The following tables set forth selected consolidated historical financial information of Conifer Holdings, Inc. and Subsidiaries as of the dates and for the periods indicated. The selected financial data for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 were derived from our audited consolidated financial statements and related notes thereto.
In 2016, as a result of the merger of ACIC into WPIC, the value of intangible assets recorded for insurance licenses on ACIC were written off resulting in a loss. In 2015, the Company recognized a gain as a result of the deconsolidation of an affiliate. In 2013, the Company recognized a gain on the acquisitions of EGI Insurance Services, Inc. and MLBA Mutual Insurance Company. The acquisitions were accounted for as bargain purchases.
Certain statements contained in this Annual Report on Form 10-K, which are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek” and similar terms and phrases, or the negative thereof, may be used to identify forward-looking statements.
We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 44 states, we are licensed to write insurance in 40 states as an admitted carrier and we offer our insurance products in all 50 states.
Through our personal insurance lines, we offer homeowners insurance and dwelling fire insurance products to individuals in several states. Our specialty homeowners insurance line is primarily comprised of either wind-exposed homeowners insurance providing hurricane and wind coverage to underserved homeowners in Texas, Hawaii and Florida or low-value dwelling insurance tailored for owners of lower valued homes, which we have historically offered in Illinois and Indiana, and have now expanded to Louisiana and Texas (where we have an office in Waco). Due to recent Florida-based industry events, we have been de-emphasizing our Florida homeowners' business and reducing our exposures in that state. Otherwise, there has been little change in our approach to managing or evaluating these lines.
We identified the accounting estimates below as critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and which require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of material contingent assets and liabilities. Actual results may differ materially from the estimates and
• Any other information considered pertinent to estimating the indemnity and expense exposure presented by the claim.
IBNR reserves are determined by subtracting case reserves from total estimated loss and LAE reserves, which are based on the ultimate expected losses and LAE less paid loss and LAE. Our actuarial department develops estimated ultimate loss and LAE on a quarterly basis. Our Reserve Review Committee (which includes our Chief Executive Officer, President, Chief Financial Officer, other members of executive management, and key actuarial, underwriting and claims personnel) meets each quarter to review our actuaries’ estimated ultimate expected loss and LAE.
• Loss ratio method-This method uses loss and LAE ratios for prior accident years, adjusted for current trends, to determine an appropriate expected loss and LAE ratio for a given accident year;
Adjusted operating loss, a non-GAAP measure, allocable to common shareholders was $9.5 million or $1.26 per share for the year ended December 31, 2016, compared to an adjusted operating loss allocable to common shareholders of $865,000 or $0.16 per share for the year ended December 31, 2015.
Our combined ratio increased 10.1 percentage points for the year ended December 31, 2016 to 112.2%, compared to 102.1% for the same period in 2015.
The increase was largely attributable to an 8.2 percentage point increase in the loss ratio in 2016, compared to 2015 attributable to higher than expected losses in Florida homeowners, commercial auto, commercial liability products and the personal auto run-off. Our expense ratio increased by 1.9 percentage points for the year ended December 31, 2016, as compared to the same period in 2015. The increase in the expense ratio was primarily due to increased policy acquisition costs as ceding commissions from a quota share agreement reduced commission expense in the first seven months of 2015. This increase was partially offset by improved operating expense ratios as we gained efficiencies from an improved earned premium base.
Our premiums are presented below for the years ended December 31, 2016 and 2015 (dollars in thousands):
Commercial lines gross written premiums increased $20.0 million, or 29.4%, to $88.2 million for the year ended December 31, 2016, as compared to $68.2 million for the year ended December 31, 2015. This increase was primarily driven by expansion in the hospitality and security services product lines.
Net written premiums increased $20.3 million, or 25.4%, to $99.9 million for the year ended December 31, 2016, as compared to $79.7 million for the year ended December 31, 2015. This result is consistent with the 22.6% increase in gross written premiums.
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings or policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the year December 31, 2016 decreased $549,000, or 32.9%, to $1.1 million as compared to $1.7 million for the year ended December 31, 2015. The decrease was primarily due to the deconsolidation of the Affiliate at September 30, 2015. Prior to the deconsolidation their income was recorded as other income, since then their net profit or loss has been recorded as equity earnings.
Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other income was 19.4% and 21.6% for the years ended December 31, 2016 and 2015, respectively. Earned premium growth on a more fixed operating expense structure has helped to reduce the operating expense ratio, which is expected to continue to decline as our earned premium grows.
The portfolio’s average quality was AA at December 31, 2016 and 2015. The portfolio produced a tax equivalent book yield of 2.2% and 2.1% for the years ended December 31, 2016 and 2015, respectively. The average duration of the fixed maturity portfolio was 3.2 years and 3.1 years at December 31, 2016 and 2015.
The Company has established an $8.4 million valuation allowance against 100% of the net deferred tax assets for 2016, which would increase book value per share by $1.10 if reversed in the future, based on current income tax rates. The valuation allowance was $5.2 million for 2015. As of December 31, 2016, the Company has net operating loss carryforwards for federal income tax purposes of $22.8 million, which expire in tax years 2019 through 2036. Of this amount, $15.1 million are limited in the amount that can be utilized in any one year and may expire before they are realized under Section 382 of the Internal Revenue Code. The Company has state net operating loss carryforwards of $8.7 million, which expire in tax years 2030 through 2036.
