The objective of management's discussion and analysis is to provide material information relevant to the assessment of the financial condition and results of operations of the Company including an evaluation of the amounts and certainty of cash flows from operations and from outside sources. This discussion and analysis focuses specifically on material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition. This includes descriptions and amounts of matters that have had a material impact on reported operations, as well as matters that are reasonably likely based on management’s assessment to have a material impact on future operations. This discussion and analysis covers the financial statements and other statistical data that the Company believes will enhance the understanding of the Company’s financial condition, cash flows and other changes in financial condition and results of operations. This discussion and analysis will provide a view of the Company from management’s perspective.
All references to "we", "us", "our", "the Company", "Trean", or similar terms refer to (i) Trean, BIC and their subsidiaries before the consummation of the reorganization transactions, and (ii) to Trean Insurance Group, Inc. and its subsidiaries after such reorganization transactions, unless the context otherwise requires.
We are a provider of products and services to the specialty insurance market. We underwrite specialty casualty insurance products both through our Program Partners and also through our Owned MGAs. We also provide our Program 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 our Program 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.
On July 20, 2020, Trean Insurance Group, Inc. closed the sale of 10,714,286 shares of its common stock in its IPO, comprised of 7,142,857 shares issued and sold by Trean Insurance Group, Inc. and 3,571,429 shares sold by selling stockholders. On July 22, 2020, Trean Insurance Group, Inc. closed the sale of an additional 1,207,142 shares by certain selling stockholders in the IPO pursuant to the exercise of the underwriters’ option to purchase additional shares to cover over-allotments. The aggregate proceeds to the Company from all shares sold by the Company in the IPO were approximately $107,142 and the aggregate IPO proceeds from all shares sold by the selling stockholders in the IPO were approximately $71,678. The shares began trading on the Nasdaq Global Select Market on July 16, 2020 under the symbol "TIG".
Prior to the completion of the above IPO, the Company effected the following reorganization transactions: (i) each of Trean and BIC contributed all of their respective assets and liabilities to Trean Insurance Group, Inc., a newly formed direct subsidiary of BIC, in exchange for shares of common stock in Trean Insurance Group, Inc. and (ii) upon the completion of the transfers by Trean and BIC, Trean and BIC were dissolved and distributed in-kind common shares to the pre-IPO unitholders.
We did not experience a material impact to our premium revenue in the year ended December 31, 2020 as a result of the COVID-19 pandemic. Less than 20.0% of our business falls under hospitality, healthcare and education, where the majority of layoffs in response to the pandemic have occurred so far. Gross written premiums increased by 17.7% and gross earned premiums have increased by 8.6% during the year ended December 31, 2020 compared to the year ended December 31, 2019 primarily driven by the increase in gross written premiums. Because over 70% of our gross written premiums are related to workers’ compensation insurance, we expect that future revenue trends could be impacted by higher unemployment rates as businesses slowly restart or if unemployment levels continue to trend high in future reporting periods. 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.
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 investments and short-term investments. Our net investment income includes interest income on our invested assets, which is net of the income earned on our reinsurance agreements, which are held for the benefit of our Program Partners, as well as unrealized gains and losses on our equity portfolio.
Net realized capital gains/losses: Net realized capital 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 and consulting fees, which are commonly based on written premiums.
•changes in the legal or regulatory environment related to the business we write;
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.
Other income: Other income consists primarily of sublease revenue and other miscellaneous income items.
Expense ratio, expressed as a percentage, is the ratio of general and administrative expenses to net earned premiums.
Return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
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.
This section of Form 10-K generally discusses fiscal year 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of fiscal year 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Registration Statement on Form S-1/A (File Number 333-239291) filed with the SEC on July 13, 2020.
(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.
•workers' compensation, which represented 76.2% of our gross written premiums for the year ended December 31, 2020, increased by $28,506, or 8.4%, compared to the year ended December 31, 2019; and
Gross earned premiums: Gross earned premiums increased $34,231, or 8.6%, to $432,034 for the year ended December 31, 2020, compared to $397,803 for the year ended December 31, 2019. The increase is driven by the increase in gross written premiums, partially offset by the increase in gross unearned premiums of $38,617, which is driven by the addition of new Program Partners during the current fiscal year whose premiums are largely unearned as of December 31, 2020. Gross earned premiums as a percentage of gross written premiums decreased to 89.2% for the year ended December 31, 2020, compared to 96.7%, for the year ended December 31, 2019.
Ceded earned premiums: Ceded earned premiums increased $12,242, or 3.9%, to $323,567 for the year ended December 31, 2020, compared to $311,325 for the year ended December 31, 2019. The increase in ceded earned premiums is primarily due to the addition of new Program Partners during the current fiscal year whose premiums are largely ceded. The total ceded earned premiums as a percentage of gross earned premiums remained relatively consistent at 74.9% for the year ended December 31, 2020, compared to 78.3% for the year ended December 31, 2019.
Net earned premiums: Net earned premiums increased $21,989, or 25.4%, to $108,467 for the year ended December 31, 2020, compared to $86,478 for the year ended December 31, 2019. The increase is due primarily due to the increase in gross written and earned premiums described above, partially offset by the increase in ceded earned premiums over the year ended December 31, 2019.
