, and risk appetite. It is a core pillar of our underwriting philosophy thatProgram Partners retain a portion of the underwriting risk of their program. We believe this best aligns interests, attracts higher quality programs, and leads to better underwriting results. Under XOL reinsurance, losses in excess of a retention level are paid by the reinsurer, subject to a limit, and are customized per program or across multiple programs. We utilize XOL reinsurance to protect against catastrophic or other unforeseen extreme loss activity that could otherwise negatively impact our profitability and capital base. The majority of our exposure to catastrophe risk stems from the workers' compensation premium we retain. Potential catastrophic events include an earthquake, terrorism, or another event that could cause more than one covered employee working at the same location to be injured in the event. We believe we mitigate this risk by our focus on small- to mid-sized accounts, which means that we generally do not have concentrated employee counts at single locations that could be exposed to a catastrophic loss. The cost and limits of the reinsurance coverage we purchase vary from year to year based on the availability of quality reinsurance at an acceptable price and our desired level of retention. Ratings We have a financial strength rating of "A" (Excellent) fromA.M. Best .A.M. Best assigns 16 ratings to insurance companies, which currently range from "A++" (Superior) to "S" (Rating Suspended). "A" (Excellent) is the third highest rating issued byA.M. Best . The "A" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. See also "Risk Factors - Risks related to our business and industry - A downgrade in theA.M. Best financial strength ratings of our insurance company subsidiaries may negatively affect our business." in our 2021 Form 10-K. The financial strength ratings assigned byA.M. Best have an impact on the ability of insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that insurance companies receive. The "A" (Excellent) rating obtained by us is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
There have been no material changes in the Company's contractual obligations as
of
Financial condition
Stockholders' Equity
As of
stockholders' equity over the period was driven primarily by
comprehensive loss.
We had
non-vested stock compensation granted. The Company recognized
compensation during the six months ended
Investment Portfolio
Our invested asset portfolio consists of fixed maturities, equity securities, other investments, and short-term investments. The majority of the investment portfolio was comprised of fixed maturity securities of$466,819 atJune 30, 2022 , that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. 44 -------------------------------------------------------------------------------- Table of Contents Our investment portfolio objectives are to maintain liquidity, facilitating financial strength and stability and ensuring regulatory and legal compliance. Our investment portfolio consists of available-for-sale fixed maturities and other equity investments, all of which are carried at fair value. We seek to hold a high-quality portfolio of investments that is managed by a professional investment advisory management firm in accordance with the Company's investment policy and routinely reviewed by our management team. Our investments, however, are subject to general economic conditions and market risks as well as risks inherent to particular securities. The Company's investment portfolio has the following objectives:
•meet insurance regulatory requirements with respect to investments under the
applicable insurance laws;
•maintain an appropriate level of liquidity to satisfy the cash requirements of
current operations and long-term obligations;
•adjust investment risk to offset or complement insurance risk based on our
total corporate risk tolerance; and
•realize the highest possible levels of investment income and after-tax total
rates of return.
The composition of our investment portfolio is shown in the following table as
of
June 30, 2022
Cost or
Amortized Cost Fair Value
Fixed maturities:
U.S. government and government securities $ 53,592 $ 51,678
Foreign governments 400 392
States, territories and possessions 11,102 10,274
Political subdivisions of states, territories and
possessions 39,098 35,925
Special revenue and special assessment obligations 107,939 99,528
Industrial and public utilities 106,575 102,514
Commercial mortgage-backed securities 110,538 98,807
Residential mortgage-backed securities 20,076 19,087
Other loan-backed securities 44,880 43,830
Hybrid securities 5,344 4,784
Total fixed maturities 499,544 466,819
Equity securities 34,248 30,698
Total investments $ 533,792 $ 497,517
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December 31, 2021
Cost or
Amortized Cost Fair Value
Fixed maturities:
U.S. government and government securities $ 41,490 $ 41,434
Foreign governments 2,500 2,490
States, territories and possessions 10,593 10,766
Political subdivisions of states, territories and
possessions 39,170 40,002
Special revenue and special assessment obligations 93,664 95,991
Industrial and public utilities 100,774 103,257
Commercial mortgage-backed securities 119,378 118,218
Residential mortgage-backed securities 16,549 17,368
Other loan-backed securities 41,236 41,425
Hybrid securities 105 110
Total fixed maturities 465,459 471,061
Equity securities 984 969
Total investments $ 466,443 $ 472,030
The following table shows the percentage of the total estimated fair value of
our fixed maturity securities as of June 30, 2022 and December 31, 2021 by
credit rating category, using the lower of ratings assigned by Moody's Investor
Service or S&P.
June 30, 2022
(in thousands, except percentages) Fair Value % of Total
AAA $ 77,745 16.7 %
AA 272,331 58.3 %
A 83,549 17.9 %
BBB 29,786 6.4 %
BB 3,382 0.7 %
Below investment grade 26 0.0 %
Total fixed maturities $ 466,819 100.0 %
December 31, 2021
(in thousands, except percentages) Fair Value % of Total
AAA $ 80,455 17.1 %
AA 278,557 59.1 %
A 77,097 16.4 %
BBB 33,959 7.2 %
BB 947 0.2 %
Below investment grade 46
0.0 %
Total fixed maturities $ 471,061
100.0 %
Critical Accounting Policies and Estimates
The unaudited interim condensed consolidated financial statements included in
this Quarterly Report on Form 10-Q include amounts based on the use of estimates
and judgments of management.
46
--------------------------------------------------------------------------------
Table of Contents We identified the accounting estimates that are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our condensed consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the condensed consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. The estimates and judgments that are most critical to the preparation of the condensed consolidated financial statements include: (i) reserves for unpaid loss and LAE; (ii) reinsurance recoveries; (iii) investment fair value measurements; (iv) goodwill and intangible assets; and (v) business combinations. For a detailed discussion of our accounting policies, see the "Notes to the Consolidated and Combined Financial Statements" included in our 2021 Form 10-K.
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EHEALTH, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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