In addition, through our subsidiary, Cosi Agency, Inc. (“Cosi”), a multi-state licensed general agency, we access alternative distribution channels. Through Cosi, we have the opportunity to partner with name-brand carriers and access nationwide insurance agencies. See “Distribution Channels” below for a discussion of our distribution channels. Cosi receives commission revenue from KICO for the policies it places with others and pays commissions to these agencies. Cosi retains the profit between the commission revenue received and the commission expense paid. Cosi revenue is included in other income and Cosi related expenses are included in other operating expenses. Cosi operations are not included in our stand-alone insurance underwriting business and, accordingly, its revenue and expenses are not included in the calculation of our combined ratio as described below.
Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from losses incurred by policyholders, which are referred to as claims. In settling these claims, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and legal expenses. In addition, insurance companies incur policy acquisition costs. Policy acquisition costs include commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including employees’ compensation and benefits.
Other operating expenses include our corporate expenses as a holding company and operating expenses of Cosi. These corporate expenses include legal and auditing fees, executive employment costs, and other costs directly associated with being a public company. Cosi operating expenses primarily include commissions paid to brokers, employment costs, and consulting costs.
Commission expenses and other underwriting expenses: Other underwriting expenses include policy acquisition costs and other expenses related to the underwriting of policies. Policy acquisition costs represent the costs of originating new insurance policies that vary with, and are primarily related to, the production of insurance policies (principally commissions, premium taxes and certain underwriting salaries). Policy acquisition costs are deferred and recognized as expense as the related premiums are earned. Other underwriting expenses represent general and administrative expenses of our insurance business and are comprised of other costs associated with our insurance activities such as regulatory fees, telecommunication and technology costs, occupancy costs, employment costs, and legal and auditing fees.
Income tax expense: We incur federal income tax expense on our condensed consolidated operations as well as state income tax expense for our non-insurance underwriting subsidiaries.
Commercial liability: Through July 2019, we offered businessowners policies, which consist primarily of small business retail, service, and office risks, with limited property exposures. We also wrote artisan’s liability policies for small independent contractors with smaller sized workforces. In addition, we wrote special multi-peril policies for larger and more specialized businessowners risks, including those with limited residential exposures. Further, we offered commercial umbrella policies written above our supporting commercial lines policies.
For the year ended December 31, 2019, Alternative Distribution made up 3.2% of direct written premiums for our homeowners and dwelling fire components of personal lines.
Our condensed consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our condensed consolidated financial statements and related notes. In preparing these condensed consolidated financial statements, our management has utilized information including our past history, industry standards, and the current economic environment, and other factors, in forming its estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates in these financial statements may not materialize. Application of the critical accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of similar companies.
2017/2019 Treaty was a two-year treaty; quota share reinsurance rate was reduced to 10% effective July 1, 2018 (the “2018 Cut-off”).
An increase in written premiums will increase the premiums ceded under our excess of loss treaties. In Year Ended 2019, our ceded excess of loss reinsurance premiums increased by $493,000 over the comparable ceded premiums for Year Ended 2018. The increase was due to an increase in premiums subject to excess of loss reinsurance.
Most of the premiums written under our personal lines policies are also subject to our catastrophe treaties. An increase in our personal lines business gives rise to more property exposure, which increases our exposure to catastrophe risk; therefore, our premiums ceded under catastrophe treaties will increase. This results in an increase in premiums ceded under our catastrophe treaties provided that reinsurance rates are stable or are increasing. In Year Ended 2019, our premiums ceded under catastrophe treaties increased by $5,604,000 over the comparable ceded premiums in Year Ended 2018. The change was due to an increase in our catastrophe limit purchased, an increase in premiums subject to catastrophe reinsurance due to continued growth, and an increase in reinsurance rates effective July 1, 2019. Our ceded catastrophe premiums are paid based on the total direct written premiums subject to the catastrophe reinsurance treaty.
Net investment income was $6,869,000 in Year Ended 2019 compared to $6,186,000 in Year Ended 2018. The increase of $683,000, or 11.0%, was due to an increase in average invested assets in Year Ended 2019. The average yield on invested assets was 3.51% as of December 31, 2019 compared to 3.79% as of December 31, 2018. The pre-tax equivalent yield on invested assets was 3.26% and 3.44% as of December 31, 2019 and 2018, respectively.
Net gains on investments were $4,591,000 in Year Ended 2019 compared to a net loss of $2,496,000 in Year Ended 2018. Unrealized gains on our equity securities and other investments in Year Ended 2019 were $4,562,000, compared to unrealized losses of $2,383,000 in Year Ended 2018. Realized gains on sales of investments were $29,000 in Year Ended 2019 compared to realized losses of $94,000 in Year Ended 2018.
The 1.2 percentage point decrease in our other underwriting expense ratio was driven by a decline of 0.9 percentage points from the impact of employment costs.