The table below shows the total premiums earned on a gross and net basis for the respective annual periods:
Net investment income: Net investment income increased $2,079, or 33.3%, to $8,324 for the year ended December 31, 2020, compared to $6,245 for the year ended December 31, 2019. The increase is primarily attributable to the fair value re-measurement and common stock investment reclassification of the Company's investment in TRI, which was previously classified as an equity method investment, which resulted in an unrealized gain of $2,000.
Net realized capital gains: Net realized capital gains increased $2,698 to $3,365 for the year ended December 31, 2020, compared to $667 for the year ended December 31, 2019. The increase is primarily due to the recording of a $3,115 realized gain on the sale of a portion of the Company's investment in TRI during the first quarter of 2020, offset by the bargain purchase gain recorded in connection with the acquisition of FCCIC during the first quarter of 2019 of $634.
Losses and loss adjustment expenses: Losses and LAE increased $6,113, or 13.7%, to $50,774 for the year ended December 31, 2020, compared to $44,661 for the year ended December 31, 2019. The increase is primarily attributable to the growth in earned premiums during the period partially offset by favorable development in the Company's prior years' loss reserves during the year ended December 31, 2020 versus the year ended December 31, 2019. The Company's loss ratio decreased to 46.8% for the year ended December 31, 2020 compared to 51.6% for the year ended December 31, 2019, primarily as a result of favorable development in the Company's prior years' loss reserves during the year ended December 31, 2019.
General and administrative expenses: General and administrative expenses increased $17,709, or 84.5%, to $38,668 for the year ended December 31, 2020, compared to $20,959 for the year ended December 31, 2019. This change resulted in an increase in the Company's expense ratio to 35.6% for the year ended December 31, 2020, compared to 24.2% for the year ended December 31, 2019. The increase is attributable to (i) an increase in net agent commissions of $6,802 due to various one-time accrual true-ups totaling $4,164 related to profit sharing, ceding commissions and deferred acquisition costs as well as a $2,638 increase due to higher commissions resulting from an increase in gross written premiums coupled with a lower offsetting effect of ceding commission as the Company retained a larger percentage of its gross written premiums during the year; (ii) an increase in salaries and benefits of $5,601, of which $3,926 directly resulted from acquisitions made in 2020 and a general increase in workforce; (iii) an increase in professional service expense of $2,905, driven by an increase of $2,365 related to the Company's new public status and post-IPO readiness efforts as well as increased legal and consulting expenses; (iv) additional rent and office-related expenses totaling $1,516 due to the addition of new office locations, rent increases and an increase in insurance expense; and (v) additional IT software and systems costs totaling $1,078 relating to new software implementation, an increased workforce and additional expenses incurred to accommodate a remote workforce due to COVID-19. These increases were partially offset by a net reduction in general and administrative expenses of $407 related to a reduction in travel as a result of COVID-19.
Intangible asset amortization: Intangible asset amortization increased $2,527 to $2,573 for the year ended December 31, 2020, compared to $46 for the year ended December 31, 2019. The increase is driven by the addition of intangible assets acquired as a result of the purchase of the remaining equity interest of Compstar in the third quarter and acquisition of 7710 in the fourth quarter.
Noncash stock compensation: Noncash stock compensation was $506 for the year ended December 31, 2020. Expenses incurred during the period related to restricted stock units and stock options granted under the Company's 2020 Omnibus Plan in fiscal 2020.
Equity earnings in affiliates, net of tax: Equity earnings in affiliates, net of tax decreased $1,225 to $2,333 for the year ended December 31, 2020, compared to $3,558 for the year ended December 31, 2019. This decrease is due to (i) the reduction in the Company's share of earnings in Compstar of $679 as a result of the acquisition of the remaining ownership interest in during the third quarter and (ii) the reduction in the Company's share of earnings in TRI of $552, which is no longer carried as an equity method investment due to the sale of a portion of the Company's investment in TRI during the first quarter of 2020.
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 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.
We are organized as a holding company with our operations conducted through our subsidiaries, including our wholly owned insurance subsidiaries: Benchmark, which is domiciled in Kansas and commercially domiciled in California; ALIC, which is domiciled in Utah; and 7710, which is domiciled in South Carolina. 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.
Under South 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 capital gains or losses as shown in the 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 7710’s most recent annual statement; or (ii) the net income, not including net realized capital gains or losses as shown in the 7710's most recent annual statement.
On July 16, 2020, the Company entered into a new Second Amended and Restated Credit Agreement with First Horizon Bank which, among other things, extended the Company's credit facility for a period of five years through May 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. The loan has a variable interest rate of 3-month LIBOR plus 3.50%, which was 4.72% as of December 31, 2020 and 6.33% as of December 31, 2019 (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 until March 2025. All equity securities of the subsidiaries of Trean Insurance Group, Inc. (other than Benchmark Holding Company and its subsidiaries) will be pledged as collateral.
In addition, and in conjunction with, the execution of the Amended and Restated Credit Agreement, the Company made dividend distribution payments to Trean members totaling $18,154 in May 2020.
