PPIX was an unincorporated exchange organized on April 20, 2004 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange. PPIX provided medical professional liability insurance consisting of claims-made, tail, claims made plus, and occurrence policies to its subscribers (policyholders). On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and became a wholly owned subsidiary of PPIX. PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018. PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”). Keystone is owned by an insured of Positive Insurance Company.
PPIX marketed its medical professional liability insurance policies directly to physicians and through independent producers to doctors and allied healthcare professionals who practice in Pennsylvania, Delaware, Maryland, New Jersey, and Ohio.
PPIX was managed by Specialty Insurance Services, LLC (“SIS”), a Pennsylvania limited liability company, pursuant to the terms of an Attorney-In-Fact Agreement between the exchange and SIS. SIS provided underwriting and administrative services to PPIX based on a percentage not to exceed 25% of gross written premiums, less return premiums. As the attorney-in-fact, SIS had the power to direct the activities of PPIX that most significantly impact PPIX’s economic performance. Diversus acquired 100% of the ownership interests of SIS on January 1, 2017.
PCA was an unincorporated, reciprocal insurance association organized on April 16, 2003 and formed for the purpose of insuring its subscribers against loss due to the imposition of legal liability. PCA provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).
PCA marketed its medical professional liability insurance policies through independent producers, primarily to doctors and allied healthcare providers who practice in Pennsylvania. In November 2015, PCA was granted a license to write insurance in Michigan and began writing policies in Michigan in the fourth quarter of 2015.
The MPLI market began to experience a soft market cycle around the second quarter of 2008, due primarily to the large rate increases taken over the previous six years. The soft market continued and was facilitated by the restructuring of the healthcare industry, partially as a result of the Affordable Care Act. This resulted in significant price competition, as the number of medical professionals practicing independent of hospitals or large professional groups began to decline. According to a study prepared by the National Association of Insurance Commissioners, MPLI direct premiums written declined by 24.0% on a national basis from 2006 to 2018 and declined by 14.6% in Pennsylvania and 33.0% in New Jersey during this same time period. This resulted in lower direct premiums written and lower operating profits for many MPLI carriers.
In addition to pricing increases, in what we perceive to be the beginnings of a hard market, we intend to achieve further premium growth with our expansion into new states. Positive Insurance Company is currently in the process of obtaining licenses to write business in the states of California and Florida and was recently admitted into Texas in November 2019.
Our operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughout the United States. These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force. Our management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on our operations and financial position and developing operational and financial plans to address those matters.
With respect to claims, our policyholder base mainly consists of physicians, their corporations and medical groups. During the COVID-19 pandemic, on-site visits to doctors have declined and been replaced by an increase in telehealth/virtual office visits. Since the COVID-19 pandemic resulted in government-issued work from home orders, we have seen the number of new claims reported begin to decrease. In general, our expectation is that the frequency of new claims reported during this time period will decrease. As to actual claims relating to COVID-19 exposures, we anticipate that the number of claims will be minimal. Unless some unforeseen fact pattern is established, we expect that the difficulty of establishing the source of a COVID-19 exposure, as well as the heroic efforts of healthcare providers, will serve to make such claims unattractive to both patients and their counsel. We do not anticipate our loss and LAE ratios to be impacted. However, this view could change in the future depending on the duration of the pandemic and if the lower frequency of new claims reported becomes a trend.
Net investment income and net realized and unrealized gains (losses) from investments
The loss and LAE ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned. Positive Insurance Company measures the loss and LAE ratio on a policy year and calendar year loss basis to measure underwriting profitability. A policy year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that year. A calendar year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior policy years as a percentage of premiums earned during that year.
The combined ratio is a measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to the sum of losses and loss adjustment expenses and other underwriting expenses, all divided by net premiums earned. If the combined ratio is below 100%, we are making an underwriting profit. If our combined ratio is at or above 100%, we are not profitable without investment income and may not be profitable if investment income is insufficient.
