facilities and equipment are generally well maintained, in good operating conditions and suitable and adequate for our present operations.
In recent years, the Florida personal residential insurance market has been characterized by increased losses and LAE due to abuses and inflated claims. These conditions have continued to worsen and have reached levels well beyond historical norms and levels experienced in other jurisdictions. The adverse conditions in the Florida personal residential insurance market can be attributed largely to the proliferation of represented claims, involving both public adjusters and attorneys, as well as by aggressive estimates and demands put forth by remediation and repair companies. In many cases, policyholders have representation even before the claims are filed or before the Company is able to provide an initial assessment of damages. In other instances, policyholder representatives are taking opportunities occasioned by hurricanes or other events to solicit customers to file other claims or to re-open prior claims, sometimes years after the purported dates of loss. These conditions are fostered in large part by the one-way right to attorneys’ fees against insurers provided under the Florida Insurance Code. These actions adversely affect both the frequency and severity of losses as otherwise understood based on historical patterns and patterns experienced in other states. See “Part I-Item 1A - Risk Factors-Risks Relating to Our Business and Operations-Actual claims incurred have exceeded, and in the future may exceed, reserves established for claims, adversely affecting our operating results and financial condition.”
The Company has taken a series of steps over time to mitigate the financial impact of these negative trends in the Florida market. We also have closely monitored rate levels, especially in the Florida market, and have submitted rate filings based upon evolving data. In addition, the Company has implemented several initiatives in its claims department in response to the adverse market trends. We utilize our process called Fast Track, which is an initiative to handle straightforward, meritorious claims as promptly as possible to mitigate the adverse impacts that can be seen with claims that remain open for longer periods. In addition, we increased our emphasis on subrogation to reduce our net losses while also recovering policyholders’ deductibles when losses are attributable to the actions of others. We have an internal staff of trained water remediation experts to address the extraordinary number of purported water damage claims filed by policyholders and vendors. We developed a specialized in-house unit for responding to the unique aspects of represented claims, and we have substantially increased our in-house legal staff in an effort to address the increase in litigated or represented claims as cost-effectively as possible.
Additionally, we have taken steps to implement claim settlement rules associated with the Florida legislation passed in 2019 designed to reduce the negative effects of claims involving assignments of benefits (“AOB”). See “Part I- Item 1 - Business-Government Regulation.” An AOB is a document signed by a policyholder that allows a third party to be paid for services performed for an insured homeowner who would normally be reimbursed by the insurance company directly after making a claim. Prior to the AOB reform legislation, the Company experienced an increase in the use of AOBs involving litigation by Florida policyholders. Claims paid under an AOB often involve unnecessary litigation, with the Company required to pay both its own defense costs and those of the plaintiff, and, as a result, cost the Company significantly more than claims settled when an AOB is not involved. In 2019, the Florida legislature passed legislation designed to increase consumer protections against AOB abuses and reduce AOB-related litigation. While the Florida legislation addressing abuses associated with AOBs may be beneficial in reducing one aspect of the concerns affecting the Florida market, the overall impact of the deterioration in claims-related tactics and behaviors, including other first-party litigation, thus far has continued to outpace benefits arising from the 2019 AOB reform legislation.
Direct premiums written continue to increase across the states we conduct business. As a result of our business strategy, rate changes and marketing and underwriting initiatives, we have seen increases in policy count, in-force premium and total insured value in almost all states for the past three years. Direct premiums written for states outside of Florida increased 17.7%, representing a $40.1 million increase during 2020. Direct premium for Florida increased 17.3%, representing a $184.6 million increase during 2020. The following table provides direct premiums written for Florida and other states for the years ended December 31, 2020 and 2019 (dollars in thousands):
The geographical distribution of our policies in force, premium in force and total insured value across all states were as follows, as of December 31, 2020, 2019 and 2018 (dollars in thousands, rounded to the nearest thousand):
The Company considers the measures and ratios in the following discussion to be key performance indicators for its businesses. Management believes that these indicators are helpful in understanding the underlying trends in the Company’s businesses. Some of these indicators are reported on a quarterly basis and others on an annual basis. Please also refer to “Item 8 - Note 2 (Summary of Significant Accounting Policies)” for definitions of certain other terms we use when describing our financial results.
Combined Ratio - the combined ratio is a measure of underwriting profitability for a reporting period and is calculated by dividing total operating costs and expenses (which is made up of losses and LAE and general and administrative expenses) by premiums earned, net, which is net of ceded premiums earned. The combined ratio and changes to the ratio over time provide management with an understanding of costs to operate its business in relation to net premiums it is earning and the impact of rate, underwriting and other business management actions on underwriting profitability. A combined ratio below 100 indicates underwriting profit; a combined ratio above 100 indicates underwriting losses.
Core Loss Ratio - a common operational metric used in the insurance industry to describe the ratio of current accident year expected losses and LAE to premiums earned. Core loss ratio is an important measure identifying profitability trends of premiums in force. Core losses consists of all other losses and LAE, excluding weather events beyond those expected and prior years’ reserve development. The financial benefit from the management of claims, including claim fees ceded to reinsurers, is recorded in the condensed consolidated financial statements as a reduction to core losses.
Debt-to-Equity Ratio - long-term debt divided by stockholders’ equity. This ratio helps management measure the amount of financing leverage in place in relation to equity and future leverage capacity.
Losses and Loss Adjustment Expense Ratio or Loss and LAE Ratio - a measure of the cost of claims and claim settlement expenses incurred in a reporting period as a percentage of premiums earned in that same reporting period. Losses and LAE incurred in a reporting period includes both amounts related to the current accident year and prior accident years, if any, referred to as development. Ultimate losses and LAE are based on actuarial estimates with changes in those estimates recognized in the period the estimates are revised. Losses and LAE consist of claim costs arising from claims occurring and settling in the current period, an estimate of claim costs for reported but unpaid claims, an estimate of unpaid claim costs for incurred-but-not-reported claims and an estimate of claim settlement expenses associated with reported and unreported claims which occurred during the reporting period. The loss and LAE ratio can be measured on a direct basis, which includes losses and LAE divided by direct earned premiums, or on a net basis, which includes losses and LAE after amounts have been ceded to reinsurers divided by net earned premiums (i.e., direct premium earned less ceded premium earned). The net loss and LAE ratio is a measure of underwriting profitability after giving consideration to the effect of reinsurance. Trends in the net loss and LAE ratio are an indication to management of current and future profitability.
Policies in Force - represents the number of active policies with coverage in effect as of the end of the reporting period. The change in the number of policies in force is a growth measure and provides management with an indication of progress toward achieving strategic objectives. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Total Insured Value - represents the amount of insurance limits available on a policy for a single loss based on all policies active as of the reporting date. This measure assists management in measuring the level of insured exposure.
Weather events - an estimate of losses and LAE from weather events occurring during the current accident year that exceed initial estimates of expected weather events when establishing the core loss ratio for each accident year. This metric informs management of factors impacting overall current year profitability.
Effective June 1, 2020, the Insurance Entities entered into multiple reinsurance agreements comprising our 2020-2021 reinsurance program. See “Part II-Item 8 - Note 4 (Reinsurance).”
•All States first event tower extends to $3.36 billion with no co-participation in any of the layers, no limitations on loss adjustment expenses and no accelerated deposit premiums.
•Assuming a first event completely exhausts the $3.36 billion tower, the second event exhaustion point would be $1.343 billion.
•Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For all layers purchased between $90 million and the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, UPCIC has purchased enough reinstatement premium protection (“RPP”) limit to pay the premium necessary for the reinstatement of these coverages.