In June 2006, the Trust issued 7,500 shares of preferred capital securities to Bear Stearns Securities Corp. and 232 common securities to Trean Corporation. The proceeds of such issuances were invested by the Trust in $7,732 aggregate principal amount of the Subordinated Notes. The Subordinated Notes represents the sole assets of the Trust. On October 7, 2020, Trean Corp redeemed all of the Subordinated Notes for a total payoff amounts of $7,807. The interest rate was a fixed rate of 9.167% until July 7, 2011, at which time a variable interest rate of 3-month LIBOR (1.99% as of December 31, 2019, respectively) plus 3.50% is in effect. The interest rate totaled 5.49% as of December 31, 2019, respectively.
We utilize quota share reinsurance to: (i) cede premium to Program Partners (non-professional reinsurers) to transfer underwriting risk and align incentives, and (ii) cede premium to professional reinsurers to increase the amount of gross premiums we can write while managing net premiums written leverage appropriately based on its capital base, A.M. Best rating and risk appetite. It is a core pillar of the Company's underwriting philosophy that Program Partners retain a significant portion of the underwriting risk of their program. We believe this best aligns interests, attracts higher quality programs and leads to better underwriting results.
We have a financial strength rating of "A" (Excellent) from A.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 by A.M. Best. The "A" (Excellent) rating is assigned to insurers that have, in A.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 the A.M. Best financial strength ratings of our insurance company subsidiaries may negatively affect our business."
As of December 31, 2020, total stockholders' equity was $410,107, compared to $141,615 as of December 31, 2019, an increase of $268,492. The increase in stockholders' equity over the period was driven primarily by the $99,204 in common shares issued for the acquisition of Compstar; the $93,139 in proceeds from common stock sold in the Company's IPO, net of offering costs; and $95,475 of comprehensive income. These increases were partially offset by distributions to members totaling $19,819 during the year ended December 31, 2020.
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 $405,604 at December 31, 2020, 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.
•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, while generating superior after-tax total rates of return.
The composition of our investment portfolio is shown in the following table as of December 31, 2020 and December 31, 2019.
The following table shows the percentage of the total estimated fair value of our fixed maturity securities as of December 31, 2020 and December 31, 2019 by credit rating category, using the lower of ratings assigned by Moody's Investor Service or S&P.
The Company estimates the liability for the expected ultimate cost of unpaid loss and LAE as of the balance sheet date. Our reserves for unpaid loss and LAE represent the cost of all reported loss and LAE expenses as well as those that have been incurred but not yet reported. The estimated losses and LAE are regularly reviewed and adjusted as necessary based on historical experience and as the Company obtains new information.
settlement of the claim. Our claims department uses their knowledge of the specific claim along with internal and external experts, including underwriters and independent actuaries, to estimate the expected ultimate losses.
Reinsurance recoverables represent the portion of our unpaid loss and LAE that are ceded to third party reinsurers. The ceding of insurance does not relieve the Company of its primary liability to policyholders. We are required to pay claims even if a reinsurer fails to pay the Company under the terms of a reinsurance contract. We calculate the amounts recoverable from reinsurers based on our estimates of the underlying loss and LAE expenses as well as the terms and conditions of the reinsurance contracts.
Our investments in fixed maturity securities are classified as available-for-sale and are reported at fair value with unrealized gains and losses reported as a component of other comprehensive income, net of deferred taxes. Our investments in equity securities are reported at fair value with unrealized gains and losses reported as net investment income in the Consolidated and Combined Statement of Operations. In determining the fair value of investments, we utilize a hierarchy based on the quality of inputs used to measure the fair value. The three levels of the fair value hierarchy are as follows:
The Market Approach asserts that the value of property of any kind is equal to the cost of obtaining an equally desired substitute. Under this approach, the appraisal is based on transactions of assets similar to the subject asset. Value multiples from these transactions are applied to the subject asset's data to arrive at the asset's value.
We have no off-balance sheet arrangements as of December 31, 2020.
Consolidated and Combined Statements of Stockholders' Equity and Redeemable Preferred Stock
We have audited the accompanying consolidated and combined balance sheets of Trean Insurance Group, Inc. and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated and combined statements of operations, comprehensive income, stockholders’ equity and redeemable preferred stock, and cash flows, for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Consolidated and Combined Statements of Stockholders’ Equity and Redeemable Preferred Stock
For the purpose of financial statement disclosures, references to the consolidated financial statements for all post-IPO periods include the accounts of Trean Insurance Group, Inc., along with its wholly owned subsidiaries, after elimination of intercompany accounts and transactions. References to the consolidated financial statements for all pre-IPO periods include the combined financial statements of BIC and Trean, along with their wholly owned subsidiaries, after elimination of intercompany accounts and transactions.
The Company provides products and services to the specialty insurance market. Historically, the Company has focused on specialty casualty markets that are believed to be under served and where the Company’s expertise allows the Company to achieve higher rates, such as niche workers' compensation markets and small- to medium-sized specialty casualty insurance programs. The Company underwrites specialty-casualty insurance products both through programs where the Company partners with other organizations (Program Partners), and also through the Company’s own managing general agencies (Owned MGAs). The Company also provides Program Partners with a variety of services, including issuing carrier services, claims administration, and reinsurance brokerage from which the Company generates fee-based revenues.
