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UNITED FIRE GROUP INC – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with Part I, Item 1
"Financial Statements."
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are representative of significant judgments and uncertainties and that potentially may result in materially different results under different assumptions and conditions. We base our discussion and analysis of our consolidated financial condition and results of operations on the amounts reported in our Consolidated Financial Statements, which we have prepared in accordance withU.S. generally accepted accounting principles ("GAAP"). As we prepare these Consolidated Financial Statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Our critical accounting policies are more fully described in our Management's Discussion and Analysis of Financial Condition and Results of Operations presented in Part II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2021 . There have been no changes in our critical accounting policies fromDecember 31, 2021 .
INTRODUCTION
The purpose of this Management's Discussion and Analysis is to provide an understanding of our results of operations and consolidated financial condition. Our Management's Discussion and Analysis should be read in conjunction with our Consolidated Financial Statements and related notes, including those in Part II, Item 8 of our Annual Report on Form 10-K for the year endedDecember 31, 2021 . Our Consolidated Financial Statements are prepared in accordance with GAAP. We also prepare financial statements for each of our insurance company subsidiaries based on statutory accounting principles and file them with insurance regulatory authorities in the states where they do business.
When we provide information on a statutory or other basis, we label it as such,
otherwise all other data is presented in accordance with GAAP.
Please note that references to our commercial line "surety" was referenced in
our previous filings as "fidelity and surety".
BUSINESS OVERVIEW
Founded in 1946 asUnited Fire & Casualty Company ,United Fire Group, Inc. ("UFG, the "Company," "we," "us," or "our") and its consolidated insurance subsidiaries provide insurance protection for individuals and businesses through several regional offices. Our property and casualty insurance company subsidiaries are licensed in 50 states plus theDistrict of Columbia and are represented by approximately 1,000 independent agencies.
Our primary sources of revenue are premiums and investment income. Major
categories of expenses from our operations include losses and loss settlement
expenses, underwriting and other operating expenses.
Reportable Segments
Our property and casualty insurance business operates and reports as one
business segment. For more information, refer to Part I, Item 1, Note 1. "Nature
of Operations and Basis of Presentation."
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Table of Contents Lloyd's Syndicates As ofJanuary 1, 2021 , the Company became a member ofLloyd's of London ("Lloyd's"). As a member of Lloyd's, the Company is required to maintain capital at Lloyd's, referred to as Funds at Lloyd's ("FAL"), to support underwriting of property and casualty and reinsurance business by Syndicate 1492, Syndicate 1729, Syndicate 1969, Syndicate 1971, Syndicate 4747, Syndicate 2988 and Syndicate 1699. AtSeptember 30, 2022 , the Company's FAL investments were comprised of cash of$21.4 million on deposit with Lloyd's in order to satisfy these FAL requirements. Personal Lines Business InMay 2020 , the Company entered into a renewal rights agreement for our personal lines business, providing our independent insurance agents with the opportunity to transfer their personal lines policies toNationwide Mutual Insurance Company ("Nationwide") beginning in the third quarter of 2020. Nationwide has been offering replacement policies to most of our personal lines policyholders at the time of renewal. The transfer of policies is substantially complete, withNew Jersey being the only state where the Company has personal lines policies in force as ofSeptember 30, 2022 . These policies will lapse over the next three years. Pooling Arrangement All of our property and casualty insurance subsidiaries are members of an intercompany reinsurance pooling arrangement. The Company's pooling arrangement permits the participating companies to rely on the capacity of the entire pool's capital and surplus, rather than being limited to policy exposures of a size commensurate with each participant's own surplus level.
Geographic Concentration
For the nine-month period endedSeptember 30, 2022 , approximately 47.7 percent of our property and casualty premiums were written inTexas ,California ,Iowa ,Missouri , andNew Jersey . Profit Factors Our profitability is influenced by many factors, including price, competition, economic conditions, investment returns, interest rates, catastrophic events and other natural disasters, man-made disasters, state regulations, court decisions, and changes in the law. To manage these risks and uncertainties, we seek to achieve consistent profitability through strong agency relationships, exceptional customer service, fair and prompt claims handling, disciplined underwriting, superior loss control services, prudent management of our investments, appropriate matching of assets and liabilities, effective use of ceded reinsurance and effective and efficient use of technology.
COVID-19
Sincemid-March 2020 , the COVID-19 pandemic has caused significant financial market volatility, economic uncertainty and interruptions to normal business activities.
In response to evolving pandemic conditions, UFG initially activated our
pre-existing business continuity plans, dispatched the majority of its staff to
work remotely, and implemented numerous safety measures for the safety and
health of our employees. As a result of the reduction in COVID-19 community
levels, an increasing number of UFG employees have resumed working onsite,
although we continue to offer remote and hybrid work arrangements to employees.