•Effective September 1, 2020, UPCIC purchased RPP limit for the layer attaching at $45 million. Combined with the RPP limit purchased at June 1, 2020, UPCIC has purchased enough RPP limit to pay for the premium necessary for the reinstatement of all catastrophe layers between $45 million and the projected FHCF retention.
•Specific 3rd and 4th event private market catastrophe excess of loss coverage of $76 million in excess of $35 million provides frequency protection for a multiple event storm season.
•For the FHCF Reimbursement Contracts effective June 1, 2020, UPCIC has continued the election of the 90% coverage level. We estimate the total mandatory FHCF layer will provide approximately $2.008 billion of coverage for UPCIC, which inures to the benefit of the open market coverage secured from private reinsurers.
•All States first event tower of $43.6 million with no co-participation in any of the layers, no limitation on loss adjustment expenses and no accelerated deposit premiums.
•Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For the layer purchased between $3 million and the projected FHCF retention, to the extent that all coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, APPCIC purchased enough RPP limit to pay the premium necessary for the reinstatement of this coverage.
The table below provides the A.M. Best and S&P financial strength ratings for each of the largest third-party reinsurers in APPCIC’s 2020-2021 reinsurance program:
The total cost of the 2020-2021 reinsurance programs for UPCIC and APPCIC is projected to be $499.8 million, representing approximately 34.0% of estimated direct premium earned for the 12-month treaty period.
YEAR ENDED DECEMBER 31, 2020 COMPARED TO YEAR ENDED DECEMBER 31, 2019
•In Florida, direct premiums written grew by $184.6 million, or 17.3%, and in our other states, direct premiums written grew by $40.1 million, or 17.7%.
•Weighted average diluted common shares outstanding were lower by 6.6% to 32.0 million shares as of December 31, 2020 from 34.2 million shares as of December 31, 2019.
•Repurchased 1,610,783 shares in 2020 at an aggregate cost of $28.9 million.
•Offered Universal DirectSM in all 19 states in which the Company writes policies as of December 31, 2020.
Net income was $19.1 million for the year ended December 31, 2020, compared to net income of $46.5 million for the same period in 2019.
Direct premiums written increased by $224.8 million, or 17.4%, for the year ended December 31, 2020, driven by growth within our Florida business of $184.6 million, or 17.3%, and growth in our other states business of $40.1 million, or 17.7%, as compared to the same period of the prior year. Rate increases in Florida and in certain other states along with slightly improved retention also contributed to the premium growth. Premium in force increased in every state in which we are writing at December 31, 2020 compared to December 31, 2019. We implemented new guidelines during the year ended December 31, 2020 on new business to address emerging loss trends that have since slowed the rate of growth in Florida in certain territories during December 31, 2020. We actively wrote policies in 19 states during 2020 compared to 18 in 2019. In addition, we are authorized to do business in Tennessee and Wisconsin and are proceeding with product filings in those states. During the second quarter of 2020 the Company withdrew its application to write business in Connecticut. Policies in force, premium in force and total insured value all increased as of December 31, 2020 when compared to December 31, 2019.
Yields from cash and cash equivalents, short-term investments and the available-for-sale debt portfolio are dependent on future market forces, monetary policy and interest rate policy from the Federal Reserve. The Federal Reserve has broadly been lowering and maintaining lower interest rates, which has impacted the effective yields on new available-for-sale portfolio and overnight cash purchases and short-term investments. The overall trend has been lower interest rates on new purchases of securities over the past year and lower returns on cash and cash equivalents and short-term investments. As discussed below, due to the significant sale of securities during the third quarter of 2020, it is expected that future portfolio returns will reflect lower book yields based on current market conditions.
There was a nominal favorable net unrealized gain in equity securities during the year ended December 31, 2020 compared to a $23.2 million favorable net unrealized gain during the year ended December 31, 2019. Unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held and the reversal of unrealized gains or losses for securities sold during the period. See “Part II-Item 8 - Note 3 (Investments).”
During 2020, the COVID-19 pandemic disrupted the financial markets. In the first quarter of 2020, our investment portfolio was negatively impacted, but has since substantially recovered. We took advantage of the recovery with the realization of gains on our available-for-sale debt securities discussed above. We believe the adverse impact to our investment portfolio was minimized during this COVID-19-induced market dislocation as a result of our conservative investment strategy’s focus on capital preservation and adequate liquidity to pay claims. We believe the high credit rating and shorter duration foundation of our portfolio and portfolio diversification will help us weather these difficult market conditions, thereby limiting the impact of future economic financial market downturns on the portfolio. Recent market yields have been lower when compared to prior years and we expect that trend to continue, negatively impacting future investment returns on our portfolio. We will continue to monitor the impact of COVID-19 on our portfolio. Significant uncertainties and emerging risks still exist regarding the potential long-term impact of COVID-19 on the credit markets and our investment portfolio.
reinsurers earned on increased reinsurance premiums due to growth in our exposures, as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year.
See “Part II-Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for change in liability for unpaid losses and LAE.
Management evaluates losses and LAE in three areas, as described below and represented in the tables above, each of which have different drivers which impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were $758.8 million resulting in a 82.2% net loss and LAE ratio for the year ended December 31, 2020. This compares to $603.4 million resulting in a 71.6% net loss and LAE ratio for the year ended December 31, 2019.
During the year ended December 31, 2020, there were a significant number of storms including Hurricane Sally compared to prior years which in the aggregate exceeded core loss ratio expectations. The number of adverse weather events and resulting claims during the fourth quarter exceeded weather event claims reported during the first three quarters. Reported losses from Hurricane Sally significantly benefited from our catastrophe reinsurance protection. Our reinsurance program reduced our direct estimate of Hurricane Sally ultimate losses of $133.4 million to $43.0 million on a net basis after estimated reinsurance recoveries. Other weather events resulting in losses with only limited benefit from our catastrophe reinsurance protection included Hurricanes Isaias, Eta, Delta and Zeta and other unnamed storms tracked by an industry numerically assigned identifier. These weather events totaled direct losses of $123.5 million and $119.0 million net after reinsurance. In 2020 the Company experienced the highest level of unnamed weather events when compared to the previous three years.
During the year ended December 31, 2019, weather events totaled $45.6 million direct and $38.7 million net, principally for Hurricane Dorian and other weather events beyond those expected.
Management identifies two drivers which influence amounts recorded as prior years’ reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes in prior estimates of direct and net ultimate losses on hurricanes. During the year ended December 31, 2020, prior years’ reserve development totaled $284.3 million of direct losses and $58.3 million of net losses after the benefit of reinsurance.
General and administrative expenses were $289.7 million for the year ended December 31, 2020, compared to $272.4 million during the same period in 2019 as detailed below (dollars in thousands):
General and administrative expenses increased by $17.3 million, which was the result of increases in policy acquisition costs of $21.6 million due to commissions associated with increased premium volume offset by a decrease in other operating costs of $4.3 million. The expense ratio as a percentage of premiums earned, net decreased from 32.3% for the year ended December 31, 2019 to 31.4% for the same period in 2020. Our increase in policy acquisition costs continued to be driven by increased premium volume and continued geographic expansion into states that typically have higher commission rates as compared to Florida. Other operating costs ratio for the year ended December 31, 2020 was 9.8% compared to 11.2% for the year ended December 31, 2019, reflecting lower share-based compensation and performance bonuses in 2020 and economies of scale as other operating costs did not increase at the same rate as premiums earned, net. In addition, due to the COVID-19 pandemic, travel and auto expenses along with meal and entertainment were lower in 2020 when compared to the prior year.
