The following tables summarize certain selected financial data that should be read in conjunction with our audited financial statements and accompanying notes thereto for the year ended December 31, 2018 included in this report and “
Two of the key financial measures that we use to evaluate our performance are return on average equity and growth in book value per share adjusted for dividends paid to shareholders. We calculate return on average equity by dividing annual net income by the average of annual shareholders’ equity. Our return on average equity was 17.2% in 2018, 10.5% in 2017 and 17.1% in 2016. We calculate book value per share by dividing ending shareholders’ equity by the number of common shares outstanding. Our book value per share was $21.26 at December 31, 2018, $22.10 at December 31, 2017 and $23.72 at December 31, 2016. We paid cash dividends of $4.38 per share in 2018, $4.30 per share in 2017 and $3.97 per share in 2016.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2019 includes 18 reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Our 2019 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable limitations, deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million for any single claimant, subject to applicable deductibles, retentions and aggregate limits. Losses in the layer between $2.0 million and $10.0 million are ceded to a multi-year reinsurance treaty with an aggregate annual deductible of approximately $5.2 million and an aggregate limit of coverage of approximately $27.8 million for 2019. As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.
Substantial 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 unreported claims, length of time to achieve ultimate settlement of claims, utilization, inflation in 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 the changes occurred, with increases in our reserves resulting in decreases in our earnings. Additional information regarding our reserves for loss and loss adjustment expenses and the actuarial methods and other factors used in establishing these reserves can be found under the caption “Business-Loss Reserves” in Item 1 of this report.
In 2018, we decreased our estimates for prior year loss reserves by $45.6 million. In 2017, we decreased our estimates for prior year loss reserves by $34.8 million. In 2016, we decreased our estimates for prior year loss reserves by $51.3 million.
Net Investment Income and Net Realized Gains and Losses on Investments. We invest our statutory surplus funds and the funds supporting our insurance liabilities in fixed maturity, equity securities and alternative investments. In addition, a portion of these funds are held in cash and cash equivalents to pay current claims. Our net investment income includes interest and dividends earned on our invested assets, amortization of premiums and discounts on our fixed-maturity securities and returns on our other investments. We assess the performance of our investment portfolio using a standard tax equivalent yield metric. Investment income that is tax-exempt is increased by our marginal federal tax rate to express yield on tax-exempt securities on the same basis as taxable securities. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their cost or amortized cost, as applicable. Net realized losses occur when our investment securities are sold for less than their cost or amortized cost, as applicable, or are written down as a result of other-than-temporary impairment. We classify the majority of our fixed maturity securities as held-to-maturity. The remainder of our fixed-maturity securities are classified as available-for-sale, as are our equity securities and other investments. Net unrealized gains or losses on our securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses incurred represents our largest expense item and, for any given reporting period, includes estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending, and administering claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious claims to take several years to settle and we revise our estimates as we receive additional information about the condition of the injured employees. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability. Additional information regarding our reserves for loss and loss adjustment expenses and the actuarial methods and other factors used in establishing these reserves can be found under the caption “Business-Loss Reserves” in Item 1 of this report.
Policyholder Dividends. In limited circumstances, we pay dividends to policyholders in particular states as an underwriting incentive.
In establishing our reserves, we review the results of analyses using actuarial methods that utilize historical loss data from our more than 33 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates.
Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and certain marketing, sales, underwriting and safety costs that vary with and primarily relate to the successful acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. In calculating deferred policy acquisition costs, these costs are limited to their estimated realizable value, which gives effect to the premiums to be earned, anticipated losses and settlement expenses and certain other costs we expect to incur as the premiums are earned, less related net investment income. Judgments as to the ultimate recoverability of these deferred policy acquisition costs are highly dependent upon estimated future profitability of unearned premiums. If the unearned premiums were less than our expected claims and expenses after considering investment income, we would reduce the deferred costs.