2020-04). This update provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. This standard is effective for the period between March 12, 2020 and December 31, 2022. The adoption of this standard did not have a material impact on the consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. This update clarifies the definition of a business when evaluating whether transactions should be accounted for as an acquisition (or disposal) of a business or assets. The Company adopted this standard effective January 1, 2019. The adoption of this standard did not have a material impact on the consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04). This update simplifies the manner in which an entity is required to test goodwill for impairment. ASU 2017-04 is effective for annual periods beginning after December 15, 2021, including interim periods thereafter, with early adoption permitted. The Company has elected to early adopt this standard effective January 1, 2020. Adoption of this standard did not have a material impact on the consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02), which provides guidance for accounting for leases. The new guidance requires companies to recognize the assets and liabilities for the rights and obligations created by leased assets, initially measured at the present value of lease payments. Management adopted this standard effective January 1, 2020 under the modified retrospective approach. Adoption of this standard resulted in the Company recognizing initial right-of-use assets of $5,946 and initial lease liabilities of $5,946 and did not result in a cumulative effect adjustment on retained earnings. The adoption of this standard did not have a material impact on the consolidated statements of operations or consolidated statements of cash flows.
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). This update substantially revises standards for the recognition, measurement and presentation of financial instruments. This standard revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. This requires the change in the value of equity securities to be reflected within the Company’s net income. The standard also amends certain disclosure requirements associated with the fair value of financial instruments. The Company adopted this standard effective January 1, 2019. The adoption of this standard did not have a material impact on the consolidated financial statements.
The Company completed its IPO in July 2020, and is an emerging growth company as defined under federal securities laws. As such, the Company has elected to adopt pending accounting policies under the dates required for private companies. Therefore, the dates included within this section reflect the effective dates for the adoption of new accounting policies required by private companies.
In March 2020, the FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments (ASU 2020-03). This update represents changes to clarify and improve the codification to allow for easier application by eliminating inconsistencies and providing clarification on items such as (i) the application of fair value option disclosures; (ii) the accounting for fees related to modifications of debt; and (iii) aligning the contractual term of a net investment in a lease in accordance with ASC Topic 326, Financial Instruments - Credit Losses, and the lease term determined in accordance with ASC Topic 842, Leases. Certain issues addressed in this update are effective for annual periods beginning after December 15, 2020 and others are effective for annual periods beginning after December 15, 2022. The Company will adopt each standard upon their respective effective dates of January 1, 2021 and January 1, 2023. Adoption of this standard is not expected to have a material impact on the consolidated financial statements.
In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivative and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323 and Topic 815 (ASU 2020-01). This update addresses the accounting for certain equity securities upon the application or discontinuation of the equity method of accounting. Further, the update addresses scope considerations for forward contracts and purchased options on certain securities. ASU 2020-01 is effective for annual periods beginning after December 15, 2021, including interim periods thereafter. The Company will adopt this standard effective January 1, 2022. Adoption of this standard is not expected to have a material impact on the consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (ASU 2016-13). This update requires financial assets measured at amortized cost to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net income. Additionally, credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses, with the amount of the allowance limited to the amount by which the fair value is below the amortized cost. ASU 2016-13 is effective for annual periods beginning after December 15, 2022, including interim periods within those fiscal years. The Company will adopt this standard effective January 1, 2023. The Company is currently evaluating the impact of this standard on the consolidated financial statements.
If a debt security is impaired and management intends to sell the security or it is more likely than not that the Company will have to sell the security before the amortized cost is recovered, then the Company recognizes impairment loss in net realized capital gains (losses). If it is determined that an impairment of a debt security is other-than-temporary and management neither intends to sell the security nor is it more likely than not that the Company will have to sell the security before it is able to recover its cost or amortized cost, then the Company separates the impairment into (a) the amount of impairment related to credit loss and (b) the amount of impairment related to all other factors. The Company records the amount of the impairment related to the credit loss as an impairment charge in net income and the amount of the impairment related to all other factors in accumulated other comprehensive income. No other-than-temporary impairment was recorded for the years ended December 31, 2020, 2019 and 2018.
Equity method investments: Certain investments where the Company does not have control but has the ability to exercise significant influence are accounted for by the equity method of accounting. Under this method, the Company's investments in certain limited liability companies are recorded at cost and the investment accounts are adjusted for the Company's share of the entities' income or loss and for the distributions and contributions. The income and losses are recorded within equity earnings (losses) in affiliates, net of tax on the consolidated statements of operations.
Premium revenue: Premiums are earned over the policy period and are stated after deduction for reinsurance. The portion of premiums that will be earned in the future is deferred and reported as unearned premiums on the consolidated balance sheets.
Brokerage revenue includes the fees earned on excess of loss (XOL) and quota share reinsurance treaties. Billings for brokerage revenues generally occur monthly. Revenue for reinsurance treaties consists of a single performance obligation whereas the total amount of consideration expected to be received is recorded on the effective date of the underlying contract. For XOL treaties, revenue is estimated based on the contractually specified minimum or deposit premiums. For quota share treaties, revenue is estimated based on the projected premium income provided by the ceding insurer. Brokerage fees are received based on the performance of the specified terms of the reinsurance treaty and thus, are considered variable consideration. Therefore, revenue is estimated and constrained to the extent it is probable a significant reversal of revenue will not occur, using the expected value method. Adjustments to revenue are recorded as additional evidence is received for the ultimate amount of brokerage earned under the contract.
processing claims. Billings for TPA fees occur on a monthly basis. TPA services consist of a single performance obligation which is recognized over time as claims are processed throughout the contract period. The volume of claims varies throughout the contract period and, therefore, the Company has elected to record revenue in an amount that reflects the total fees that the Company has a right to invoice for during the period.