Benefiting the year ended December 31, 2019 were increases in net earned premium, net investment income, commission revenue and increases in the net change in unrealized gains of equity securities, offset by realized losses on investments and increased operating costs for losses and LAE and general and administrative costs. Direct and net earned premium were up 8.6% and 9.9%, respectively, due to growth in all states in which we are licensed and writing during the past 12 months. Increases in losses and LAE were the result of several factors including (1) premium growth and change in mix between Florida and other states, (2) reduced financial benefit from the management of claims including claim fees ceded to reinsurers, (3) increased estimated core losses and LAE for the current year compared to prior year, (4) adverse development on prior years’ loss and LAE reserves and (5) weather events in excess of plan this year.
Direct premium earned increased by $111.5 million, or 9.9%, for the year ended December 31, 2019, reflecting the earning of premiums written over the past 12 months and changes in rates and policy count during that time.
Net investment income was $30.7 million for the year ended December 31, 2019, compared to $24.8 million for the year ended December 31, 2018, an increase of $5.9 million, or 23.9%. The increase is driven by the combination of the growth in cash and invested assets compared to the prior year and benefits from higher yielding assets offset by a lower trend in yields on cash and short term investments during 2019. Total invested assets were $914.6 million with an average fixed income credit rating of A+ during the year ended December 31, 2019 compared to $908.2 million with an average fixed credit rating of A+ for the same period in 2018. The duration of fixed income securities was 3.8 years at December 31, 2019 compared to 3.6 years at December 31, 2018. Cash and cash equivalents were $182.1 million at December 31, 2019 compared to $166.4 million at December 31, 2018, an increase of 9.4%. Cash and cash equivalents are invested short term until needed to settle payments to reinsurers, loss and LAE payments and operating cash needs.
Yields from the fixed income portfolio are dependent on future market forces, monetary policy and interest rate policy from the Federal Reserve. In 2019, the Federal Reserve lowered interest rates, which impacted effective yields on new fixed income and overnight cash purchases. The impact from this trend in 2019 has been somewhat limited as investments mature over many future years based on the effective maturity of the portfolio, subjecting only the current year redemptions to the lower interest rate environment. The Company’s investment strategy is to invest in assets with multi-year effective maturities, locking in book yields for future years, which dampers the impact that market fluctuations have on current investment income.
We sell securities from our investment portfolio and real estate investments from time to time to meet our investment objectives. As further described in “Item 1 - Note 3 (Investments)”, we realize both gains and losses on the sale of securities and real estate. We sold securities and investment real estate during the year ended December 31, 2019. Net of realized gains, sales resulted in a net realized loss of $12.7 million during the year ended December 31, 2019 compared to net realized loss of $2.1 million for the year ended December 31, 2018. The realized losses during the year ended December 31, 2019 resulted primarily from the sale of equity securities, whereas the realized loss for the year ended December 31, 2018 resulted primarily from the sale of municipal securities, which were liquidated in light of their diminished after-tax returns following the enactment of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). See “Part II-Item 8 - Note 3 (Investments).”
There was a $23.2 million favorable net unrealized gain in equity securities during the year ended December 31, 2019 compared to a $17.2 million unfavorable net unrealized loss during the year ended December 31, 2018 Unrealized gains or losses are the result of changes in the fair market value of our equity securities during the period for securities still held and the reversal of unrealized gains or losses for securities sold during the period. See “Part II-Item 8 - Note 3 (Investments).”
Commission revenue is comprised principally of brokerage commissions we earn from reinsurers on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1 to May 31 of the following year. For the year ended December 31, 2019, commission revenue was $26.1 million, an increase of $3.7 million, or 16.3%, compared to $22.4 million for the year ended December 31, 2018.
Losses and LAE, net of ceded losses for the year ended December 31, 2019 were $603.4 million compared to $414.5 million in the same period in 2018, an increase of $189.0 million, or 45.6%.
•In the Florida market, claims understood to have been satisfactorily resolved and closed are being re-opened, sometimes years later, typically with representation from policyholder representatives or vendors who actively solicit policyholders for the purpose of filing claims.
•Both the frequency (number of claims) and severity (cost of a claim) of claims in Florida have risen beyond anticipated levels, largely driven by consumer behavior responding to the industry that has arisen around profiting from such
claims. This in turn is facilitated by Florida’s legal climate, including the one-way threat of attorneys’ fees against insurers and the relatively high cost of defending against inflated claims demands in relation to amounts in dispute.
•We have reduced our estimate for subrogation recoveries due to changes in the Florida claims and legal environment. Subrogation reduces an insurer’s net losses and results in recoveries of policyholders’ deductibles. Historically, the subrogation process often has resulted in a straightforward apportionment of losses based upon parties’ respective responsibilities. However, adverse conditions and claims-related behaviors in Florida have led to a proliferation of represented claims, claims that are inflated or of questionable merit, and claims that are reported or re-opened well after the purported dates of loss. Losses and LAE patterns associated with these claims differ from historical patterns from industry norms found in other states. Accordingly, we have reduced our estimate of subrogation recoveries to recognize that conditions in Florida likewise could impact the effectiveness of our subrogation efforts by reducing amounts otherwise owed to us and our policyholders and by increasing our subrogation costs. Losses are recorded, net of estimated subrogation recoveries in the financial statements. Estimated subrogation recoveries totaled $73.0 million at December 31, 2019 compared to $99.0 million at December 31, 2018. During 2019, we reduced our estimate of subrogation recoveries by $40.7 million.
•Direct and ceded losses include prior year reserve development on major hurricanes where the settlement of claims and the re-estimation of expected costs for losses and LAE remaining to be settled exceed previously carried reserves. In 2019, for Hurricanes Irma, Florence, Michael and Matthew, we recorded adverse development of $469.9 million of gross losses and $465.4 million of ceded losses resulting in $4.5 million net impact. This compares to only one hurricane having adverse development in 2018 of $513 million of gross losses and $513 million of ceded losses, resulting in zero net losses in 2018 from Hurricane Irma. In addition, we recorded $2.6 million in 2019, compared to$20.7 million in 2018, of contractually based costs for reinstatement premiums as a result of adverse development of ceded losses for Hurricane Irma recorded during 2019 and 2018.
The financial benefit from the management of claims ceded, including claim fees ceded to reinsurers, was $3.2 million for the year ended December 31, 2019, compared to $72.2 million during the year ended December 31, 2018. The reduction in the benefit was in line with the runoff of claims from hurricanes which occurred in 2017 and 2018. The financial benefit from the management of claims fees ceded to reinsurers was recorded in the condensed consolidated financial statements as a reduction to losses and LAE and included as a reduction to All other losses and loss adjustment expenses in the chart above.
Income tax expense decreased by $18.8 million, or 52.5%, for the year ended December 31, 2019, as a result of a 58.5% reduction in income before income taxes, when compared with the year ended December 31, 2018. Our effective tax rate increased to 26.8% for the year ended December 31, 2019, as compared to 23.4% for the year ended December 31, 2018. The effective tax rate increased slightly as a result of permanent items relative to income before taxes, principally non-deductible compensation, offset by a lower level of excess tax benefit. See “Part II-Item 8 - Note 12 (Income Taxes)” for an explanation of the change in our effective tax rates.
Other comprehensive income, net of taxes for the year ended December 31, 2019 was $28.4 million of net unrealized gains related to debt securities available-for-sale compared to other comprehensive loss of $4.7 million related to net unrealized losses on debt securities available-for-sale for the same period in 2018. See “Part II-Item 8 - Note 14 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income and loss for these periods.