Operating income (loss) measures the profitability of business operations. We define it as GAAP net income (loss) excluding net realized investment gains and losses, net of tax. Net realized investment activity is excluded because net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business operations. Operating income is a non-GAAP measure which is important for an understanding of our overall results of operations. However, it does not replace net income (loss) as the GAAP measure of our consolidated results of operations, nor should it be viewed as a substitute for measures determined in accordance with GAAP.
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. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments:
the valuation of our investment portfolio and assessment of other-than-temporary impairments (“OTTI”);
We believe our accounting policies for these items are of critical importance to our consolidated financial statements. The following discussion provides more information regarding the estimates and assumptions required to arrive at these amounts.
exposure presented by the claim. Each claim is contested or settled individually based upon its merits, and some claims may take years to resolve, especially if legal action is involved. Case reserves are reviewed on a regular basis and are updated as new information becomes available.
We accrue liabilities for unpaid losses and LAE based upon estimates of the ultimate amount payable. We project our estimate of ultimate losses and LAE by using the following actuarial methodologies:
Bornhuetter-Ferguson Method (Paid and Incurred) - The Bornhuetter-Ferguson Method is a blended method that explicitly takes into account both actual loss development to date and expected future loss emergence. This method is applied on both a paid loss development basis and an incurred loss development basis. This method uses the selected loss development patterns from each of the two loss development methods to calculate the expected percentage of loss unpaid or unreported, as applicable. The expected future loss component of the method is calculated by multiplying earned premium for the given exposure period by a selected a priori (i.e. deductive) loss ratio. The resulting dollars are then multiplied by the expected percentage of unpaid (or unreported) loss described above. This provides an estimate of future paid (or reported) losses that is then added to actual paid (or incurred) loss data to produce estimated ultimate loss.
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, and legislative changes, among others. The impact of many of these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Loss reserve estimation is affected by the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. We continually refine our loss reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. We consider all significant facts and circumstances known at the time loss reserves are established.
Our independent actuary determined a range of reasonable reserve estimates shown in the tables below, which reflect the uncertainty inherent in the loss reserve process. This range does not represent the range of all possible outcomes. We believe that the actuarially determined ranges represent reasonably likely changes in the loss and LAE estimates, however, actual results could differ significantly from these estimates. The range was determined after a review of the output generated by the various actuarial methods utilized. Our actuary reviewed the variance around the select loss reserve estimates for each of the actuarial methods and selected reasonable low and high estimates based on their knowledge and judgment. In addition, when selecting these low and high estimates, the actuary considered:
The width of the range in reserves arises primarily because specific losses may not be known and reported for some time and the ultimate losses and LAE paid and incurred with respect to known losses may be larger or smaller than currently estimated. The ultimate frequency or severity of the claims can be very different than the assumptions used in the estimation of our ultimate reserves for these exposures.
Specifically, the following factors could impact the frequency and severity of claims and, therefore, the ultimate amount of losses and loss adjustment expenses paid:
The rate of increase in medical costs that underlie insured risks; and
The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts less than originally estimated or a reduction in the estimate for unpaid losses and loss adjustment expense (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts greater than originally estimated or an increase in the estimate for unpaid losses and loss adjustment expense (unfavorable development).
experience. Tail policy development factors were derived from the occurrence factors. Management does not believe that the effects of these changes had a material impact on the Company’s estimates. The year-end loss reserve analysis also assumes that the Company will no longer utilize Andrews Outsource Solutions LLC to provide claims processing and risk management services following 2020, a measure which is expected to reduce the amount of LAE incurred in subsequent periods. If this action is not taken, then the Company’s reserves for loss adjustment expenses would increase as a result. There were no other significant changes in the methodologies and assumptions used to develop the liabilities for losses and LAE during the year ended December 31, 2019.
At December 31, 2019 and 2018, Positive Insurance Company’s total liability for losses and LAE was $63,607,975 and $68,392,333, respectively.