The implementation of our business continuity plans has not had a material
effect on our internal control environment at any time during the pandemic.
Additionally, we believe our operational processes, internal controls over
financial reporting and disclosures, and financial reporting systems continue to
operate effectively in the present environment.
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Table of Contents Nearly all of the policies we have issued specifically exclude business interruption coverage for losses due to viruses such as the COVID-19 pandemic, but we continue to carefully investigate each claim and intend to afford coverage when appropriate. We expect the effect of the COVID-19 pandemic on claims currently under our coverages to be manageable, based upon losses reported to date. We continue to evaluate the dynamic nature of the pandemic, including the emergence of variant strains, and cannot predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted. Additionally, if established written contract policy exclusions of business interruption coverage for losses attributable to the COVID-19 pandemic are voided or changed through legislation, regulations or interpretations by the courts, such changes have the potential to materially increase claims, losses and legal expenses which could impact our business, financial condition, results of operations and liquidity.
As of
honor the terms of the contracts. We have also evaluated for impairment the four
lease contracts in which we are the lessor. As of
payments on these contracts had been received and we fully expect to timely
receive all future payments.
The Company's investment philosophy, objectives, approach and program have not
changed as a result of the COVID-19 pandemic.
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FINANCIAL HIGHLIGHTS
Three Months Ended September 30, Nine Months Ended September 30,
(In Thousands, Except Ratios) 2022 2021 % 2022 2021 %
Revenues
Net premiums earned $ 238,256 $ 238,909 (0.3) % $ 703,746 $ 722,837 (2.6) %
Investment income, net of investment
expenses 11,606 11,571 0.3 32,062 42,447 (24.5)
Net investment gains (losses) (14,250) (2,269) NM (35,647) 28,243 (226.2)
Other income (loss) (39) 332 (111.7) (38) 163 (123.3)
Total revenues $ 235,573 $ 248,543 (5.2) % $ 700,123 $ 793,690 (11.8) %
Benefits, Losses and Expenses
Losses and loss settlement expenses $ 182,411 $ 175,444 4.0 % $ 464,295 $ 533,981 (13.1) %
Amortization of deferred policy
acquisition costs 53,107 51,261 3.6 156,116 150,533 3.7
Other underwriting expenses 30,487 35,468 (14.0) 87,885 82,236 6.9
Interest expense 797 797 - 2,391 2,391 -
Total benefits, losses and expenses $ 266,802 $ 262,970 1.5 % $ 710,687 $ 769,141
(7.6) %
Income (loss) before income taxes
(116.5) %$ (10,564) $ 24,549
(143.0)
Federal income tax expense (benefit) (8,248) (4,834) (70.6) (5,475) 1,690 NM Net income (loss)$ (22,981) $ (9,593) (139.6)$ (5,089) $ 22,859 (122.3) % GAAP Ratios: Net loss ratio (without catastrophes) 65.2 % 56.9 % 14.6 % 57.3 % 61.4 % (6.7) % Catastrophes - effect on net loss ratio 11.4 16.5 (30.9) 8.7 12.5 (30.4) Net loss ratio(1) 76.6 % 73.4 % 4.4 % 66.0 % 73.9 % (10.7) % Expense ratio(2) 35.1 36.3 (3.3) 34.6 32.2 7.5 Combined ratio(3) 111.7 % 109.7 % 1.8 % 100.6 % 106.1 % (5.2) % (1) The net loss ratio is calculated by dividing the sum of losses and loss settlement expenses by net premiums earned. We use the net loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio is meaningful in evaluating our financial results as reported in our unaudited Consolidated Financial Statements. (2) The expense ratio is calculated by dividing other underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company's operational efficiency in producing, underwriting and administering its insurance business. (3) The combined ratio is a commonly used financial measure of property and casualty underwriting performance. A combined ratio below 100.0 percent generally indicates a profitable book of business. The combined ratio is the sum of the net loss ratio and the underwriting expense ratio. NM = Not meaningful
The following is a summary of our financial performance for the three- and
nine-month periods ended
RESULTS OF OPERATIONS
For the three-month period endedSeptember 30, 2022 , net loss was$23.0 million compared to a net loss of$9.6 million for the same period of 2021. The change was primarily due to a decrease in the fair value of our investments in equity securities along with higher losses and loss settlement expenses partially offset by lower other underwriting expenses. For the nine-month period endedSeptember 30, 2022 , net loss was$5.1 million compared to net income of$22.9 million for the same period of 2021. The change was primarily due to a decrease in the fair value of our investments 40
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in equity securities and a decrease in net premiums earned partially offset by a
decrease in losses and loss settlement expenses.
