Our executive offices and insurance operations are located in Richmond, Virginia, which occupy approximately 53,000 square feet of office space for annual rent of approximately $0.4 million. The lease for this space expires in 2020. During 2019, we purchased land in Henrico County, Virginia and began construction of a new corporate headquarters.
We believe that our facilities are adequate for our current needs.
(1) Prior to our IPO in 2016, a significant amount of our business was reinsured through our multi-line quota share reinsurance treaty ("MLQS") with third-party reinsurers. The MLQS transferred a portion of the risk related to certain lines of business written by us to reinsurers in exchange for a portion of the gross written premiums on that business. Effective January 1, 2017, the Company commuted the remaining outstanding MLQS covering the period January 1, 2015 to December 31, 2015, which reduced reinsurance recoverables on unpaid losses by approximately $27.9 million. The commutation did not have any effect on the Company's results of operations or cash flows for the applicable period.
(6) Tangible stockholders’ equity is a non-GAAP financial measure. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Financial Condition" for a reconciliation of stockholders’ equity to tangible stockholders’ equity.
(7) The ratio, expressed as a percentage, of total indebtedness for borrowed money, including financing leases, to the sum of total indebtedness for borrowed money, including financing leases, and stockholders’ equity.
(14) Operating return on equity is net operating earnings expressed as a percentage of average beginning and ending stockholders’ equity during the period. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income to net operating income.
For a comparison of years ended December 31, 2018 and December 2017, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended December 31, 2018, which was filed with the SEC on February 28, 2019.
We have one reportable segment, our Excess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2019, the percentage breakdown of our gross written premiums was 87.6% casualty and 12.4% property. Our commercial lines offerings include construction, small business, excess casualty, commercial property, product liability, allied health, general casualty, professional liability, life sciences, energy, management liability, health care, environmental, inland marine, commercial insurance and public entity. We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 4.3% of our gross written premiums in 2019.
Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is ceded to third-party reinsurers under our reinsurance agreements.
Changes in the legal or regulatory environment related to the business we write;
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs that are directly related to the successful acquisition of those policies are deferred. The amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the policy life. Other underwriting expenses represent the general and administrative expenses of our insurance business including employment costs, telecommunication and technology costs, and legal and auditing fees.
Net realized investment gains (losses) on investments are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost, as well as any "other-than-temporary" impairments recognized in earnings.
Currently all of our income tax expense relates to federal income taxes. Kinsale Insurance is generally not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Return on equity is net income as a percentage of average beginning and ending total stockholders’ equity during the period.
Net income was $63.3 million for the year ended December 31, 2019 compared to $33.8 million for the year ended December 31, 2018, an increase of $29.5 million, or 87.4%. The increase in net income in 2019 over 2018 was due to a number of factors including, higher fair value of equity securities, higher underwriting income resulting from favorable E&S market conditions and strong growth in written premiums, and an increase in investment income. The change in fair value of equity investments for the year ended December 31, 2019 reflected favorable valuations in the broader stock market compared to the prior year, which experienced a significant decline in the fourth quarter
Construction, which represented approximately 18.2% of our gross written premiums in 2019, increased by $20.2 million, or 39.6%, for the year ended December 31, 2019 over the prior year;
Small business, which represented approximately 16.2% of our gross written premiums in 2019, increased by $18.8 million, or 42.4%, for the year ended December 31, 2019 over the prior year, and
Net earned premiums were $283.0 million for the year ended December 31, 2019 compared to $212.7 million for the year ended December 31, 2018, an increase of $70.3 million, or 33.0%. As previously discussed, the increase was due to growth in gross written premiums in 2019 compared to 2018.
Our loss ratio was 59.9% for the year ended December 31, 2019 compared to 60.2% for the year ended December 31, 2018. The slight decrease in the loss ratio for the year ended December 31, 2019 was due to lower current year catastrophe losses in 2019 compared to 2018.
During the year ended December 31, 2018, loss reserves for prior accident years developed favorably by $7.0 million, which was largely attributable to accident years 2016 and 2017 of $10.6 million. This favorable development was offset in part by adverse development in the accident years 2011 through 2015 of $3.6 million.