On December 22, 2017, the Tax Act was signed into law making significant changes to the Internal Revenue Code. The reduction of the U.S. corporate tax rate from 35% to 21% caused us to adjust our deferred tax assets and liabilities to the lower federal base rate of 21%. The impact resulted in a net deferred tax expense of $12.6 million in the fourth quarter of 2017, the period in which the legislation was enacted.
The net dividend ratio is calculated by dividing policyholder dividends by the current year’s net premiums earned.
Net Realized Gains (Losses) on Investments. Net realized losses on investments in 2018 totaled $1.5 million, compared to losses of $0.6 million in 2017. In 2018, net realized losses of $1.1 million resulted from sale of equity and fixed maturity securities classified as available-for-sale. The remaining $0.4 million of realized losses resulted from redemptions of fixed maturity securities. In 2017, net realized losses of $1.1 million resulted from the redemption of fixed maturity securities. These losses were partially offset by realized gains of $0.5 million on the sale of equity and fixed maturity securities classified as available-for-sale.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2018 were $81.1 million, compared to $78.8 million for 2017, an increase of $2.4 million, or 3.0%. This increase was primarily due to a $1.5 million increase in premium taxes, a $1.3 million increase in commission expense, a $0.4 million increase in compensation expense and a $0.3 million increase in legal and professional fees. These increases were partially offset by a decrease of $0.7 million in accounts receivable write-offs and a decrease of $0.6 million in insurance related assessments. Our underwriting expense ratio increased to 23.2% in 2018 from 22.8% in 2017.
Income tax expense. Income tax expense for 2018 was $15.9 million, compared to $36.0 million for 2017. The effective tax rate also decreased to 18.2% for 2018, compared to 43.8% for 2017. This decrease is mainly due to the impact of tax reform legislation which reduced the U.S. corporate tax rate from 35% to 21% in 2018 and resulted in a revaluation of our net deferred tax assets in prior year. The impact resulted in a net deferred tax expense of $12.6 million in the fourth quarter of 2017, the period in which the legislation was enacted.
Gross Premiums Written. Gross premiums written for 2017 were $350.3 million, compared to $373.1 million for 2016, a decrease of 6.1%. The decrease was attributable to a $14.1 million decrease in annual premiums on voluntary policies written during the period, a $7.5 million decrease in premiums resulting from payroll audits and related premium adjustments, a $0.6 million decrease in premiums from mandatory pooling arrangements and a $0.6 million decrease in direct assigned risk premiums. Related premium adjustments in 2017 include a $1.4 million decrease in “earned but unbilled”, or EBUB, premium.
Net Premiums Earned. Net premiums earned for 2017 were $346.2 million, compared to $368.7 million for 2016, a decrease of 6.1%. The decrease was attributable to the decrease in net premiums written in the period.
Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $209.3 million for 2017, compared to $199.0 million for 2016, an increase of $10.3 million, or 5.2%. The current accident year losses and LAE incurred were $244.1 million, or 70.5%of net premiums earned, compared to $250.3 million, or 67.9% of net premiums earned for 2016. We recorded favorable prior accident year development of $34.8 million in 2017, compared to $51.3 million in 2016. This is discussed in more detail below in “Prior Year Development.” Our net loss ratio was 60.5% for 2017 and 54.0% for 2016.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2017 were $78.8 million, compared to $80.6 million for 2016, a decrease of $1.8 million, or 2.3%. This decrease was primarily due to a $1.4 million decrease in commission expense and a $1.4 million decrease in premium taxes. These decreases were partially offset by an increase of $0.7 million in compensation expense and an increase of $0.5 million in insurance related assessments. Our underwriting expense ratio increased to 22.8% in 2017 from 21.9% in 2016.
The table below sets forth the number of open claims as of December 31, 2018, 2017 and 2016, and the numbers of claims reported and closed during the years then ended.
