Our corporate headquarters and Standard Commercial P&C operating unit are currently located at 777 Main Street, Suite 1000, Fort Worth, Texas. The suite is located in a high-rise office building and contains 27,808 square feet of space. The rent is currently $53,299 per month pursuant to a lease which terminates June 30, 2019 pursuant to our exercise of an early termination option.
Our Specialty Commercial operating unit is currently located at 13727 Noel Road, Dallas, Texas. These leased premises consist of 15,072 square feet of office space. The rent is currently $29,830 per month pursuant to a lease that expires November 30, 2022. Our Specialty Commercial operating unit also maintains branch offices in the following locations:
Standard Commercial Segment. The Standard Commercial Segment includes the standard lines commercial property/casualty and occupational accident insurance products and services handled by our Standard Commercial P&C operating unit and the workers compensation insurance products handled by our Workers Compensation operating unit. Effective June 1, 2016, we ceased marketing new or renewal occupational accident policies. Effective July 1, 2015, the Workers Compensation operating unit ceased retaining any risk on new or renewal policies. Our Standard Commercial P&C operating unit is comprised of our American Hallmark Insurance Services and ECM subsidiaries. Our Workers Compensation operating unit is comprised of our TBIC Holdings, TBIC and TBICRM subsidiaries.
Personal Segment. Our Personal Segment includes the non-standard personal automobile and renters insurance products and services handled by our Specialty Personal Lines operating unit. Our Specialty Personal Lines operating unit is comprised of our AHGA and HCS subsidiaries.
Equity Investments: On January 1, 2018, we adopted ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”. ASU 2016-01 requires equity investments that are not consolidated or accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income each reporting period. As a result of the new standard, equity securities with readily determinable fair values are no longer required to be evaluated for other-than-temporary-impairment.
Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available on active exchanges for identical instruments. We use a third party pricing service to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used by the pricing service and have determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. We have not adjusted any prices received from third-party pricing sources.
Goodwill. Goodwill is tested for impairment at the reporting unit level (operating unit or one level below an operating unit) on an annual basis (October 1) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. For purposes of evaluating goodwill for impairment, we have determined that our reporting units are the same as our operating units except for the Specialty Commercial operating unit for which reporting units are at the component level (“one level below”). Our consolidated balance sheet as of December 31, 2018 includes goodwill of acquired businesses of $44.7 million that is assigned to our
The income approach to determining fair value computed the projections of the cash flows that the reporting unit is expected to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach model include income projections, discount rates and terminal growth values. The income projections reflect an improved premium rate environment across most of our lines of business that continued throughout 2018. The income projections also include loss and LAE assumptions which reflect recent historical claim trends and the movement towards a more favorable pricing environment. The income projections also include assumptions for expense growth and investment yields which are based on business plans for each of our operating units. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific company risk premium. The assumptions were based on historical experience (including factors such as prior year loss reserve development), expectations of future performance (including premium growth rates, premium rate increases and loss costs), expected market conditions and other factors requiring judgment and estimates. While we believe the assumptions used in these models were reasonable, the inherent uncertainty in predicting future performance and market conditions may change over time and influence the outcome of future testing.
The fair values of each of our operating units were in excess of their respective carrying values, including goodwill, as a result of our annual test for impairment during the fourth quarter 2018. However, a 13% decline in the fair value of our Standard Commercial P&C operating unit, a 5% decline in the fair value of our Contract Binding operating unit, a 20% decline in the fair value of our Specialty Personal Lines operating unit, a 61% decline in the fair value of our excess and umbrella component or a 29% decline in the fair value of our general aviation and satellite component would have caused the carrying value of the respective reporting unit to be in excess of its fair value, resulting in the need to perform the second step of impairment testing prescribed by ASC 350, which could have resulted in an impairment to our goodwill.
operating units and goodwill impairment. Such events include, but are not limited to, increased competition in insurance markets and global economic changes.
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2018 was $426.5 million to $538.8 million. Our best estimate of unpaid losses and LAE as of December 31, 2018 is $527.2 million. Our carried reserve for unpaid losses and LAE as of December 31, 2018 is comprised of $242.3 million in case reserves and $284.9 million in incurred but not reported reserves. In setting this estimate of unpaid losses and LAE, we have assumed, among other things, that current trends in loss frequency and severity will continue and that the actuarial analysis was empirically valid. We have established a best estimate of unpaid losses and LAE which is $44.6 million higher than the midpoint, or 97.8% of the high end, of the actuarial range at December 31, 2018 as compared to $39.9 million above the midpoint, or 96.3% of the high end, of the actuarial range at December 31, 2017. We expect our best estimate to move within the actuarial range from year to year due to changes in our operations and changes within the marketplace. Due to the inherent uncertainty in reserve estimates, there can be no assurance that the actual losses ultimately experienced will fall within the actuarial range. However, because of the breadth of the actuarial range, we believe that it is reasonably likely that actual losses will fall within such range.
