The following tables set forth our selected historical consolidated financial and operating information for the periods ended and as of the dates indicated. The income statement data for the years ended December 31, 2017, 2016 and 2015 and the balance sheet data as of December 31, 2017 and 2016 are derived from our audited financial statements included elsewhere in this annual report. These historical results are not necessarily indicative of results to be expected from any future period.
The operating results of property and casualty insurance companies are subject to quarterly and yearly fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. While these cycles can have a large impact on a company’s ability to grow and retain business, we have sought to focus on niche markets and regions where we are able to maintain premium rates at generally consistent levels and maintain underwriting discipline throughout these cycles. We believe that the nature of our P&C insurance products, including their relatively low limits, the relatively short duration of time between when claims are reported and when they are settled, and the broad geographic distribution of our customers, have allowed us to grow and retain our business throughout these cycles. In addition, we have limited our exposure to catastrophe losses through reinsurance. With regard to seasonality, we tend to experience higher claims and claims expense in our P&C segment during periods of severe or inclement weather. Our operating results for the year ended December 31, 2017 have been negatively impacted by losses resulting from severe weather, including Hurricanes Harvey, Irma and Maria, and by losses from California wildfires.
Our most significant balance sheet liability is our unpaid loss and loss adjustment expense (“LAE”) reserves. As of December 31, 2017 and 2016, our reserves, net of reinsurance recoverables on unpaid losses, were $1.5 billion and $1.4 billion, respectively. We record reserves for estimated losses under insurance policies that we write and for loss adjustment expenses related to the investigation and settlement of policy claims. Our reserves for loss and loss adjustment expenses represent the estimated cost of all reported and unreported loss and loss adjustment expenses incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.
Net premium written. Net premium written is gross premium written less that portion of premium that we cede to third-party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement.
Ceding commission income. Ceding commission income is commission we receive based on the earned premium ceded to third-party reinsurers to reimburse us for our acquisition, underwriting and other operating expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, generally on a pro rata basis over the terms of the policies reinsured. The portion of ceding commission revenue which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition costs and other underwriting expenses.
are generally designed to offset expenses incurred in the administration of our insurance business, and are generated as follows. Installment fees are charged to permit a policyholder to pay premiums in installments rather than in a lump sum. Late payment fees are charged when premiums are remitted after the due date and any applicable grace periods. Policy cancellation fees are charged to policyholders when a policy is terminated by the policyholder prior to the expiration of the policy’s term or renewal term, as applicable. Reinstatement fees are charged to reinstate a policy that has lapsed, generally as a result of non-payment of premiums. Insufficient fund fees are charged when the customer’s payment is returned by the financial institution.
All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is canceled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. An insufficient fund fee is recognized when the customer’s payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked.
general and administrative expenses include those charges that are related to the amortization of tangible and intangible assets and non-insurance activities in which we engage.
Interest expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates.
Net operating expense. These expenses consist of the sum of general and administrative expenses and acquisition costs and other underwriting expenses less ceding commission income and service and fee income.
Net combined ratio (non-GAAP). The net combined ratio (non-GAAP) is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss ratio and net operating expense ratio (non-GAAP). If the net combined ratio (non-GAAP) is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. Our definition of net loss ratio and net operating expense ratio is as follows:
Net operating expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net operating expense, is calculated by offsetting acquisition costs and other underwriting expenses and general and administrative expenses by ceding commission income and service and fee income, and is therefore a non-GAAP measure. Management uses net operating expense ratio (non-GAAP) and net combined ratio (non-GAAP) to evaluate financial performance against historical results and establish targets on a consolidated basis. We believe this presentation enhances the understanding of our results by eliminating what we believe are volatile and unusual events and presenting the ratios with what we believe are the underlying run rates of the business. Other companies may calculate these measures differently, and, therefore, their measures may not be comparable to those used by the Company’s management. For a reconciliation showing the total amounts by which acquisition costs and other underwriting expenses and general and administrative expenses were offset by ceding commission income and service and fee income in the calculation of net operating expense, see “Results of Operations - Consolidated Results of Operations” below.
Our significant accounting policies are discussed in Note 2, “Significant Accounting Policies” in the notes to our consolidated financial statements.
Use of estimates and assumptions. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our principal estimates include unpaid losses and LAE reserves; deferred acquisition costs; reinsurance recoverables, including the provision for uncollectible premiums; recording of impairment losses for other-than-temporary declines in fair value; determining the fair value of investments; determining the fair value of share-based awards for stock compensation; the valuation of intangibles and the determination of goodwill and goodwill impairment; and income taxes. In developing the estimates and assumptions, management uses all available evidence. Because of uncertainties associated with estimating the amounts, timing and likelihood of possible outcomes, actual results could differ from estimates.
Reinsurance. We account for reinsurance premiums, losses and LAE ceded to other companies on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Earned premiums and losses and LAE incurred ceded to other companies have been recorded as a reduction of premium revenue and losses and LAE. Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the costs to acquire the underlying policies, generally on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission which represents reimbursement of acquisition costs related to the underlying policies is recorded as an offset to acquisition costs and other underwriting expenses. Commission in excess of acquisition costs is recorded as ceding commission income over the terms of the policies. Certain reinsurance agreements contain provisions whereby the ceding commission rates vary based on the loss experience of the policies covered by the agreements. The Company records ceding commission revenue based on its current estimate of losses on the reinsured policies subject to variable commission rates. The Company records adjustments to the ceding commission revenue in the period that changes in the estimated losses are determined. Reinsurance recoverables are reported based on the portion of reserves and paid losses and LAE that are ceded to other companies. Assessing whether or not a reinsurance contract meets the condition for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums and losses, and is based, in part, on the use of actuarial and pricing models and assumptions. If we determine that a reinsurance contract does not transfer sufficient risk, we account for the contract under deposit accounting.
other comprehensive income in the consolidated statements of comprehensive income. Trading securities are reported at their estimated fair values with all gains and losses included in earnings.
the length of time that the security’s fair value has been below its amortized cost;
the financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations or earnings;
In the event of the decline in fair value of a debt security, a holder of that security that does not intend to sell the debt security and for whom it is not more likely than not that such holder will be required to sell the debt security before recovery of its amortized cost basis is required to separate the decline in fair value into (a) the amount representing the credit loss and (b) the amount related to other factors. The amount of total decline in fair value related to the credit loss shall be recognized in earnings as an other-than-temporary impairment (“OTTI”) with the amount related to other factors recognized in accumulated other comprehensive income or loss, net of tax. OTTI credit losses result in a permanent reduction of the cost basis of the underlying investment. The determination of OTTI is a subjective process, and different judgments and assumptions could affect the timing of the loss realization.
another liability, as applicable and is amortized proportionately to the reduction in the related loss reserves (i.e., over the estimated payout period of the acquired loss and LAE reserves). We assign fair values to intangible assets acquired based on valuation techniques including the income and market approaches. We record contingent consideration at fair value based on the terms of the purchase agreement with subsequent changes in fair value recorded through earnings. The determination of fair value may require management to make significant estimates and assumptions. The purchase price is the fair value of the total consideration conveyed to the seller and we record the excess (deficiency) of the purchase price over the fair value of the acquired net assets, where applicable, as goodwill or bargain purchase gain in earnings. We expense costs associated with the acquisition of a business in the period incurred.
Fair value of financial instruments. Our estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820, “Fair Value Measurements and Disclosures.” The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the ASC 820 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. Additionally, valuation of fixed-maturity investments is more subjective when markets are less liquid due to lack of market-based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction could occur. Fair values of other financial instruments which are short-term in nature approximate their carrying values.
ASC 820 defines fair value as 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. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring the fair value of a liability.
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. We use prices and inputs that are current as of the measurement date. In periods of market dislocation, the observability
of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified between levels.
We utilize the fair values received from the pricing service to estimate fair value measurements for all our fixed maturities and equity securities. The following describes the valuation techniques we used to determine the fair value of financial instruments held as of December 31, 2017 and 2016:
•Foreign Government - Comprised of bonds issued by foreign governments. The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, these are classified within Level 2 of the fair value hierarchy. We also hold certain foreign government bonds that are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and are classified as Level 3 in the fair value hierarchy.
•Equity Securities - The pricing service utilizes market quotations for equity securities that have quoted market prices in active markets and their respective quoted prices are provided as fair value. We classified the values of these equity securities as
In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that we will generate future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and projected future taxable income in making this assessment. If necessary, we establish a valuation allowance to reduce the deferred tax assets to the amounts that are more likely than not to be realized.