Net premiums earned decreased 0.3 percent and decreased 2.6 percent during the three- and nine-month periods endedSeptember 30, 2022 , respectively, compared to the same periods of 2021. Profitable growth is our primary consideration when putting new business on the books and these results reflect growth in assumed reinsurance, other liability, and surety. For the three-month period endedSeptember 30, 2022 , the overall average increase in renewal premiums was 9.5%, with 3.8% from exposure changes and 5.7% from rate increases. Excluding the workers' compensation line of business, the overall average increase in renewal premiums was 10.7%, with 4.0% from exposures changes and 6.7% from rate changes. Net investment income was$11.6 million for the third quarter of 2022 as compared to$11.6 million for the same period in 2021. Third quarter of 2022 reflected a slight increase over third quarter of 2021 related to higher yields on the fixed income portfolio mostly offsetting the change in fair value of our investments in limited liability partnerships. The valuation of these investments in limited liability partnerships varies from period to period due to the current equity market conditions, specifically related to financial institutions. Year-to-date, net investment income was$32.1 million compared to net investment income of$42.4 million for the same period in 2021. The decrease in net investment income in the nine-month period endedSeptember 30, 2022 was primarily due to the change in the fair value of our investments in limited liability partnerships. The Company recognized net investment losses of$14.3 million during the third quarter of 2022, compared to net investment losses of$2.3 million for the same period in 2021. Year to date, the Company recognized net investment losses of$35.6 million during the nine-month period endedSeptember 30, 2022 , compared to net investment gains of$28.2 million for the same period in 2021. The change in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same period in 2021 was primarily due to the change in the fair value of our investments in equity securities. Losses and loss settlement expenses increased by 4.0 percent during the three-month period endedSeptember 30, 2022 driven by an increase in frequency of large losses and unfavorable reserve development, offset by lower catastrophe losses during the quarter. For the nine-month period endedSeptember 30, 2022 the same metric decreased by 13.1 percent compared to the same period in 2021. The year-to-date change was primarily driven by lower catastrophe losses and a decrease in frequency and severity of claims. The GAAP combined ratio increased by 2.0 percentage points to 111.7 percent for the third quarter of 2022, compared to 109.7 percent in the same period in 2021. The change was driven by an increase in the net loss ratio, most notably the reserve development effect on the ratio in the quarter. For the nine-month period endedSeptember 30, 2022 , the GAAP combined ratio decreased 5.5 percentage points to 100.6 percent compared to 106.1 percent for the nine-month period endedSeptember 30, 2021 . The decrease in the combined ratio during the nine-month period endedSeptember 30, 2022 as compared to the same period in 2021 was driven by a decrease in the net loss ratio. The net loss ratio increased 3.2 percentage points during the third quarter of 2022 as compared to the same period in 2021. This change was driven by unfavorable reserve development in the quarter and an increase in frequency of claims, offset by catastrophe loss improvement. Year-to-date, the net loss ratio decreased 7.9 percentage points to 66.0 percent compared to 73.9 percent for the nine-month period endedSeptember 30, 2021 . The year-to-date change was primarily driven by lower catastrophe losses and a decrease in the frequency and severity of claims. Pre-tax catastrophe losses in the third quarter of 2022 added 11.4 percentage points to the combined ratio, which included 5.7 percentage points for the impacts from Hurricane Ian. This compares to 16.5 percentage points added to the combined ratio in the third quarter of 2021, and is 1.6 percentage points above our 10-year historical average for the third quarter. During the third quarter of 2022, the higher than average catastrophe losses were driven primarily by Hurricane Ian, however, there were 9 smaller catastrophic events, primarily wind and hail, which collectively resulted in above average catastrophe losses. Year-to-date catastrophe losses totaled$61.4 million ($1.93 per diluted share) compared to$90.3 million ($2.81 per diluted share) for the same period in 2021, which included losses from Hurricane Ida as well as winter storm Uri, which was a full retention loss. 41
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Table of Contents The underwriting expense ratio for the third quarter of 2022 was 35.1 percent compared to 36.3 percent for the third quarter of 2021. The decrease was primarily driven by lower costs resulting from the change in design of our pension plan, which resulted in a reduction in quarterly expenses beginning in 2022. Year-to-date, the underwriting expense ratio was 34.6 percent compared to 32.2 percent in the same period in 2021. The increase in the expense ratio during the nine-month period endedSeptember 30, 2022 was primarily driven by a non-recurring benefit in the prior year related to the change in the design of our employee post-retirement health benefit plan.