At December 31, 2018, our incurred amounts for certain accident years, particularly 2014, 2015 and 2016, developed more favorably than management previously expected. Multiple factors can cause loss development both unfavorable and favorable. The favorable loss development we experienced across accident years was largely due to favorable case reserve development from closed claims and claims where the worker had reached maximum medical improvement. We believe the favorable loss development in 2014 and 2015 resulted primarily from an intensive claims management focus with the Company actively seeking to settle claims, leading to favorable development.
The assumptions we used in establishing our reserves for these accident years were based on our historical claims data. However, as of December 31, 2018, actual results for these accident years have been better than our assumptions would have predicted. We do not presently intend to modify our assumptions for establishing reserves in light of recent results. However, if actual results for current and future accident years are consistent with, or different than, our results in these recent accident years, our historical claims data will reflect this change and, over time, will impact the reserves we establish for future claims.
We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short- and long-term basis. Cash payments, net of reinsurance, for claims were $200.7 million in 2018, $186.9 million in 2017 and $187.7 million in 2016. We fund claim payments out of cash flow from operations, principally premiums, net of amounts ceded to our reinsurers, and net investment income. Our investment portfolio increased from $1.0 billion at December 31, 2013 to $1.2 billion at December 31, 2018.
As discussed above under “Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2019 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
Net cash provided by operating activities was $98.3 million in 2018, as compared to $130.8 million in 2017, and $114.2 million in 2016. Major components of cash provided by operating activities in 2018 were net premiums collected of $354.0 million and investment income collected of $41.7 million. These increases were offset in-part by claim payments of $200.5 million, $74.2 million of operating expenditures, federal taxes paid of $11.2 million, a $7.9 million increase in amounts held by others, and dividends to policyholders paid of $2.9 million.
Major components of cash provided by operating activities in 2016 were net premiums collected of $364.6 million and investment income collected of $44.7 million, offset in-part by claim payments of $189.9 million, $72.9 million of operating expenditures, federal taxes paid of $32.5 million and dividends to policyholders paid of $0.5 million.
In 2017, major components of net cash used in investing activities included investment purchases of $401.8 million and net purchases of furniture, fixtures and equipment of $0.5 million, offset by proceeds from sales and maturities of investment of investments of $350.7 million.
Net cash used in financing activities was $84.4 million in 2018, as compared to net cash used in financing activities of $82.6 million in 2017 and net cash used in financing activities of $74.3 million in 2016. Cash used in financing activities in 2018 included cash used for dividends paid to shareholders of $84.5 million.
The Company has a line of credit agreement with Frost Bank for borrowings up to a maximum of $20.0 million. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR and are unsecured. Under the agreement, the Company pays a fee of 0.25% on the unused portion of the loan in arrears quarterly, for a fee of $50,000 annually. At December 31, 2018, there were no outstanding borrowings. Unless renewed, the agreement will expire in December 2019.
The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $1.00 per share in 2019.
Under Nebraska and Texas law, as applicable, each of AIIC, SOCI and AIICTX is required to invest only in securities that are either interest-bearing, interest-accruing or eligible for dividends, and must limit its investment in the securities of any single issuer, other than direct obligations of the United States, to five percent of the insurance company’s assets. As of December 31, 2018, we were in compliance with these requirements.
As of December 31, 2018, our investment portfolio, including cash and cash equivalents, totaled $1.2 billion, a decrease of 1.7% from December 31, 2017. The majority of our fixed maturity securities are classified as held-to-maturity, as defined by FASB ASC Topic 320, Investments-Debt and Equity Securities. As such, the reported value of those securities is equal to their amortized cost, and is not impacted by changing interest rates. The remainder of our fixed maturity securities and all of our equity securities are classified as available-for-sale and reported at fair value.
The composition of our investment portfolio, including cash and cash equivalents, as of December 31, 2018 is shown in the following table.