We recognize tax benefits only on tax positions that are more likely than not to be sustained upon examination by taxing authorities. Our policy is to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in our income tax provision. We file our consolidated tax returns as prescribed by the tax laws of the jurisdictions in which we and our subsidiaries operate.
As a result of the reduction in the corporate income tax rate, we were required to revalue our deferred tax assets and deferred tax liabilities to account for the future impact of lower corporate tax rates on these deferred tax amounts. Under the SEC guidance, Staff Accounting Bulletin No. 118, we recognized additional provision for income taxes in the amount of $20.6 million (net of $5.2 million benefit in the Reciprocal Exchanges) related to this revaluation.
During 2016, we entered into a number of acquisitions and other transactions, including the following: (i) in November 2016, we closed on the acquisition of Elara Holdings, Inc., the parent company of Direct General Corporation, a Tennessee-based property and casualty insurance company (“Direct General”), (ii) in October 2016, we closed on the acquisition of Standard Property and Casualty Insurance Company, an Illinois-based property and casualty insurance company (“SPCIC”), (iii) in June 2016, we closed on the acquisition of Century-National Insurance Company, a California-based property and casualty insurance company and Western General, a California corporation (“Century-National”), and (iv) we had an increase in premium volume from our 2015 acquired company Assigned Risk Solutions Ltd. (“ARS”), which began being written on our paper on January 1, 2016. In addition, in the first quarter of 2016, the Reciprocal Exchanges were deconsolidated at January 1, 2016, and subsequently reconsolidated at March 31, 2016.
As a result of these transactions and reinsurance agreements, comparisons in our results of operation between 2017 and 2016, and between 2016 and 2015, will be less meaningful. Other than the life portion of Direct General and the Assurant Transaction, all these transactions impacted our P&C segment only.
Net premium written. Net premium written increased by $504.9 million, or 16.4%, from $3,072.7 million for the year ended December 31, 2016 to $3,577.6 million for the year ended December 31, 2017. Net premium written for the P&C segment increased by $388.3 million for the year ended December 31, 2017 compared to the same period in 2016, as a result of the acquisitions of Direct General ($367.2 million), Century-National ($69.5 million) and SPCIC ($34.0 million), from organic growth ($464.2 million) and the consolidation of the Reciprocal Exchanges ($55.1 million), partially offset by the Quota Shares ($565.8 million) and a decline in lender-placed premiums ($36.0 million). Net premium written for the A&H segment increased by $116.6 million for the year ended December 31, 2017 compared to the same period in 2016, as a result of the acquisition of Direct General ($10.4 million) and organic growth ($106.2 million).
Net earned premium. Net earned premium increased by $659.0 million, or 22.0%, from $2,995.2 million for the year ended December 31, 2016 to $3,654.2 million for the year ended December 31, 2017. The increase by segment was: P&C $540.1 million and A&H $118.9 million. The increase in the P&C segment was attributable to the acquisitions of Direct General ($352.8 million), Century-National ($84.0 million) and SPCIC ($35.2 million), from organic growth ($392.4 million) and the consolidation of the Reciprocal Exchanges ($59.5 million), partially offset by the Quota Shares ($291.1 million) and a decline in lender-placed premiums ($92.7 million). The increase in the A&H segment was primarily due to the acquisition of Direct General ($10.7 million) and organic growth ($108.2 million).
Ceding commission income. Ceding commission income increased by $70.9 million, from $45.6 million for the year ended December 31, 2016 to $116.5 million for the year ended December 31, 2017, mainly driven by an increase in the P&C segment primarily from the Quota Shares ($51.2 million) and the consolidation of the Reciprocal Exchanges ($16.7 million).
Service and fee income. Service and fee income increased by $122.1 million, or 32.1%, from $380.8 million for the year ended December 31, 2016 to $502.9 million for the year ended December 31, 2017. The increase was attributable to our P&C segment ($106.4 million), primarily resulting from the acquisition of Direct General ($85.7 million) and from organic growth ($13.8 million); and an increase in the A&H segment ($15.7 million) primarily due to growth in our domestic business.
