Direct Auto leases office space at 515 North State Street, Chicago, Illinois until March 31, 2020. Effective April 1, 2020, Direct Auto has entered a new office space lease at 8700 West Bryn Mawr Avenue, Chicago, Illinois, to expire on August 31, 2029. Direct Auto employees at these locations administer their non-standard auto business.
Battle Creek is managed by Nodak Insurance, and Nodak Insurance reinsures 100% of the risk on all insurance policies issued by Battle Creek. Nodak Agency is an inactive shell corporation.
We monitor the market place both on a regional and line of business basis. The private passenger market place would best be described as stable with ample capacity to grow business with a challenging pricing environment. Rates for private passenger are
Unlike property and casualty insurance, the total crop insurance premiums written each year vary mainly based on prevailing commodity prices for the type of crops planted, because the aggregate number of acres planted does not vary much from year to year. Because the premiums that are charged for crop insurance are established by the RMA, which is a division of the United States Department of Agriculture, and the policy forms and terms are also established by the RMA, insurers do not compete on price or policy terms and conditions. Moreover, because participation in other federal farm programs by a farmer is conditioned upon participation in the federal crop insurance program, most commercial farmers obtain crop insurance on their plantings each year.
The Company derives its revenue primarily from net premiums earned, net investment income, and net capital gain (loss) on investments.
Premiums earned is the earned portion of net premiums written. Gross premiums written include all premiums recorded by an insurance company during a specified policy period. Insurance premiums on property and casualty policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies or, in the case of crop insurance, over the period of risk to the Company. At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and is realized as revenue in subsequent periods over the remaining term of the policy or period of risk. NI Holdings’ property and casualty policies typically have a term of twelve months. For example, for an annual policy that is written on July 1, 2019, one-half of the premiums would be earned in 2019 and the other half would be earned in 2020.
Due to the nature of the crop planting and harvesting cycle and the deadlines for filing and processing claims under the federal crop insurance program, insurance premiums for crop insurance are generally recognized and earned during the period of risk, which usually begins in spring and ends with harvest in the fall. Under the federal crop insurance program, farmers must purchase crop insurance with respect to spring planted crops by March 15. By July 15, the farmer must report the number of acres he has planted in each crop. On September 1, the insurer bills the farmer for the insurance premium, which is due and payable by the farmer by October 1. If the farmer does not pay the premium by such date, the insurer must essentially provide a loan to the farmer in an amount equal to the premium at an annual interest rate of 15% because the insurer is required to pay the farmer’s portion of the premium to the Federal Crop Insurance Corporation (“FCIC”) by November 15, regardless of whether the farmer pays the premium to the insurer. Except for claims occurring in the spring (primarily for prevented planting and required replanting claims), claims are required to be filed with the FCIC by December 15. A different cycle exists for crops planted in the fall, such as winter wheat, but the vast majority of crop insurance written by NI Holdings covers crops planted in the spring.
NI Holdings invests its surplus and the funds supporting its insurance liabilities (including unearned premiums, and unpaid loss and loss adjustment expenses) in cash, cash equivalents, equity securities, and fixed income securities. Investment income includes interest and dividends earned on invested assets, and is reported net of investment-related expenses. Net capital gains and losses on investments are reported separately from net investment income. NI Holdings recognizes realized capital gains when investments are sold for an amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized capital losses when investments are written down as a result of an other-than-temporary impairment or sold for an amount less than their cost or amortized cost, as applicable.
Losses and LAE represent the largest expense item and include (1) claim payments made, (2) estimates for future claim payments and changes in those estimates from prior periods, and (3) costs associated with investigating, defending, and adjusting claims, including legal fees.
The net premiums written to statutory surplus ratio represents the ratio of net premiums written to statutory surplus. This ratio is designed to measure the ability of the Company to absorb above-average losses and the Company’s financial strength. In general, a low premium to surplus ratio is considered a sign of financial strength because the Company has an adequate provision for adverse development of loss reserves within the Company’s current book of business and provides a capacity to write more business. Statutory surplus is determined using accounting principles prescribed or permitted by the insurance subsidiaries’ state of domicile and differs from GAAP equity.
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. NI Holdings is required to make estimates and assumptions in certain circumstances that affect amounts reported in its Consolidated Financial Statements and related footnotes. NI Holdings evaluates these estimates and assumptions on an ongoing basis based on historical developments, market conditions, industry trends, and other information that it believes to be reasonable under the circumstances. There can be no assurance that actual results will conform to these estimates and assumptions and that reported results of operations would not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. NI Holdings believes the following policies are the most sensitive to estimates and judgments.