The Company acts as a managing general agent (MGA) to provide certain administrative and underwriting services. The consideration received varies based on certain factors including the contractual MGA rate and the total amount of premium written or collected under the contract. Billings for management fees occur on a monthly basis. Management fees consist of a single performance obligation that are recognized by the Company over time as services are provided. The volume of premium written or collected for a single contract varies throughout the contract period and, therefore, the Company has elected to record revenue in an amount that reflects the total fees that the Company has a right to invoice for during the period.
Premiums and other receivables: Premiums receivable are uncollateralized customer obligations due under normal terms requiring payment by the policy due date. Amounts outstanding that are deemed uncollectible are written off. When payments are received on amounts previously written off, the total premiums written off is reduced in the period in which the payment is received. Advanced premiums are recognized when payment is received prior to the beginning coverage date and are included within unearned premiums on the consolidated balance sheets.
Deferred policy acquisition costs: The Company incurs policy acquisition costs that vary with and are directly related to the production of new and renewal business. These costs consist of underwriting costs, net commissions (including ceding commissions) paid to agents, program managers and reinsurers, and premium taxes. Proceeds from reinsurance transactions that represent recovery of acquisition costs reduce applicable unamortized acquisition costs in such a manner that net acquisition costs are capitalized and charged to expense. Amortization of such policy acquisition costs is charged to general and administrative expense in proportion to premium earned over the estimated policy term.
Property and equipment, net: Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is based on the estimated useful lives of the various classes of property and equipment and is determined based on the straight-line method. The estimated useful lives of property and equipment range from three to thirty years. Maintenance and repairs are expensed as incurred; major improvements and betterments are capitalized. The depreciation periods by asset class are as follows:
Reserve for unpaid loss and loss adjustment expenses: The liability for unpaid losses and LAE in the consolidated balance sheets represent the Company’s estimated losses incurred that remain unpaid as of the balance sheet date. The liability is recorded on an undiscounted basis.
The consolidated balance sheets include reserves of unpaid losses gross of the amounts related to unpaid losses recoverable from reinsurers. The consolidated statements of operations include the losses net of amounts ceded to reinsurers.
Reinsurance: The Company cedes all, or a portion of, its insurance in order to limit its maximum losses, diversify its exposure and provide statutory surplus relief. Ceding insurance does not relieve the Company of its primary liability to policyholders.
Guaranty funds: State guaranty associations assess insurance companies for the estimated loss resulting from insurers encountering financial difficulty. The Company records these assessments, as well as any return assessments, upon notification of the state guaranty associations. The effect on operations or financial position relating to any estimated losses are not material for the years ended December 31, 2020, 2019 and 2018.
Income taxes: The Company recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company measures deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which it is expected to recover or settle those temporary differences. Should a change in tax rates occur, the effect on deferred tax assets and liabilities will be recognized in operations in the period that includes the enactment date.
The Company, from time to time, maintains its cash position at banks in excess of federally insured limits. The Company has not experienced any losses on such accounts.
Goodwill: Goodwill represents the cost to acquire a business over the fair value of the net assets acquired. Goodwill is not amortized but is reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event for a potential impairment has occurred. The Company had $140,640 and $2,822 of goodwill on the consolidated balance sheets as of December 31, 2020 and 2019, respectively.
An impairment loss would generally be recognized when the carrying amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. For the years ended December 31, 2020, 2019 and 2018, no impairment loss was recorded.
Intangible assets: Acquired intangible assets include client relationships, customer lists, non-compete agreements and trade names acquired. Intangible assets with a finite life are amortized over the estimated useful life. In valuing these assets, assumptions are made regarding useful lives and projected growth rates and significant judgment is required. The Company periodically reviews identifiable intangibles for impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the carrying amounts of the assets exceed their undiscounted cash flows, an impairment loss is recorded. For the years ended December 31, 2020, 2019 and 2018, no impairment loss was recorded.
Effective October 1, 2020, Benchmark Holding Company acquired 100% ownership of 7710 Insurance Company as well as its associated program manager and agency, 7710 Service Company, LLC and Creekwood Insurance Agency, LLC for a purchase price of $12,140. 7710 Insurance Company underwrites workers' compensation primarily for emergency services, including firefighters and emergency medical services (EMS). 7710 Insurance Company focuses on reducing costs and claims through the implementation of a proprietary safety preparedness and loss control program, created and staffed by experienced firefighters and EMS professionals.
The following table summarizes the consideration paid and the amounts of estimated fair value of the net assets acquired and liabilities assumed at the acquisition date:
The Company recorded $2,873 of goodwill associated with the business combination. The goodwill recognized is attributable to the assembled workforce and the expected growth resulting from the acquisition.