General and administrative expenses. General and administrative expenses increased by $203.8 million, or 28.7%, from $709.1 million for the year ended December 31, 2016 to $913.0 million for the year ended December 31, 2017, due to an increase
of $160.7 million in the P&C segment, primarily as a result of the acquisition of Direct General ($152.4 million); and an increase of $43.2 million in the A&H segment, primarily from organic growth ($27.5 million).
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $186.3 million, or 23.9%, from $779.7 million for the year ended December 31, 2016 to $966.0 million for the year ended December 31, 2017, due to an increase of $106.4 million from the P&C segment and an increase of $80.0 million from the A&H segment.
Net investment income. Net investment income increased by $11.2 million, or 11.2%, from $99.6 million for the year ended December 31, 2016 to $110.7 million for the year ended December 31, 2017.
Consolidated Results of Operations for the Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015
Net premium written. Net premium written increased by $886.2 million, or 40.5%, from $2,186.5 million for the year ended December 31, 2015 to $3,072.7 million for the year ended December 31, 2016. Net premium written for the P&C segment increased by $683.4 million for the year ended December 31, 2016 compared to the same period in 2015, primarily as a result of the acquisitions of Direct General ($58.5 million) and Century-National ($122.1 million), additional premiums from the LPI Business ($238.2 million) and ARS ($74.6 million), and organic growth ($183.4 million), partially offset by the first quarter 2016 deconsolidation of the Reciprocal Exchanges ($5.5 million). Net premium written for the A&H segment increased by $202.7 million, primarily as a result of additional premiums from the Assurant Transaction ($133.7 million) and organic growth ($67.4 million).
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $263.4 million, or 51.0%, from $516.3 million for the year ended December 31, 2015 to $779.7 million for the year ended December 31, 2016. The consolidated net operating expense ratio, which includes the Reciprocal Exchanges, increased to 26.0% in the year ended December 31, 2016 from 24.2% in the year ended December 31, 2015. Excluding the Reciprocal Exchanges, the net operating expense ratio was 25.9% and 24.7% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 30.0% and 16.9% for the years ended December 31, 2016 and 2015, respectively.
Net investment income. Net investment income increased by $24.2 million, or 32.2%, from $75.3 million for the year ended December 31, 2015 to $99.6 million for the year ended December 31, 2016, primarily as a result of our higher amount of invested assets.
Interest expense. Interest expense for the years ended December 31, 2016 and 2015 was $40.2 million and $28.9 million, respectively. The increase of $11.3 million is primarily due to interest under our credit facility and the promissory note issued in connection with the Century-National acquisition, partially offset by our purchase of the Reciprocal Exchanges’ surplus notes.
P&C Segment Results of Operations for the Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016
Net premium written. Net premium written increased by $388.3 million, or 14.6%, from $2,654.0 million for the year ended December 31, 2016 to $3,042.3 million for the year ended December 31, 2017, as a result of the acquisitions of Direct General ($367.2 million), Century-National ($69.5 million) and SPCIC ($34.0 million), from organic growth ($464.2 million) and the consolidation of the Reciprocal Exchanges ($55.1 million), partially offset by the Quota Shares ($565.8 million) and a decline in lender-placed premiums ($36.0 million).
Net earned premium. Net earned premium increased by $540.1 million, or 20.9%, from $2,580.7 million for the year ended December 31, 2016 to $3,120.9 million for the year ended December 31, 2017, attributable to the acquisitions of Direct General ($352.8 million), Century-National ($84.0 million) and SPCIC ($35.2 million), from organic growth ($392.4 million) and the consolidation of the Reciprocal Exchanges ($59.5 million), partially offset by the Quota Shares ($291.1 million) and a decline in lender-placed premiums ($92.7 million).
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $516.5 million, or 28.8%, from $1,791.1 million for the year ended December 31, 2016 to $2,307.6 million for the year ended December 31, 2017, reflecting the acquisitions of Direct General ($234.7 million), SPCIC ($29.4 million) and Century-National ($26.4 million), increased premiums from organic growth ($341.6 million), significant catastrophe losses in 2017 compared to 2016 ($72.1 million) and the consolidation of the Reciprocal Exchanges ($50.6 million), partially offset by the Quota Shares ($221.1 million).
Our P&C segment net loss ratio, which includes the Reciprocal Exchanges, increased from 69.4% for the year ended December 31, 2016 to 73.9% for the year ended December 31, 2017, primarily due to significant catastrophe losses in 2017 compared to 2016, a decline in lender-placed premiums and higher catastrophe losses in the Reciprocal Exchanges in 2017 compared to 2016, partially offset by the Quota Shares.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $106.4 million, or 15.4%, from $688.9 million for the year ended December 31, 2016 to $795.3 million for the year ended December 31, 2017, primarily as a result of our 2016 acquisitions, organic growth, commission income from the Quota Shares and the consolidation of the Reciprocal Exchanges, partially offset by a reduction in transition related expenses in the lender-placed business. Our P&C segment net operating expense ratio decreased from 26.7% for the year ended December 31, 2016 to 25.5% for the year ended December 31, 2017, primarily as a result of higher net earned premium in 2017 compared to 2016.
Gross premium written. Gross premium written increased by $698.8 million, or 29.9%, from $2,338.1 million for the year ended December 31, 2015 to $3,036.9 million for the year ended December 31, 2016, primarily as a result of the acquisitions of Direct General ($58.5 million) and Century-National ($140.0 million), additional premiums from the LPI Business ($249.5 million) and ARS ($74.6 million), and organic growth ($204.5 million), partially offset by the first quarter 2016 deconsolidation of the Reciprocal Exchanges ($40.8 million).
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $53.6 million, or 15.7%, from $340.7 million for the year ended December 31, 2015 to $394.3 million for the year ended December 31, 2016. The increase was due to the Direct General ($1.9 million) and Century-National ($12.0 million) acquisitions, additional costs from the LPI Business ($33.3 million) and ARS ($7.3 million), and organic growth and other ($12.8 million), partially offset by lower costs on the Reciprocal Exchanges ($12.7 million).
General and administrative expenses. General and administrative expenses increased by $236.0 million, or 68.4%, from $344.9 million for the year ended December 31, 2015 to $580.8 million for the year ended December 31, 2016, as a result of the Direct General ($38.0 million) and Century-National ($34.4 million) acquisitions, additional expenses from the LPI Business ($148.7 million) and ARS ($7.7 million), higher expenses on the Reciprocal Exchanges ($18.2 million), and organic growth and other ($17.4 million).
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $220.9 million, or 47.2%, from $468.1 million for the year ended December 31, 2015 to $688.9 million for the year ended December 31, 2016. Our P&C segment net operating expense ratio, which includes the Reciprocal Exchanges, increased from 24.4% for the year ended December 31, 2015 to 26.7% for the year ended December 31, 2016. Excluding the Reciprocal Exchanges, the net operating expense ratio was 26.5% and 25.0% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges’ net operating expense ratio was 30.0% and 16.9% for the years ended December 31, 2016 and 2015, respectively.
Underwriting income; net combined ratio (non-GAAP). Underwriting income decreased from $137.0 million for the year ended December 31, 2015 to $100.7 million for the year ended December 31, 2016. Our P&C segment net combined ratio, which includes the Reciprocal Exchanges, for the year ended December 31, 2016 increased to 96.1% compared to 92.9% for the same period in 2015, primarily as a result of an increase in our net loss ratio due to catastrophe losses. Excluding the Reciprocal Exchanges,
the combined ratio was 96.2% and 92.5% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges’ combined ratio was 92.7% and 97.5% for the years ended December 31, 2016 and 2015, respectively.
A&H Segment Results of Operations for the Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016
Net earned premium. Net earned premium increased by $118.9 million, or 28.7%, from $414.4 million for the year ended December 31, 2016 to $533.3 million for the year ended December 31, 2017, primarily as a result of the acquisition of Direct General ($10.7 million) and organic growth, both domestic ($89.1 million) and international ($19.1 million).
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $17.3 million, or 5.7%, from $301.2 million for the year ended December 31, 2016 to $318.5 million for the year ended December 31, 2017. Our A&H net loss ratio decreased from 72.7% for the year ended December 31, 2016 to 59.7% for the year ended December 31, 2017. The loss ratio decrease was a result of higher premiums with lower loss experience due to a change in product mix primarily in our domestic business.
