We offer property and casualty insurance products to individuals through our wholly owned subsidiary, Kingstone Insurance Company (“KICO”). KICO’s insureds are located primarily in downstate New York, consisting of New York City, Long Island and Westchester County, although we are actively writing business in New Jersey, Rhode Island, Connecticut and Massachusetts. We are licensed in the States of New York, New Jersey, Rhode Island, Connecticut, Massachusetts, Pennsylvania, Maine, and New Hampshire. For the year ended December 31, 2020, 80.0% of KICO’s direct written premiums came from the New York policies.
In addition, through our subsidiary, Cosi Agency, Inc. (“Cosi”), a multi-state licensed general agency, we access alternative distribution channels. Through Cosi, we have the opportunity to partner with name-brand carriers and access nationwide insurance agencies. See “Distribution Channels” below for a discussion of our distribution channels. Cosi receives commission revenue from KICO for the policies it places with others and pays commissions to these agencies. Cosi retains the profit between the commission revenue received and the commission expense paid. Net Cosi revenue is eliminated against commission expense and Cosi related operating expenses are included in other operating expenses. Cosi related operating expenses are not included in our stand-alone insurance underwriting business and, accordingly, its expenses are not included in the calculation of our combined ratio as described below.
Other operating expenses include our corporate expenses as a holding company and operating expenses of Cosi. These corporate expenses include legal and auditing fees, executive employment costs, and other costs directly associated with being a public company. Cosi operating expenses primarily include employment, occupancy and consulting costs.
Ceding commission revenue: Commissions on reinsurance premiums ceded to quota share treaties are earned in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured.
Other operating expenses: Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc., and operating expenses of Cosi. These expenses include executive employment costs, legal and auditing fees, and other costs directly associated with being a public company. Cosi operating expenses primarily include employment costs, occupancy costs and consulting costs.
In May 2019, due to the poor performance of this line we placed a moratorium on new commercial lines and new commercial umbrella submissions while we further reviewed this business. In July 2019, due to the continuing poor performance of these lines, we made the decision to no longer underwrite commercial lines or commercial umbrella risks. In-force policies as of July 31, 2019 for these lines were non-renewed at the end of their annual terms. As of December 31, 2020 there are no commercial liability policies in-force. For the year ended December 31, 2020, these expired policies represent approximately 2.5% of net premiums earned and 33.7% of loss and LAE reserves net of reinsurance recoverables. See discussion below under “Additional Financial Information”.
Other: We write canine legal liability policies and have a small participation in mandatory state joint underwriting associations.
Underwriting income: Underwriting income is net pre-tax income attributable to our insurance underwriting business before investment activity. It excludes net investment income, net realized gains from investments, and depreciation and amortization (net premiums earned less expenses included in combined ratio). Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, depreciation and amortization, interest expense and income taxes.
For the years ended December 31, 2020 and 2019, Alternative Distribution made up 4.5% and 3.2%, respectively, of direct written premiums for our homeowners and dwelling fire components of personal lines. As discussed above, on July 10, 2020, KICO’s A.M. Best Financial Strength Rating was downgraded from A- (Excellent) to B++ (Good). This action has resulted in and will continue to result in a decrease in the business from Cosi, a multi-state licensed general agent that had partnered with name-brand carriers, some of which require an A.M. Best rating of A- (Excellent) from its partners.
Our consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these consolidated financial statements, our management has utilized information including our past history, industry standards, and the current economic environment, and other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates in these financial statements may not materialize. Application of the critical accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of similar companies.
We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred ceding commission revenue, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock-based compensation. See Note 2 to the Consolidated Financial Statements following Item 16 of this Annual Report.
The following table summarizes the changes in the results of our operations for the periods indicated:
Effective July 1, 2019, our personal lines 10% quota share treaty expired on a run-off basis. Effective December 15, 2019, we entered into a 25% quota share treaty. Effective December 31, 2020, our personal lines 25% quota share treaty expired on a cut-off basis.
The year ended December 31, 2020 includes catastrophe losses from Tropical Storm Isaias, which has been designated PCS Storm 2044.
Direct written premiums during the year ended December 31, 2020 (“Year Ended 2020”) were $169,318,000 compared to $171,214,000 during the year ended December 31, 2019 (“Year Ended 2019”). The decrease of $1,896,000, or 1.1%, was primarily due to the decrease in premiums from our commercial lines business as result of our decision in July 2019 to no longer underwrite this line of business. Direct written premiums from our personal lines business in Year Ended 2020 were $162,184,000, an increase of $12,264,000, or 8.2%, from $149,920,000 in Year Ended 2019.