Restricted cash and cash equivalents increased $10.1 million to $12.7 million as of December 31, 2020 as a result of collateral held by a reinsurance captive arrangement with one of the Insurance Entities reported as a Variable Interest Entity (“VIE”) in the consolidated financial statements. See “Part II-Item 8 - Note 18 (Variable Interest Entities)” for more information.
Prepaid reinsurance premiums represent the portion of unearned ceded written premium that will be earned pro-rata over the coverage period of our reinsurance program, which runs from June 1st to May 31st of the following year. The increase of $40.5 million to $215.7 million as of December 31, 2020 was due to additional ceded written premium for the reinsurance costs relating to our 2020-2021 catastrophe reinsurance program beginning June 1, 2020, less amortization of prepaid reinsurance premiums recorded during 2020.
Premiums receivable, net represents amounts receivable from policyholders. The increase in premiums receivable, net of $3.0 million to $66.9 million as of December 31, 2020 relates to growth and consumer payment behavior of our business. The amount of direct premiums written during a calendar year tends to increase just prior to the second quarter and tends to decrease approaching the fourth quarter.
Property and equipment, net increased by $12.2 million to $53.6 million as of December 31, 2020, primarily as the result of new spend on capitalized software expenditures and, to a lesser extent, the remaining capitalized costs to outfit a new office building in Fort Lauderdale, Florida, which will be used to meet the staffing needs of the Company as the business continues to expand, and new IT equipment to address work-from-home IT equipment needs during the COVID-19 pandemic.
Deferred policy acquisition costs (“DPAC”) increased by $18.7 million to $110.6 million as of December 31, 2020, which is consistent with the underlying premium growth. See “Part II-Item 8 - Note 5 (Insurance Operations)” for a roll-forward in the balance of our DPAC.
Income taxes recoverable represents the difference between estimated tax obligations and tax payments made to taxing authorities. As of December 31, 2020, the balance recoverable was $30.6 million, representing amounts due from taxing authorities at that date, compared to a balance recoverable of $34.3 million as of December 31, 2019. Income taxes recoverable as of December 31, 2020 will be applied to future periods to offset future federal and state income tax obligations.
See “Part II-Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a roll-forward in the balance of our unpaid losses and LAE. Unpaid losses and LAE increased by $54.7 million to $322.5 million as of December 31, 2020. The increase in unpaid losses and LAE was principally due to increased 2020 weather in excess of plan reduced by the settlement of claims from previous hurricane and storm events, as more newly reported and expected claims from 2020 exceeded prior year claim settlements. Overall unpaid losses and LAE increased, as new emerging claims exceeded claim settlements. Unpaid losses and LAE are net of estimated subrogation recoveries of $71 million as of December 31, 2020 compared to $73 million as of December 31, 2019.
Unearned premiums represent the portion of direct premiums written that will be earned pro-rata in the future. The increase of $121.9 million to $783.1 million as of December 31, 2020 reflects both organic growth and the seasonality of our business, which varies from month to month.
Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $18.6 million from December 31, 2019 to $49.6 million as of December 31, 2020 reflects customer payment behavior and organic growth.
Reinsurance payable, net, represents the unpaid reinsurance premium installments owed to reinsurers, unpaid reinstatement premiums due to reinsurers and cash advances received from reinsurers, if any. On June 1st of each year, we renew our catastrophe reinsurance program and record the estimated annual cost of our reinsurance program. The annual cost initially increases reinsurance payable, which is then reduced as installment payments are made over the policy period of the reinsurance, which runs from June 1st to May 31st. The balance decreased by $112.3 million to $10.3 million as of December 31, 2020 as a result of an acceleration of payments in December 2020 for amounts typically paid in January and April of the following year relating to the 2020-2021 reinsurance program.
Other liabilities and accrued expenses increased by $30.7 million to $52.3 million as of December 31, 2020, primarily driven by an increase in the collection of advanced reinsurance commission of $15.4 million received by BARC, payable for unsettled security purchases of $8.8 million and an increase of $8.9 million due to timing of accrued obligations. Advance reinsurance commission represents the early collection of reinsurance commissions by BARC as a result of the Company settling its reinsurance obligations before the contractual due date. Payable for securities purchased represents payables relating to available-for-sale debt securities purchases which settled after December 31, 2020. There were payable for securities purchased totaling $8.8 million as of December 31, 2020. There were no payable for securities purchased as of December 31, 2019.
Additional paid-in-capital increased by $7.4 million primarily from share-based compensation expense of $8.7 million for the year ended December 31, 2020. This was offset by the common stock value acquired and cancelled through tax withholdings on the intrinsic value of restricted stock vested, performance units vested, and restricted stock units vested for share-based payment transactions of $1.3 million for the year ended December 31, 2020.
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short- and long-term obligations. Funds generated from operations have been sufficient and we expect them to be sufficient to meet our current and long term liquidity requirements. We will continue to monitor liquidity as the economic consequences of COVID-19 continue to unfold. See discussion below regarding the COVID-19 pandemic’s impact. Also see the discussion above under “Overview-Trends-Impact of COVID-19” regarding our response to COVID-19, the financial impact to us in 2020, our general outlook and plans to monitor the economic consequences of COVID-19.
During 2020, there was one significant hurricane which occurred, Hurricane Sally, where estimated losses benefited from UPCIC’s reinsurance program. During 2019, there was one hurricane which occurred, Hurricane Dorian, where claims were within UPCIC’s retention under its reinsurance program. The Company’s reinsurance program provides sufficient liquidity in the form of cash advances for paid losses ceded to the reinsurers. During 2020, the Company routinely collected amounts ceded to reinsurers and, as in the past did not have to use funds in the Company’s investment portfolio. See “ Results of Operations” for more information.
The balance of restricted cash and cash equivalents as of December 31, 2020 and 2019 represents cash equivalents on deposit with certain regulatory agencies in the various states in which our Insurance Entities do business and, in 2020, restricted cash and cash equivalents also includes collateral held by a reinsurance captive arrangement with one of the Insurance Entities reported as a VIE in the condensed consolidated financial statements. The amount of collateral held was $10.1 million as of December 31, 2020. See “Part II-Item 8 - Note 18 (Variable Interest Entities)” for more information.
The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the FLOIR is subject to restrictions as referenced below and in “Item 8 - Note 5 (Insurance Operations).” The maximum dividend that may be paid by the Insurance Entities to PSI without prior approval is limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the years ended December 31, 2020 and 2019 the Insurance Entities did not pay dividends to PSI.
In addition to the liquidity generally provided from operations, we maintain a conservative, well-diversified investment portfolio, predominantly comprised of fixed income securities with an average credit rating of A+, that focuses on capital preservation and providing an adequate source of liquidity for potential claim payments and other cash needs. The portfolio’s secondary investment objective is to provide a total rate of return with emphasis on investment income. Historically, we have consistently generated funds from operations, allowing our cash and invested assets to grow. We have not had to liquidate investment holdings to fund either operations or financing activities. During March 2020, we initially saw extreme instability and dysfunction in the fixed income market, which settled down as the Federal Reserve provided liquidity to that marketplace in the latter part of March. Subsequent to March 2020, we took advantage of the market recovery and recognized $56.6 million of net realized gains on the sales of our available-for-sale debt securities that were in an unrealized gain position. In addition to monetizing an unrealized gain that was recognized in stockholders’ equity under the United States Generally Accepted Accounting Principles (“U.S. GAAP”) on a consolidated basis for available-for-sale debt securities and carried at fair value, the realized gains served to increase surplus for UPCIC since available-for-sale debt securities are generally carried at amortized cost under statutory accounting rules.