General and administrative expenses. General and administrative expenses increased by $43.2 million, or 33.6%, from $128.3 million for the year ended December 31, 2016 to $171.5 million for the year ended December 31, 2017, primarily from organic growth ($27.5 million).
Net earned premium. Net earned premium increased by $203.1 million, or 96.1%, from $211.3 million for the year ended December 31, 2015 to $414.4 million for the year ended December 31, 2016, primarily as a result of additional premiums from the Assurant Transaction ($134.1 million) and organic growth ($66.9 million).
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $129.6 million, or 75.5%, from $171.6 million for the year ended December 31, 2015 to $301.2 million for the year ended December 31, 2016, primarily as a result of the Assurant Transaction and higher loss experience in our legacy domestic stop loss programs. Our net loss ratio decreased from 81.2% for the year ended December 31, 2015 to 72.7% for the year ended December 31, 2016. The loss ratio decrease in the year ended December 31, 2016, was primarily driven by our international business.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $36.7 million, or 55.7%, from $66.0 million for the year ended December 31, 2015 to $102.7 million for the year ended December 31, 2016, primarily due to the Assurant Transaction ($23.9 million) and organic growth ($12.5 million).
Our equity interest in the LSC Entities as of December 31, 2017 and 2016, was $160.7 million and $186.0 million, respectively. For the years ended December 31, 2017, 2016 and 2015, we recorded equity in earnings (losses) from the LSC Entities of $(1.2) million, $20.8 million and $8.9 million, respectively, and made cash contributions of $21.0 million, $11.5 million, $0.6 million, respectively, and received distributions of $45.1 million, $0.0 million and $1.9 million, respectively. During 2017, the LSC Entities sold a substantial portion of the life settlement contracts. See Note 4, “Investments - LSC Entities” for additional information on our investments in LSC Entities and these transactions in the notes to our consolidated financial statements.
We are organized as a holding company with twenty-two domestic insurance company subsidiaries, various foreign insurance and reinsurance subsidiaries, as well as various other non-insurance subsidiaries. Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. The primary sources of cash for the management companies of the Reciprocal Exchanges are management fees for acting as the attorneys-in-fact for the exchanges. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed-maturity securities and, to a lesser extent, equity securities. Except as set forth below, we expect that projected cash flows from operations, as well as the net proceeds from our debt and equity issuances, will provide us with sufficient liquidity to fund our anticipated growth by providing capital to increase the surplus of our insurance subsidiaries, as well as to pay claims and operating expenses, and to pay interest and principal on debt and debt facilities and other holding company expenses for the foreseeable future. However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected. To support our current and future policy writings, we have raised substantial capital using a combination of debt and equity, and entered into third party quota share reinsurance agreements. We may raise additional capital over the next twelve months or obtain additional capital support in the form of third party quota share reinsurance.
We forecast claim payments based on our historical experience. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on both a short-term and long-term basis. Cash payments for claims were $2.5 billion, $1.9 billion and $1.4 billion in the years ended December 31, 2017, 2016 and 2015, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third-party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and cash equivalents (including restricted cash) and total investments increased from $3.1 billion at December 31, 2015 to $3.9 billion at December 31, 2016, and increased to $4.0 billion at December 31, 2017. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods.
Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurers. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of “A-” (Excellent) or are fully collateralized at the time we enter into our reinsurance agreements. We also enter into reinsurance relationships with third-party captives formed by agents as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account.
We assume and cede insurance risks under various reinsurance agreements, on both a pro rata basis and an excess of loss basis. We purchase reinsurance to mitigate the volatility of direct and assumed business, which may be caused by the aggregate value or the concentration of written exposures in a particular geographic area or business segment and may arise from catastrophes or other events. As part of our overall risk and capacity management strategy, we purchase various quota share, excess of loss catastrophic and casualty reinsurance for protection against catastrophic events and other large losses.
As of May 1, 2017, our reinsurance property catastrophe excess of loss program provides a total of $575.0 million in coverage in excess of a $70.0 million retention, with one reinstatement. Effective July 1, 2017, the casualty program provides $45.0 million in coverage in excess of a $5.0 million retention. We pay a premium as consideration for ceding the risk.
All automobile insurers doing business in Michigan are required to participate in the MCCA. The MCCA is a reinsurance mechanism that covers no-fault first party medical losses of retentions in excess of a set limit. Insurers are reimbursed for their covered losses in excess of $545,000 in the first half of 2017 and $555,000 until June 30, 2019. Funding for the MCCA comes from assessments against automobile insurers based upon their share of insured automobiles in the state. Insurers are allowed to pass along this cost to Michigan automobile policyholders.
The following is a summary of premium and related losses ceded to the MCCA:
The NCRF is a non-profit organization established to provide automobile liability reinsurance to those insurance companies that write automobile insurance in North Carolina. Companies licensed to write automobile insurance in the state must be members of the NCRF and must offer liability coverage to any eligible North Carolina resident applicant for coverages and limits which may be ceded to the NCRF. The NCRF accepts cession of liability for bodily injury and property damage, medical payments, uninsured and combined uninsured/underinsured motorist coverages. Funding for the NCRF comes from premiums collected from automobile insurers based upon the amounts of coverage provided with respect to insured automobiles in the state. North Carolina law provides that cumulative losses incurred by the NCRF are recoverable either through direct surcharges to North Carolina motorists or indirectly by assessments of member companies, which recoup the costs from individual policyholders.
The following is a summary of premium and related losses ceded to the NCRF:
The Company has a concentration of credit risk associated with its reinsurance recoverables and premiums ceded to reinsurers. The following tables present information for each reinsurer by reinsurance recoverable, prepaid reinsurance and funds held balances:
Funds held for reinsurers are recorded within reinsurance payable in our consolidated balance sheets. Additionally, collateral is available to us in the form of letters of credit and trust agreements in the amounts of $93.2 million and $55.8 million, as of December 31, 2017 and 2016, respectively. See Note 16, “Related Party Transactions” for additional information about reinsurance agreements with related parties in the notes to our consolidated financial statements.
Borrowings under the Credit Agreement bear interest at either the Alternate Base Rate (“ABR”) or LIBOR. ABR borrowings (which are borrowings bearing interest at a rate determined by reference to the ABR) under the Credit Agreement will bear interest at the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate on such day plus 0.5 percent or (c) the adjusted LIBOR for a one-month interest period on such day plus 1.0 percent. Eurodollar borrowings under the Credit Agreement will bear interest at the adjusted LIBOR for the interest period in effect. Fees payable by us under the Credit Agreement include a letter of credit participation fee (the margin applicable to Eurodollar borrowings), a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range of 0.20% to 0.30% based on our consolidated leverage ratio, and which rate was 0.30% as of December 31, 2017).
As of December 31, 2017, there was $190.0 million outstanding under the Credit Agreement. The weighted average interest rate on the amount outstanding as of December 31, 2017 was 3.77%. Interest payments are due the last day of the interest period in intervals of three months duration, commencing on the date of such borrowing. Interest expense on the Credit Agreement for the years ended December 31, 2017 and 2016 was $4.2 million and $0.9 million, respectively. We were in compliance with all of the covenants under the Credit Agreement as of December 31, 2017.
In 2014, we completed a public offering of 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock, Series A, $0.01 par value per share (the “Series A Preferred Stock”). Dividends will be payable on the liquidation preference amount of $25 per share, on a non-cumulative basis, when, as, and if declared by the Board of Directors, quarterly in arrears on the 15th day of January, April, July and October of each year at an annual rate of 7.50%. Dividends on the Series A Preferred Stock are not cumulative. Accordingly, in the event dividends are not declared on the Series A Preferred Stock for payment on any dividend payment date, then those dividends will not accumulate and will not be payable. If we have not declared a dividend before the dividend payment date for any dividend period, we will have no obligation to pay dividends for that dividend period, whether or not dividends on the Series A Preferred Stock are declared for any future dividend payment. The Series A Preferred Stock is not redeemable prior to July 15, 2019. After that date, we may redeem at our option, in whole or in part, the Series A Preferred Stock at a redemption price of $25 per share, plus any declared and unpaid dividends for prior dividend periods and accrued but unpaid dividends (whether or not declared) for the then current dividend period.
The following table sets forth certain of our contractual obligations as of December 31, 2017:
The interest related to our debt by period as of December 31, 2017 was as follows: $42.9 million - less than 1 year, $79.2 million - 1 - 3 years, $71.4 million - 3 - 5 years and $340.3 million - more than 5 years.