The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Item 1A of this report. These factors could cause our actual results in 2017 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements.
For example, for the five-year period ended December 31, 2016 we had recorded 62 severe claims, or an average of 12 severe claims per year for accident years 2012 through 2016. The number of severe claims reported in any one accident year in this five-year period ranged from a low of eight in 2012 to a high of 17 in 2016. The average reported case severity for these claims ranged from $1.6 million for the 2012 accident year to $3.5 million for the 2014 accident year. For the five accident years, the case incurred for these severe claims accounted for an average of 8.0 percentage points of our overall loss and loss adjustment expense, or LAE, ratio, measured at December 31, 2016.
Our gross reserves for loss and loss adjustment expenses at December 31, 2016, 2015 and 2014 were $742.8 million, $718.0 million and $687.6 million, respectively. As a percentage of gross reserves at year end, IBNR represented 22.2% in 2016, 22.2% in 2015 and 22.4% in 2014.
In 2016, we decreased our estimates for prior year loss reserves by $51.3 million. In 2015, we decreased our estimates for prior year loss reserves by $47.8 million. In 2014, we decreased our estimates for prior year loss reserves by $23.7 million.
Premiums are earned on a daily pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2016 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2016 and the other half in 2017. On a monthly basis, we also recognize net premiums earned from mandatory pooling arrangements.
Gross Premiums Written. Gross premiums written for 2016 were $373.1 million, compared to $386.5 million for 2015, a decrease of 3.5%. The decrease was attributable to a $8.4 million decrease in annual premiums on voluntary policies written during the period, a $4.2 million decrease in premiums resulting from payroll audits and related premium adjustments and a $0.9 million decrease in premiums from mandatory pooling arrangements.
Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $199.0 million for 2016, compared to $214.6 million for 2015, a decrease of $15.5 million, or 7.2%. The current accident year losses and LAE incurred were $250.3 million, or 67.9% of net premiums earned, compared to $262.4 million, or 69.8% of net premiums earned for 2015. We recorded favorable prior accident year development of $51.3 million in 2016, compared to $47.8 million in 2015. This is discussed in more detail below in “Prior Year Development.” Our net loss ratio was 54.0% for 2016 and 57.1% for 2015.
Income tax expense. Income tax expense for 2016 was $35.0 million, compared to $30.5 million for 2015. The increase was primarily attributable to an increase in pre-tax income, from $101.0 million for 2015 to $112.8 million for 2016. The effective tax rate also increased to 31.0% for 2016, compared to 30.2% for 2015. This increase is due to improvement in underwriting margins which resulted in a higher proportion of underwriting income to tax-exempt investment income relative to 2015.
Net Premiums Written. Net premiums written for 2015 were $375.3 million, compared to $380.0 million for 2014, a decrease of 1.2%. The decrease was primarily attributable to the decrease in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 2.9% for 2015 compared to 3.5% for 2014.
The table below sets forth the number of open claims as of December 31, 2016, 2015 and 2014, and the numbers of claims reported and closed during the years then ended.
The assumptions we used in establishing our reserves for these accident years were based on our historical claims data. However, as of December 31, 2016, actual results for these accident years have been better than our assumptions would have predicted. We do not presently intend to modify our assumptions for establishing reserves in light of recent results. However, if actual results for current and future accident years are consistent with, or different than, our results in these recent accident years, our historical claims data will reflect this change and, over time, will impact the reserves we establish for future claims.
Net cash provided by operating activities was $114.2 million in 2016, as compared to $92.9 million in 2015, and 140.7 million in 2014. Major components of cash provided by operating activities in 2016 were net premiums collected of $364.6 million and investment income collected of $44.7 million, offset in-part by claim payments of $189.9 million, $72.9 million of operating expenditures, federal taxes paid of $32.5 million and dividends to policyholders paid of $0.5 million.
Net cash used in investing activities was $50.5 million in 2016, as compared to $49.8 million in 2015 and $141.3 million in 2014. In 2016, major components of net cash used in investing activities included investment purchases of $354.6 million and net purchases of furniture, fixtures and equipment of $1.6 million, offset by proceeds from sales and maturities of investment of investments of $305.8 million. In 2015, major components of net cash used in investing activities included investment purchases of $326.2 million and net purchases of furniture, fixtures and equipment of $1.0 million, offset by proceeds from sales and maturities of investment of investments of $277.3 million. In 2014, major components of net cash used in investing activities included investment purchases of $455.2 million and net purchases of furniture, fixtures and equipment of $1.0 million, offset by proceeds from sales and maturities of investments of $315.2 million.