The Company also recorded preliminary intangible assets totaling $3,299 which are comprised of the following:
Effective July 15, 2020, Trean Compstar Holdings LLC purchased the remaining 55% ownership interest in Compstar Holding Company LLC (Compstar), a holding company along with its wholly owned subsidiary Compstar Insurance
Effective April 1, 2020, Trean Corp purchased 100% of the operating assets and assumed the liabilities of LCTA Risk Services, Inc. The total purchase price was $1,400. The following table summarizes the consideration paid and the amounts of estimated fair value of the net assets acquired and liabilities assumed at the acquisition date:
The Company recorded approximately $2,154 of goodwill associated with the business combination. The goodwill recognized is attributable to the expected growth resulting from the acquisition and the ability to direct the operations of Westcap. Further, the goodwill is attributable to synergies gained to assist in reducing future expenses.
Effective December 12, 2018, the Company acquired certain operating assets of CTS Underwriters, LLC located in Florida. The total purchase price was $50.
Level 2: Fair values primarily based on observable inputs, other than quoted prices included in Level 1, or based on prices for similar assets and liabilities.
Funds held under reinsurance agreements: The Company holds certain investments as collateral under reinsurance contracts and values these investments consistent with its other investments using third-party pricing services. To validate the reasonableness of the quoted prices, the Company performs various qualitative and quantitative procedures such as analysis of recent activity, analytical review of fair values and an evaluation of the underlying pricing methodologies. Based on these procedures, the Company did not adjust the prices or quotes from the third-party pricing service.
Debt: The Company holds debt related to multiple credit agreements. The Company has determined that the remaining balance of the debt reflected its fair value as this would represent the total amount to repay the debt.
The cost or amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the Company's investments are as follows:
The unrealized losses on the Company’s available for sale securities as of December 31, 2020 were primarily attributable to COVID-19 related credit spread widening and an increase in interest rates since first quarter lows, which predominantly impacted fixed maturities acquired during the second and third quarter of 2020. The unrealized losses on the Company's available for sale securities as of December 31, 2019 were primarily caused by widening in corporate and tax exempt credit spreads, rather than credit-related problems.
Actual maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Realized gains and losses on investments included in the consolidated statements of operations for the years ended December 31, 2020, 2019 and 2018 are as follows:
The Company had investments in Compstar, Trean Intermediaries (TRI) and Stop-Loss Re, LLC (Stop-Loss). Equity earnings and losses are reported in equity earnings (losses) in affiliates, net of tax on the consolidated statements of operations.
On July 15, 2020, the Company purchased the remaining 55% ownership interest in Compstar (See Note 3). Prior to the acquisition, the Company owned 45% of Compstar which had a carrying value of approximately $11,831 as of December 31, 2019. The Company recorded earnings for the years ended December 31, 2020 and 2019 of 2,333 and $3,012, respectively, and losses of $1,788 for the year ended December 31, 2018. Distributions received from Compstar for the years ended December 31, 2020, 2019 and 2018 were $2,842, $4,649 and $2,542, respectively.
Effective December 31, 2019, the Company surrendered its ownership in Stop-Loss. The Company recorded a loss on disposal of approximately $34 for the year ended December 31, 2019 which is included within net realized capital gains
*2020 amounts are not included as the Company no longer maintains an equity method investment in Compstar, TRI or Stop-Loss.
The Company had a variable interest in Trean Capital Trust I (the "Trust") that had mandatory redeemable preferred securities outstanding with a liquidation value of $7,500. The Trust was a variable interest entity under current accounting guidance because the Company had limited ability to make decisions about its activities. However, the Company was not the primary beneficiary of the Trust; and therefore, the Trust and the mandatory redeemable preferred securities issued by the Trust are not reported on the Company’s consolidated and combined balance sheets. During 2020, the Company redeemed all of the redeemable preferred securities of the Trust. As of December 31, 2020, the Trust is no longer considered a VIE.
The Company sold one building on October 15, 2018. Proceeds from the sale were $2,296 and the realized loss on disposal was $619.
The interest rate was a fixed rate of 9.167% until July 7, 2011, after which a variable interest rate of LIBOR (1.99% and 2.44% as of December 31, 2019 and 2018, respectively) plus 3.50% was in effect. The interest rate totaled 5.49% and 5.94% as of December 31, 2019 and 2018, respectively. The preferred capital securities issued by the Trust in turn pay quarterly cash distributions at an annual rate of 9.167% per annum of the liquidation amount of $1 per security until July 7, 2011 and thereafter at a variable rate per annum, reset quarterly, equal to LIBOR plus 3.50%.
During the years ended December 31, 2020, 2019 and 2018, the Company recorded $271, $464 and $433 of interest expense, respectively, associated with the Subordinated Notes.
In April 2018, Trean Corp entered into a credit agreement with a bank which includes a term loan facility totaling $27,500 and a revolving credit facility of $3,000. Borrowings are secured by substantially all of the assets of Trean and its subsidiaries.
Revenue from contracts with customers, included in other revenue, includes brokerage, management, third-party administrative and consulting fees. Revenue from contracts with customers was $12,104 and $9,125 for the years ended December 31, 2020 and 2019, respectively.
The Company did not have any contract liabilities as of December 31, 2020 or December 31, 2019. The following table provides information related to the contract assets from contracts with customers. Contract assets are included within other assets on the consolidated balance sheets.