With respect to its traditional property and casualty insurance products, the Company maintains reserves for the payment of claims (indemnity losses) and expenses related to adjusting those claims (LAE). The Company’s liability for unpaid losses and LAE
consists of (1) case reserves, which are reserves for claims that have been reported to it, and (2) reserves for claims that have been incurred but have not yet been reported and for the future development of case reserves (“IBNR”).
The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, inflation, legal trends, increases in the state-dictated minimum liability limits in the recent case of nonstandard auto insurance, and legislative changes, among others. The impact of many of these items on ultimate costs for losses and loss adjustment expenses is difficult to estimate. Loss reserve estimation is also affected by the volume of claims, the potential severity of individual claims, the determination of
Factors exist that can drive the cost to settle claims for reasons other than standard inflation. For example, demand surge caused by a very large catastrophe (as in the case of Hurricane Katrina) has an impact on not only the availability and cost of building materials such as roofing and other materials, but also on the availability and cost of labor. Other factors such as increased vehicle traffic in an area not designed to handle the increased congestion and increased speed limits on busy roads are examples of changes that could cause claim severity to increase beyond what the Company’s historic reserves would reflect. In addition, unexpected increases in the labor costs and healthcare costs that underlie insured risks, changes in costs of building materials, or changes in commodity prices for insured crops may cause fluctuations in the ultimate development of the case reserves. Recently, the state of Nevada mandated the incorporation of higher minimum liabilities for nonstandard auto insurance policies written in the state. While it is certain that this action will increase the average claim cost experienced in the state, the actual amount of this increase is subject to judgement until further claim experience is obtained.
When establishing IBNR reserves, the Company’s actuary takes into account many of the factors discussed above. One of the more important factors that is considered when setting reserves is the past or historical claim settlement experience. Our actuary considers factors such as the number of files entering litigation, payment patterns, length of time it takes Company claims personnel to settle the claims, and average payment amounts when estimating reserve amounts. Should future settlement patterns change due to the
legal environment, Company claims handling philosophy, or personnel, it may have an impact on the future claims payments, which could cause existing reserves to either be redundant (excessive) or deficient (below) compared to the actual loss amount.
The following tables provides case and IBNR reserves for unpaid losses and LAE by segment.
When a claim is reported, claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. It is possible that the level of adequacy in the case reserve may differ from historical levels and/or the claims reporting pattern may change. The following table displays the impact on net income, after federal income taxes of 21%, which results from various changes to the level of case reserves as of December 31, 2019. This variance in future IBNR emergence could occur in one year or over multiple years, depending when the change is recognized.
NI Holdings’ fixed income securities and equity securities are classified as available-for-sale and carried at estimated fair value as determined by management based upon quoted market prices or a recognized pricing service at the reporting date for those or similar investments. Changes in unrealized investment gains or losses on the fixed income securities, and on equity securities through December 31, 2018, net of applicable income taxes, are reflected directly in Equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income (loss). Effective January 1, 2019, changes in unrealized investments gains or losses on equity securities will be recorded in net income (loss), rather than as a component of other comprehensive income (loss). Investment income is recognized when earned, and realized capital gains and losses on investments are recognized when investments are sold, or an other-than-temporary impairment is recognized.
The fixed income portion of the portfolio experienced increases in unrealized gains and decreases in unrealized losses during the year ended December 31, 2019, which was driven by a sharp decline in U.S. interest rates over 2019 to result in a strong rally for the fixed income asset class. The net increase of $9,566 is reflected directly in Equity as a component of other comprehensive income.
The equity portion of the portfolio experienced increases in unrealized gains and decreases in unrealized losses, which are attributed to favorable conditions in the stock market during the year ended December 31, 2019. The net increase of $11,537 is included in net capital gain on investments on the Company’s Consolidated Statements of Operations.
NI Holdings has evaluated each security and taken into account the severity and duration of any impairment, the current rating on the security (if any), and the outlook for the issuer according to independent analysts. The Company’s fixed income portfolio is managed by Conning Asset Management, which specializes in the handling of insurance company investments and participates in this evaluation.
For more information on the Company’s investments, see Note 6 to the Consolidated Financial Statements, included elsewhere in this Form 10-K.
Level II: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level II includes fixed income securities with quoted prices that are traded less frequently than exchange traded instruments. Valuation techniques include matrix pricing which is a mathematical technique used widely in the industry to value fixed income securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.