Under Nebraska and Texas law, as applicable, each of AIIC, SOCI and AIICTX is required to invest only in securities that are either interest-bearing, interest-accruing or eligible for dividends, and must limit its investment in the securities of any single issuer, other than direct obligations of the United States, to five percent of the insurance company’s assets. As of December 31, 2016, we were in compliance with these requirements.
As of December 31, 2016, our investment portfolio, including cash and cash equivalents, totaled $1.1 billion, an increase of 2.6% from December 31, 2015. The majority of our fixed maturity securities are classified as held-to-maturity, as defined by FASB ASC Topic 320, Investments-Debt and Equity Securities. As such, the reported value of those securities is equal to their amortized cost, and is not impacted by changing interest rates. The remainder of our fixed maturity securities and all of our equity securities are classified as available-for-sale and reported at fair value.
The composition of our investment portfolio, including cash and cash equivalents, as of December 31, 2016 is shown in the following table.
During 2016, the Company had no impairments losses recognized for other-than-temporary declines in the fair value of our investments.
During 2015, the Company impaired securities totaling $2.7 million related to four fixed maturity securities. The impairment charge is included in “Net realized gains (losses) on investments” for 2015. We impaired the securities due to downgrades of the securities and the amounts of the accumulated unrealized losses.
During 2014, the Company impaired securities totaling $0.2 million related to a fixed maturity security. The impairment charge is included in “Net realized gains (losses) on investments” for 2014. We impaired the security due to a downgrade of the security and the amount of the accumulated unrealized loss.
We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. As of December 31, 2016, the present value of these annuities was $96.1 million, as estimated by our annuity providers. Substantially all of the annuities are issued or guaranteed by life insurance companies that have an A.M. Best rating of “A” (Excellent) or better. For additional information, see Note 16 to our consolidated financial statements in Item 8 of this report.
We lease equipment and office space under noncancelable operating leases. Future minimum lease payments at December 31, 2016, were as follows:
We have audited the accompanying consolidated balance sheets of AMERISAFE, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AMERISAFE, Inc. and subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AMERISAFE, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2017 expressed an unqualified opinion thereon.
The terms “AMERISAFE,” the “Company,” “we,” “us” or “our” refer to AMERISAFE, Inc. and its consolidated subsidiaries, as the context requires.
guidance permits reporting entities to elect to estimate forfeitures related to share-based payments or recognize them as they occur. The threshold to qualify for equity classification has also been revised to permit withholding up to the maximum statutory tax rates in the applicable jurisdictions. The standard is effective for us in the first quarter of 2017. Adoption of this guidance is not expected to have a material impact on our financial condition and results of operations.
The Company regularly reviews the fair value of its investments. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the security declines below the cost or amortized cost, as applicable, for the security and the impairment is deemed to be other-than-temporary. The Company regularly reviews its investment
portfolio to evaluate the existence of other-than-temporary declines in the fair value of investments. The Company considers various factors in determining if a decline in the fair value of an individual security is other-than-temporary, including but not limited to a reduction or interruption in scheduled cash flows, the financial condition of the issuer, how long and by how much the fair value has been below amortized cost, losses due to credit concerns, downgrades and the Company’s intent to sell or ability to hold the security.
Premiums receivable consist primarily of premium-related balances due from policyholders. The Company considers premiums receivable as past due based on the payment terms of the underlying policy. The balance is shown net of the allowance for doubtful accounts. Receivables due from insureds are charged off when a determination has been made by management that a specific balance will not be collected. An estimate of amounts that are likely to be charged off is established as an allowance for doubtful accounts as of the balance sheet date. The estimate is primarily comprised of specific balances that are considered probable to be charged off after all collection efforts have ceased, as well as historical trends and an analysis of the aging of the receivables.
Experience-rated commissions are earned from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers. These commission revenues on reinsurance contracts are recognized during the related reinsurance treaty period and are based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and certain other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in income from current operations. Experience-rated commissions had no impact on underwriting and certain other operating costs in 2016 compared to $0.3 in 2015 and no impact in 2014.
All advertising expenditures incurred by the Company are charged to expense in the period to which they relate and are included in underwriting and certain other operating costs in the consolidated statements of income. Total advertising expenses incurred were $0.7 million in 2016 and 2015 and $0.5 million in 2014.
Under the two-class method, net income available to common and participating common shareholders is reduced by the amount of dividends declared in the current period and by the contractual amount of dividends that must be paid for the current period related to the Company’s common and participating common shares. Participating common shares include unvested share-based payment awards that contain nonforfeitable rights to dividends, whether paid or unpaid. Any remaining undistributed earnings are allocated to the common and participating common shareholders to the extent that each security shares in earnings as if all of the earnings for the period had been distributed. The amount of earnings allocable to each security is divided by the number of outstanding shares of the security to which the earnings are allocated to determine the EPS for the security. In a period of loss, no losses are allocated to the participating common shareholders. Instead, all such losses are allocated to the common shareholders.