In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.
At December 31, 2019, our carried reserves for losses and loss adjustment expenses, net of reinsurance, reflect an estimate of loss and LAE reserves that is approximately the point estimate of our actuaries’ range of loss reserves. If the liability for losses and loss adjustment expenses were recorded at the high end of the actuarially determined range, then the liability for losses and loss adjustment expenses would increase, which would result in a higher net loss and lower equity. If the liability for losses and loss adjustment expenses were recorded at the low end of the actuarially determined range, then the liability for losses and loss adjustment expenses would be reduced with a corresponding increase in net income and equity.
Our investment portfolio is invested primarily in publicly traded, investment grade, fixed maturity securities with an average credit quality of A as rated by nationally recognized credit rating agencies. The portfolio is externally managed by independent, professional investment managers and is broadly diversified across sectors and issuers. Exposures are aggregated, monitored, and actively managed by our Investment Committee. We also have an investment policy statement which requires managers to maintain highly diversified exposures to individual issuers and closely monitor compliance with portfolio guidelines. Our investment portfolio also includes equity securities.
At December 31, 2019, our fixed maturity securities had an overall average credit quality of A. The credit quality of our fixed maturity securities at the end of the year was broken down as follows:
Ratings as assigned by Standard and Poor’s. Such ratings are generally assigned at the time of the issuance of the securities, subject to revision on the basis of ongoing evaluations.
At December 31, 2019, all but 17 of the publicly traded securities in our fixed maturity portfolio were of investment grade credit quality. The 17 below investment grade securities had an aggregate fair value of $838,762 and a net unrealized loss of $(3,761).
For 2019, our investment portfolio experienced a gain in the net change in unrealized gains/losses of $5,088,803, with gains occurring in fixed maturity securities and equity securities.
The table below presents the level within the fair value hierarchy generally utilized to estimate the fair value of assets disclosed on a recurring basis at December 31, 2019 and 2018:
Our reinsurance recoverable balance at December 31, 2019 was $7,850,409, which we anticipate will be fully collectible. Although the contractual obligation of individual reinsurers to pay their reinsurance obligations is determinable from specific contract provisions, the collectability of such amounts requires estimation by management. Many years may pass between the occurrence of a claim, when it is reported to us and when we ultimately settle and pay the claim. As a result, it can be several years before a reinsurer has to actually remit amounts to us. Over this period of time, economic conditions and operational performance of a particular reinsurer may impact their ability to meet these obligations and while they may still acknowledge their contractual obligation to do so, they may not have the financial resources to fully meet their obligation to us. If this occurs, we may have to write down a reinsurance recoverable to its then determined net realizable value and reflect that write-down in earnings in the period such determination is made. We attempt to limit any such exposure to uncollectible reinsurance recoverable by assessing the creditworthiness of our reinsurers. In addition, we require collateral, such as assets held in trust or letters of credit, for certain reinsurance recoverable balances. However, if our future estimate of uncollectible recoverable exceeds our current expectations, we may need to record an allowance for uncollectible reinsurance recoverable. This allowance would result in a charge to earnings in the period recorded. Accordingly, any related charge could have a material adverse effect on our financial condition, results of operations and liquidity.
At December 31, 2019, the amount of our reinsurance recoverable which was uncollateralized was $1,799,409. This uncollateralized balance was recoverable from reinsurers rated “A” or better by A.M. Best.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) into law. The CARES Act includes certain income tax-related law changes that we believe will have a material effect on our deferred income taxes in 2020. The most significant effect on our deferred income taxes is expected to be due to changes in the Federal net operating loss (“NOL”) carryback provisions which will allow us to carryback NOLs originating in 2018 and 2019 to prior tax years with corporate income tax rates of 34% (as opposed to forward to future tax years with corporate income tax rates of 21%). We estimate that this change will result in additional Federal income tax refunds of approximately $1.1 million during 2020 and will reduce our NOL by about $3.1 million, or about $650,000 tax-effected.