NI Holdings uses quoted values and other data provided by an independent pricing service in its process for determining fair values of its investments. The evaluations of such pricing services represent an exit price and a good faith opinion as to what a buyer in the marketplace would pay for a security in a current sale. This pricing service provides NI Holdings with one quote per instrument. For fixed income securities that have quoted prices in active markets, market quotations are provided. For fixed income securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of observable inputs including relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. The observable market inputs that the Company’s independent pricing service utilizes may include (listed in order of priority for use) benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, and other reference data on markets, industry, and the economy. Additionally, the independent pricing service uses an option-adjusted spread model to develop prepayment and interest rate scenarios. The pricing service did not use broker quotes in determining fair values for any of the Company’s investments at December 31, 2019, 2018, or 2017.
Management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. Management reviews all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in common sectors, durations, and credit ratings. This review will also include all fixed income securities rated lower than “A” by Moody’s or Standard & Poor’s. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service. In its review, management did not identify any such discrepancies, and no adjustments were made to the estimates provided by the pricing service, for the years ended December 31, 2019, 2018, or 2017. The classification within the fair value hierarchy is then confirmed based on the final conclusions from the pricing review.
No deferred policy acquisition costs (“DAC”) were recorded in the acquisition for Direct Auto in accordance with purchase accounting guidance. Rather, a separate intangible asset representing the value of business acquired (”VOBA”) was valued at $5,134 and established at the closing date. This VOBA intangible asset was amortized into expense as the acquired unearned premiums were reported into income, in the same way as DAC. Policy acquisition costs relating to new business written by Direct Auto was deferred following the closing date. The release of the VOBA asset and the establishment of new DAC generally offset each other over the twelve months following the acquisition of Direct Auto.
Accounting guidance provides companies the option to reclassify income tax effects that are stranded in accumulated other comprehensive income as a result of income tax reform to retained earnings. The Company accumulates unrealized gains on investments in equity with the corresponding income tax effects. The Company early adopted this guidance on a prospective basis as of December 31, 2017, and elected to reclassify material stranded income tax effects in accumulated other comprehensive income to retained earnings using a portfolio method.
NI Holdings premium levels and underwriting results have been, and will continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle and makes it difficult to attract and retain properly priced business. During a hard market cycle, it is more likely that insurers will be able to increase their rates or profit margins. A hard market typically has a positive effect on premium growth. The markets that NI Holdings serve are diversified, which requires management to regularly monitor the Company’s performance and competitive position by line of business and geographic market to schedule appropriate rate actions.
Assumed premiums earned decreased slightly, primarily related to crop hail business from Rural Mutual. Ceded premiums earned decreased due to less gain-sharing of multi-peril crop premiums to the federal government.
Our personal lines of business (private passenger auto, home and farm) continued their strong growth in South Dakota. Our non-standard auto premiums also increased year-over-year due to the acquisition of Direct Auto. Direct premiums for crop business are lower in 2019 compared to 2018 due in part to lower commodity prices, although 2019 net premiums are higher than 2018 net
During 2019, reported losses and LAE included $6,509 of net favorable development on prior accident years, compared to $589 of net favorable development on prior accident years during 2018. Net favorable development is the result of prior years’ claims settling for less than originally estimated, while net unfavorable development is the result of prior years’ claims settling for more than originally estimated. Adjustments to our original estimates resulting from claims are not made until the period in which there is reasonable evidence that an adjustment to the reserve is appropriate.
Underlying expenses were $11,667 higher in the year ended December 31, 2019 compared to a year ago. The new Direct Auto subsidiary contributed $16,792 of underlying expenses to the current year, compared to $5,981 a year ago. Policy acquisition costs have increased due to higher written premiums.
NI Holdings had realized capital gains on investment of $3,246 for the year ended December 31, 2019, compared to $3,974 a year ago.
The consolidated net income for NI Holdings was $31,244 for the year ended December 31, 2018 compared to $15,612 for the year ended December 31, 2017. The major components of NI Holdings’ operating revenues and net income for the two years were as follows:
NI Holdings’ net premiums earned for the year ended December 31, 2018 increased 9.1% to $195,720 compared to $179,464 for the year ended December 31, 2017.
Direct premiums earned for the year ended December 31, 2018 increased $30,182, or 15.9%, to $219,600 from $189,418 for 2017. Assumed premiums earned decreased slightly. Ceded premiums earned were $13,729 more in 2018 compared to 2017 due to increased ceding of 2018 crop insurance premiums back to the FCIC under the gain-sharing provision of the federal crop insurance
Loss experience for our crop business improved considerably year-over-year. Conditions were very favorable during the 2018 growing season, and early snows and cold temperatures did not materially affect crop production through the harvest. During 2017, early season drought conditions in western North Dakota was the primary reason for the higher loss ratio.