Through June 30, 2019, our quota share reinsurance treaties were on a July 1 through June 30 fiscal year basis. Effective December 15, 2019, we entered into a quota share reinsurance treaty for our personal lines business covering the period from December 15, 2019 through December 30, 2020 (“2019/2020 Treaty”). Our personal lines quota share reinsurance treaty in effect for Year Ended 2019 was covered through June 30, 2019 (together with the run-off period) under a treaty covering a two-year period from July 1, 2017 through June 30, 2019 (“2017/2019 Treaty”). The treaty in effect during Year Ended 2019 was covered through June 30, 2019 (together with the run-off period) under the July 1, 2018 through June 30, 2019 treaty year (“2018/2019 Treaty Year”). The following table describes the quota share reinsurance ceding rates in effect for each treaty year during Year ended 2020 and Year Ended 2019 under the 2019/2020 Treaty and the 2017/2019 Treaty, respectively. This table should be referred to in conjunction with the discussions for net written premiums, net premiums earned, ceding commission revenue and net loss and loss adjustment expenses that follow.
The 2019/2020 Treaty was effective December 15, 2019 with a quota share reinsurance rate of 25%.
See “Reinsurance” below for changes to our personal lines quota share treaty effective December 15, 2019, and July 1, 2019 and 2018.
Most of the premiums written under our personal lines policies are also subject to our catastrophe treaties. An increase in our personal lines business gives rise to more property exposure, which increases our exposure to catastrophe risk; therefore, our premiums ceded under catastrophe treaties will increase. This results in an increase in premiums ceded under our catastrophe treaties provided that reinsurance rates are stable or are increasing. In Year Ended 2020, our premiums ceded under catastrophe treaties increased by $4,624,000 over the comparable ceded premiums in Year Ended 2019. The change was due to an increase in our catastrophe limit purchased through June 30, 2020, partially offset by a decrease in our limit effective July 1, 2020and an increase in reinsurance rates effective July 1, 2019. Through June 30, 2020, our ceded catastrophe premiums were paid based on the total direct written premiums subject to the catastrophe reinsurance treaty. Effective July 1, 2020, and continuing through June 30, 2021, our ceded catastrophe premiums will be paid based on the total insured value of our risks calculated as of August 31, 2021.
The 2019/2020 Treaty and 2017/2019 Treaty structure calls for a higher upfront provisional ceding commission and there is not an opportunity to earn additional contingent ceding commissions under these treaties. The amount of contingent ceding commissions we are eligible to receive under our prior years’ quota share treaties is subject to change based on losses incurred related to claims with accident dates before July 1, 2017. Under our prior years’ quota share treaties, we received a contingent ceding commission based on a sliding scale in relation to the losses incurred under our quota share treaties. The lower the ceded loss ratio, the more contingent commission we receive.
Net investment income was $6,506,000 in Year Ended 2020 compared to $6,869,000 in Year Ended 2019, a decrease of $363,000, or 5.3%. The average yield on invested assets was 3.39% as of December 31, 2020 compared to 3.51% as of December 31, 2019.
Net gains on investments were $1,591,000 in Year Ended 2020 compared to net gains of $4,591,000 in Year Ended 2019. Unrealized gains on our equity securities and other investments in Year Ended 2020 were $758,000, compared to unrealized gains of $4,562,000 in Year Ended 2019. Realized gains on sales of investments were $832,000 in Year Ended 2020 compared to realized gains of $29,000 in Year Ended 2019.
Other income was $990,000 in Year Ended 2020 compared to $1,385,000 in Year Ended 2019. The decrease of $395,000, or 28.5%, was primarily due to a decrease in finance and service charges during Year Ended 2020.
Net loss and LAE was $66,431,000 in Year Ended 2020 compared to $90,182,000 in Year Ended 2019. The net loss ratio was 61.5% in Year Ended 2020 compared to 70.7% in Year Ended 2019, a decrease of 9.2 percentage points.
Prior year development was stable for Year Ended 2020, with minimal impact on the overall loss ratio. This compared to 8.7 points of unfavorable impact in Year Ended 2019, which was primarily related to adverse loss development from commercial lines business of which there were no in-force policies as of December 31, 2020.
The impact of catastrophe losses was larger in Year Ended 2020. The total catastrophe loss ratio for Year Ended 2020 was 10.7 points, compared to 6.0 points for Year Ended 2019. During Tropical Storm Isaias we incurred $8.125 million of losses, or a 7.5-point impact on the overall loss ratio. There were 13 PCS catastrophe events (excluding Tropical Storm Isaias) during Year Ended 2020, with a 3.2-point impact on the overall loss ratio compared to 9 PCS catastrophe events during Year Ended 2019 with a 6.0-point impact on the overall loss ratio as noted above.
Other underwriting expenses were $25,425,000 in Year Ended 2020 compared to $24,420,000 in Year Ended 2019. The increase of $1,005,000, or 4.1%, was primarily due to expenses related to growth in personal lines direct written premiums and salaries. Expenses directly related to the increase in personal lines direct written premiums primarily consist of underwriting expenses, software usage fees, and state premium taxes. Expenses indirectly related to the increase in personal lines direct written premiums primarily consist of salaries along with related other employment costs.
Depreciation and amortization was $2,865,000 in Year Ended 2020 compared to $2,546,000 in Year Ended 2019. The increase of $319,000, or 12.5%, in depreciation and amortization was primarily due to depreciation of our new systems platform for handling business being written in Expansion states, newly purchased assets used to upgrade our systems infrastructure.