The major components of consolidated revenues and pre-tax loss for 2019 and major components of combined revenues and pre-tax loss for 2018 are as follows:
The following table sets forth our average cash and invested assets and investment income for 2019 and 2018:
The total gain on sales of investments in 2019 includes a realized gain of $556,723 related to sales of our interests in limited partnership equity hedge funds. Our fixed maturity investments and equity investments are available-for-sale because we may, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies.
The improved loss and LAE ratio for 2019 reflects lower adverse loss reserve development in prior accident years. During 2019, we recorded unfavorable prior year loss reserve development of $136,271, compared to unfavorable prior year development of $4,057,821 in 2018.
The MPLI line of business is prone to variability in the loss reserving process due to the extended period of time during which claims can be made and the subsequent time required to settle those claims. 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.
The provision for income taxes for 2019 and 2018 resulted in an income tax expense (benefit) of $6,986 and $(1,935,328), respectively. The Company’s effective tax rate for 2019 and 2018 was 21%.
Liquidity is a measure of an entity’s ability to secure sufficient cash to meet its contractual obligations and operating needs. Our insurance operations generate cash by writing policies and collecting premiums. The cash generated is used to pay losses and LAE as well as other underwriting expenses. Any excess cash is invested and earns investment income.
Cash flows used in operating activities increased during 2019, compared to prior year, primarily attributable to the current year payment of the $10,000,000 prepaid management fee to Diversus. Cash flows from investing activities decreased in 2019, compared to 2018, mainly due to additional purchases of fixed maturity securities. The increase in cash flows from financing activities reflects the initial public offering stock issuance of $33,574,401 in March 2019.
Our insurance subsidiary, Positive Insurance Company, is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the holding company. In considering future dividend policy, Positive Insurance Company will consider, among other things, applicable regulatory constraints. At December 31, 2019, Positive Insurance Company had statutory surplus of $39,415,264.
An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by PPHI to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of PPHI, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions. Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to PPHI for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.
Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department. This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity.
Results presented in accordance with GAAP vary in certain respects from results presented in accordance with statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department (collectively “SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners publications. Permitted SAP encompasses all accounting practices that are not prescribed. Our domestic insurance subsidiary uses SAP to prepare various financial reports for use by insurance regulators.
For a discussion of recent accounting guidance, see Note 4 to the Consolidated and Combined Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
Consolidated Balance Sheet as of December 31, 2019 and Combined Balance Sheet as of December 31, 2018
Consolidated Statement of Operations for the Year Ended December 31, 2019 and Combined Statement of Operations for the Year Ended December 31, 2018
Consolidated Statement of Stockholders’ Equity for the Year Ended December 31, 2019 and Combined Statement of Stockholders' Equity for the Year Ended December 31, 2018
Consolidated Statement of Cash Flows for the Year Ended December 31, 2019 and Combined Statement of Cash Flows for the Year Ended December 31, 2018
The accompanying notes are an integral part of these consolidated and combined financial statements.
The accompanying consolidated financial statements include the accounts of Positive Physicians Holdings, Inc. and its wholly owned subsidiary (collectively referred to as the “Company”). Positive Physicians Holdings, Inc. is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”). In connection with the completion of the Company’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies and were merged together to form Positive Physicians Insurance Company (“Positive Insurance Company”), a wholly owned subsidiary of the Company. The Company’s initial public offering and its acquisition of Positive Insurance Company were completed on March 27, 2019. Prior to that time, the Company had minimal assets and liabilities and had not engaged in any operations. References to the Company or Positive Insurance Company financial information in this Annual Report prior to the conversion and merger date is to the financial information of PPIX, PCA, and PIPE on a combined basis. When used in this Annual Report, “we” and “our” mean PPIX, PCA, and PIPE prior to March 27, 2019, and Positive Insurance Company thereafter.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and notes. Actual results could differ from these estimates and such differences could be material. The Company’s principal estimates include the liability for losses and loss adjustment expenses, deferred acquisition costs, other-than-temporary impairments of investments, and valuation of deferred tax assets.