The significant components of deferred tax assets and liabilities are as follows:
The Company purchased annuities from life insurers under which the claimants are the payees. The purchase of these annuities allowed the Company to reduce reserves for unpaid losses by approximately $2,553 in previous years. Under the terms of settlement with the claimants, the Company remains liable for payments to the claimants of approximately $1,717 and $1,773 as of December 31, 2020 and 2019, respectively, in the event of default or insolvency of the life insurers.
The following tables represent cumulative incurred loss and allocated loss adjustment expenses, net of reinsurance by accident year and cumulative paid loss and allocated loss adjustment expenses, net of reinsurance by accident year, for the years ended December 31, 2011 to 2020, as well as total IBNR and the cumulative number of reported claims for the year ended December 31, 2020, by reportable line of business and accident year (dollars in thousands). The Company’s primary lines of business are workers’ compensation and other liability.
The reconciliation of the net incurred and paid claims development tables to the liability for unpaid loss and loss adjustment expense in the consolidated balance sheets is as follows:
Amounts recoverable from reinsurers are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. The Company has diversified its credit risk related to the reinsurance ceded. There were no disputes with reinsurers as of December 31, 2020 and 2019. The Company has no reinsurance recoverables deemed uncollectible during the years ended December 31, 2020, 2019 and 2018.
The Company holds collateral on a funds held basis or requires collateral in a trust or as a letter of credit to secure recoverable balances from reinsurers not authorized in the insurance carriers state of domicile as follows:
Total lease expense for the year ended December 31, 2020 was $2,501, inclusive of $362 in variable lease expense. The Company also sublets some of its leased office space and recorded $84 of sublease income for the year ended December 31, 2020, which is included in other income on the consolidated statement of operations. Total rent expense was $1,575 and $1,115 and sublease income was $90 and $309 for the years ended December 31, 2019 and 2018, respectively, which were recorded prior to the adoption of ASU 2016-02.
The Company had the following minimum annual commitments for payment of leases as of December 31, 2019:
On July 20, 2020, Trean Insurance Group, Inc. closed the sale of 10,714,286 shares of its common stock in its IPO, comprised of 7,142,857 shares issued and sold by Trean Insurance Group, Inc. and 3,571,429 shares sold by selling stockholders. On July 22, 2020, Trean Insurance Group, Inc. closed the sale of an additional 1,207,142 shares by certain selling stockholders in the IPO pursuant to the exercise of the underwriters’ option to purchase additional shares to cover over-allotments. The IPO price per share was $15.00. The aggregate IPO price for all shares sold in the IPO was approximately $107,142 and the aggregate initial public offering price for all shares sold by the selling stockholders in the IPO was approximately $71,678. The shares began trading on the Nasdaq Global Select Market on July 16, 2020 under the symbol "TIG". The offer and sale was pursuant to a registration statement on Form S-1 (File No. 333-239291), which was declared effective by the SEC on July 15, 2020.
In conjunction with the IPO and corporate restructuring, the Company paid a termination payment to Altaris Capital Partners, LLC in connection with the termination of the Company's consulting and advisory agreements as well as paid bonuses to employees and pre-IPO unitholders for the successful completion of the IPO. The aggregate amount of these payments totaled $11,054 and is included in other expenses on the consolidated statement of operations.
The Company currently has authorized 600,000,000 shares of common stock with a par value of $0.01. As of December 31, 2020, there were 51,148,782 shares of common stock issued and outstanding.
2)Class B Units: Receive an allocation of profits and losses incurred by the Company as well as maintain the right to receive distributions, along with Class A Units, on a pro rata basis prior to distributions made to other classes of ownership units. Class B maintains both voting and non-voting units. Each Class B Voting Unit is entitled to one vote per Class B Voting Unit on each matter to which the members are entitled to vote. Class B Non-Voting Units maintain all rights, preferences and privileges allowed to Class B Voting Units with the exception of voting rights.
As part of the corporate reorganization performed in conjunction with the IPO of Trean Insurance Group, all ownership units were exchanged for a total of 37,386,394 shares of the Company's common stock.
The cumulative dividends earned by Series B holders totaled $128 for the year ended December 31, 2020 which consist of the following (in thousands, except share and per share amounts):
The following table presents the calculation of basic and diluted EPS of common stock:
For the year ended December 31, 2020, a total of 89,920 stock options with an exercise price of $15.00 per share were excluded from the calculation of diluted EPS because the options' exercise price was greater than the average market price of common shares, resulting in an antidilutive effect.
The fair value of each time-based vesting option award is estimated on the date of grant using the Black-Scholes option pricing model that uses assumptions noted in the following table. The Company’s expected volatility for the period was based on a weighted average expected volatility of an industry peer group of insurance companies of similar size, life cycle and lines of business. Expected term is calculated using the simplified method taking into consideration the option's contractual life and vesting terms. The Company’s stock option grants qualify as plain vanilla options and as such the Company uses the simplified method in estimating its expected option term as the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its common shares have been publicly traded. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected dividend yields were not used in the fair value computations as the Company has never declared or paid dividends on its common stock and currently intends to retain earnings for use in operations.
A summary of the status of the Company's stock option activity as of December 31, 2020 and changes during the year then ended are as follows:
The following table summarizes information regarding stock options outstanding as of December 31, 2020:
The weighted average grant-date fair value of options granted in the year ended December 31, 2020 was $4.43. The estimated fair value of restricted stock units is based on the grant date closing price of the Company's stock for time-based vesting awards. As of December 31, 2020, total unrecognized compensation cost related to stock options was $337 and is expected to be recognized over a weighted average period of approximately 1.4 years.