Short-term investments held at December 31, 2016 include $ 21.9 million of U.S. Treasury securities and obligation of U.S. government agencies, $4.9 million of states and political subdivisions and $2.8 million of corporate bonds. Short-term investments held at December 31, 2015 include $7.7 million of corporate bonds.
AMERISAFE holds an investment in a limited partnership hedge fund accounted for under the equity method. The carrying value of this investment is $13.3 million at December 31, 2016.
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2016 are summarized as follows:
The gross unrealized gains and losses on, and the cost or amortized cost and fair value of, those investments classified as available-for-sale at December 31, 2015 are summarized as follows:
A summary of the amortized cost and fair value of investments in fixed maturity securities, classified as held-to-maturity at December 31, 2016, by contractual maturity, is as follows:
In 2016, the Company sold bonds that were classified as held-to-maturity. In February, Moody’s downgraded the bonds to B2 from B1 citing increasing liquidity concerns and also placed the bonds on negative outlook indicating the rating could be downgraded further. Given the evidence of significant deterioration, the Company elected to sell the bonds for $3.0 million, recognizing a $0.1 million realized gain.
We also defer a portion of employee total compensation costs directly related to time spent performing specific acquisition or renewal activities.
The Company made a partial disposition election under tax regulations to write-off capitalized amounts for book and tax purposes of certain fixed assets and deductible repairs in the amount of $0.6 million in 2015 and this amount is included in “Loss on disposal of assets.”
The Company cedes certain premiums and losses to various reinsurers under quota share and excess-of-loss treaties. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers on a continual basis. The effect of reinsurance on premiums written and earned in 2016, 2015 and 2014 was as follows:
Amounts recoverable from reinsurers consists of ceded case reserves, ceded incurred but not reported (“IBNR”) reserves, paid losses recoverable and experience-rated commissions recoverable. Ceded case and ceded IBNR reserves represent the portion of gross loss and loss adjustment expense liabilities that are recoverable under reinsurance agreements, but are not yet due from reinsurers. Paid losses recoverable are receivables currently due from reinsurers for ceded paid losses. The Company considers paid losses recoverable outstanding for more than 90 days to be past due. At December 31, 2016, there were no paid losses recoverable past due. Experience-rated commissions recoverable represents earned commission from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers, and these amounts declined during 2016 as a result of the December 2016 commutation of the 2011 through 2013 reinsurance agreements with Hannover and Tokio.
The Company generally secures large reinsurance recoverable balances with various forms of collateral, including funds withheld accounts, irrevocable letters of credit and secured trusts. At December 31, 2016, reinsurance recoverables from reinsurers that exceeded 1.5% of statutory surplus of the Company’s insurance subsidiaries are shown below (in thousands). The A.M. Best Company rating for the reinsurer is shown parenthetically.
During 2016, 2015 and 2014, there was no valuation allowance on the Company’s deferred income tax assets and liabilities.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions as of December 31, 2016, 2015 and 2014.
In 2013, the Company entered into an agreement providing for a line of credit in the maximum amount of $20.0 million with Frost Bank. In December 2016, the agreement was renewed. The agreement expires in December 2019. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR. Under the agreement, the Company will pay a fee of 0.25% on the unused portion of the loan in arrears quarterly for a fee of $50,000 annually, assuming the line of credit is not used during the calendar year. The line of credit is unsecured. No borrowings or letters of credit were outstanding under the line of credit arrangement at December 31, 2016 or 2015.
The following development tables provide the incurred and paid claims and allocated claim adjustment expenses, net of reinsurance, for workers’ compensation and general liability for accident years 2007 through 2016. The incurred but not reported (“IBNR”) claims and claims frequency is included for each accident year presented.
The foregoing reconciliation reflects favorable development of the net reserves at December 31, 2016, 2015 and 2014. The favorable development reduced loss and loss adjustment expense incurred by $51.3 million in 2016 driven primarily by accident years 2012, 2013 and 2014 of $9.1 million, $13.2 million and $19.7 million, respectively. In 2015 and 2014, the Company recorded favorable development of $47.8 million and $23.7 million, respectively. The revisions to the Company’s reserves reflect new information gained by claims adjusters in the normal course of adjusting claims and is reflected in the financial statements when the information becomes available. It is typical for more serious claims to take several years or longer to settle and the Company continually revises estimates as more information about claimants’ medical conditions and potential disability becomes known and the claims get closer to being settled. Multiple factors can cause loss development both unfavorable and favorable. The favorable loss development we experienced across accident years was largely due to favorable case reserve development from closed claims and claims where the worker had reached maximum medical improvement.