We reviewed all securities with unrealized losses in accordance with the impairment policy described above. We determined that the unrealized losses in the fixed maturity securities portfolio related primarily to changes in market interest rates since the date of purchase, current conditions in the capital markets and the impact of those conditions on market liquidity and prices. We expect to recover the carrying value of these securities as it is not more likely than not that we will be required to sell the security before the recovery of its amortized cost basis. In addition, none of the unrealized losses on debt securities are considered credit losses.
The pre-tax investment yield on our investment portfolio was 2.6% and 2.5% per annum during the twelve months ended December 31, 2018 and 2017, respectively.
We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. As of December 31, 2018, the present value of these annuities was $100.1 million, as estimated by our annuity providers. Substantially all of the annuities are issued or guaranteed by life insurance companies that have an A.M. Best rating of “A” (Excellent) or better. For additional information, see Note 16 to our consolidated financial statements in Item 8 of this report.
We lease equipment and office space under noncancelable operating leases. Future minimum lease payments at December 31, 2018, were as follows:
We have audited the accompanying consolidated balance sheets of AMERISAFE, Inc. and subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedules listed in the Index at Item 15 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
AMERISAFE, Inc. is an insurance holding company incorporated in the state of Texas. The accompanying consolidated financial statements include the accounts of AMERISAFE and its subsidiaries: American Interstate Insurance Company (“AIIC”) and its insurance subsidiaries, Silver Oak Casualty, Inc. (“SOCI”) and American Interstate Insurance Company of Texas (“AIICTX”), Amerisafe Risk Services, Inc. (“RISK”) and Amerisafe General Agency, Inc. (“AGAI”). AIIC and SOCI are property and casualty insurance companies organized under the laws of the state of Nebraska. AIICTX is a property and casualty insurance company organized under the laws of the state of Texas. RISK, a wholly owned subsidiary of the Company, is a claims and safety service company currently servicing only affiliated insurance companies. AGAI, a wholly owned subsidiary of the Company, is a general agent for the Company. AGAI sells insurance, which is underwritten by AIIC, SOCI and AIICTX, as well as by nonaffiliated insurance carriers. The assets and operations of AGAI are not significant to that of the Company and its consolidated subsidiaries.
The Company provides workers’ compensation insurance for small to mid-sized employers engaged in hazardous industries, principally construction, trucking, logging and lumber, manufacturing, agriculture, maritime, and oil and gas. Assets and revenues of AIIC and its subsidiaries represent at least 95% of comparable consolidated amounts of the Company for each of 2018, 2017 and 2016.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). This ASU provided new guidance on reclassification from Other Comprehensive Income (“OCI”) of tax effects related to the recently passed tax reform legislation (the “Tax Act”). The guidance gives entities the option to reclassify to retained earnings tax effects related to items in accumulated OCI deemed to be stranded as a result of tax reform. The guidance was effective for us in the first quarter of 2018 and was applied retrospectively. The Company’s policy for releasing income tax effects from accumulated OCI was the individual securities approach for available-for-sale securities. The adoption of this guidance did not have a material impact on our financial condition and results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses. The new guidance replaces the methodology of credit loss impairment, which currently, delays the recognition of credit losses until a probable loss has been incurred. The new guidance requires credit losses for securities measured at amortized cost to be determined using current expected credit loss estimates. These estimates are to be derived from historical, current and reasonable supporting forecasts, including prepayments and estimates, and will be recorded through a valuation allowance account that will run through the income statement. The same method will be used for available-for-sale securities, but the valuation allowance will be limited to the amount by which the fair value is below amortized cost. The standard is effective for us in the first quarter of 2020. The Company will continue to monitor and evaluate the impact as the implementation date approaches.
All other issued but not yet effective accounting and reporting standards as of December 31, 2018 are either not applicable to the Company or are not expected to have a material impact on the Company.
Impairment losses on fixed maturities are recognized in the financial statements depending on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, an other-than-temporary impairment would be recognized in net income for the difference between amortized cost and fair value. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. The credit loss portion would be recognized in net income and the noncredit loss portion in other comprehensive income.