Although volatility in the markets remains a key risk as the world continues to navigate the consequences of the COVID-19 pandemic, there has been significant recovery in values since the low point on or about March 23, 2020. The proceeds from the sales of available-for-sale debt securities discussed above are in the process of reinvestment which accounts for a temporary increase in cash and cash equivalents as of December 31, 2020. The sales took advantage of increased market prices occurring on our available-for-sale debt investment portfolio. As a result of the sales and reinvestment of available-for-sale debt
securities, it is expected that future portfolio investment income will reflect current market rates which are below the book yield of the securities sold. We remain in regular contact with our advisors to monitor credit actions taken to issuers of our securities and discuss appropriate responses to those actions. We believe these measures, when combined with the inherent liquidity generated by our business model and in our investment portfolio, will allow us to continue to meet our short- and long-term obligations.
We implemented certain premium payment grace periods in Florida and other states to assist policyholders affected by COVID-19. In addition, we have waived late payment fees that otherwise would apply to those policyholders. To date we have not seen significant use of these grace periods. However, the effects of stay-at-home orders are still unfolding and some affected policyholders might not have yet had their next premium payments come due. We are not able at this time to estimate the number of policyholders who might avail themselves of an extended grace period. Generally, a significant number of our policies are subject to payment by mortgage companies, which are likely to continue remitting payments as scheduled. Our collection experience since March 2020 was consistent with our average experience. This reflects on the nature of homeowners’ insurance and the priority that mortgage companies and policyholders place on maintaining coverage for insured properties. We will monitor this as the impact of COVID-19 and its economic consequences are felt by our policyholders.
We may repurchase shares from time to time at our discretion, based on ongoing assessments of our capital needs, the market price of our common stock and general market conditions. We will fund the share repurchase program with cash from operations.
In total, during the year ended December 31, 2020, we repurchased an aggregate of 1,610,783 shares of our common stock in the open market at an aggregate purchase price of $28.9 million. Also see “Part II-Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities-Registrant Purchases of Equity Securities” for share repurchase activity during 2020 and the three months ended December 31, 2020.
(1)The ratios are net of ceded premiums and losses and LAE, including premiums ceded to our catastrophe reinsurers which comprise a significant cost, and losses and LAE ceded to reinsurers. The expense ratio includes management fees and commissions, which are based on market rates, paid to an affiliate of the Insurance Entities in the amount of $118.1 million and $104.6 million for UPCIC for the years ended December 31, 2020 and 2019, respectively, and $0.9 million and $0.6 million for each of the years ended December 31, 2020 and 2019, respectively, for APPCIC. The management fees and commissions paid to the affiliate are eliminated in consolidation.
The Insurance Entities’ financial strength is rated by a rating agency to measure the Insurance Entities’ ability to meet their financial obligations to its policyholders. The agency maintains a letter scale Financial Stability Rating® system ranging from “A” (A double prime) to “L” (licensed by state regulatory authorities).
In November 2020, Demotech, Inc. affirmed the Financial Stability Rating® of “A” for the Insurance Entities. According to Demotech, Inc., the assigned rating represents a company’s continued positive surplus related to policyholders, liquidity of invested assets, an acceptable level of financial leverage, reasonable loss and LAE reserves, and realistic pricing. The ratings of the Insurance Entities are subject to at least annual review by Demotech, Inc., and may be revised upward or downward or revoked at the sole discretion of Demotech, Inc. Financial Stability Ratings® are primarily directed towards policyholders, and are not evaluations directed toward the protection of investors in a company, including holders of a company’s common stock, and are not recommendations to buy, sell or hold securities. See “Part I-Item 1A - Risk Factors-Risks Relating to Our Business and Operations-A downgrade in our Financial Stability Rating® may have an adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition.”
The Company does not have any off-balance arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company, except for multi-year reinsurance contract commitments for future years that will be recorded at the commencement of the coverage period. See “Part II-Item 8 - Note 15 (Commitments and Contingencies)” for more information.
(1)The 1-3 years amount represents the payment of reinsurance premiums payable under multi-year commitments. See “Part II-Item 8 - Note 15 (Commitments and Contingencies).”
(2)There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the unpaid losses and LAE do not represent all the obligations that will arise under the contracts, but rather only the estimated liability incurred through December 31, 2020. Unpaid losses and LAE are net of estimated subrogation recoveries. In addition, these balances exclude amounts recoverable from our reinsurance program. See “Part II-Item 8 - Note 4 (Reinsurance).”
The financial statements and related data presented herein have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE.
We entered into a reinsurance captive arrangement with a VIE in the normal course of business, and consolidated the VIE since we are the primary beneficiary.
For a further discussion of our involvement with the VIE, see “Part II-Item 8 - Note 2 (Summary of Significant Accounting Policies)” and “Item 8 - Note 18 (Variable Interest Entities).”
The preparation of financial statements in conformity with 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 financial statements and the reported amounts of revenues and expenses during the reporting periods.
periods in which we determine the adjustments are necessary. We estimate and accrue our right to subrogate reported or estimated claims against other parties. Subrogated claims are recorded at amounts estimated to be received from the subrogated parties, net of expenses and netted against unpaid losses and LAE.
•Five-year accident year table on incurred claim and allocated claim adjustment expenses, net of reinsurance including columns of:
•Reconciliation of net incurred and paid claims development tables to the liability for unpaid losses and LAE in the consolidated balance sheet,
Reserve estimates are developed based on the processes and historical development trends discussed in “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. These estimates are considered in conjunction with known facts and interpretations of circumstances and factors including our experience with similar cases, actual claims paid, differing payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. When these types of changes are experienced, actuarial judgment is applied in the determination and selection of development factors in order to better reflect new trends or expectations. For example, if a change in law is expected to have a significant impact on the development of claim severity, actuarial judgment is applied to determine appropriate development factors that will most accurately reflect the expected impact on that specific estimate. This example appropriately describes the reserving methodology selection for use in estimating sinkhole liabilities after the passing of legislation, as noted in “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. Another example would be when a change in economic conditions is expected to affect the cost of repairs to property; actuarial judgment is applied to determine appropriate development factors to use in the reserve estimate that will most accurately reflect the expected impacts on severity development.
Changes in homeowners current year claim severity are generally influenced by inflation in the cost of building materials, the cost of construction and property repair services, the cost of replacing home furnishings and other contents, the types of claims that qualify for coverage, the presence of third party representation, such as legal or repair contractors (which serve to inflate claim expenses) and other economic and environmental factors. We employ various loss management programs to mitigate the effects of these factors.
Key assumptions that may materially affect the estimate of the reserve for loss and LAE relate to the effects of emerging claim and coverage issues. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverages may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent, lengthening the time to final settlement, or by increasing the number or size of claims. Key assumptions that are premised on future emergence that are inconsistent with historical loss reserve development patterns include but are not limited to:
•Adverse changes in loss cost trends, including inflationary pressures in home repair costs;
Loss and LAE reserves also include reserves for catastrophe losses. Catastrophe losses are an inherent risk of the property-casualty insurance industry that have contributed, and will continue to contribute, to potentially material year-to-year fluctuations in results of operations and financial position. A catastrophe is an event that produces significant insured losses before reinsurance and involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are commonly caused by various natural events including high winds, tornadoes, wildfires, winter storms, tropical storms and hurricanes.
In selecting the range of reasonable estimates, the range of indications produced by the various methods is evaluated, the relative strengths and weaknesses of each method are considered, and from those inputs a range of estimates can be selected. For reasons cited above, this range of estimated ultimate losses is typically smaller for older, more mature accident periods and greater for more recent, less mature accident periods. The greatest level of uncertainty is associated with the most recent accident years, and particularly years during which catastrophe events occurred.