Investments in fixed maturity securities are classified as available-for-sale and are stated at fair value. Unrealized holding gains and losses, net of related tax effects, on available-for-sale fixed maturity securities are recorded directly to accumulated other comprehensive income (loss). Investments in equity securities are stated at fair value and unrealized holding gains and losses are credited or charged to net income (loss) as incurred and are included in realized investment (losses) gains, net in the accompanying consolidated and combined statements of operations.
A fixed maturity security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) we intend to sell the security, 2) it is more likely than not that we will be required to sell the security before recovery of the security’s amortized cost basis, or 3) we believe we will be unable to recover the entire amortized cost basis of the security (i.e., credit loss has occurred). Other-than-temporary-impairments (“OTTI”) of fixed maturity securities are separated into credit and noncredit-related amounts when there are credit-related losses associated with the impaired fixed maturity security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors is recorded in other comprehensive income (loss). A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, computed using original yield as the discount rate, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.”
Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the successful production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, then they would be written off.
Prepaid management fee comprises costs incurred by the Company to execute a new management agreement with Diversus Management and is amortized on a straight-line basis over the seven-year useful life of the agreement.
Liability for losses and loss adjustment expenses include an amount determined from individual case estimates and loss reports and an amount, based on prior experience, actuarial assumptions and management judgments for losses incurred but not reported. Such liabilities are necessarily based on assumptions and estimates, and while management believes the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates for establishing the resulting liabilities are continually reviewed. Estimating the ultimate cost of future losses and loss adjustment expenses is an uncertain and complex process. This estimation process is based upon the assumption that past developments are an appropriate indicator of future events and involves a variety of actuarial techniques that analyze experience, trends, and other relevant factors. The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedure, as well as external factors, such as economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future. Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.
The Company cedes insurance risk to other insurance companies. This arrangement allows us to minimize the net loss potential arising from large risks. Reinsurance contracts do not relieve the Company of its obligation to its policyholders. Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract.
No one insured accounted for over 10% of premiums receivable at December 31, 2019 and December 31, 2018 or gross written premium for the years ended December 31, 2019 and 2018. We have reinsurance contracts with various reinsurers all of whom have A.M. Best ratings of A or better or have provided collateral to secure their obligations.
Premiums are earned on a daily pro rata basis over the terms of the insurance policies. Unearned premium reserves are established to cover the unexpired portion of the policies in force less amounts ceded to reinsurers. For consideration received for policies with effective dates subsequent to the reporting period, the Company records an advance premium liability in lieu of written premium.
Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale fixed maturity securities and unrealized losses related to factors other than credit on fixed maturity securities, are reported as a separate component in the equity section in the accompanying consolidated and combined balance sheets. Such items, along with net income (loss), are components of comprehensive income (loss), and are reflected in the accompanying consolidated and combined statements of comprehensive income (loss). Reclassifications of realized gains and losses on sales of investments out of accumulated other comprehensive income (loss) are recorded in realized investment (losses) gains, net in the accompanying consolidated and combined statements of operations.
Prior to March 27, 2019, PPIX, PCA, and PIPE filed separate federal income tax returns. The Company did not recognize any interest and penalties in the accompanying consolidated statement of operations for the year ended December 31, 2019 and the combined statement of operations for the year ended December 31, 2018. PPIX, PCA, and PIPE remain subject to examination by the Internal Revenue Service for tax years 2016 through 2018 and the short stub period in 2019. Beginning with 2019 tax year, the Company will file a consolidated federal income tax return.