Short-term investments include municipal securities and corporate bonds with an original maturity greater than 90 days but less than one year.
Reserves for loss and loss adjustment expenses represent the estimated ultimate cost of all reported and unreported losses incurred through December 31. The Company does not discount loss and loss adjustment expense reserves. The reserves for loss and loss adjustment expenses are estimated using individual case-basis valuations, statistical analyses and estimates based upon experience for unreported claims and their associated loss and loss adjustment expenses. Such estimates may be more or less than the amounts ultimately paid when the claims are settled. The estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in these estimates, management believes that the reserves for loss and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in income from current operations.
Reinsurance premiums, losses and allocated 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 contracts.
Experience-rated commissions are earned from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers. These commission revenues on reinsurance contracts are recognized during the related reinsurance treaty period and are based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and certain other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in income from current operations. Experience-rated commissions increased underwriting and certain other operating costs by $0.2 million in 2018 and 2017 and had minimal impact in 2016.
The Company recognizes the impact of its share-based compensation in accordance with FASB ASC Topic 718, Compensation-Stock Compensation. All share-based grants are recognized as compensation expense over the vesting period. The target value of long-term incentive awards are recognized as compensation over the performance period.
Short-term investments held at December 31, 2018 include $ 13.4 million of corporate bonds and $0.8 million of obligations of states and political subdivisions. Short-term investments held at December 31, 2017 include $25.8 million of U.S. Treasury securities and obligations of U.S. government agencies.
In 2017, AMERISAFE redeemed an investment in a limited partnership hedge fund accounted for under the equity method.
The gross unrealized gains and losses on, and the cost of equity securities at December 31, 2018 are summarized as follows:
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2017 are summarized as follows:
A summary of the amortized cost and fair value of investments in fixed maturity securities, classified as available-for-sale at December 31, 2018, by contractual maturity, is as follows:
At December 31, 2018, there were $16.1 million of held-to-maturity investments and $2.5 million of available-for-sale investments on deposit with regulatory agencies of states in which the Company does business.
A summary of the Company’s realized gains and losses on sales, calls or redemptions of investments for 2018, 2017 and 2016 is as follows:
In 2016, the Company sold $3.0 million in bonds that were classified as held-to-maturity. In January 2016, Moody’s downgraded the bonds to B2 from B1 citing increasing liquidity concerns and also placed the bonds on negative outlook indicating the rating could be downgraded further. Given the evidence of significant credit deterioration, the Company elected to sell the bonds for $3.0 million, recognizing a $0.1 million realized gain.
We reviewed all securities with unrealized losses in accordance with the impairment policy described above. The Company determined that the unrealized losses in the fixed maturity securities portfolio related primarily to changes in market interest rates since the date of purchase, current conditions in the capital markets and the impact of those conditions on market liquidity and prices generally. We expect to recover the carrying value of these securities as it is not more likely than not that we will be required to sell the securities before the recovery of its amortized cost basis.
Included in premiums receivable at December 31, 2018, 2017 and 2016 is the Company’s estimate for EBUB premium of $7.5 million, $6.3 million and $7.7 million, respectively.
Furniture and equipment included property held under capital leases of $0.2 million at December 31, 2018. Accumulated depreciation includes $120,000 that is related to these properties at December 31, 2018. Furniture and equipment included property held under capital leases of $0.2 million at December 31, 2017. Accumulated depreciation includes $58,000 that is related to these properties at December 31, 2017. Furniture and equipment included property held under capital leases of $0.2 million at December 31, 2016. Accumulated depreciation includes $80,000 that is related to these properties at December 31, 2016. The capital lease obligations related to these properties are included in accounts payable and other liabilities.
The Company cedes certain premiums and losses to various reinsurers under excess-of-loss treaties. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers on a continual basis. The effect of reinsurance on premiums written and earned in 2018, 2017 and 2016 was as follows:
Amounts recoverable from reinsurers consists of ceded case reserves, ceded incurred but not reported (“IBNR”) reserves, paid losses recoverable and experience-rated commissions recoverable. Ceded case and ceded IBNR reserves represent the portion of gross loss and loss adjustment expense liabilities that are recoverable under reinsurance agreements, but are not yet due from reinsurers. Paid losses recoverable are receivables currently due from reinsurers for ceded paid losses. The Company considers paid losses recoverable outstanding for more than 90 days to be past due. At December 31, 2018, there were no paid losses recoverable past due.
The Company generally secures large reinsurance recoverable balances with various forms of collateral, including funds withheld accounts, irrevocable letters of credit and secured trusts. At December 31, 2018, reinsurance recoverables from reinsurers that exceeded 1.5% of statutory surplus of the Company’s insurance subsidiaries are shown below (in thousands).
During 2018, 2017 and 2016, there was no valuation allowance on the Company’s deferred income tax assets and liabilities.
Income tax expense from operations is different from the amount computed by applying the U.S. federal income tax statutory rate of 21% in 2018 and 35% in 2017 and 2016 to income before income taxes as follows:
In December 2018, the IRS released its guidance for determining the Tax Act transition adjustment related to the discounting of loss reserves. During the period ended December 31, 2018, the Company recorded an increase in its deferred tax assets and a corresponding increase in its deferred tax liabilities as a result of the transition adjustment, which had no impact on tax expense recognized in 2018. As of December 31, 2018, we have completed our accounting for the tax effects of enactment of the Tax Act.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions as of December 31, 2018, 2017 and 2016.
Tax years 2015 through 2018 are subject to examination by the federal and state taxing authorities.
The Company has an agreement providing for a line of credit in the maximum amount of $20.0 million with Frost Bank. The agreement expires in December 2019. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR. Under the agreement, the Company pays a fee of 0.25% on the unused portion of the loan in arrears quarterly, or a fee of $50,000 annually, assuming the line of credit is not used during the calendar year. The line of credit is unsecured. No borrowings or letters of credit were outstanding under the line of credit arrangement at December 31, 2018 or 2017.
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Unaudited)
The foregoing reconciliation reflects favorable development of the net reserves at December 31, 2018, 2017 and 2016. The favorable development reduced loss and loss adjustment expenses incurred by $45.6 million in 2018, driven primarily by accident years 2014, 2015 and 2016 of $8.1 million, $17.0 million and $9.1 million, respectively. In 2017 and 2016, the Company recorded favorable development of $34.8 million and $51.3 million, respectively. The revisions to the Company’s reserves reflect new information gained by claims adjusters in the normal course of adjusting claims and is reflected in the financial statements when the information becomes available. It is typical for more serious claims to take several years or longer to settle and the Company continually revises estimates as more information about claimants’ medical conditions and potential disability becomes known and the claims get closer to being settled. Multiple factors can cause loss development both unfavorable and favorable. The favorable loss development we experienced across accident years was largely due to favorable case reserve development from closed claims and claims where the worker had reached maximum medical improvement.
The Company’s insurance subsidiaries file financial statements prepared in accordance with statutory accounting principles prescribed or permitted by the insurance regulatory authorities of the states in which the subsidiaries are domiciled. Statutory-basis shareholders’ capital and surplus at December 31, 2018, 2017 and 2016 of the directly owned insurance subsidiary, AIIC, and the combined statutory-basis net income and realized investment gains for all AMERISAFE’s insurance subsidiaries for the three years in the period ended December 31, 2018, were as follows (in thousands):
Property and casualty insurance companies are subject to certain risk-based capital requirements, or RBC requirements, specified by the National Association of Insurance Commissioners. Under these requirements, a target minimum amount of capital and surplus maintained by a property/casualty insurance company is determined based on the various risk factors related to it. At December 31, 2018, the capital and surplus of AIIC and its subsidiaries exceeded the minimum RBC requirement.