Interest expense in Year Ended 2020 and Year Ended 2019 was $1,826,000. We incurred interest expense in connection with our $30.0 million issuance of long-term debt in December 2017.
In July 2019, we decided that we will no longer underwrite Commercial Liability risks. See discussions above regarding the discontinuation of this line of business.
See discussions above with regard to “Net Written Premiums and Net Premiums Earned”, as to changes in quota share ceding rates effective December 31, 2020, December 15, 2019 and July 1, 2019.
Our insurance underwriting business reported on a standalone basis for the years ended December 31, 2020 and 2019 follows:
The key measures for our insurance underwriting business for the years ended December 31, 2020 and 2019 are as follows:
KICO placed certain residential mortgage backed securities as eligible collateral in a designated custodian account related to its membership in the Federal Home Loan Bank of New York ("FHLBNY") see Note 9, in the accompanying consolidated financial statements following Item 16 of this Annual Report). The eligible collateral would be pledged to FHLBNY if KICO draws an advance from the FHLBNY credit line. As of December 31, 2020, the estimated fair value of the eligible investments was approximately $11,391,000. KICO will retain all rights regarding all securities if pledged as collateral. As of December 31, 2020, there was no outstanding balance on the FHLBNY credit line.
The table below summarizes the credit quality of our available-for-sale fixed-maturity securities as of December 31, 2020 and 2019 as rated by Standard and Poor’s (or, if unavailable from Standard and Poor’s, then Moody’s or Fitch):
The table below lists the weighted average maturity and effective duration in years on our fixed-maturity securities as of December 31, 2020 and 2019:
As disclosed in Note 4 to the condensed consolidated financial statements, with respect to “Fair Value Measurements,” we define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction involving identical or comparable assets or liabilities between market participants (an “exit price”). The fair value hierarchy distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of December 31, 2020 and December 31, 2019, 81% and 80%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices.
The table below summarizes the gross unrealized losses of our fixed-maturity securities available-for-sale and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2020 and 2019:
There were 16 securities at December 31, 2020 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. There were 39 securities at December 31, 2019 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
KICO is a member of the Federal Home Loan Bank of New York (“FHLBNY”), which provides additional access to liquidity. Members have access to a variety of flexible, low cost funding through FHLBNY’s credit products, enabling members to customize advances. Advances are to be fully collateralized; eligible collateral to pledge to FHLBNY includes residential and commercial mortgage backed securities, along with U.S. Treasury and agency securities. See Note 3 to our condensed consolidated financial statements - Investments, for eligible collateral held in a designated custodian account available for future advances. Advances are limited to 5% of KICO’s net admitted assets as of the end of the previous quarter, which is September 30, 2020, and are due and payable within 90 days of borrowing. The maximum allowable advance as of December 31, 2020, based on the net admitted assets as of September 30, 2020, was approximately $12,066,000. Advances are limited to 85% of the amount of available collateral, which was approximately $9,682,000 as of December 31, 2020. There were no borrowings under this facility during the year ended December 31, 2020.
Net cash used in financing activities was $3,274,000 in Year Ended 2020 compared to $3,632,000 used in Year Ended 2019. The $358,000 decrease in net cash used in financing activities was attributable to a $1,544,000 reduction in dividends paid, partially offset by $1,183,000 purchases of treasury stock in Year Ended 2020 compared to Year Ended 2019.
Reinsurance recoverable from Cavello Bay Reinsurance Limited is secured pursuant to a collateralized trust agreement. Assets held in the trust are not included in our invested assets and investment income earned on this asset is credited to the reinsurer.
Through June 30, 2019, our quota share reinsurance treaties were on a July 1 through June 30 fiscal year basis. Effective December 15, 2019, we entered into a quota share reinsurance treaty for our personal lines business covering the period from December 15, 2019 through December 30, 2020 (“2019/2020 Treaty”). Effective December 31, 2020, the 2019/2020 Treaty expired on a cut off basis; this treaty was not renewed.
Effective July 1, 2019, our 2017/2019 Treaty and commercial umbrella treaty expired on a run-off basis; these treaties were not renewed. We entered into new excess of loss and catastrophe reinsurance treaties effective July 1, 2020. Material terms for our reinsurance treaties in effect for the treaty years shown below are as follows:
Plus losses in excess of catastrophe coverage. For the period July 1, 2020 through December 30, 2020, there was no reinsurance coverage for the $2,500,000 gap between quota share limit of $7,500,000 and first $10,000,000 layer of catastrophe coverage (see note (7) below).
The personal lines quota share (homeowners, dwelling fire and canine legal liability) expired on December 30, 2020; reinsurance coverage from December 31, 2020 through June 30, 2021 is only for excess of loss and catastrophe reinsurance.
The financial statements required by this Item 8 are included in this Annual Report following Item 16 hereof. As a smaller reporting company, we are not required to provide supplementary financial information.