The inherent uncertainty associated with our loss and LAE liability is magnified due to our concentration of property business in catastrophe-exposed and litigious states, primarily Florida. In 2018, for example, loss and expense payments for Hurricane Irma claims exceeded initial liability estimates that were established at year-end 2017, which was shortly after the event occurred. This unexpected development was partially due to the influence of plaintiff attorneys in the claim filing process; both at initial contact prior to coverage validation or damage assessment, and after claims were settled and closed which resulted in a large number of claims being reopened during the year. In 2019, UPCIC continued to experience unanticipated unfavorable development on losses from claims being reopened and new claims being opened due to public adjusters encouraging policyholders to file new claims. Due to the relatively low frequency and inherent uncertainty of catastrophe events, the parameters utilized in loss estimation methodologies are updated whenever new information emerges.
Due to the uncertainties involved, the ultimate cost of losses and LAE may vary materially from recorded amounts, which are based on our best estimates. The liability for unpaid losses and LAE at December 31, 2020 is $322.5 million.
In the normal course of business, we seek to reduce the risk of loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. While ceding premiums to reinsurers reduces our risk of exposure in the event of catastrophic losses, it also reduces our potential for greater profits in the event that such catastrophic events do not occur. We believe that the extent of our reinsurance level of protection is typical of, or exceeds, that of other insurers actively writing in the Florida homeowners insurance market. Amounts recoverable from reinsurers are estimated in a manner consistent with the provisions of the reinsurance agreement and consistent with the establishment of our gross liability. The Insurance Entities’ reinsurance policies do not relieve them from their obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses; consequently, allowances are established for amounts deemed uncollectible from reinsurers. No such allowance was deemed necessary as of December 31, 2020.
Consolidated Statements of Income for the Years Ended December 31, 2020, 2019 and 2018
We have audited the accompanying balance sheets of Universal Insurance Holdings, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and schedules (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in the COSO framework.
•We obtained an understanding, evaluated the design, and tested the operating effectiveness of key controls over the process and data used by management to estimate the liability for unpaid losses and LAE including those controls related to the estimation of and management’s review of the estimated liability of unpaid losses and LAE;
•We tested the completeness, integrity and accuracy of the underlying data used by the Company’s actuary such as paid loss data, case reserve data, loss adjustment expense data and loss development tables;
•With assistance from our actuarial specialist, we reviewed the reasonableness of the methods and assumptions used by the Company and their engaged actuary to develop their unpaid losses and LAE reserve estimate;
(1) See “-Note 5 (Insurance Operations),” for a discussion of the nature of the restrictions for restricted cash and cash equivalents and “-Note 18 (Variable Interest Entities),” for a discussion of restricted cash held in a trust account.
Universal Insurance Holdings, Inc. (“UVE”, and together with its wholly-owned subsidiaries, “the Company”) is a Delaware corporation incorporated in 1990. The Company is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. Through its wholly-owned insurance company subsidiaries, Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC”, and together with UPCIC, the “Insurance Entities”), the Company is principally engaged in the property and casualty insurance business offered primarily through its network of independent agents. Risk from catastrophic losses is managed through the use of reinsurance agreements. The Company’s primary product is residential homeowners’ insurance offered in 19 states as of December 31, 2020, including Florida, which comprises the majority of the Company’s policies in force. See “-Note 5 (Insurance Operations)” for more information regarding the Company’s insurance operations.
The Company generates revenues primarily from the collection of premiums and investment returns on funds invested on cash flows in excess of those retained and used for claims-paying obligations and insurance operations. Other significant sources of revenue include brokerage commissions collected from reinsurers on certain reinsurance programs placed on behalf of the Insurance Entities, policy fees collected from policyholders by the Company’s wholly-owned managing general agent (“MGA”) subsidiary and payment plan fees charged to policyholders who choose to pay their premiums in installments. The Company’s wholly-owned adjusting company receives claims-handling fees from the Insurance Entities. The Insurance Entities are reimbursed for these fees on claims that are subject to recovery under the Insurance Entities’ respective reinsurance programs. These fees, after expenses, are recorded in the Consolidated Financial Statements as an adjustment to losses and loss adjustment expense (“LAE”).
To conform to the current period presentation, certain amounts in the prior periods’ consolidated financial statements and notes have been reclassified. Such reclassifications were of an immaterial amount and had no effect on net income or stockholders’ equity.
The preparation of financial statements in conformity with 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 as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. The Company’s primary use of estimates is in the recognition of liabilities for unpaid losses, loss adjustment expenses, subrogation recoveries, and reinsurance recoveries. Actual results could differ from those estimates.
On January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic ASC 326), which introduces a new process for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new ASU applies to premiums receivable, reinsurance recoverable and available-for-sale debt securities. The ASU replaces the current practice of recording a permanent write down (other than temporary impairment) for probable credit losses with a new requirement that would estimate credit losses and record those estimated losses through a temporary allowance account that can be re-measured as estimates of credit losses change. The ASU further limited estimated credit losses relating to available-for-sale securities to the amount which fair value is below amortized cost. The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost. Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable U.S. GAAP. The Company recorded a decrease to retained earnings of $0.6 million as of January 1, 2020 for the cumulative after-tax effect of adopting ASC 326.
Consolidation Policy: The Financial Statements include the accounts of the Company, its wholly-owned subsidiaries and VIEs in which the Company is determined to be the primary beneficiary. This analysis includes a review of the VIE’s capital structure, related contractual relationships and terms, nature of the VIE’s operations and purpose, nature of the VIE’s interests issued and the Company’s involvement with the entity. When assessing the need to consolidate a VIE, the Company evaluates
Cash and Cash Equivalents. The Company includes in cash equivalents all short-term, highly liquid investments that are readily convertible to known amounts of cash and have an original maturity of three months or less. These amounts are carried at cost, which approximates fair value. The Company excludes any net negative cash balances from cash and cash equivalents that the Company has with any single financial institution. These amounts represent outstanding checks or drafts not yet presented to the financial institution and are reclassified to liabilities and presented as book overdraft in the Company’s Consolidated Balance Sheets.
Restricted Cash and Cash Equivalents. The Company classifies amounts of cash and cash equivalents that are restricted in terms of their use and withdrawal separately in the face of the Consolidated Balance Sheets. See “-Note 5 (Insurance Operations)” and “-Note 18 (Variable Interest Entities)” for discussions on the nature of the restrictions.
Investment, Securities Available for Sale. The Company’s investments in debt securities and short-term investments are classified as available-for-sale with maturities of greater than three months. Available-for-sale debt securities and short-term investments are recorded at fair value in the Consolidated Balance Sheet, net of any allowance for credit losses, if any. Unrealized gains and losses, excluding the credit loss portion, on available-for-sale debt securities and short-term investments are excluded from earnings and reported as a component of other comprehensive income (“OCI”), net of related deferred taxes until reclassified to earnings upon the consummation of a sales transaction with an unrelated third party. Gains and losses realized on the disposition of available-for-sale debt securities are determined on the first in, first out (“FIFO”) basis and credited or charged to income. Premium and discount on investment securities are amortized and accreted using the interest method and charged or credited to investment income.
Allowance for Credit Losses-Available-For-Sale Securities. For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For available-for-sale debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by rating agencies, market sentiment and trends and adverse conditions specifically related to the security, among other quantitative and qualitative factors utilized at establishing an estimate for credit losses. If the assessment indicates that a credit loss exists, the present values of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in OCI.