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-01 for the year ended December 31, 2018.
require, among other things, that equity investments be measured at fair value with changes in fair value recognized in net income (loss),
simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment,
eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet,
require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes,
require an entity to present separately in other comprehensive income the portion of the total change in the fair value of the liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments,
require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the consolidated financial statements, and
New accounting rules and disclosure requirements can impact the results and the comparability of the Company’s consolidated and combined financial statements. The following recently issued accounting pronouncements are relevant to the Company’s consolidated and combined financial statements:
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments. The amendments in this Update require a new topic to be added (Topic 326) to the Accounting Standards Codification ("ASC") and removes the thresholds that entities apply to measure credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities. Under current GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred. The guidance under ASU 2016-13 will remove all current recognition thresholds and will require entities under the new current expected credit loss ("CECL") model to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that an entity expects to collect over the instrument's contractual life. The new CECL model is based upon expected losses rather than incurred losses. Additionally, the credit loss recognition guidance for available-for-sale securities is amended and will require that credit losses on such debt securities should be recognized as an allowance for credit losses rather than a direct write-down of amortized cost balance. The ASU was effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which extended the effective date of adopting ASU 2016-13. Under ASU 2019-10, ASU 2016-13 will be effective for Public Business Entities that are SEC filers, excluding smaller reporting companies such as the Company, for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. For all other entities, including smaller reporting companies like the Company, ASU 2016-13 will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all entities, early adoption will continue to be permitted; that is, early adoption is allowed for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (that is, effective January 1, 2019, for calendar year-end companies). The Company is currently a smaller reporting company, so once the ASU becomes effective, the Company’s expected adoption date for ASU 2016-13 would change from fiscal years beginning after December 15, 2019 to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. At this time, we are evaluating the potential impact of ASU 2016-13 in the Company’s consolidated financial statements.
Under ASC Topic 820, we base fair values of assets on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of the consolidated and combined financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.
Amortized cost/cost, gross unrealized gains, gross unrealized losses, and fair value of fixed maturity securities by major security type for the results at December 31, 2019 and 2018 are as follows:
The following table shows fair value and gross unrealized losses of our fixed maturity investments with unrealized losses that are not deemed to be other-than temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019:
At December 31, 2018, we had 210 fixed maturity securities in unrealized loss positions of less than 12 months with a combined gross unrealized loss of $581,464 and 243 fixed maturity securities in unrealized loss positions of 12 months or longer with a combined gross unrealized loss of $1,197,367.
Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates, which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions.
We evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. We found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed. Our fixed maturity portfolio is managed by our investment committee in concert with an outside investment manager for investment grade bond investments. By agreement, the investment manager cannot sell any security without the consent of our investment committee if such sale will result in a net realized loss.
We monitor our investment portfolio and review securities that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. When assessing whether the amortized cost basis of the security will be recovered, we compare the present value of the cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as the “credit loss.” If there is a credit loss, the impairment is considered to be other-than-temporary. If we identify that an other-than-temporary impairment loss has occurred, we then determine whether we intend to sell the security, or if it is more likely than not that we will be required to sell the security prior to recovering the amortized cost basis less any current-period credit losses. If we determine that we do not intend to sell, and it is more likely than not that we won’t be required to sell the security, then the amount of the impairment loss related to the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of tax. If we determine that we intend to sell the security, or that it is more likely than not that we will be required to sell the security prior to recovering its amortized cost basis less any current-period credit losses, then the full amount of the other-than-temporary impairment will be recognized in earnings.
The following table summarizes the movements in deferred acquisition costs for the years ended December 31, 2019 and 2018:
Effective as of March 27, 2019, Positive Insurance Company entered into a new policy reinsurance agreement. Under the new agreement, the Company retains a portion of its exposure and pays to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by us are reinsured with other insurance companies principally to:
cover us against losses in excess of policy limits and extra contractual obligation claims;
Other states in which we write insurance require doctors to maintain certain minimum coverage and provide a fund that provides coverage for losses above a certain amount, but some states do not prescribe insurance requirements for doctors.