The overall 2.2 percentage point increase in provisional ceding commissions was driven entirely by the change in our quota share ceding rates and its impact on provisional ceding commission revenue due to the additional retention resulting from the cut-off to our quota share treaty on July 1, 2018 and run-off to our expired quota share treaty on July 1, 2019. Additionally, through December 15, 2019 we had a reduction in our quota share reinsurance rates resulting in a reduction of provisional ceding commissions. The components of our net underwriting expense ratio related to other underwriting expenses, other income and commissions improved in nearly all categories, resulting in an overall 0.3 percentage point decrease in the net underwriting expense ratio.
Other operating expenses, related to the expenses of our holding company and Cosi, were $4,178,000 for Year Ended 2019 compared to $2,575,000 for Year Ended 2018. The increase in Year Ended 2019 of $1,603,000, or 62.3%, as compared to Year Ended 2018 was primarily due to increases in equity compensation and salaries, partially offset by a decrease in executive bonuses. The increase in salary was due to the initial hiring of staff for Cosi and the increase in equity compensation was due to 2019 annual restricted stock awards to directors and executives. Executive bonus compensation is accrued pursuant to the employment agreement in effect through December 31, 2019 with Barry B. Goldstein, our Executive Chairman and current Chief Executive Officer. The bonus is a one-time payment computed at the end of the three-year period ended December 31, 2019, and as of December 31, 2019 the three-year computation did not meet the required terms of profitability, resulting in no payment and a reversal of the $698,000 previously accrued.
Interest expense in Year Ended 2019 was $1,826,000 and $1,822,000 in Year Ended 2018. We incurred interest expense in connection with our $30.0 million issuance of long-term debt in December 2017.
See discussions above with regard to “Net Written Premiums and Net Premiums Earned”, as to changes in quota share ceding rates, effective July 1, 2019 and 2018.
For the year ended December 31, 2019 and 2018, includes the sum of net catastrophe losses and loss adjustment expenses of $7,694,817 and $6,227,883, respectively.
(1) In 2017, KICO placed certain residential mortgage backed securities as eligible collateral in a designated custodian account related to its relationship with the Federal Home Loan Bank of New York ("FHLBNY"). The eligible collateral would be pledged to FHLBNY if KICO draws an advance from FHLBNY. As of December 31, 2019, the estimated fair value of the eligible investments was $7,284,000. KICO will retain all rights regarding all securities if pledged as collateral. As of December 31, 2019, there was no outstanding balance on the FHLBNY credit line.
(1) In 2017, KICO placed certain residential mortgage backed securities as eligible collateral in a designated custodian account related to its relationship with the Federal Home Loan Bank of New York ("FHLBNY"). The eligible collateral would be pledged to FHLBNY if KICO draws an advance from FHLBNY. As of December 31, 2018, the estimated fair value of the eligible investments was $5,116,000. KICO will retain all rights regarding all securities if pledged as collateral. As of December 31, 2018, there was no outstanding balance on the FHLBNY credit line.
The table below summarizes the credit quality of our available-for-sale fixed-maturity securities as of December 31, 2019 and 2018 as rated by Standard and Poor’s (or, if unavailable from Standard and Poor’s, then Moody’s or Fitch):
As disclosed in Note 4 to the condensed consolidated financial statements, with respect to “Fair Value Measurements,” we define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction involving identical or comparable assets or liabilities between market participants (an “exit price”). The fair value hierarchy distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of December 31, 2019 and December 31, 2018, 80% and 81%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices.
There were 39 securities at December 31, 2019 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. There were 156 securities at December 31, 2018 that accounted for the gross unrealized loss, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.
KICO is a member of the Federal Home Loan Bank of New York (“FHLBNY”), which provides additional access to liquidity. Members have access to a variety of flexible, low cost funding through FHLBNY’s credit products, enabling members to customize advances. Advances are to be fully collateralized; eligible collateral to pledge to FHLBNY includes residential and commercial mortgage backed securities, along with U.S. Treasury and agency securities. See Note 3 to our Consolidated Financial Statements - Investments, for eligible collateral held in a designated custodian account available for future advances. Advances are limited to 5% of KICO’s net admitted assets as of the end of the previous quarter, which is September 30, 2019, and are due and payable within one year of borrowing. The maximum allowable advance as of December 31, 2019, based on the net admitted assets as of September 30, 2019, was approximately $11,888,000. Advances are limited to 90% of the amount of available collateral, which was approximately $6,556,000 as of December 31, 2019. There were no borrowings under this facility for the year ended December 31, 2019.
Net cash provided by operating activities was $29,859,000 in Year Ended 2019 as compared to $22,295,000 in Year Ended 2018. The $7,564,000 increase in cash flows provided by operating activities in Year Ended 2019 was primarily a result of a decrease in net income (adjusted for non-cash items) of $16,383,000, increases in other assets, accounts payable, accrued expenses and other liabilities of $5,924,000, offset by an increase in net cash arising from insurance related items from KICO of $18,023,000.
Effective July 1, 2019, our 2017/2019 Treaty and commercial umbrella treaty expired on a run-off basis; these treaties were not renewed. We entered into new excess of loss and catastrophe reinsurance treaties effective July 1, 2019. Material terms for our reinsurance treaties in effect for the treaty years shown below are as follows: