The MPLI industry is affected by recurring industry cycles known as “hard” and “soft” markets. A soft cycle is characterized by intense competition resulting in lower pricing in order to compete for business. A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing. From approximately 2001 until approximately 2007, the Pennsylvania MPLI market experienced a hard market cycle. This resulted in the creation of several alternative MPLI providers, such as PPIX, PCA, and PIPE. The MPLI market began to experience a soft cycle around the second quarter of 2008 due primarily to the large rate increases taken over the previous six years. That soft cycle has continued and has been contributed to by the restructuring of the healthcare industry, partially as a result of the Affordable Care Act. This has resulted in significant price competition as the number of medical professionals practicing independent of hospitals or large professional groups began to decline. According to a study prepared by the National Association of Insurance Commissioners (“NAIC”), MPLI direct premiums written have declined by 25.3% on a national basis from 2006 to 2017 and have declined by 15.9% in Pennsylvania and 32.0% in New Jersey during this same time period. This has resulted in lower direct premiums written and lower operating profits for many MPLI carriers.
We invest our surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expenses) in cash, cash equivalents, and equity and debt securities. Investment income includes interest and dividends earned and net realized gains and losses on invested assets. With the adoption of an accounting standard as of January 1, 2018, unrealized gains and losses on equity securities previously classified as available-for-sale securities are included in net investment income. Prior to 2018, unrealized gains and losses on available-for-sale equity securities were charged or credited to accumulated other comprehensive income (loss). We recognize realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognize realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost, as applicable. Our portfolio of investment securities is managed by Wilmington Trust and the investment committee, who have discretion to buy and sell securities in accordance with the investment policy approved by Positive Insurance Company’s board of directors.
If the liability for losses and loss adjustment expenses were recorded at the high end of the actuarially-determined range, the liability for losses and loss adjustment expenses would increase by $3.6 million. This increase in reserves would have the effect of decreasing net income and equity as of December 31, 2018 by $2.9 million. If the liability for losses and loss adjustment expenses were recorded at the low end of the actuarially-determined range, the liability for losses and loss adjustment expenses at December 31, 2018 would be reduced by $1.4 million with a corresponding increase in net income and equity of $1.1 million.
Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off.
The major components of PPIX’s operating revenues and net income are as follows (dollars in thousands):
The following table sets forth PPIX’s average cash and invested assets and investment income for the reported periods (dollars in thousands) (unaudited):
PPIX had net realized investment losses of $26,000 and $66,000 for the years ended December 31, 2018 and December 31, 2017, respectively.
At December 31, 2018, PPIX had total equity of $16.8 million as compared to $17.5 million at December 31, 2017. The change in equity during the year ended December 31, 2018 is attributable to comprehensive loss of $(696,000). The change in equity during the year ended December 31, 2017 is related to comprehensive income of $652,000.
Increases in the cost of medical procedures and related services can affect the losses that we may incur in connection with resolving claims under policies that we issue. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We, like all insurance companies, establish insurance premiums levels before the amount of loss and loss expenses, or the extent to which inflation may impact these expenses, are known. Therefore, we attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, financial results have not been significantly affected by it.
Underwriting income measures the pretax profitability of a company’s insurance business. It is derived by subtracting losses and loss adjustment expenses, amortization of deferred policy acquisition costs, and underwriting and administrative expenses from earned premiums. Each of these captions is presented in our statements of operations but not subtotaled. The sections below provide more insight into the variances in the categories of losses and loss adjustment expenses and amortization of deferred policy acquisition costs and underwriting and administrative expense, which impact underwriting profitability.
As discussed in “Critical Accounting Policies”, the MPLI line of business is prone to variability in the loss reserving process due to the extended period of time during which claims can be made. Adjustments to our original estimates resulting from claims are not made until the period in which there is reasonable evidence that an adjustment to the reserve is appropriate.
For the year ended December 31, 2018, PIPE had a pre-tax loss of $(1.2) million as compared to pre-tax income of $41,000 for the year ended December 31, 2017.
The effective date for the Securities and Exchange Commission Form S-1 Registration Statement for the initial public offering of Holdings was February 11, 2019. The offering was completed on March 27, 2019. A total of 3,615,500 shares of the Company’s common stock were sold in the offering resulting in gross proceeds of $36,155,000. The Company is listed on the NASDAQ Capital Market under the symbol of “PPHI.”
The Company is authorized to issue 10,000,000 shares of no-par value common stock. At December 31, 2018, there were no shares of common stock issued and outstanding.
Subsequent events have been evaluated through the date the financial statements were available to be issued.
As discussed in Notes 3 and 4, on February 5, 2019 the Department approved the conversion plans of PPIX, PCA, and PIPE. The effective date for the Securities and Exchange Commission Form S-1 Registration Statement for the initial public offering of Holdings was February 11, 2019. The subscribers of PPIX, PCA, and PIPE approved the conversions from reciprocal insurance exchanges to stock insurance companies on March 25, 2019. The conversions from reciprocal insurance exchanges to stock insurance companies took place on March 27, 2019. On the same date, PCA Conversion Corp. and PIPE Conversion Corp. merged with and into PPIX Conversion Corp. and the resulting company was renamed Positive Physicians Insurance Company. Further, on March 27, 2018, the offering was completed. A total of 3,615,500 shares of the Company’s common stock were sold in the offering, resulting in gross proceeds of $36,155,000. Additionally, as discussed in Note 7, on March 27, 2019 the Company and Diversus entered into an option agreement for the possible merger of the Company and Diversus.