Personal lines gross written premiums decreased $3.2 million, or 11.2%, to $25.6 million for the year ended December 31, 2015, as compared to $28.8 million for the same period in 2014. The premium decline was driven by the run-off of our personal automobile line in 2015, which saw a $7.3 million decline in premiums, year over year, for 2015. Partially offsetting the lower personal automobile premiums was a $4.1 million increase in premiums for our homeowners line of business. Homeowner premiums grew as a result of strategic underwriting and marketing changes to these lines implemented in late 2014. These changes favorably impacted our personal lines mix of business and drove a 40% increase in premiums in our more profitable wind-exposed business.
The calendar year loss ratios were 56.8% and 68.6% for the years ended December 31, 2015 and 2014, respectively. The 11.8 percentage point decrease in the loss ratio was mainly the result of lower losses in the low-value dwelling and commercial multi-peril lines. Both lines experienced losses that were historically higher in 2014 due to weather-related property damage. In addition, the mix of business continues to evolve as our lines of business with historically lower overall loss ratios grow (such as wind-exposed homeowners, and commercial liability lines), and the historically higher loss ratio businesses decline (such as low-value dwelling in the Midwest and nonstandard automobile).
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased slightly to 23.7% for the year ended December 31, 2015, compared to 24.8% in 2014.
The portfolio’s average quality was AA at December 31, 2015 and December 31, 2014. The portfolio produced a tax equivalent book yield of 2.1% and 1.9% for the years ended December 31, 2015 and 2014, respectively. The average duration of the fixed maturity portfolio was 3.1 years at December 31, 2015 and 2014.
We conduct our business operations primarily through our Insurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the holding company. Secondarily, the holding company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the holding company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the holding company under certain circumstances. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10% of statutory surplus at the end of the preceding year. There were $5.5 million, $3.1 million and $500,000 of dividends paid from our Insurance Company Subsidiaries to the holding company during the years ended December 31, 2016, 2015 and 2014, respectively.
Operating Activities. Cash provided by operating activities for the year ended December 31, 2016, was $6.2 million as compared to cash used in operating activities of $3.1 million for the year ended December 31, 2015. The increase in cash provided by operations was attributable to the overall growth of the business.
Cash used in operating activities for the year ended December 31, 2015 was $3.1 million as compared to cash provided by operating activities of $6.3 million for December 31, 2014. $7.3 million of the change in cash from operating activities in 2015 from 2014 was primarily attributable to the change in the ceded unearned premium related to the quota share arrangement which was adopted December 31, 2014 and dissolved August 1, 2015.
Investing Activities. Cash used in investing activities for the year ended December 31, 2016, was $10.8 million as compared to $15.3 million for the same period in 2015. The fluctuation in the funds used in routine investing activities was due to the timing of standard purchases and sales to fund our insurance operations.
Net cash used in investing activities for the year ended December 31, 2015 was $15.3 million and was primarily attributable to net investments into fixed maturity securities of $23.9 million, offset by the sale of short term investments of $10.3 million.
Financing Activities. Cash provided by financing activities for the year ended December 31, 2016, was $4.4 million as compared to $12.6 million for the same period in 2015. The higher cash provided by financing activities in 2015 was from the proceeds of the initial public offering, partially offset by the repayment of the line of credit.
During the year ended December 31, 2015, we received net funds of $30.4 million from our IPO, received proceeds of $3.1 million for common stock issued to former holders of preferred stock. In addition, we used $6.3 million of the proceeds to repurchase outstanding shares of preferred stock and pay accrued preferred , used $17.0 million to pay off our revolving line of credit, received proceeds from our revolving line of credit of $4.4 million, and used $1.8 million for our routine payments on our term loans.
The Credit Facility contains various restrictive covenants that relate to the Company’s shareholders’ equity, premiums-to-capital and surplus ratios, fixed-charge coverage ratio, risk-based capital ratios, and A.M. Best ratings of its Insurance Company Subsidiaries. At December 31, 2016, the Company was in compliance with all of its Credit Facility covenants except for a minimum tangible net worth (as defined by the agreement) requirement to remain above $65.0 million. The Company’s tangible net worth was $64.1 million at December 31, 2016. The Company received a waiver on March 13, 2017 for this covenant breach as of December 31, 2016, and the agreement was amended to reduce the minimum requirement to $62.0 million from March 31, 2017 to December 30, 2017 and $64.0 million from December 31, 2017 and thereafter, which management expects the Company will exceed in future periods.
The following table is a summary of our contractual obligations and commitments as of December 31, 2016 (dollars in thousands):
At December 31, 2016, both of our Insurance Company Subsidiaries were in excess of any minimum threshold at which corrective action would be required.
Insurance operations are subject to various leverage tests (e.g., premium-to-statutory surplus ratios), which are evaluated by regulators and rating agencies. As of December 31, 2016, on a trailing twelve-month statutory combined basis, the gross written and net written premium leverage ratios were 1.9 to 1.0 and 1.6 to 1.0, respectively.
Refer to list of Financial Statement Schedules (including the Report of Independent Registered Public Accounting Firm referenced therein) set forth in Item 15 of this Annual Report on Form 10-K and Note 19 ~ Quarterly Financial Data (Unaudited) of the Notes to the Consolidated Financial Statements.