For a detailed discussion of our investment results, refer to the "Investment
Portfolio" section below.
Reserve Development For many liability claims, significant periods of time, ranging up to several years, and for certain construction defect claims, more than a decade, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement or other disposition of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability. Reserves for these long-tail coverages represent a significant portion of our overall carried reserves. When establishing reserves and monitoring reserve adequacy, we analyze historical data and consider the potential impact of various loss development factors and trends, including historical loss experience, legislative enactments, judicial decisions, legal developments in imposition of damages, experience with alternative dispute resolution, results of our medical bill review process, the potential impact of salvage and subrogation, and changes and trends in general economic conditions, including the effects of inflation. All of these factors influence our estimates of required reserves and, for long-tail lines these factors can change over the course of the settlement of the claim. However, there is no precise method for evaluating the specific dollar impact of any individual factor on the development of reserves. Our reserving philosophy is to reserve claims to their ultimate expected loss amount as soon as practicable after information about a claim becomes available. This approach tends to produce, on average, cautiously pessimistic case reserves, which we expect to result in some level of favorable development over the course of settlement. 2022 Development The property and casualty insurance business experienced$14.1 million unfavorable and$1.2 million of favorable development in our net reserves for prior accident years for the three- and nine-month periods endedSeptember 30, 2022 , respectively. For the three-month period endedSeptember 30, 2022 the unfavorable development was primarily driven by$31.7 million other liability and$5.4 million commercial fire and allied lines of business offset by favorable development in commercial automobile and workers' compensation lines of business of$12.4 and$11.6 , respectively. For the nine-month period endedSeptember 30, 2022 the overall favorable development was primarily driven by commercial automobile line of business and workers' compensation line of business, with$28.9 million and$9.2 million , respectively, in net ultimate loss & loss adjustment expense estimates. The favorable reserve development was partially offset by unfavorable reserve development for$22.2 million other liability and$14.1 million commercial fire and allied lines.
2021 Development
The property and casualty insurance business experienced
million
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Table of Contents in our net reserves for prior accident years for the three- and nine-month periods endedSeptember 30, 2021 , respectively. For the three-month period endedSeptember 30, 2021 the majority of favorable development was from commercial automobile with$11.0 million of favorable development followed by commercial fire and allied lines with$4.1 million favorable development. The favorable development was partially offset by$7.1 million of unfavorable development in commercial liability. All other lines of insurance, in total, contributed$3.1 million of favorable development during the quarter. For the nine-month period endedSeptember 30, 2021 the majority of favorable development was from commercial automobile with$21.5 million favorable development, followed by workers' compensation with$7.7 million favorable development, commercial fire and allied lines with$5.6 million favorable development, and personal fire and allied lines with$4.0 million favorable development. Partially offsetting this was unfavorable development was contributed primarily by commercial liability with$17.1 million of unfavorable development. All other lines of insurance, in total, contributed$4.3 million of favorable development. Development amounts can vary significantly from quarter-to-quarter and year-to-year depending on a number of factors, including the number of claims settled and the settlement terms, and are subject to reallocation between accident years and lines of business. AtSeptember 30, 2022 , our total reserves were within our actuarial estimates. 43
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The following tables display our net premiums earned, net losses and loss
settlement expenses and net loss ratio by line of business:
Three Months Ended September 30, 2022 2021
Net Losses Net Losses
and Loss and Loss
Net Settlement Net Net Settlement Net
(In Thousands, Except Ratios) Premiums Expenses
Loss Premiums Expenses Loss Unaudited Earned Incurred Ratio Earned Incurred Ratio Commercial lines Other liability(1)$ 80,231 $ 85,738 106.9 %$ 75,559 $ 47,416 62.8 % Fire and allied lines(2) 60,263 47,857 79.4 60,457 44,855 74.2 Automobile 51,939 32,093 61.8 60,991 42,034 68.9 Workers' compensation 14,043 (1,888) (13.4) 15,183 11,265 74.2 Surety(3) 9,756 3,598 36.9 7,939 909 11.4 Miscellaneous 267 449 168.2 323 176 54.5 Total commercial lines$ 216,499 $ 167,847 77.5 %$ 220,452 $ 146,655 66.5 % Personal lines Fire and allied lines(4)$ 529 $ 1,195 225.9 %$ 2,559 $ 11,382 NM Automobile (1) (775) NM 734 343 46.7 Miscellaneous 10 (1,020) NM 50 (9) (18.0) Total personal lines$ 538 $ (600)