Investment, Equity Securities. The Company’s investments in equity securities are recorded at fair value in the Consolidated Balance Sheet with changes in the fair value of equity securities reported in current period earnings in the Consolidated Statements of Income within net change in unrealized gains (losses) of equity securities as they occur.
Fair Value Measurements. The Company’s policy is to record transfers of assets and liabilities, if any, between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. There were no transfers during the years ended December 31, 2020 or 2019.
Share-based Compensation. The Company accounts for share-based compensation based on the estimated grant-date fair value. The Company recognizes these compensation costs in general and administrative expenses and generally amortizes them on a straight-line basis over the requisite service period of the award, which is the vesting term. Individual tranches of performance-based awards are amortized separately since the vesting of each tranche is either subject to annual measures or time vesting. The fair value of stock option awards is estimated using the Black-Scholes option pricing model with the grant-date assumptions discussed in “-Note 9 (Share-Based Compensation).” The fair value of the restricted share grants, performance share units and restricted stock units are determined based on the market price on the date of grant.
Statutory Accounting. UPCIC and APPCIC are highly regulated and prepare and file financial statements in conformity with the statutory accounting practices prescribed or permitted by the Florida Office of Insurance Regulation (the “FLOIR”) and the National Association of Insurance Commissioners (“NAIC”), which differ from U.S. GAAP. The FLOIR requires insurance companies domiciled in Florida to prepare their statutory financial statements in accordance with the NAIC Accounting Practices and Procedures Manual (the “Manual”), as modified by the FLOIR. Accordingly, the admitted assets, liabilities and capital and surplus of UPCIC and APPCIC as of December 31, 2020 and 2019 and the results of operations and cash flows, for the years ended December 31, 2020, 2019 and 2018, for their regulatory filings have been prepared in accordance with statutory accounting principles as promulgated by the FLOIR and the NAIC. The statutory accounting principles are more restrictive than U.S. GAAP and are designed primarily to demonstrate the ability to meet obligations to policyholders and claimants.
Results for reporting periods beginning after January 1, 2020 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable U.S. GAAP.
The following table provides the amortized cost and fair value of available-for-sale debt securities as of the dates presented (in thousands):
Results for reporting periods occurring before January 1, 2020 continue to be reported in accordance with previously applicable U.S. GAAP and not presented under ASC 326, which was adopted by the Company on January 1, 2020.
The following table presents a reconciliation of the beginning and ending balances for expected credit losses on available-for-sale debt securities (in thousands):
See “-Note 2 (Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements)” for more information about the methodology and significant inputs used to measure the amount related to expected credit losses on available-for-sale debt securities.
The following table provides certain information related to available-for-sale debt securities, equity securities and investment real estate during the periods presented (in thousands):
The following table provides the unrealized gains and losses recognized for the periods presented on equity securities still held at the end of the reported period (in thousands):
During the year ended December 31, 2019, the Company completed the sale of an investment real estate property. The Company received net cash proceeds of approximately $10.5 million and recognized a pre-tax gain of approximately $1.2 million that is included in net realized gains (losses) on investments in the Consolidated Statements of Income for the year ended December 31, 2019.
The following table presents ratings from rating agencies and the unsecured amounts due from the reinsurers whose aggregate balance exceeded 3% of the Company’s stockholders’ equity as of the dates presented (in thousands):
In accordance with Florida Insurance Code, and based on the calculations performed by the Company as of December 31, 2020, UPCIC has the capacity to pay ordinary dividends of $2.1 million during 2021. APPCIC, based on its accumulated earnings history as of December 31, 2020, is unable to pay any ordinary dividends during 2021. For the years ended December 31, 2020 and 2019, no dividends were paid from the Insurance Entities to PSI.
(2) Statutory capital and surplus for UPCIC at December 31, 2019 includes a $30 million capital contribution funded in February 2020 by UVE through PSI, the Insurance Entities’ parent company, which the FLOIR permitted to be included in the statutory capital and surplus at December 31, 2019 under statutory accounting principles. This contribution was not recognized on a U.S. GAAP basis at December 31, 2019.
As of the dates in the table above, the Insurance Entities each exceeded the minimum statutory capitalization requirement. UPCIC also met the capitalization requirements of the other states in which it is licensed as of December 31, 2020. The Insurance Entities each are also required to adhere to prescribed premium-to-capital surplus ratios and each have met those requirements at such dates.
The following table summarizes combined net income (loss) for the Insurance Entities determined in accordance with statutory accounting practices for the periods presented (in thousands):
The Insurance Entities are required by various state laws and regulations to maintain certain assets in depository accounts. The following table represents assets held by insurance regulators as of the dates presented (in thousands):
Property and equipment consisted of the following as of the dates presented (in thousands):
The following table provides an estimate of principal payments to be made for the amounts due on the surplus note as of December 31, 2020 (in thousands):
As of December 31, 2020 and 2019, the Company had shares outstanding of Series A Preferred Stock. Each share of Series A Preferred Stock is convertible by the Company into shares of common stock.
From time to time, the Company’s Board of Directors may authorize share repurchase programs under which the Company may repurchase shares of the Company’s common stock in the open market. The following table presents repurchases of the Company’s common stock for the periods presented (in thousands, except total number of shares repurchased and per share data):
(1)Includes dividend equivalents due to employees who hold performance share units or restricted share units which are subject to time-vesting conditions.
(2)All shares outstanding as of December 31, 2020, are expected to vest.
(1)All shares acquired represent shares tendered to cover the strike price for options and tax withholdings on the intrinsic value of Stock Options exercised, Restricted Stock vested, PSUs vested or RSUs vested. These shares have been canceled by the Company.
The plan titled the “Universal Property & Casualty 401(k) Profit Sharing Plan” (the “401(k) Plan”) is a defined contribution plan that allows employees to defer compensation through contributions to the 401(k) Plan. The contributions are invested on the employees’ behalf, and the benefits paid to employees are based on contributions and any earnings or losses. The 401(k) Plan includes a Company contribution of 100 percent of each eligible participant’s contribution up to a maximum of five percent of the participant’s compensation during the 401(k) Plan year. The Company may make additional profit-sharing contributions. However, no additional profit-sharing contribution was made during the years ended December 31, 2020, 2019 and 2018.
The Company recognized excess income tax shortfall of $0.2 million during the year ended December 31, 2020 and excess income tax benefit of $0.6 million during the year ended December 31, 2019 from stock-based compensation awards that vested and/or were exercised. Excess income tax benefits (shortfalls) are reflected in the consolidated statements of income as a component of the provision for income taxes.
Changes in federal tax law have affected the Company’s balances of deferred income tax assets and liabilities. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Act”) was signed into law. The Tax Act amended the definition of annual rate and the computational rules for loss payment patterns. The Tax Act also provided transitional rules for the application of the amendments in the first taxable year beginning after December 31, 2017. Under the transitional rules, the Company is required to revalue discounted loss reserves under the new computational rules of the Tax Act and include in income that adjustment over an eight-year period in gross income of the Company. The effect of this change in tax law resulted in an immaterial adjustment to income tax in 2018 through 2020.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred income tax assets when it is more likely than not that all, or some portion, of the deferred income tax assets will not be realized. A valuation allowance would be based on all available information including the Company’s assessment of uncertain tax positions and projections of future taxable income and capital gain from each tax-paying component in each jurisdiction, principally derived from business plans and available tax planning strategies.
Management has reviewed all available evidence, both positive and negative, in determining the need for a valuation allowance with respect to the gross deferred tax assets. In determining the manner in which available evidence should be weighted, management has determined that the need for a valuation allowance is not warranted at this time.