Total underwriting and general expenses, including amortization of deferred policy acquisition costs, increased $9,694 in 2018, or 21.8%, compared to 2017.
Expense deferrals were $8,196 higher in 2018 than 2017 due to the increase in direct premiums written in 2018, whereas amortization of those costs was $4,106 higher in 2018 due to the increase in direct premiums earned in 2018. The net increase in
Rate increases and other underwriting actions on our Primero non-standard auto business reduced the underwriting loss considerably from the prior year. Fee income attributable to this segment is a key component in measuring its profitability. The new Direct Auto non-standard auto business is expected to experience a lower loss and LAE ratio while generating only minimal fee income. Fee income on the non-standard auto business was $1,406 and $1,087 for the years ended December 31, 2018 and 2017, respectively.
The following table sets forth our average cash and invested assets, net investment income, and return on average cash and invested assets for the reported periods:
Investment income, net of investment expense, increased $1,149 for the year ended December 31, 2018 compared to 2017. This increase is attributable to an increase in invested assets caused the timing of the investment actions taken with respect to the receipt of the proceeds of over $90 million from the Company’s initial public offering in March 2017. Cash and invested assets also increased a net $53,533 in September 2018 from the acquisition of Direct Auto. The majority of Direct Auto cash and invested assets was in short term cash and cash equivalents at the closing date. The weighted average gross yield on invested assets remained level at 2.5% in 2018 compared to 2017.
NI Holdings had net capital gains on investment of $3,974 for the year ended December 31, 2018, compared to $2,997 for the year ended December 31, 2017. The Company recorded $382 and $330 of other-than-temporary impairments during the years ended December 31, 2018 and 2017, respectively.
The Company’s fixed income securities and equity securities are classified as available for sale because it will, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies. At December 31, 2018, the Company had net unrealized losses on fixed income securities of $2,325 and net unrealized gains on equity securities of $10,359. At December 31, 2017, the Company had net unrealized gains on fixed income securities of $1,780 and net unrealized gains on equity securities of $18,533. The decrease in the fair value of our fixed income securities is attributable to a general rise in the interest rate environment during 2018. The decrease in the fair value of our equity securities is attributable to a general decline in the overall stock market during December 2018.
For the year ended December 31, 2018, NI Holdings had pre-tax income of $39,165 compared to pre-tax income of $22,006 for the year ended December 31, 2017. The increase in pre-tax income was largely attributable to favorable loss experience in our crop business and our all other segment, the gain realized as a result of the purchase accounting afforded the acquisition of Direct Auto, and favorable operating results from Direct Auto.
Accounting guidance requires that companies re-measure existing deferred income tax assets (including loss carryforwards) and liabilities in the period of enactment of a tax rate change. The guidance also requires any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforwards to be recognized in the period of enactment. The resulting impact on our deferred income taxes and the related valuation allowance was recognized in the fourth quarter of 2017. The valuation allowance against certain deferred income tax assets decreased to $587 at December 31, 2018 from $628 at December 31, 2017.
For the year ended December 31, 2018, NI Holdings had annualized return on average equity, after non-controlling interest, of 11.8% compared to annualized return on average equity, after non-controlling interest, of 7.9% for the year ended December 31,
2017. Average equity is calculated as the average between beginning and ending equity excluding non-controlling interest for the period.
At December 31, 2019, NI Holdings’ total assets increased $49,667, or 10.8%, from December 31, 2018. Cash and investments increased due to positive earnings in the business, as well as unrealized appreciation in equity securities. Deferred policy acquisition costs also increased due to growth in the business and the addition of Direct Auto.
At December 31, 2019, total liabilities increased $15,617, or 8.6%, from December 31, 2018. Unpaid losses and LAE increased for the crop segment. Unearned premium increased due to growth across most segments. Deferred income tax liabilities increased $3,879, reflecting the increase in unrealized gains in investments.
Total equity increased by $34,050, or 12.4%, during the year ended December 31, 2019. The increase in equity primarily reflects consolidated net income of $26,500 for the year and other comprehensive income of $7,557, due to higher fair values within our fixed income securities portfolio.
The change in cash and cash equivalents for the years ended December 31, 2019, 2018, and 2017 were as follows:
application of purchase accounting to the Direct Auto acquisition, additional deferral of policy acquisition costs, and changes to the receivable from FCIC and federal income tax recoverable/payable were offset by unearned premiums to serve as the primary reconciling items between net income and net cash flows from operating activities.