(111.5) %$ 3,343 $ 11,716
NM
Assumed reinsurance$ 21,219 $ 15,164 71.5 %$ 15,114 $ 17,073 113.0 % Total$ 238,256 $ 182,411 76.6 %$ 238,909 $ 175,444 73.4 % (1) Commercial lines "Other liability" is business insurance covering bodily injury and property damage arising from general business operations, accidents on the insured's premises and products manufactured or sold. (2) Commercial lines "Fire and allied lines" includes fire, allied lines, commercial multiple peril and inland marine. (3) Commercial lines "Surety" previously referred to as "Fidelity and surety". (4) Personal lines "Fire and allied lines" includes fire, allied lines, homeowners and inland marine. NM = Not meaningful 44
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Nine Months Ended September 30, 2022 2021
Net Losses Net Losses
and Loss and Loss
Net Settlement Net Net Settlement Net
(In Thousands, Except Ratios) Premiums Expenses
Loss Premiums Expenses Loss Unaudited Earned Incurred Ratio Earned Incurred Ratio Commercial lines Other liability$ 225,323 $ 159,859 70.9 %$ 225,572 $ 134,286 59.5 % Fire and allied lines 172,361 144,397 83.8 177,066 150,032 84.7 Automobile 157,927 107,021 67.8 190,238 151,632 79.7 Workers' compensation 42,389 16,345 38.6 47,260 33,601 71.1 Surety 26,700 5,723 21.4 22,436 3,000 13.4 Miscellaneous 817 593 72.6 1,007 174 17.3 Total commercial lines$ 625,517 $ 433,938 69.4 %$ 663,579 $ 472,725 71.2 % Personal lines Fire and allied lines$ 2,127 $ 2,144 100.8 %$ 13,120 $ 22,400 170.7 % Automobile - (1,919) NM 7,069 5,904 83.5 Miscellaneous 42 (1,110) NM 337 (1,369) NM Total personal lines$ 2,169 $ (885) (40.8) %$ 20,526 $ 26,935 131.2 % Assumed reinsurance$ 76,060 $ 31,242 41.1 %$ 38,732 $ 34,321 88.6 % Total$ 703,746 $ 464,295 66.0 %$ 722,837 $ 533,981 73.9 % NM = Not meaningful
Below are explanations regarding significant changes in the net loss ratios by
line of business:
•Other liability lines - The net loss ratio deteriorated 44.1 and 11.4 percentage points, respectively, in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same periods in 2021. Reserves were strengthened in the third quarter of 2022 as the frequency of large claims and exhaustion of primary coverage limits has increased due to inflationary pressures and other factors. This has increased exposure to the excess umbrella policies.
•Commercial fire and allied lines - The net loss ratio deteriorated 5.2
percentage points in the three-month period ending
non-catastrophe commercial fire losses were offset by improved catastrophe
losses as compared to 2021. The net loss ratio improved 0.9 percentage points in
the nine-month periods ended
improvement.
•Commercial automobile - The net loss ratio improved 7.1 and 11.9 percentage points, respectively, in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same periods in 2021. These improvements are the direct result of our strategic plan to increase the quality of this line by non-renewing underperforming accounts and increasing rates. •Workers' compensation - The net loss ratio improved 87.6 and 32.5 percentage points, respectively, in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same periods in 2021. For both periods the recognition of lower loss adjustment expense and continued favorable loss experience allowed for reserve releases producing a negative loss ratio in the current three-month period and lowering the current nine-month period loss ratio. The prior year three- and nine-month periods higher loss ratios were impacted by severity adding to the differences between current and prior periods. 45
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Table of Contents •Assumed reinsurance - The net loss ratio improved 41.5 and 47.5 percentage points, respectively, in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same periods in 2021. The improvement in both current periods is primarily attributable to continued favorable loss experience and attractive reinsurance rates. This book had exposure to Hurricane Ian in the current three-month period but not to the level of catastrophes experienced in the prior period. Financial Condition Stockholders' equity decreased to$700.8 million atSeptember 30, 2022 , from$879.1 million atDecember 31, 2021 . The Company's book value per share was$27.82 , which is a decrease of$7.23 per share, or 20.6 percent, fromDecember 31, 2021 . The decrease is primarily attributable to the$156.1 million decrease in the net unrealized value from our fixed maturity securities, net of tax, shareholder dividends of$11.8 million , and net losses of$5.1 million during the first nine months of 2022.
Investment Portfolio
Our invested assets totaled$1.8 billion atSeptember 30, 2022 , compared to$2.1 billion atDecember 31, 2021 , a decrease of$241.2 million . AtSeptember 30, 2022 , fixed maturity securities and equity securities made up 84.8 percent and 8.2 percent of the value of our investment portfolio, respectively. Because the primary purpose of our investment portfolio is to fund future claims payments, we use a conservative investment philosophy, investing in a diversified portfolio of high-quality, intermediate-term taxable corporate bonds, taxableU.S. government bonds and tax-exemptU.S. municipal bonds.