Pursuant to regulatory requirements, AIIC cannot pay dividends to the Company in excess of the greater of 10% of statutory surplus, or statutory net income, excluding realized investment gains, for the preceding 12-month period, without the prior approval of the Nebraska Director of Insurance. However, for purposes of this dividend calculation, net income from the previous two calendar years may be carried forward to the extent that it has not already been paid out as dividends. AIIC paid $65.4 million in dividends to the Company in 2018, $78.9 million in 2017 and $67.0 million in 2016. Based upon the dividend limitation described above, AIIC could pay to the Company dividends of up to $71.0 million in 2019 without seeking regulatory approval.
The Company is authorized to issue 50,000,000 shares of common stock, par value $0.01 per share. At December 31, 2018, there were 20,528,230 shares of common stock issued and 19,269,980 shares outstanding.
The Company is authorized to issue 10,000,000 shares of preferred stock, par value $0.01 per share. At December 31, 2018, there were no shares of preferred stock outstanding.
Stock options granted under the 2005 Incentive Plan are exercisable, subject to vesting requirements determined by the Compensation Committee, for periods of up to ten years from the date of grant. Stock options generally expire 90 days after the cessation of an optionee’s service as an employee. However, in the case of an optionee’s death or disability, the unexercised portion of a stock option remains exercisable for up to one year after the optionee’s death or disability. Stock options granted under the 2005 Incentive Plan are not transferable, except by will or the laws of descent and distribution.
The Company recognized compensation expense of $12,000 in 2018 and $56,000 in 2017 and $58,000 in 2016, related to awards made under the 2005 Incentive Plan. There were no tax benefits realized for tax deductions from vesting of restricted stock in 2018 and 2017. Tax benefits realized for tax deductions from vesting of restricted stock in 2016 were $110,000.
In 2018, 3,304 shares of common stock were granted under the 2012 Incentive Plan. In 2017, 7,434 shares of common stock and 1,892 shares of restricted stock were granted under the 2012 Incentive Plan, which will vest through 2022. At December 31, 2018, there were 343,147 shares of common stock available for future awards under the 2012 Incentive Plan.
As of December 31, 2018, there were 5,761 shares of restricted stock outstanding under the Non-Employee Director Restricted Stock Plan, all of which will vest on the date of the annual meeting of shareholders in 2019.
The calculation of basic and diluted EPS for the years ended December 31, 2018, 2017 and 2016 are presented below.
Comprehensive income includes net income plus unrealized gains/losses on our available-for-sale investment securities, net of tax. The following table illustrates the changes in the balance of each component of accumulated other comprehensive income (loss) for each period presented in the financial statements.
The Company’s 401(k) benefit plan is available to all employees. The Company matches up to 3% of employee compensation for participating employees, subject to certain limitations. Employees are fully vested in employer contributions to this plan after five years. Company contributions to this plan were $0.7 million in 2018, $0.6 million in 2017, and $0.4 million in 2016.
The Company leases equipment and office space under noncancelable operating leases. At December 31, 2018, future minimum lease payments are as follows (in thousands):
The Company derives its premium revenues from its operations in the workers’ compensation insurance line of business.
Other Investments- Other investments consisted of a limited partnership interest that was accounted for under the equity method valued using the net asset value provided by the general partner of the limited partnership, which approximates the fair value of the interest. The limited partnership’s objective was to generate absolute returns by investing long and short in publicly-traded global securities. The investment in the limited partnership was fully redeemed during 2017. The Company has no unfunded commitments to the limited partnership.
In ASC Topic 820, inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable:
Assets and liabilities measured at amortized cost as of December 31, 2018 and 2017 are as follows:
The following table represents unaudited quarterly financial data for the years ended December 31, 2018 and 2017.