For the year ended December 31, 2017, net cash provided by operating activities totaled $18,425, including consolidated net income of $15,612. During 2017, changes to the receivable from FCIC, federal income tax recoverable/payable, and unearned premiums were offset by changes in unpaid losses and LAE to serve as the primary reconciling items between net income and net cash flows from operating activities.
Net cash used by financing activities was $2,025 and $2,996 for the years ended December 31, 2019 and 2018, respectively, and was attributable to the purchase of treasury stock. Net cash provided by financing activities of $82,708 for the year ended December 31, 2017 reflects the net proceeds from our initial public offering, offset by the initial funding of our new employee stock option plan and the purchase of treasury stock.
declaration of the dividend or at least 10 days prior to payment of the dividend. However, Maryland law imposes additional limitations on “extraordinary dividends”. Maryland law defines an extraordinary dividend as a dividend that, when combined with the value of other dividends made in the preceding 12 months, exceeds the lesser of (i) 10% of the insurer’s surplus as regards policyholders as of the preceding December 31, or (ii) the insurer’s net investment income not including (a) realized capital gains for the 12-month period ending December 31 of the preceding year and (b) pro rata distributions of any class of the insurer’s own securities. An insurer may not pay an extraordinary dividend unless the insurer provides notice of the declaration to the Maryland Insurance Commissioner at least 30 days before the declaration is made and the Maryland Insurance Commissioner has approved or not disapproved the declaration within 30 days.
The following table summarizes, as of December 31, 2019, NI Holdings’ future payments and estimated claims and claims related payments.
We have audited the accompanying consolidated balance sheets of NI Holdings, Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income, changes in equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and the schedule listed in Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal controls over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
The Company paid $3,500, $10,300, and $4,550 in federal income taxes during 2019, 2018, and 2017, respectively.
NI Holdings, Inc. (“NI Holdings”) is a North Dakota business corporation that is the stock holding company of Nodak Insurance Company and became such in connection with the conversion of Nodak Mutual Insurance Company from a mutual to stock form of organization and the creation of a mutual holding company. The conversion was consummated on March 13, 2017. Immediately following the conversion, all of the outstanding shares of common stock of Nodak Insurance Company (the successor to Nodak Mutual Insurance Company) were issued to Nodak Mutual Group, Inc., which then contributed the shares to NI Holdings in exchange for 55% of the outstanding shares of common stock of NI Holdings. Nodak Insurance Company then became a wholly-owned stock subsidiary of NI Holdings. Prior to completion of the conversion, NI Holdings conducted no business and had no assets or liabilities. As a result of the conversion, NI Holdings became the holding company for Nodak Insurance Company and its existing subsidiaries. The newly issued shares of NI Holdings were available for public trading on March 16, 2017.
Nodak Insurance is the largest domestic property and casualty insurance company in North Dakota. Nodak Insurance was incorporated on April 15, 1946 under the laws of North Dakota, and benefits from a strong marketing affiliation with the North Dakota Farm Bureau Federation (“NDFB”). Nodak Insurance specializes in providing private passenger auto, homeowners, farmowners, commercial, crop hail, and Federal multi-peril crop insurance coverages.
Battle Creek is controlled by Nodak Insurance via a surplus note and 100% quota-share agreement. The terms of the surplus note and quota-share agreement allow Nodak Insurance to appoint two-thirds of the Battle Creek Board of Directors. Battle Creek is a property and casualty insurance company writing personal auto, homeowners, and farm coverages solely in the state of Nebraska.
The same executive management team provides oversight and strategic direction for the entire organization. Nodak Insurance provides common product oversight, pricing practices, and underwriting standards, as well as underwriting and claims administration, to itself, American West, and Battle Creek. Primero and Direct Auto personnel manage the day-to-day operations of their respective companies. The insurance companies share a combined business plan to achieve market penetration and underwriting profitability objectives. Distinctions within the products of the insurance companies generally relate to the states in which the risk is located and specific risk profiles targeted within similar classes of business.
Our Consolidated Financial Statements, which we have prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), include our accounts and those of our wholly-owned subsidiaries, as well as Battle Creek, an entity we control via contract. We have eliminated all significant inter-company accounts and transactions in consolidation. The terms “we”, “us”, “our”, or “the Company” as used herein refer to the consolidated entity.
Cash and cash equivalents include certain investments in highly liquid debt instruments with original maturities of three months or less. Cost approximates fair value for these short-term investments.