Composition
We develop our investment strategies based on a number of factors, including estimated duration of reserve liabilities, short- and long-term liquidity needs, projected tax status, general economic conditions, expected rates of inflation, regulatory requirements, interest rates and credit quality of assets. We administer our investment portfolio based on investment guidelines approved by management and the investment committee of our Board of Directors that comply with applicable statutory regulations.
The composition of our investment portfolio at
at carrying value in the following table:
Property & Casualty Insurance
Percent
(In Thousands, Except Ratios) of Total
Fixed maturities (1)
Available-for-sale $ 1,547,061 84.8 %
Equity securities 149,505 8.2
Mortgage loans 46,692 2.6
Other long-term investments 79,917 4.4
Short-term investments 275 -
Total $ 1,823,450 100.0 %
(1) Available-for-sale securities fixed maturities are carried at fair value.
As of
to investments in subprime mortgages or other credit enhancement vehicles.
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Table of Contents Credit Quality The table below shows the composition of fixed maturity securities held in our available-for-sale and trading security portfolios, by credit rating atSeptember 30, 2022 andDecember 31, 2021 . Information contained in the table is generally based upon the issued credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain credit ratings fromStandard & Poor's . (In Thousands, Except Ratios) September 30, 2022 December 31, 2021 Rating Carrying Value % of Total Carrying Value % of Total AAA $ 543,719 35.2 % $ 670,222 39.0 % AA 490,427 31.7 586,426 34.1 A 225,603 14.6 209,076 12.2 Baa/BBB 269,783 17.4 241,547 14.0 Other/Not Rated 17,529 1.1 12,519 0.7$ 1,547,061 100.0 %$ 1,719,790 100.0 % Duration Our investment portfolio is invested primarily in fixed maturity securities whose fair value is susceptible to market risk, specifically interest rate changes. Duration is a measurement we use to quantify our inherent interest rate risk and analyze our ability to match our invested assets to our reserve liabilities. If our invested assets and reserve liabilities have similar durations, then any change in interest rates will have an equal effect on these accounts. The primary purpose for matching invested assets and reserve liabilities is liquidity. With appropriate matching, our investments will mature when cash is needed, preventing the need to liquidate other assets prematurely. Mismatches in the duration of assets and liabilities can cause significant fluctuations in our results of operations.
Investment Results
We invest the premiums received from our policyholders in order to generate investment income, which is an important component of our revenues and profitability. The amount of investment income that we are able to generate is affected by many factors, some of which are beyond our control. Some of these factors are volatility in the financial markets, economic growth, inflation, interest rates, world political conditions, terrorist attacks or threats of terrorism, adverse events affecting other companies in our industry or the industries in which we invest and other unpredictable national or world events. Our net investment income increased slightly in the three-month period endedSeptember 30, 2022 , compared with the same period of 2021 primarily due to the higher yields in the fixed income portfolio offset by the change in the fair value of our investments in limited liability partnerships. Net investment income decreased in the nine-month period endedSeptember 30, 2022 , compared with the same period of 2021 primarily due to the change in the fair value of our investments in limited liability partnerships. Fixed income securities average yields have risen from both the third quarter of 2021 and on a year-to-date basis driven by higher interest rates. 47
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Investment Results
Nine Months Ended
(unaudited) Three Months Ended September 30, September 30,
(In Thousands) 2022 2021 2022 2021
Investment income:
Interest on fixed maturities $ 12,792 $ 10,671 $ 35,879 $ 32,441
Dividends on equity securities 1,325 1,383 3,934 3,711
Income on other long-term investments (1,348) 1,305 (3,959) 10,822
Other 891 605 2,279 1,788
Total investment income $ 13,660 $ 13,964 $ 38,133 $ 48,762
Less investment expenses 2,054 2,393 6,071 6,315
Net investment income $ 11,606 $ 11,571 $ 32,062 $ 42,447
Average yields:
Fixed income securities: Pre-tax (1) 3.07 % 2.55 % 2.88 % 2.58 %
(1) Fixed income securities yield excluding net unrealized investment
gains/losses and expenses
We hold certain investments in limited liability partnerships that are recorded on the equity method of accounting, with changes in value of these investments recorded in investment income. In the three- and nine-month periods endedSeptember 30, 2022 , the change in value of our investments in limited liability partnerships resulted in an investment loss of$1.3 million and$4.0 million as compared to investment income of$1.3 million and$10.8 million in the same periods of 2021. We had net investment losses of$14.3 million and$35.6 million during the three- and nine-month periods endedSeptember 30, 2022 , as compared to net investment losses of$2.3 million and net investment gains$28.2 million in the same periods of 2021. The change in the three- and nine-month periods endedSeptember 30, 2022 as compared to the same periods in 2021 was primarily due to the change in the fair value of our equity securities investments driven by equity market losses in 2022. We regularly monitor the difference between our cost basis and the estimated fair value of our investments. For our available-for-sale fixed-maturity portfolio an allowance for credit losses is recorded net of available-for-sale fixed maturities in the Consolidated Balance Sheets and a corresponding credit loss recognized as a realized loss or gain in the Consolidated Statements of Income and Comprehensive Income. The Company determines if an allowance for credit losses is recorded based on a number of factors including the current economic conditions, management's