The following tables summarize the effect of the factors indicated above on the loss ratios for the years ended December 31, 2019 and 2018:
The overall expense ratio was lower for the year ended December 31, 2019 compared to the year ended December 31, 2018. The decrease in the expense ratio was due to higher net earned premiums without a proportional increase in the amount of other underwriting expenses. This decrease was offset in part by higher net commissions incurred as a percentage of earned premiums year over year, which was largely due to lower ceding commissions as a result of a change in the mix of business, some of which has no ceding commissions. In addition, as previously discussed, we increased the retention on our reinsurance treaties, which resulted in lower ceded premiums and
associated commissions for the year ended December 31, 2019. Direct commissions paid as a percent of gross written premiums was 14.6% and 14.7% for the years ended December 31, 2019 and 2018, respectively.
Our net investment income increased by 28.3% to $20.1 million for the year ended December 31, 2019 from $15.7 million for the year ended December 31, 2018, primarily due to growth in our investment portfolio balance generated from excess operating funds and to a lesser degree, proceeds from our equity offering in August 2019.
The following table summarizes the components of net investment income and net investment gains for the years ended December 31, 2019 and 2018:
Our return on equity was 18.9% for the year ended December 31, 2019 compared to 13.5% for the year ended December 31, 2018. Operating return on equity was 15.9% for the full year of 2019, an increase from 15.4% for the full year of 2018. The increase in the operating return on equity was primarily due to growth in the business year over year, offset in part by the impact of the equity offering of $65.9 million in August 2019.
As of December 31, 2019, our holding company had $14.7 million in cash and investments, compared to $10.0 million as of December 31, 2018.
Management believes there is sufficient liquidity available at the holding company and in its insurance subsidiary, Kinsale Insurance, as well as in its other operating subsidiaries, to meet its operating cash needs and obligations and committed capital expenditures for the next 12 months.
In January 2019, we purchased land for $2.5 million in Henrico County, Virginia for the development of a new corporate headquarters and we are currently targeting a third quarter 2020 completion date. The project is estimated to cost approximately $50 million to $55 million, substantially all of which we expect will be capitalized. We expect to fund the project through a combination of existing cash flows from operations and debt financing. The current balance of construction in progress related to this project is $19.8 million at December 31, 2019, which is classified under property and equipment within "other assets" on the balance sheet. See "-Liquidity and Capital Resources, Credit agreement" below for further details regarding this financing.
In August 2019, we filed a universal shelf registration statement with the SEC that expires in 2022. We can use this shelf registration to issue an unspecified amount of debt securities, common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements.
Our cash flows for the years ended December 31, 2019 and 2018 were:
We have historically generated positive operating cash flows. The increase in cash provided by operating activities in 2019 compared to 2018 was due primarily to growth in business and the timing of claim payments and reinsurance recoverable balances. Cash flows from operations were used to fund investing activities and to pay dividends to our stockholders.
Net cash used in investing activities increased by $124.3 million in 2019 from 2018, which reflected higher proceeds from growth in our business operations and proceeds from our equity offering in August 2019 of $65.9 million. These proceeds were used to purchase fixed-maturity securities, particularly corporate bonds and residential mortgage-backed securities of $203.0 million, and to a lesser extent, other asset-backed securities of $60.4 million and municipal bonds of $42.8 million. During 2019, we also received proceeds of $35.5 million from sales of fixed-maturity securities, largely municipal bonds in order to take advantage of favorable valuations. In addition, we received proceeds of $67.9 million from redemptions of asset and mortgage-backed securities and corporate bonds.
During 2019, the Company reallocated its ETFs from foreign and small-cap funds to domestic equity funds to more closely mirror the broader U.S. stock market. For the year ended December 31, 2019, purchases and sales of ETFs were $19.3 million and $13.7 million, respectively. For the year ended December 31, 2019, purchases and sales of non-redeemable preferred stocks were $10.6 million and $7.8 million, respectively. Net cash used in investing
activities during 2019 included purchases of property and equipment of $19.6 million and was principally comprised of expenditures related to the construction of our new corporate headquarters, discussed previously.
Net cash used in investing activities during the year ended December 31, 2018 reflected purchases of fixed-maturity securities, particularly other asset-backed securities and, to a lesser extent, corporate bonds and residential and commercial mortgage obligations. This was offset in part by redemptions of asset and mortgage-backed securities and corporate bonds.
For the year ended December 31, 2019, net cash provided by financing activities was $77.8 million and reflected the proceeds from our equity offering of $65.9 million, previously discussed, and the drawdown of $17.3 million on our Credit Facility, which was used to fund construction of our new headquarter facilities. During the year ended December 31, 2019, we paid dividends of $0.32 per common share, or $6.9 million in the aggregate. During 2019, we received proceeds of $2.8 million from the exercise of vested stock options.
For the year ended December 31, 2019, property insurance represented 12.4% of our gross written premiums. When we write property insurance, we buy reinsurance to significantly mitigate our risk. We use computer models to analyze the risk of severe losses from weather-related events and earthquakes. We measure exposure to these catastrophe losses in terms of PML, which is an estimate of what level of loss we would expect to experience in a windstorm or earthquake event occurring once in every 100 or 250 years. We manage this PML by purchasing catastrophe reinsurance coverage. Effective June 1, 2019, we purchased catastrophe reinsurance coverage of $77.5 million per event in excess of our $7.5 million per event retention.
Kinsale Insurance has a financial strength rating of "A-" (Excellent) from A.M. Best. A.M. Best assigns 16 ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A-" (Excellent) is the fourth highest rating issued by A.M. Best. The "A-" (Excellent) rating is assigned to insurers that have, in A.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation
Reserves for losses and loss adjustment expenses represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by period are based on industry and peer-group claims payment experience. Due to the uncertainty inherent in the process of estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed above. Amounts disclosed above are gross of anticipated amounts recoverable from reinsurers. Reinsurance balances recoverable on reserves for losses and loss adjustment expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. Reinsurance balances recoverable on reserves for paid and unpaid losses and loss adjustment expenses totaled $72.6 million at December 31, 2019.
agreement. These costs are based on our current estimates; however, the costs we actually incur and the timing of the actual payments may vary from these estimates.
As of December 31, 2019, we had $17.3 million outstanding under the Credit Facility, which has a maturity of May 28, 2024. Interest on the outstanding amounts is estimated based on 3-month LIBOR plus a margin of 1.75%. Current borrowings under the Credit Facility have been used to fund construction of our new headquarters and we anticipate utilizing the Credit Facility to fund the remaining construction costs. However, we may choose to fund the project with other resources or may decide to repay the Credit Facility without penalty. As a result, actual amounts paid and the associated interest may differ from the estimates presented.
At December 31, 2019, total stockholders' equity was $405.9 million and tangible stockholders' equity was $403.1 million, compared to total stockholders' equity of $264.0 million and tangible stockholders' equity of $261.2 million at December 31, 2018. The increase in both total stockholders' equity and tangible stockholders' equity in 2019 compared to 2018 was primarily due to proceeds received from the public equity offering in August of 2019, profits generated during the period, an increase in unrealized gains on available-for-sale investments, net of taxes, and net activity related to stock-based compensation plans. These increases were offset in part by the dividends declared during 2019.
Stockholders' equity at December 31, 2019, 2018, 2017, 2016 and 2015, reconciles to tangible stockholders' equity as follows:
During 2019, 62,015 shares of restricted stock awards were granted under the 2016 Incentive Plan to the Company’s employees and non-employee directors. The restricted stock had a weighted average fair value on the date of grant of $80.59 per share and vest over a term of 1 to 4 years.
On November 13, 2019, the Company’s Board of Directors declared a cash dividend of $0.08 per share of common stock. This dividend was paid on December 12, 2019 to all stockholders of record on November 29, 2019.
At December 31, 2019, our cash and invested assets of $908.2 million consisted of fixed-maturity securities, cash and cash equivalents and equity securities. At December 31, 2019, the majority of the investment portfolio was comprised of fixed-maturity securities of $729.5 million that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on those securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. At December 31, 2019, we also held $100.4 million of cash and cash equivalents and $78.3 million of equity securities, which are comprised of ETFs and non-redeemable preferred stock. Effective January 1, 2018, we adopted a new accounting standard ASU 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities," ("ASU 2016") which eliminated the available-for-sale classification for equity securities and required changes in unrealized gains and losses in fair value of these investments to be recognized in net income. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 4.3 years and an average rating of "AA" at December 31, 2019. Our investment portfolio, excluding cash equivalents, had a gross return of 3.1% as of December 31, 2019, compared to 3.0% as of December 31, 2018.
At December 31, 2019, the amortized cost and fair value of our investments were as follows:
In order to conduct business in certain states, we are required to maintain letters of credit or assets on deposit to support state-mandated insurance regulatory requirements and to comply with certain third-party agreements. Assets held on deposit or in trust accounts are primarily in the form of cash or certain high-grade securities. The fair value of our restricted assets was $6.9 million at December 31, 2019 and 2018.
Underwriting income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting income represents the pre-tax profitability of our insurance operations and is derived by subtracting losses and loss adjustment expenses and underwriting, acquisition and insurance expenses from net earned premiums. We use underwriting income as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define underwriting income differently.
Net operating earnings is defined as net income excluding the effects of net unrealized gains and losses on equity
The reserves for unpaid losses and loss adjustment expenses are the largest and most complex estimate in our consolidated balance sheet. The reserves for unpaid losses and loss adjustment expenses represent our estimated ultimate cost of all unreported and reported but unpaid insured claims and the cost to adjust these losses that have occurred as of or before the balance sheet date. As a relatively new company, our historical loss experience is limited. We estimate the reserves using individual case-basis valuations of reported claims and statistical analyses. Those estimates are based on our historical information, industry information and our estimates of future trends in variable factors such as loss severity, loss frequency and other factors such as inflation. We regularly review our estimates and adjust them as necessary as experience develops or as new information becomes known to us. Such adjustments are included in current operations. Additionally, during the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates. Accordingly, the ultimate settlement of losses and the related loss adjustment expenses may vary significantly from the estimate included in our consolidated financial statements.
The following tables summarize our reserves for unpaid losses and loss adjustment expenses, on a gross basis and net of reinsurance, at December 31, 2019 and 2018:
Case reserves are established for individual claims that have been reported to us. We are notified of losses by our insureds or their brokers. Based on the information provided, we establish case reserves by estimating the ultimate losses from the claim, including defense costs associated with the ultimate settlement of the claim. Our claims department personnel use their knowledge of the specific claim along with advice from internal and external experts, including underwriters and legal counsel, to estimate the expected ultimate losses. During the life cycle of a particular claim, as more information becomes available, we may revise our estimate of the ultimate value of the claim either upward or downward. The amount of the individual claim reserve is based on the most recent information available.
there were no other-than-temporary impairments recognized. See Note 2 of the notes to the consolidated financial statements for further discussion regarding our investments.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedules I, II and V (collectively, the consolidated financial statements), and our report dated March 2, 2020 expressed an unqualified opinion on those consolidated financial statements.
Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We have audited the accompanying consolidated balance sheets of Kinsale Capital Group, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedules I, II, and V (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
As discussed in Notes 1 and 14 to the consolidated financial statements, the Company changed its method of accounting for recognizing changes in unrealized gains and losses in fair value of equity investments in 2018 due to the adoption of Accounting Standards Update 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
Assessment of the estimation of reserves for unpaid losses and loss adjustment expenses
Assessing the actuarial methodology used by the Company for consistency with generally accepted actuarial standards and practices;
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles ("U.S. 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management periodically reviews its estimates and assumptions. These reviews include evaluating the adequacy of reserves for unpaid losses and loss adjustment expenses, allowance for doubtful accounts and uncollectible reinsurance, fair value of investments, as well as evaluating the investment portfolio for other-than-temporary declines in fair value.
Interest on fixed-maturity securities is credited to earnings as it accrues. Premiums and discounts are amortized or accreted over the lives of the related fixed maturities, or to the earliest call date. Dividends on equity securities are included in earnings on the ex-dividend date. Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the trade date.
The Company defers commissions, net of ceding commissions, and certain other costs that are directly related to the successful acquisition of insurance contracts. All eligible costs are capitalized and charged to expense in proportion to premium earned over the estimated policy life. To the extent that unearned premiums on existing policies are not adequate to cover the related costs and expenses, referred to as a premium deficiency, deferred policy acquisition costs are charged to earnings. The Company considers anticipated investment income in determining whether a premium deficiency exists.
Property and equipment are stated at cost less accumulated depreciation. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives range from 7 to 10 years for furniture and equipment, 3 to 7 years for electronic data processing hardware and software, and from 2 to 6 years for leasehold improvements, which is the shorter of the estimated useful life or the lease term.
In January 2019, the Company purchased land for $2.5 million in Henrico County, Virginia for the development of its new corporate headquarters and is currently targeting a third quarter 2020 completion date. The project is estimated to cost approximately $50 million to $55 million, which will be funded through a combination of existing cash flows from operations and draw down on the credit facility. See Note 11 for further discussion.
Reserves for unpaid losses and loss adjustment expenses represent management's best estimate of ultimate unpaid cost of all reported and unreported losses and loss adjustment expenses incurred prior to the financial statement date. The estimates are based on an actuarial method that uses management’s initial expected loss ratios, expected reporting patterns for losses based on industry data and the Company’s actual reported losses and loss adjustment expenses. All estimates are regularly reviewed and, as experience develops and new information becomes known, the reserves for unpaid losses and loss adjustment expenses are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are determined. Although management believes that the reserves for losses and loss adjustment expenses are reasonable, due to the inherent uncertainty in estimating reserves for unpaid losses and loss adjustment expenses, it is possible that the Company’s actual incurred losses and loss adjustment expenses will not develop in a manner consistent with the assumptions inherent in the determination of these reserves. If actual liabilities exceed recorded amounts, there will be an increase to the Company’s reserves resulting in a reduction in net income and stockholders’ equity in the period in which the deficiency is identified. Furthermore, management may determine that recorded reserves are more than adequate to cover expected losses which will result in a reduction to the reserves. The Company believes that the reserves for unpaid losses and loss adjustment expenses at December 31, 2019 and 2018 are adequate and represent a reasonable estimate of the Company's future obligations. See Note 7 for a further discussion of reserves for unpaid losses and loss adjustment expenses.
The Company uses the portfolio approach to release stranded tax effects in accumulated other comprehensive income ("AOCI") related to its available-for-sale fixed-maturity securities. Under this approach, stranded tax effects remaining in AOCI are released only when the entire portfolio of the available-for-sale fixed-maturity securities are liquidated, sold or extinguished.
For equity securities, the Company’s investment manager uses prices from independent pricing vendors to estimate fair value. The fair value estimates of exchange traded funds are based on quoted prices in an active market and are disclosed as Level 1. The fair value estimates of preferred stock are based on observable market data and, as a result, are disclosed as Level 2.
awards are recognized as they occur. See Note 9 for further discussion and related disclosures regarding stock-based compensation.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" to improve the financial reporting of leasing transactions. Under this ASU, lessees will recognize a right-of-use ("ROU") asset and corresponding liability on the balance sheet for all leases, except for leases covering a period of 12 months or less. The lessee’s income statement treatment for leases will vary depending on the nature and classification of the lease. Effective January 1, 2019, the Company adopted this ASU and recorded a ROU asset and corresponding lease liability of approximately $0.9 million. The ROU and operating lease liability are included in "other assets" and "other liabilities," respectively, in the accompanying consolidated balance sheet.
The Company elected the package of practical expedients permitted under the adoption of the new standard, which allowed the Company to account for existing leases under their current classification, as well as omit any new costs classified as initial direct costs, under the new standard. This election kept the existing agreements as operating leases. The Company also elected the practical expedient allowing an accounting policy election by class of underlying asset, to account for separate lease and nonlease components as a single lease component. In addition, the Company has implemented the necessary internal controls relating to the adoption of the standard.
On August 29, 2018, the FASB issued new guidance on a customer's accounting for implementation, set-up and other up-front costs incurred in a cloud computing arrangement hosted by the vendor. The new guidance requires an entity to determine the stage of a project that the implementation activity relates to and the nature of the associated costs in order to determine whether those costs should be expensed as incurred or capitalized. The new guidance also requires the entity to amortize the capitalized implementation costs as an expense over the term of the hosting arrangement. This guidance is
effective for reporting periods beginning after December 15, 2019. The adoption of the guidance is not expected to have a material effect on the Company’s financial statements.
The Company regularly reviews all its available-for-sale investments with unrealized losses to assess whether the declines in the securities’ fair value are deemed to be an other-than-temporary impairment ("OTTI"). The Company considers a number of factors in completing its OTTI review, including the length of time and the extent to which a security's fair value has been below cost and the financial condition of an issuer. In addition to specific issuer information, the Company also evaluates the current market and interest rate environment. Generally, a change in a security’s value caused by a change in the market or interest rate environment does not constitute an OTTI, but rather a temporary decline in fair value.
For fixed-maturity securities, the Company also considers whether it intends to sell the security or if it is more likely than not that it will be required to sell the security before recovery and the ability to recover all amounts outstanding
when contractually due. When assessing whether it intends to sell a fixed-maturity security or if it is likely to be required to sell a fixed-maturity security before recovery of its amortized cost, the Company evaluates facts and circumstances including, but not limited to, decisions to reposition the investment portfolio, potential sales of investments to meet cash flow needs and potential sales of investments to capitalize on favorable pricing.
For fixed-maturity securities where a decline in fair value is considered to be other-than-temporary and the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost, an impairment is recognized in net income based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security. If the decline in fair value of a fixed-maturity security below its amortized cost is considered to be other-than-temporary based upon other considerations, the Company compares the estimated present value of the cash flows expected to be collected to the amortized cost of the security. The extent to which the estimated present value of the cash flows expected to be collected is less than the amortized cost of the security represents the credit-related portion of the OTTI, which is recognized in net income, resulting in a new cost basis for the security. Any remaining decline in fair value represents the noncredit portion of the OTTI, which is recognized in other comprehensive income
At December 31, 2019, the Company held 137 fixed-maturity securities with a total estimated fair value of $199.3 million and gross unrealized losses of $2.3 million. Of those securities, 51 were in a continuous unrealized loss position for greater than one year. Unrealized losses were caused by interest rate changes or other market factors and were not credit specific issues. At December 31, 2019, 89% of the Company’s fixed-maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities. Based on its review, the Company concluded that there were no other-than-temporary impairments from fixed-maturity securities with unrealized losses for the year ended December 31, 2019.
At December 31, 2018, the Company held 317 fixed-maturity securities with a total estimated fair value of $350.9 million and gross unrealized losses of $6.9 million. Of these securities, 158 were in a continuous unrealized loss position for greater than one year. Unrealized losses were caused by interest rate changes or other market factors and were not credit specific issues. At December 31, 2018, 86.4% of the Company’s fixed-maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities. Based on its review, the Company concluded that there were no other-than-temporary impairments from the fixed-maturity or equity securities with unrealized losses at December 31, 2018.
The amortized cost and estimated fair value of available-for-sale fixed-maturity securities at December 31, 2019 are summarized, by contractual maturity, as follows:
Fair values of the Company's investment portfolio are estimated using unadjusted prices obtained by its investment manager from nationally recognized third-party pricing services, where available. For securities where the Company is unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from the Company's investment manager. Management performs several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements at December 31, 2019 and 2018, including 1) obtaining and reviewing internal control reports from the Company's investment manager that assess fair values from third party pricing services, 2) discussing with the Company's investment manager its process for reviewing and validating pricing obtained from third party pricing services and 3) reviewing the security pricing received from the Company's investment manager and monitoring changes in unrealized gains and losses at the individual security level. The Company has evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs.
Amortization of net policy acquisition costs is included in the line item "Underwriting, acquisition and insurance expenses" in the accompanying consolidated statements of income and comprehensive income.
Other operating expenses within underwriting, acquisition and insurance expenses included salaries, employee benefits and bonus expense of $27.8 million, $19.7 million and $17.7 million, for the years ended December 31, 2019, 2018 and 2017, respectively.
Income tax expense includes the following components for the years ending December 31, 2019, 2018 and 2017:
The prevailing federal income tax rate was 21% in 2019 and 2018 and 35% in 2017. The Company’s effective income tax rate on income before income taxes differs from the prevailing federal income tax rate and is summarized as follows:
The significant components of the net deferred tax asset are summarized as follows:
At December 31, 2019 and 2018, the Company had state net operating loss carryforwards ("NOLS") of $31.6 million and $19.5 million, respectively. The state NOLs are available to offset future taxable income or reduce taxes payable and begin expiring in 2029.
The following table presents a reconciliation of consolidated beginning and ending reserves for unpaid losses and loss adjustment expenses:
business. This adverse development largely resulted from management’s decision to lengthen the actuarial loss development factors to provide for emergence of reported losses over a longer period of time based on trends observed in loss experience, which added a modest amount of conservatism to the Company’s IBNR reserves.
Prior to 2017, the Company participated in a multi-line quota share treaty ("MLQS") that transferred a portion of its risk related to certain lines of business to reinsurers that received a portion of the direct written premiums on that business. Effective January 1, 2017, the Company commuted the remaining outstanding MLQS covering the period January 1, 2015 to December 31, 2015, which reduced reinsurance recoverables on unpaid losses by approximately $27.9 million. The commutation did not have any effect on the Company's results of operations or cash flows for the applicable period.
The information about incurred and paid claims development for the years ended December 31, 2010 to December 31, 2018, is presented as unaudited supplementary information.
The Company purchases reinsurance from other insurance companies ("reinsurers") in order to limit its exposure to large losses and enable it to underwrite policies with sufficient limits to meet policyholder needs. In a reinsurance transaction, an insurance
The following table summarizes the effect of reinsurance on premiums written and earned:
Credit risk exists with reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. Reinsurance recoverables for unpaid losses were $69.8 million and $55.4 million, at December 31, 2019 and 2018, respectively. Reinsurance recoverables for paid losses were $2.8 million and $1.4 million at December 31, 2019 and 2018, respectively. Ceded unearned premiums related to reinsurance were $16.1 million and $16.1 million, at December 31, 2019 and 2018, respectively. Allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. All reinsurance receivables are from companies with A.M. Best ratings of "A" (Excellent) or better. To further reduce credit exposure to reinsurance recoverable balances, the Company has received letters of credit from certain reinsurers that are not authorized as reinsurers under U.S. state insurance regulations. The Company has not recorded an allowance for doubtful accounts related to its reinsurance balances at December 31, 2019 and 2018 and believes this to be appropriate after consideration of all currently available information; however, the deterioration in the credit quality of existing reinsurers or disputes over reinsurance agreements could result in future charges.
The Company’s authorized capital stock consists of 400,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share. There were no shares of preferred stock issued or outstanding at December 31, 2019 or December 31, 2018.
Expected life was calculated using the simplified method, which was an average of the contractual term of the option and its ordinary vesting period, as the Company did not have sufficient historical data for determining the expected term of our stock option awards.
A summary of option activity under the employee share option plan as of December 31, 2019, and changes during the year then ended is presented below:
The total intrinsic value of options exercised was $11.9 million during the year ended December 31, 2019 and $4.7 million during the year ended December 31, 2018. As of December 31, 2019, the Company had $0.3 million of unrecognized share-based compensation expense expected to be charged to earnings over a weighted-average period of 0.6 years.
The weighted average grant-date fair value of the Company's restricted stock awards granted during the years ended December 31, 2019 and 2018 was $80.59 and $52.99, respectively. There were no restricted stock awards granted during the year ended December 31, 2017. The fair value of restricted stock awards that vested during the year ended December 31, 2019 was $2.1 million.There were no restricted stock awards that vested during the years ended December 31, 2018 or 2017. As of December 31, 2019, the Company had $6.5 million of total unrecognized stock-based compensation expense expected to be charged to earnings over a weighted-average period of 3.0 years.