We offer primary coverage up to $1,000,000 for each claim and $3,000,000 of annual aggregate coverage in Delaware, Maryland, Michigan, Ohio, New Jersey, and South Carolina. We retain the first $300,000 in loss for claims from these states, and reinsurance covers the excess up to $1,000,000. If an insured in New Jersey requests, additional coverage of $1,000,000, each claim, each insured, each policy can be provided and is fully ceded to the reinsurer up to a maximum aggregate liability of $2,000,000 to the reinsurer per the term of the reinsurance agreement. In South Carolina and Michigan, the insured can elect policy limits of $200,000 per claim and, on these claims, we retain the first $100,000 and the reinsurer covers the next $100,000.
Our premiums under the new reinsurance agreement are based on a percentage of our earned premiums during the term of the agreement. The agreement was renewed on April 1, 2020.
We generally do not assume risks from other insurance companies. However, we could be required by statute to participate in guaranty funds, which are formed to pay claims on policies issued by insolvent property and casualty insurers domiciled in certain states, such as Pennsylvania. This participation, where applicable, requires us to pay an annual assessment based on our premiums written and determined on a market share basis. At December 31, 2019, our participation was not material.
The following is supplemental information about average historical claims duration at December 31, 2019:
At December 31, 2019 and 2018, the Company had unused net operating loss (“NOL”) carryforwards of $3,600,298 and $3,865,253, respectively, which will begin to expire in 2038, if unused. At the time of the conversions and merger, the Company had unused NOLs of $4,313,198, which are subject to limitations under Section 382 of the Internal Revenue Code and are limited in the amount that can be utilized in any one year. The Company also has AMT credits of $14,754, which are expected to be fully utilized by 2021. Refer to Note 16, Subsequent Events, for the effects on the NOL carryforwards resulting from the Coronavirus Aid, Relief, and Economic Security Act.
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax planning strategies in making this assessment. At December 31, 2019 and 2018, management determined that it is more likely than not that all of the deferred tax assets will be realized by the Company in future years. Accordingly, the Company did not record a valuation allowance against its deferred tax assets at December 31, 2019 and 2018.
Positive Insurance Company has contracts with Gateway Risk Services, LLC and Andrews Outsource Solutions LLC, both of which are wholly owned subsidiaries of Diversus, under which those companies provide claims processing and risk management services. Fees incurred by Positive Insurance Company under these contracts for 2019 and 2018 were recorded in other underwriting expenses in the consolidated and combined statements of operations, respectively, as follows:
Additionally, the former attorney-in-fact of PCA earned commissions related to our gross written premium and other accounts. Beginning March 27, 2019, these commissions were paid to Specialty Insurance Agency, LLC, a wholly owned subsidiary of Diversus. These commissions for 2019 and 2018 are recorded in other underwriting expenses in the consolidated and combined statements of operations, respectively. Positive Insurance Company incurred related commission expenses for the respective periods, as follows:
The Company and Diversus entered into a loan agreement dated March 27, 2019 to provide a $6,000,000 credit facility to Diversus for working capital purposes. Diversus may borrow in one or more advances up to $5,500,000 under a term loan and up to $500,000 under a revolving loan. Outstanding borrowings under the credit facility will bear interest at 8%, will be unsecured, and will be subordinate to the existing senior debt and other commercial loan obligations of Diversus. The loan is convertible into common stock shares of Diversus at a price of $1 per share at the option of the Company. At December 31, 2019, there was no outstanding balance on the credit facility.
The Company is authorized to issue 10,000,000 shares of $0.01 par value common stock. At December 31, 2018, there were no shares of common stock issued and outstanding. In connection with the completion of the initial public offering on March 27, 2019, 3,615,500 shares of the Company’s common stock were issued. At December 31, 2019, 3,615,500 shares of common stock remain issued and outstanding.