Comparison of Years ended December 31, 2018 and December 31, 2017
Management overview. During fiscal 2018, our total revenues were $379.3 million, which was $6.2 million less than the $385.5 million in total revenues for fiscal 2017. During the year ended December 31, 2018, we reported net income before tax of $12.8 million as compared to a net loss before tax of $16.6 million during the same period of 2017.
The increase in income before tax for the year ended December 31, 2018 was due primarily to decreased losses and loss adjustment expenses (“LAE”) of $32.3 million and lower operating expenses of $3.4 million as compared to the same periods in 2017, partially offset by the decrease in revenue discussed. The decrease in losses and LAE was primarily the result of unfavorable net prior year loss reserve development of $40.1 million for the year ended December 31, 2017 as compared to $6.0 million of unfavorable net prior year loss reserve development for the year ended December 31, 2018. The decrease in operating expenses was primarily due to lower production related expenses due primarily to increased ceding commission in our Specialty Commercial Segment, partially offset by increased salary and related expenses, professional service fees and other operating expenses during the year ended December 31, 2018 as compared to the same period during 2017.
Pre-tax income for the Specialty Commercial Segment of $28.8 million for the year ended December 31, 2018 was $26.8 million higher than the $2.0 million reported for the same period in 2017. This increase in pre-tax income was primarily due to lower loss and LAE expenses of $18.8 million, lower operating expense of $5.6 million and the increased revenue discussed above.
Gross premiums written for the Standard Commercial Segment were $86.1 million for the year ended December 31, 2018, which was $7.9 million, or 10%, more than the $78.2 million reported for the same period in 2017. The gross premiums written for the Standard Commercial P&C operating unit increased $8.2 million, offset by a decrease of $0.3 million due to the discontinued marketing of new and renewal occupational accident policies. Net premiums written were $69.2 million for the year ended December 31, 2018 as compared to $69.3 million reported for the same period in 2017. The net premiums written include a $0.2 million increase in our Standard Commercial P&C operating unit for the year ended December 31, 2018 as compared to the same period during 2017, offset by a decrease in premium volume of $0.2 million due to the discontinued marketing of new and renewal occupational accident policies and a $0.1 million decrease due to the discontinued marketing of workers compensation policies.
Total revenue for the Standard Commercial Segment of $76.5 million for the year ended December 31, 2018 was $6.2 million more than the $70.3 million reported during the year ended December 31, 2017. This 9% increase was primarily due to higher net premiums earned of $6.1 million primarily as a result of increased net premiums earned of $6.6 million in our Standard Commercial P&C operating unit and higher commissions and fees of $0.3 million, partially offset by lower net investment income and finance charges of $0.2 million for the year ended December 31, 2018 as compared to the same period in 2017.
Our Standard Commercial Segment reported pre-tax income of $13.1 million for the year ended December 31, 2018, which was $10.7 million higher than the $2.4 million reported for the same period of 2017. The increase in pre-tax income was the result of the increased revenue discussed above and lower losses and LAE of $5.8 million, partially offset by higher operating expenses of $1.3 million primarily as the result of higher production related expenses.
The net loss ratio for the year ended December 31, 2018 was 54.5% as compared to the 68.3% reported for the year ended December 31, 2017. The gross loss ratio before reinsurance was 61.9% for the year ended December 31, 2018 as compared to 63.3% for the prior year. The decreases in the gross and net loss ratios were due predominantly to favorable prior year net loss reserve development of $9.0 million during the year ended December 31, 2018 as compared to $1.0 million of favorable prior year net loss reserve development for the same period of 2017. Further contributing to the lower gross and net loss ratios were lower catastrophe losses during the year ended December 31, 2018 as compared to the same period of 2017. The Standard Commercial Segment reported $3.3 million of net catastrophe losses during the year ended December 31, 2018 as compared to $3.6 million of net catastrophe losses during the same period of 2017. The Standard Commercial Segment reported a net expense ratio of 33.5% during the year ended December 31, 2018 as compared to 34.5% for the same period of 2017. The decrease in the expense ratio was primarily due to the increased earned premium.
Gross premiums written for the Personal Segment were $75.1 million for the year ended December 31, 2018, which was $13.9 million more than the $61.2 million reported for the same period in 2017. Net premiums written for our Personal Segment were $42.8 million for the year ended December 31, 2018, which was an increase of $11.5 million from the $31.3 million reported for the same period of 2017. The increase in gross written premiums was due primarily to increased production in our current geographical footprint. The increase in net written premiums was also due to increased production as well as increased retention of business effective October 1, 2018.
Our Personal Segment reported pre-tax income of $3.1 million for the year ended December 31, 2018 as compared to a pre-tax loss of $3.1 million for the same period of 2017. The pre-tax income was primarily the result of decreased losses and LAE of $7.7 million and lower operating expenses of $0.3 million for the year ended December 31, 2018 as compared to the same period during 2017, partially offset by the decreased revenue discussed above.