We review our investments each quarter to determine whether a decline in fair value below the amortized cost basis is other than temporary. Accordingly, we assess whether we intend to sell or it is more likely than not that we will be required to sell a security before recovery of its amortized cost basis. For fixed income securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as losses in the Consolidated Statement of Operations, but is recognized in other comprehensive income.
Level III - Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the reporting entity’s own assumptions that market participants would use in pricing the asset or liability. Level III assets and liabilities include financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Certain amounts in the 2018 Consolidated Financial Statements have been reclassified to conform to the 2019 presentation. The reclassifications did not impact the 2017 Consolidated Financial Statements.
The Company uses the direct write-off method for recognizing bad debts. Accounts billed directly to the policyholder are provided grace payment and cancellation notice periods per state insurance regulations. Any earned but uncollected premiums are written off within 90 days after the effective date of policy cancellation.
Direct Auto also provides for agency billing for a portion of their agents. Accounts billed to agents are due within 60 days of
With the exception of Battle Creek, which files a stand-alone federal income tax return, we currently file a consolidated federal income tax return. For the year ended December 31, 2017 and thereafter, the consolidated federal income tax return included, and will include thereafter, NI Holdings and its wholly-owned subsidiaries. Direct Auto became part of the consolidated federal income tax return as of its acquisition date.
company by the sellers. The goodwill that arose from this transaction is included in the basis of the net assets acquired and is not deductible for income tax purposes.
Intangible assets arising from the acquisition of Direct Auto in 2018 represent the estimated fair values of certain intangible assets, including a favorable lease contract, a state insurance license, the value of the Direct Auto trade name, and the value of business acquired (“VOBA”). The state insurance license asset has an indefinite life, while the favorable lease contract, Direct Auto trade name, and VOBA assets will be amortized over eighteen months, five years, and twelve months, respectively, from the August 31, 2018 acquisition/valuation date.
On August 31, 2018, the Company completed the acquisition of 100% of the common stock of Direct Auto from the private shareholders of Direct Auto, and Direct Auto became a consolidated subsidiary of the Company. Direct Auto is a property and casualty insurance company specializing in non-standard automobile insurance in the state of Illinois. The Company realized a $4,578 gain on the purchase of Direct Auto due to the use of applicable purchase accounting guidance (known as a “bargain purchase”).
We assigned fair values to the acquired intangibles consisting of favorable lease contract, state insurance license, Direct Auto trade name, and VOBA of $20, $100, $248, and $5,134, respectively. The state insurance license has an indefinite life, while the other intangibles will be amortized over useful lives of up to five years.
During the years ended December 31, 2019 and 2018, the acquired Direct Auto business contributed revenues of $49,135 and $14,178, respectively, and net income of $9,867 and $2,979, respectively, to the Company. The following unaudited pro forma summary presents consolidated information of the Company as if the business combination had occurred on January 1, 2017:
These pro forma amounts have been calculated after applying the Company’s accounting policies and adjusting the results of Direct Auto’s operations to reflect the deferral and amortization of policy acquisition costs and the additional amortization that would have been charged assuming the fair value adjustments to intangibles had been applied from January 1, 2017, with the related income tax effects.
In March 2016, the FASB issued amended guidance to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the Consolidated Statement of Cash Flows. All excess income tax benefits and income tax deficiencies should be recognized as income tax expense or benefit in the Consolidated Statement of Operations, instead of affecting additional paid-in-capital on the Consolidated Balance Sheet. These discrete income tax items should be classified along with other income tax cash flows as an operating activity on the Consolidated Statement of Cash Flows. In addition, cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity. Amendments requiring recognition of excess income tax benefits
and income tax deficiencies in the Consolidated Statement of Operations should be applied prospectively. The Company early adopted this guidance on a prospective basis for the year ended December 31, 2017. At the date of adoption, there was an immaterial impact to the computation of diluted earnings per share, but no impact to the Company’s financial position or results of operations.
2019 for Securities and Exchange Commission filers that are not smaller reporting companies. For private companies, smaller reporting companies and emerging growth companies, this guidance is effective for annual reporting periods beginning after December 15, 2022 and interim periods within those fiscal years. Early adoption is permitted for all entities as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are evaluating the impact this new guidance will have on our financial position, results of operations, and cash flows.
In March 2017, the FASB issued amended guidance to shorten the amortization period of premiums on certain purchased callable fixed income securities to the earliest call date. The amended guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for public business entities. For private companies and emerging growth companies, this amended guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are evaluating the requirements of this guidance and the potential impact to our financial position, results of operations, and cash flows.