The Company’s insurance subsidiaries file financial statements prepared in accordance with statutory accounting principles prescribed or permitted by the insurance regulatory authorities of the states in which the subsidiaries are domiciled. Statutory-basis shareholders’ capital and surplus at December 31, 2016, 2015 and 2014 of the directly owned insurance subsidiary, AIIC, and the combined statutory-basis net income and realized investment gains for all AMERISAFE’s insurance subsidiaries for the three years in the period ended December 31, 2016, were as follows (in thousands):
Property and casualty insurance companies are subject to certain risk-based capital (“RBC”) requirements specified by the National Association of Insurance Commissioners. Under these requirements, a target minimum amount of capital and surplus maintained by a property/casualty insurance company is determined based on the various risk factors related to it. At December 31, 2016, the capital and surplus of AIIC and its subsidiaries exceeded the minimum RBC requirement.
The Company recognized compensation expense of $58,000 in 2016 and $138,000 in 2015 and $325,000 in 2014, related to awards made under the 2005 Incentive Plan. Total tax benefits realized for tax deductions from vesting of restricted stock in 2016, 2015 and 2014 were $110,000, $81,000 and $38,000, respectively.
Under the Restricted Stock Plan, each non-employee director is automatically granted a restricted stock award for a number of shares equal to $45,000 divided by the closing price of the Company’s common stock on the date of the annual meeting of shareholders at which the non-employee director is elected or is continuing as a member of the Board. Each restricted stock award vests on the date of the next annual meeting of shareholders following the date of grant, subject to the continued service of the non-employee director. Under the terms of the Restricted Stock Plan, the Company’s Board of Directors may increase the dollar amount of the annual award to an amount up to $75,000 without shareholder approval.
As of December 31, 2016, there were 5,576 shares of restricted stock outstanding under the Non-Employee Director Restricted Stock Plan, all of which will vest on the date of the annual meeting of shareholders in 2017.
The following table summarizes information about the restricted stock outstanding under the Non-Employee Director Restricted Stock Plan at December 31, 2016:
The Company recognized compensation expense of $361,000 in 2016, $266,000 in 2015 and $184,000 in 2014 related to the Non-Employee Director Restricted Stock Plan. Total tax benefits realized for tax deductions from vesting of restricted stock in 2016, 2015 and 2014 were $52,000, $13,000 and $7,000, respectively.
The calculation of basic and diluted EPS for the years ended December 31, 2016, 2015 and 2014 are presented below.
The Company manages risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated carriers. In the event these carriers are unable to meet their obligations under these contracts, the Company could be liable to the claimants. The following table summarizes (in thousands) the fair value of the annuities at December 31, 2016, that the Company has purchased to satisfy its obligations. The A.M. Best Company rating is shown parenthetically.
In February 2015, the Company was notified of an adverse verdict against its subsidiary, AIIC, related to a 2009 workers’ compensation claim in the State of Iowa. The verdict was for $25.3 million, of which $0.3 million was for actual damages and $25.0 million was awarded for punitive damages. AIIC is appealing both the verdict and the damage awards. The Company has posted an appeal bond in the amount of $27.8 million, as required by law. The Company maintains reinsurance against catastrophic losses, including court ordered judgments. As of December 31, 2016, the Company’s total reserve for the claim was $2.4 million. The $2.4 million reserve does not include payments that the Company has previously paid in this case. The payments, plus the $2.4 million reserve, total $5.4 million. The Company’s retention is $5.0 million before its reinsurance providers are obligated to reimburse the Company for additional costs. The Company presently believes that the reserve amount, together with its reinsurance coverage, is adequate to satisfy this claim.
Investments-The fair values for fixed maturity and equity securities are based on quoted market prices where available. For those securities not actively traded, fair values were obtained from a third-party investment manager.
The fair values of the Company’s investments are based upon prices provided by an independent pricing service. The Company has reviewed these prices for reasonableness and has not adjusted any prices received from the independent provider. Securities reported at fair value utilizing Level 1 inputs represent assets whose fair value is determined based upon observable unadjusted quoted market prices for identical assets in active markets. Level 2 securities represent assets whose fair value is determined using observable market information such as previous day trade prices, quotes from less active markets or quoted prices of securities with similar characteristics. There were no transfers between Level 1 and Level 2 during the year ended December 31, 2016.
Assets and liabilities measured at amortized cost as of December 31, 2016 and 2015 are as follows:
The following table represents unaudited quarterly financial data for the years ended December 31, 2016 and 2015.
On February 21, 2017 the Company declared a regular quarterly cash dividend of $0.xx per share payable on March 24, 2017 to shareholders of record on March 10, 2017. In 2016, the Company paid a quarterly cash dividend of $0.18 per share.
The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $x.xx per share.