There were approximately 54 thousand and approximately 86 thousand anti-dilutive stock awards for the years ended December 31, 2019 and 2018, respectively. There were no anti-dilutive stock awards for the year ended December 31, 2017.
Basic earnings per share was computed by dividing the earnings attributable to the common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share was computed by dividing earnings attributable to common stockholders by the weighted average shares outstanding of common stock outstanding during the period, including potentially dilutive shares of common stock for the period determined using the treasury stock method.
The Company has established a defined contribution employee retirement plan ("Plan") in accordance with Section 401(k) of the Internal Revenue Code. Expenses related to the Plan were $1.3 million, $1.0 million and $1.0 million in 2019, 2018 and 2017, respectively.
The sale of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive income to realized gains or losses in current period earnings. The related tax effect of the reclassification adjustment is recorded in income tax expense in current period earnings. See Note 2 for additional information.
Small business underwrites commercial general liability on smaller risks with an emphasis on artisan contractors and premises related exposures.
Professional liability underwrites small-to-medium sized non-medical professional liability risks. The classes of risks we cover include accountants, architects and engineers, financial planners, insurance agents, lawyers, realtors, and certain other professions.
Energy underwrites commercial general liability, pollution liability, professional liability and excess liability on enterprises engaged in the business of energy production or distribution or mining including drillers, lease operators, contractors and product manufacturers. As previously discussed, during 2019, certain business previously underwritten by this division is now underwritten by the Excess Casualty division and prior year amounts have been reclassified to conform to the current year's presentation.
Inland marine underwrites a variety of inland marine coverages including builders risk, contractors' equipment, transportation risks and mobile equipment.
Kinsale Insurance maintains its accounts in conformity with accounting practices prescribed or permitted by state regulatory authorities that vary in certain respects from GAAP. In converting from statutory accounting principles to GAAP, typical adjustments include deferral of policy acquisition costs, the inclusion of statutory nonadmitted assets and the inclusion of net unrealized gains or losses relating to fixed maturities in stockholders’ equity. The Company does not use any permitted practices that are different from prescribed statutory accounting practices.
Statutory net income and statutory capital and surplus for Kinsale Insurance as of December 31, 2019, 2018, and 2017 and for the years then ended are summarized as follows:
Kinsale Insurance is subject to risk-based capital ("RBC") requirements. RBC is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of RBC is calculated using various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the RBC results, as determined by the formula. Companies that do not maintain statutory capital and surplus at a level in excess of the company action level RBC are required to take specified actions. At December 31, 2019 and 2018, actual statutory capital and surplus for Kinsale Insurance substantially exceeded the regulatory requirements.
Loans under the Credit Facility may be subject to varying rates of interest depending on whether the loan is a Eurodollar loan or an alternate base rate (ABR) loan, at the Company's election. Eurodollar loans bear an interest rate per annum equal to adjusted LIBOR for the applicable interest period plus a margin of 1.75%. ABR loans bear an interest rate per annum equal to the higher of the prime rate, the New York Federal Reserve Board Rate or the one-month adjusted LIBOR, plus the applicable margin of 0.75% to 1.75%, depending on which interest option was applicable for the particular ABR loan. As of December 31, 2019, there was $17.3 million outstanding under the Credit Facility, net of debt issuance cost of $0.6 million, with a weighted average interest rate of 3.75%. Total interest expense under the Credit Facility was $0.2 million for the year ended December 31, 2019 and was capitalized as part of the real estate project under construction. See Note 1 for further details. Interest paid was $0.1 million for the year ending December 31, 2019. There were no credit agreements outstanding at December 31, 2018 or December 31, 2017.
Cash dividends paid to Kinsale Capital Group, Inc. by its wholly-owned subsidiary, Kinsale Insurance Company, were $5.0 million for the year ended December 31, 2019, $11.5 million for the year ended December 31, 2018, and $4.5 million for the year ended December 31, 2017.