The amortized cost and estimated fair value of investment securities as of December 31, 2019 and 2018 were as follows:
Fixed income securities with a fair value of $5,585 at December 31, 2019 and $4,900 at December 31, 2018 were deposited with various state regulatory agencies as required by law. The Company has not pledged any assets to secure any obligations.
As of December 31, 2019, we held 88 fixed income securities with unrealized losses. As of December 31, 2018, we held 317 fixed income securities with unrealized losses. In conjunction with our outside investment advisors, we analyzed the credit ratings of the securities as well as the historical monthly amortized cost to fair value ratio of securities in an unrealized loss position. This analysis yielded no fixed income securities that had fair values less than 80% of amortized cost for the preceding 12-month period.
Our available-for-sale investments are comprised of a variety of different securities, which are classified into levels based on the valuation technique and inputs used in their valuation. The valuation of cash equivalents and equity securities are generally based on Level I inputs, which use the market-approach valuation technique. The valuation of our fixed income securities generally incorporates significant Level II inputs using the market and income approach techniques. We may assign a lower level to inputs typically considered to be Level II based on our assessment of liquidity and relative level of uncertainty surrounding inputs. There were no assets or liabilities classified at Level III at December 31, 2019 or 2018.
The following tables set forth our assets that are measured on a recurring basis by the level within the fair value hierarchy in which fair value measurements fall:
There were no liabilities measured at fair value on a recurring basis at December 31, 2019 or 2018.
As a group, during the year ended December 31, 2019, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $78,600 in excess of its $10,000 retained risk. During the years ended December 31, 2018 and 2017, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $74,600 in excess of its $10,000 retained risk. For 2020, the catastrophe retention amount remains at $10,000 while the overall catastrophic reinsurance program limit increased to $97,000. See Note 24.
The Company actively monitors and evaluates the financial condition of the reinsurers and develops estimates of the uncollectible amounts due from reinsurers. Such estimates are made based on periodic evaluation of balances due from reinsurers, judgments regarding reinsurers’ solvency, known disputes, reporting characteristics of the underlying reinsured business, historical experience, current economic conditions, and the state of reinsurer relations in general. Collection risk is mitigated from reinsurers by entering into reinsurance arrangements only with reinsurers that have strong credit ratings and statutory surplus above certain levels. The Company’s largest reinsurance recoverables on paid and unpaid losses were due from reinsurance companies with A.M. Best ratings of “A-” or higher.
If 100% of our ceded reinsurance was cancelled as of December 31, 2019, no ceded commissions would need to be returned to the reinsurers. Reinsurance contracts are typically effective from January 1 through December 31 each year.
The following table presents required supplementary information about average historical claims duration as of December 31, 2019:
We were organized by the NDFB to provide insurance protection for its members. We have a royalty agreement with the NDFB that recognizes the use of their trademark and provides royalties to the NDFB based on the premiums written on Nodak Insurance’s insurance policies. Royalties paid to the NDFB were $1,352, $1,315, and $1,289 during the years ended December 31, 2019, 2018, and 2017 respectively. Royalty amounts payable of $115 and $108 were accrued as a liability to the NDFB at December 31, 2019 and 2018, respectively.
State insurance laws require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance subsidiaries are subject to regulations that restrict the payment of dividends from statutory surplus and may require prior approval from their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital (“RBC”) requirements that may further affect their ability to pay dividends. Our insurance subsidiaries statutory capital and surplus at December 31, 2019 exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements, by a significant margin.
The amount available for payment of dividends from Nodak Insurance to NI Holdings during 2020 without the prior approval of the North Dakota Insurance Department is $18,984 based upon the policyholders’ surplus of Nodak Insurance at December 31, 2019. Prior to its payment of any extraordinary dividend, Nodak Insurance will be required to provide notice of the dividend to the North Dakota Insurance Department. This notice must be provided to the North Dakota Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The North Dakota Insurance Department has the power to limit or prohibit dividend payments if Nodak Insurance is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity. No dividends were declared or paid by Nodak Insurance during the years ended December 31, 2019, 2018, or 2017.
The following table illustrates the impact of including Battle Creek in our Consolidated Balance Sheets prior to intercompany eliminations:
The Company sponsors a money purchase plan that covers all eligible employees. Plan costs are funded annually as they are earned. The Company reported expenses related to the money purchase plan totaling $618, $598, and $854 during the years ended December 31, 2019, 2018, and 2017, respectively.
The Company also sponsors a 401(k) plan with an automatic contribution to all eligible employees and a matching contribution for eligible employees of 50% up to 3% of eligible compensation. The Company reported expenses related to the 401(k) plan totaling $516, $475, and $411 during the years ended December 31, 2019, 2018, and 2017, respectively. All fees associated with both plans are deducted from the eligible employee accounts.
The Company has established an Employee Stock Ownership Plan (the “ESOP”). The ESOP is intended to be an employee stock ownership plan within the meaning of Internal Revenue Code Section 4975(e)(7) and will invest solely in common stock of the Company.
It is anticipated that the only assets held by the ESOP will be shares of the Company’s common stock. Participants in the ESOP cannot direct the investment of any assets allocated to their accounts. The initial ESOP participants are employees of Nodak Insurance. The employees of Primero and Direct Auto do not participate in the ESOP. American West and Battle Creek have no employees.
The Company recognized compensation expense of $405, $400, and $401 during the years ended December 31, 2019, 2018, and 2017, respectively, related to the ESOP.
At December 31, 2019 and 2018, we had no unrecognized tax benefits, no accrued interest and penalties, and no significant uncertain tax positions. No interest and penalties were recognized during the years ended December 31, 2019, 2018, or 2017.
At December 31, 2019 and 2018, the Company, other than Battle Creek, had no income tax related carryovers for net operating losses, alternative minimum tax credits, or capital losses. Battle Creek, which files its federal income tax returns on a stand-alone basis, had net operating loss carryovers of $4,652 and $4,786 at December 31, 2019 and 2018, respectively. The net operating loss carryforward expires beginning in 2021 through 2030.
The Company does not have any unrecorded or potential contingent liabilities or material commitments requiring the use of assets as of December 31, 2019 and 2018.
On May 23, 2017, our Board of Directors approved an authorization for the repurchase of up to $8 million of the Company’s outstanding common stock. We completed the repurchase of 446,671 shares of our common stock for $8,037 during the three months ended June 30, 2017, and reflected the cost of this treasury stock as a reduction of Equity within our Consolidated Balance Sheet.
At December 31, 2019, there was $994 of unrecognized compensation cost related to outstanding PSUs. That cost is expected to be recognized over a weighted-average period of 1.61 years.
As described in Note 1, the conversion of the mutual company to a stock company resulted in the issuance of NI Holdings common shares on March 13, 2017. Earnings per share is computed by dividing net income available to common shareholders for the period by the weighted average number of common shares outstanding for the same period. The weighted average number of common shares outstanding was 22,179,747, 22,358,858, and 22,512,401 for the years ended December 31, 2019, 2018, and 2017, respectively. For the period prior to the date of the conversion, we assumed that the net common shares issued in the initial public offering of 22,760,000 shares were outstanding since January 1, 2017.
Unearned ESOP shares are not considered outstanding until they are released and allocated to plan participants. Unearned RSU and PSU shares are not considered outstanding until they are earned by award participants.
We do not assign or allocate all Consolidated Statement of Operations or Consolidated Balance Sheet line items to our operating segments. Those line items include investment income, net capital gain on investments, other income excluding non-standard auto insurance fees, and income taxes within the Consolidated Statement of Operations. For the Consolidated Balance Sheet, those items include cash and investments, property and equipment, other assets, accrued expenses, federal income taxes recoverable or payable, and equity.
State insurance laws require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance subsidiaries are subject to regulations that restrict the payment of dividends from statutory surplus and may require prior approval from their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital (“RBC”) requirements that may further affect their ability to pay dividends. Our insurance subsidiaries statutory capital and surplus at December 31, 2019 and 2018 exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements, by a significant margin.
The following table provides a summary of unaudited quarterly results for the periods presented.
On January 1, 2020, the Company completed the acquisition of 100 percent of the issued and outstanding stock of Westminster American Insurance Company (“Westminster American”) from private shareholders. Westminster American is headquartered in Owings Mills, Maryland and writes commercial multi-peril commercial insurance in the states of Delaware, Georgia, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Virginia, and West Virginia, and the District of Columbia through independent agents. The current president of Westminster American will continue to manage the Westminster American insurance operations along with the current staff and management team.
Under the terms of the stock purchase agreement, NI Holdings paid Westminster American shareholders $20,000 at the closing date, and will pay approximately $6,667 annually over the three-year period from the date of closing, subject to certain adjustments. In addition, in connection with his continued employment after closing, NI Holdings has agreed to pay the current president of Westminster American a retention bonus in the aggregate amount of $5,000, payable over the five-year period from the date of closing.