expectations of future economic conditions and performance indicators, such as market value vs. amortized cost, investment spreads widening or contracting, rating actions, payment and default history. Non-credit related changes in unrealized gains and losses on available-for-sale fixed maturity securities are recognized as a component of other comprehensive income, impact stockholders' equity and book value per share, but do not affect net income. We believe that any unrealized losses on our available-for-sale securities atSeptember 30, 2022 are temporary based upon our current analysis of the issuers of the securities that we hold and current market conditions. We have no intent to sell, and it is more likely than not that we will not be required to sell, these securities until the fair value recovers to at least equal our cost basis or the securities mature. For mortgage loans, an allowance for losses is established based on historical loss information of the collective pool of the Company's commercial mortgage loan investments that have similar risk characteristics. This allowance is presented as a separate line in the Consolidated Balance Sheets with an offset to "Net investment gains (losses)" in the Consolidated Statements of Income and Comprehensive Income. To calculate the allowance for mortgage loan losses, the Company starts with historical loan experience to predict the future expected losses and then layers on a market-linked adjustment. An example of a market linked adjustment is the change in commercial market price appreciation or change in gross domestic product, with every point of fall 48
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Table of Contents leading to an increase in loss reserve. Local market economics are also considered. On a quarterly basis, quantitative credit risk metrics, including for example, cash-flows, rent rolls and financial statements are reviewed for each loan to determine if it is performing in line with its expectations.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity measures our ability to generate sufficient cash flows to meet our short- and long-term cash obligations. Our cash inflows are primarily a result of the receipt of premiums, reinsurance recoveries, sales or maturities of investments, and investment income. Cash provided from these sources is used to fund the payment of losses and loss settlement expenses, the purchase of investments, operating expenses, dividends, pension plan contributions, and in recent years, common stock repurchases. We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by various rating agencies, at a level considered necessary by management to enable our insurance company subsidiaries to compete and (2) sufficient capital to enable our insurance company subsidiaries to meet the capital adequacy tests performed by regulatory agencies inthe United States . Cash outflows may be variable because of the uncertainty regarding settlement dates for losses. In addition, the timing and amount of individual catastrophe losses are inherently unpredictable and could increase our liquidity requirements. The timing and amount of reinsurance recoveries may be affected by reinsurer solvency and reinsurance coverage disputes. Historically, we have generated substantial cash inflows from operations. It is our policy to invest the cash generated from operations in securities with maturities that, in the aggregate, correlate to the anticipated timing of payments for losses and loss settlement expenses. The majority of our assets are invested in available-for-sale fixed maturity securities.
The following table displays a consolidated summary of cash sources and uses for
the nine-month periods ended
Cash Flow Summary Nine Months Ended September 30, (In Thousands) 2022 2021 Cash provided by (used in) Operating activities $ (29,793)$ 18,188 Investing activities (38,314) 40,358 Financing activities (10,980) (13,721) Net change in cash and cash equivalents $ (79,087)
Our cash flows were sufficient to meet our liquidity needs for the nine-month
periods ended
sufficient to meet our future liquidity needs for at least the next twelve
months. We also have the ability to draw on our credit facility if needed.
Operating Activities
Net cash flows from operating activities had outflows of$29.8 million and inflows of$18.2 million for the nine-month periods endedSeptember 30, 2022 and 2021, respectively. In the nine-month period endedSeptember 30, 2022 , the net operating cash outflows were driven by loss and loss adjustment expense and tax related outflows not being fully offset by premium and investment income cash inflows. 49
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Table of Contents Investing Activities Cash in excess of operating requirements is generally invested in fixed maturity securities and equity securities. Fixed maturity securities provide regular interest payments and allow us to match the duration of our liabilities. Equity securities provide dividend income, potential dividend income growth and potential appreciation. For further discussion of our investments, including our philosophy and our strategy for our portfolio, see the "Investment Portfolio" section of this Item 2. In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years,$490.0 million , or 31.7 percent, of our fixed maturity portfolio will mature. We invest funds required for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. AtSeptember 30, 2022 , our cash and cash equivalents included$10.0 million related to these money market accounts, compared to$43.4 million atDecember 31, 2021 . Net cash flows used by investing activities were$38.3 million for the nine-month period endedSeptember 30, 2022 , compared to net cash flows provided by investing activities of$40.4 million for the nine-month period endedSeptember 30, 2021 . For the nine-month periods endedSeptember 30, 2022 and 2021, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments of$232.3 million and$389.0 million , respectively. Our cash outflows for investment purchases were$267.9 million for the nine-month period endedSeptember 30, 2022 , compared to$337.7 million for the same period of 2021.