The holding company has cash and other liquid assets aggregating $16,843,126 at December 31, 2019. The holding company’s principal source of future liquidity will be dividend payments from Positive Insurance Company, which is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the Company.
An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by the Company to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of the Company, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions. Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to the Company for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.
Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department. This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation.
As discussed in Note 1, the conversions of PPIX, PCA, and PIPE to stock insurance companies and the simultaneous acquisition of these companies resulted in the issuance of the Company’s common stock at March 27, 2019. The weighted average number of common shares outstanding was 3,615,500 for the year ended December 31, 2019. For the period prior to the date of the conversions, the net common shares issued in the initial public offering were assumed to be outstanding since January 1, 2019.
The following table presents a reconciliation of the numerators and denominators that were used in the basic and diluted per share computations for the Company’s common stock:
In the event a property and casualty insurer operating in a jurisdiction where Positive Insurance Company also operates becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. The Company receives such assessments from the Pennsylvania Property and Casualty Insurance Guaranty Association for which it accrued liabilities of $194,715 and $171,550 at December 31, 2019 and 2018, respectively. These accruals are included in accounts payable, accrued expenses, and other liabilities in the accompanying consolidated and combined balance sheets. Positive Insurance Company has not recorded applicable premium tax credits at December 31, 2019 and 2018 related to guaranty assessments. Total guaranty fund expense, net of prior years’ refunds and premium tax credits, for the years ended December 31, 2019 and 2018 was $70,076 and $35,623, respectively.
The New Jersey Property-Liability Insurance Guaranty Association (“NJPIGA”) was created by the State of New Jersey to provide a safety net for policyholders and claimants of insolvent property-casualty insurance companies. Positive Insurance Company assesses its policyholders as required by NJPIGA in addition to collecting the premium assessed. The assessments collected from policyholders are included in accounts payable, accrued expenses, and other liabilities in the accompanying consolidated and combined balance sheets, and no income is recognized by Positive Insurance Company. At December 31, 2019 and 2018, Positive Insurance Company had liabilities of $40,301 and $36,777, respectively, for amounts collected on behalf of NJPIGA.
Accounting principles used to prepare statutory financial statements differ from those used to prepare these consolidated financial statements under GAAP. Prescribed statutory accounting practices (“SAP”) include state laws, regulations, and general administration rules, as well as a variety of publications from the National Association of Insurance Commissioners (“NAIC”). The statutory financial statements of Positive Insurance Company are prepared in accordance with SAP prescribed by the Pennsylvania Insurance Department.
The Pennsylvania Insurance Department.has adopted certain prescribed accounting practices that differ from those found in NAIC SAP. Specifically, the Pennsylvania Insurance Department permits the deduction of management fees related to unearned premiums from unearned premiums reserve and charging operations on a pro-rata basis over the period covered by these policies; whereas under NAIC SAP, the unearned premiums would not be reduced by the management fees paid related to unearned premiums reserve. With the conversions of PPIX, PCA, and PIPE from reciprocal insurance exchanges into stock insurance companies as of March 27, 2019, the prescribed practice of deducting management fees related to unearned premiums from unearned premiums reserve is no longer applicable to Positive Insurance Company.
A reconciliation of statutory surplus and other funds between NAIC SAP and practices prescribed by the Pennsylvania Insurance Department for the years ended December 31, 2019 and 2018 are as follows:
Positive Insurance Company is subject to minimum risk-based capital (“RBC”) requirements that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances and various levels of risk activity. Regulatory compliance is determined by a ratio of Positive Insurance Company’s total adjusted capital, as defined by the NAIC, to its authorized control level RBC. At December 31, 2019 and 2018, our RBC exceeded minimum RBC requirements.
Subsequent events have been evaluated through May 14, 2020, which is the date the consolidated and combined financial statements were available to be issued.
The Company’s operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughout the United States. These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force. The Company’s management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on the Company’s operations and financial position and developing operational and financial plans to address those matters.