Compensation expense relating to restricted stock unit grants was $445 for the year ended December 31, 2020. As of December 31, 2020 there was $1,402 of total unrecognized compensation cost related to non-vested restricted stock unit grants. That cost is expected to be recognized over a weighted average expected life of 2.5 years. The total fair value of restricted stock units vested during the year ended December 31, 2020 was $174.
The Company has granted restricted stock units to certain key employees as part of the Company's long-term incentive program. The restricted stock underlying these awards generally vests in three equal annual installments beginning one year from the grant date and is amortized as compensation expense over the three-year vesting period. The Company has also granted restricted stock units to non-employee directors as part of the Company's annual director compensation program. Each restricted stock grant to non-employee directors vests on the day immediately preceding the next annual meeting of stockholders following the date of grant assuming continued service on our board of directors through the vesting date. These grants are amortized as director compensation expense over the twelve-month vesting period.
U.S. state insurance laws and regulations prescribe accounting practices for determining statutory net income and capital and surplus for insurance companies. In addition, state regulators may permit statutory accounting practices that differ from prescribed practices. Statutory accounting practices prescribed or permitted by regulatory authorities for the Company’s insurance company subsidiaries, Benchmark, ALIC and 7710 differ from GAAP. The principal differences between statutory accounting practices ("SAP") and GAAP as they relate to the financial statements of Benchmark, ALIC and 7710 are (i) policy acquisition costs are expensed as incurred under SAP, whereas they are deferred and amortized under GAAP, (ii) deferred tax assets are subject to more limitations regarding what amounts can be recorded under SAP and (iii) bonds are recorded at amortized cost under SAP and fair value under GAAP. Benchmark is domiciled in Kansas, ALIC is domiciled in Utah and 7710 is domiciled in South Carolina. As of December 31, 2020 and 2019, and during the years then ended, Benchmark, ALIC and 7710 met all regulatory requirements of the states in which they operate.
Risk-based capital ("RBC") requirements as promulgated by the National Association of Insurance Commissioners ("NAIC") require property and casualty insurers to maintain minimum capitalization levels determined based on formulas incorporating various business risks (e.g. investment risk, underwriting profitability, etc.) of the insurance company subsidiaries. As of December 31, 2020 and 2019, the insurance company subsidiaries’ adjusted capital and surplus exceeded their authorized control level as determined by the NAIC’s risk-based capital models.
The amount of dividends that our insurance subsidiaries may pay in any twelve-month period, without prior approval by their respective domestic insurance regulators, is restricted under the laws of Kansas, California, Utah and South Carolina.
Under Kansas and California 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 the Kansas Insurance Department and the California Department of Insurance, respectively, or (ii) 100% of net income during the applicable twelve-month period (not including realized capital gains). Dividends shall not include pro rata distributions of any class of Benchmark's own securities. For the years ended December 31, 2020 and 2019 the Company could approve dividends without the approval of the state up to $23,475 and $13,551, respectively. The Kansas Insurance Department does not have any limitations on the total amount of dividends paid.
Under Utah 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 the Utah Insurance Department (ii) 100% of net income during the applicable twelve- month period (not including realized capital gains). Dividends shall not include pro rata distributions of any class of ALIC's own securities. For the years ended December 31, 2020 and 2019 the Company could approve dividends without the approval of the state up to $266 and $467, respectively.
The Company has a 401(k) Plan and Trust. This Plan covers all eligible employees of the Company. An employee becomes eligible on the first day of each calendar quarter if they are at least 21 years old. Participants may elect to contribute from 1 percent up to 15 percent of their salary annually. The Company matches 50 percent of each dollar an employee contributes on the first 5 percent of compensation. In addition, under the safe-harbor plan, the Company contributes 3 percent of each participant's gross wages regardless of the employee's contributions. The Company may also make discretionary profit sharing contributions. The employees vest 25 percent per year of service beginning in the second full year of service. The Company contributed approximately $942, $721 and $662 to the plan for the years ended December 31, 2020, 2019 and 2018, respectively.
From time to time, the Company is subject to litigation related to its insurance business. Management does not believe that the Company is a party to any such pending litigation that would have a material adverse effect on its future operations.
Effective July 15, 2020, Trean Compstar Holdings LLC purchased the remaining ownership interest in Compstar (See Note 3). Prior to the acquisition, the Company owned a 45% interest in Compstar, a program manager that handles the underwriting, premium collection and servicing of insurance policies for the Company. The Company recorded $90,199 of gross earned premiums resulting in gross commissions of $17,709 for the year ended December 31, 2020 prior to the acquisition. The Company recorded $176,083 and $116,584 of gross earned premiums resulting in gross commissions of $37,034 and $24,711 due to Compstar for the years ended December 31, 2019 and 2018, respectively. All receivables are stated net of the commissions due under the Program Manager Agreement and totaled $22,207 as of December 31, 2019 which is recorded in related party receivables on the consolidated balance sheets.
Events or transactions that occur after the balance sheet date, but before the consolidated financial statements are complete, are reviewed by the Company to determine if they are to be recognized and/or disclosed as appropriate.