The Personal Segment reported a net loss ratio of 68.6% for the year ended December 31, 2018 as compared to 84.0% for the same period of 2017. The gross loss ratio before reinsurance was 66.7% for the year ended December 31, 2018 as compared to 80.1% for the same period in 2017. The lower gross and net loss ratios were primarily the result of favorable prior year net loss reserve development of $1.5 million during the year ended December 31, 2018 as compared to unfavorable net loss reserve development of $0.6 million reported during the same period of 2017, as well as lower current accident year loss trends. The Personal Segment reported a net expense ratio of 26.3% for the year ended December 31, 2018 as compared to 29.3% for the same period of 2017. The decrease in the expense ratio was due predominately to higher finance charges, partially offset by lower net premiums earned.
Total revenue for Corporate decreased by $13.0 million for the year ended December 31, 2018 as compared to the same period the prior year. This decrease in total revenue was due predominately to investment losses of $10.2 million during the year ended December 31, 2018 as compared to investment losses of $0.2 million reported for the same period of 2017 and lower net investment income of $3.0 million for the year ended December 31, 2018 as compared to the same period during 2017. The investment losses during 2018 include $9.3 million in loss attributable to the adoption of ASU 2016-01 effective January 1, 2018.
Operating expenses increased $1.1 million primarily as a result of higher salary and related expenses of $0.9 million due primarily to higher incentive compensation accruals during the year ending December 31, 2018 as compared to the same period during 2017. Further contributing to the higher operating expenses were increased occupancy and related expenses of $0.4 million primarily related to the early termination of our Ft. Worth office lease. These increases to operating expenses were partially offset by lower professional service fees and other expenses of $0.2 million.
Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), commissions and processing and service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to meet operating expenses and debt obligations. As of December 31, 2018, we had $15.6 million in unrestricted cash and cash equivalents, as well as $0.8 million in debt securities, at the holding company and our non-insurance subsidiaries. As of that date, our insurance subsidiaries held $20.0 million of unrestricted cash and cash equivalents as well as $545.1 million in debt securities with an average modified duration of 1.4 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-month period, without the prior written consent of the Texas Department of Insurance, to the greater of statutory net income for the prior calendar year or 10% of statutory policyholders’ surplus as of the prior year end. HIC and HNIC, both domiciled in Arizona, are limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year’s net income, without prior written approval from the Arizona Department of Insurance. HSIC, domiciled in Oklahoma, is limited in the payment of dividends to the greater of 10% of prior year policyholders’ surplus or prior year’s statutory net income, not including realized capital gains, without prior written approval from the Oklahoma Insurance Department. For all our insurance companies, dividends may only be paid from unassigned surplus funds. During 2019, the aggregate ordinary dividend capacity of these subsidiaries is $33.9 million, of which $22.9 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the years ended December 31, 2018 and 2017 our insurance company subsidiaries paid $5.5 million and $11.4 million, respectively, in dividends to Hallmark.
Net cash used by our consolidated operating activities was $32.9 million for the year ended December 31, 2018 compared to net cash flow provided by operations of $7.2 million for the year ended December 31, 2017. The decrease in operating cash flow was driven by a temporary acceleration of paid claims as we improved our claims practices to address the increase in frequency and severity in our commercial auto portfolio as well as increased paid operating expenses. These decreases in operating cash flow were partially offset by higher collected net premiums, higher collected finance charges and collected income tax recoverable during the year ended December 31, 2018 as compared to the same period the prior year.
Net cash provided by investing activities during the year ended December 31, 2018 was $7.3 million as compared to net cash used in investing activities of $21.4 million for the prior year. The cash provided by investing activities during the year ended December 31, 2018 was comprised of a decrease in purchases of debt and equity securities of $83.2 million and a decrease of $0.6 million in purchases of property and equipment, partially offset by a decrease of $55.1 million in maturities, sales and redemptions of investment securities.
Net cash used in financing activities during the year ended December 31, 2018 was $1.6 million as a result of $1.8 million related to the repurchase of our common stock, partially offset by $0.2 million related to proceeds from the exercise of employee stock options. Cash used in financing activities during the year ended December 31, 2017 was $5.1 million as a result of $5.3 million related to the repurchase of our common stock, partially offset by $0.2 million related to proceeds from the exercise of employee stock options.
The Second Restated Credit Agreement with Frost also provides a $30.0 million revolving credit facility (“Facility B”), in addition to Facility A. We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. We may borrow, repay and reborrow under Facility B until December 17, 2019, at which time all amounts outstanding under Facility B are converted to a term loan. Through December 17, 2019, we pay Frost a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2019, interest only on amounts from time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B as of December 17, 2019 are converted to a term loan payable in quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and accrued interest on Facility B become due and payable on December 17, 2024. As of December 31, 2018, we had $30.0 million outstanding under Facility B.
The obligations under both Facility A and Facility B are secured by a security interest in the capital stock of AHIC and HIC. Both Facility A and Facility B contain covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with all of these covenants.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018 and 2017