Financing Activities
Net cash flows used in financing activities was$11.0 million for the nine-month period endedSeptember 30, 2022 which decreased$2.7 million compared to$13.7 million used in the nine-month period endedSeptember 30, 2021 .
Credit Facilities
OnMarch 31, 2020 ,United Fire & Casualty Company , as borrower ("Borrower"), wholly owned subsidiary ofUnited Fire Group, Inc. entered into a credit agreement (the "Credit Agreement") withWells Fargo Bank, National Association ("Wells Fargo"), as administrative agent, issuing lender, swing line lender and lender, and the other lenders from time to time party thereto (collectively with Wells Fargo, the "Lenders"), providing for a$50 million revolving credit facility, which includes a$20 million letter of credit sub-facility and a$5 million swing line loan for working capital and other general corporate purposes. The Credit Agreement is provided on an unsecured basis, and the Borrower has the option to increase the Credit Agreement by$100 million if agreed to by the Lenders providing such incremental facility. As ofSeptember 30, 2022 and 2021, there were no balances outstanding under the Credit Agreement. For the nine-month period endedSeptember 30, 2022 and 2021, we did not incur any interest expense related to the credit facility. For further discussion of the Credit Agreement, refer to Part I, Item 1, Note 8 "Debt."
Dividends
Dividends paid to shareholders totaled$11.8 million and$11.3 million in the nine-month periods endedSeptember 30, 2022 and 2021, respectively. Our practice has been to pay quarterly cash dividends, which we have paid every quarter sinceMarch 1968 . Payments of any future dividends and the amounts of such dividends will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors out of legally available funds.
As a holding company with no independent operations of its own, we rely on
dividends received from our insurance company subsidiaries in order to pay
dividends to our common shareholders. Dividends payable by our insurance
subsidiaries are governed by the laws in the states in which they are domiciled,
and if applicable, commercially
50
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Table of Contents domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, underIowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the precedingDecember 31 , or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, atSeptember 30, 2022 , UFG's sole direct insurance company subsidiary,United Fire & Casualty Company , is able to make a maximum of$70.4 million in dividend payments without prior regulatory approval. We do not believe that these restrictions have a material impact in meeting the cash obligations of UFG.
Stockholders' Equity
Stockholders' equity decreased to$700.8 million atSeptember 30, 2022 , from$879.1 million atDecember 31, 2021 . The Company's book value per share was$27.82 , which is a decrease of$7.23 per share, or 20.6 percent, fromDecember 31, 2021 . The decrease is primarily attributable to the$156.1 million decrease in the net unrealized value from our fixed maturity securities, net of tax, stockholders' dividends of$11.8 million , and net losses of$5.1 million during the first nine months of 2022.
Funding Commitments
Pursuant to an agreement with one of our limited liability partnership
investments, we are contractually committed through
capital contributions upon request of the partnership. Our remaining potential
contractual obligation was
In addition, the Company invested$25.0 million inDecember 2019 in a limited liability partnership investment fund that is subject to a three year lockup with a 60 day minimum notice, with 4 possible repurchase dates per year after the three-year lockup period has concluded. The fair value of the investment atSeptember 30, 2022 was$25.0 million and there are no remaining capital contribution obligations with this investment. 51
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Table of Contents MEASUREMENT OF RESULTS Management evaluates our operations by monitoring key measures of growth and profitability. The following section provides further explanation of the key measures management uses to evaluate our results. Catastrophe losses is a commonly used financial measure that uses the designations of theInsurance Services Office ("ISO") and are reported with losses and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in$25.0 million or more inU.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may includeU.S. or international losses that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophe losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance business, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings. Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2022 2021 2022 2021 ISO catastrophes $ 27,816 $
33,105 $ 62,179
Non-ISO catastrophes (1)
(607) 6,361 (806) 9,049 Total catastrophes $ 27,209$ 39,466 $ 61,373$ 90,326
(1) This number includes international assumed losses.
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Table of Contents
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