The Company files its income tax returns as prescribed by the tax laws of the jurisdictions in which it operates. During the 2018 tax year, the Company’s 2015 tax return was subject to audit by the Internal Revenue Service, and the audit subsequently concluded during 2018 with no change to the income tax return. The Company’s 2017 through 2019 tax years are still subject to examination by the Internal Revenue Service and various tax years remain open to examination in certain state jurisdictions.
Basic earnings per share (“EPS”) is computed based on the weighted average number of common shares outstanding for the period, excluding any dilutive common share equivalents. Diluted EPS reflects the potential dilution resulting from exercises of stock options, vesting of performance share units, vesting of restricted stock units, vesting of restricted stock, and conversion of preferred stock.
The following table provides the components of other comprehensive income (loss) on a pre-tax and after-tax basis for the periods presented (in thousands):
The following table provides the reclassification adjustments for gains and losses out of AOCI for the periods presented (in thousands):
The Company purchases reinsurance coverage to protect its capital and to limit its losses when certain major events occur. The Company’s reinsurance commitments run from June 1st of the current year to May 31st of the following year. Certain of the Company’s reinsurance agreements are for periods longer than one year. Amounts payable for coverage during the current June 1st to May 31st contract period are recorded as “Reinsurance Payable, net” in the Consolidated Balance Sheet. Multi-year contract commitments for future years will be recorded at the commencement of the coverage period. Amounts payable for future reinsurance contract years that the Company is obligated to pay are: (1) $128.3 million in 2021 and (2) $71.3 million in 2022.
Lawsuits are filed against the Company from time to time. Many of these lawsuits involve claims under policies that the Company underwrites and reserves for as an insurer. The Company is also involved in various other legal proceedings and litigation unrelated to claims under the Company’s policies that arise in the ordinary course of business operations. Management believes that any liabilities that may arise as a result of these legal matters will not have a material adverse effect on the Company’s financial condition or results of operations. The Company contests liability and/or the amount of damages as appropriate in each pending matter.
•Level 2 - Observable market-based inputs or unobservable inputs that are corroborated by market data.
Corporate bonds: Comprise investment-grade debt securities. The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields and credit spreads.
Municipal bonds: Comprise debt securities issued by a state, municipality or county. The primary inputs to the valuation include quoted prices for identical assets in inactive markets or similar assets in active or inactive markets, contractual cash flows, benchmark yields and credit spreads.
The following table summarizes the carrying value and estimated fair values of the Company’s financial instruments not carried at fair value as of the dates presented (in thousands):
The liability for losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported (“IBNR”). Such liabilities are necessarily based on estimates and, although management believes that the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are reflected in earnings currently. The reserve for losses and loss adjustment expenses is reported net of receivables for salvage and subrogation of approximately $71 million and $73 million at December 31, 2020 and 2019, respectively.
For the year ended December 31, 2020, development of direct and net losses on previously reported hurricanes was $242.2 million direct and $18.1 million net after the benefit of reinsurance. This was principally driven by continued adverse development of previous estimated losses and LAE on Hurricanes Irma, Michael, Florence and Matthew. Net development for the year ended December 31, 2020 principally resulted from an increase in our previously estimated losses and LAE on Hurricane Irma for claims which are not eligible for recovery from the FHCF.
Company continues to adjust and settle Hurricane Irma claims that were reported prior to the expiration of the three-year period.
Reserve estimates for both unpaid losses and LAE are derived using several different actuarial estimation methods in order to provide the actuary with multiple predictive viewpoints to consider for each of the sectors discussed above. Each of the methods has merit, because they each provide insight into emerging patterns. These methods are each variations on two primary actuarial techniques: “chain ladder development” techniques and “counts and average” techniques. The “chain ladder development” actuarial technique is an estimation process in which historical payment and reserving patterns are applied to actual paid and/or reported amounts (paid losses, recovered subrogation or LAE plus individual case reserves established by claim adjusters) for an accident period to create an estimate of how losses or recoveries are likely to develop over time. The
“counts and average” technique includes an evaluation of historical and projected costs per claim, and late-reported claim counts, for open claims by accident period. An accident period refers to classification of claims based on the date in which the claims occurred, regardless of the date they were reported to the company. These analyses are used to prepare estimates of required reserves for payments or recoveries to be made in the future. Transactions are organized into half-year accident periods for purposes of the reserve estimates. Key data elements used to determine the Company’s reserve estimates include historical claim counts, loss and LAE payments, subrogation received, case reserves, earned policy exposures, and the related development factors applicable to this data.
The first method for estimating unpaid amounts for each sector is a chain ladder method called the paid development method. This method is based upon the assumption that the relative change in a given accident period’s paid losses from one evaluation point to the next is similar to the relative change in prior periods’ paid losses at similar evaluation points. In utilizing this method, actual 6-month historical loss activity is evaluated. Successive periods can be arranged to form a triangle of data. Paid-to-Paid (“PTP”) development factors are calculated to measure the change in cumulative paid losses, LAE, and subrogation recoveries, from one evaluation point to the next. These historical PTP factors form the basis for selecting the PTP factors used in projecting the current valuation of losses to an ultimate basis. In addition, a tail factor is selected to account for loss development beyond the observed experience. The tail factor is based on trends shown in the data and consideration of industry loss development benchmarks. Utilization of a paid development method has the advantage of avoiding potential distortions in the data due to changes in case reserving methodology. This method’s implicit assumption is that the rate of payment of claims has been relatively consistent over time, and that there have been no material changes in the rate at which claims have been reported or settled. In instances where changes in settlement rates are detected, the PTP factors are adjusted accordingly, utilizing appropriate actuarial techniques. These adjusted techniques each produce additional development method estimates for consideration.
A fourth method, called the counts and averages method, is utilized for estimates of loss, subrogation and LAE for each Florida sector. In this method, an estimate of unpaid losses or expenses is determined by separately projecting ultimate reported claim counts and ultimate claim severities (cost or recoveries per claim) on open and unreported claims for each accident period. Typically, chain ladder development methods are used to project ultimate claim counts and claim severities based on historical data using the same methodology described in the paid and reported development methods above. Estimated ultimate losses are then calculated as the product of the two items. This method is intended to avoid data distortions that may exist with the other methods for the most recent years as a result of changes in case reserve levels, settlement rates and claims handling fees. In addition, it may provide insight into the drivers of loss experience. For example, this method is utilized for sinkhole losses due to unique settlement patterns that have emerged since the passage of legislation that codified claim settlement practices with respect to sinkhole related claims and subsequent policy form changes, the Company implemented. The method is also utilized to evaluate segments impacted by the implementation of the Company’s Fast Track Initiative, which is an initiative to settle claims on an accelerated basis. These claims are expected to be reported and settled at different rates and ultimate values than historically observed, requiring a departure from traditional development methodologies.
Estimates of unpaid losses for hurricane experience are developed using a combination of company-specific and industry patterns, due to the relatively infrequent nature of storms and the high severity typically associated with them. Development patterns and other benchmarks are based on consideration of all reliable information, such as historical events with similar
Reserves are re-estimated periodically by combining historical payment and reserving patterns with current actual results. When actual development of claims reported, paid losses or case reserve changes are different than the historical development pattern used in a prior period reserve estimate, and as actuarial studies validate new trends based on indications of updated development factor calculations, new ultimate loss and LAE predictions are determined. This process incorporates the historic and latest trends, and other underlying changes in the data elements used to calculate reserve estimates. The difference between indicated reserves based on new reserve estimates and the previously recorded estimate of reserves is the amount of reserve re-estimates. The resulting increase or decrease in the reserve re-estimates is recorded and included in “Losses and loss adjustment expenses” in the Consolidated Statements of Income.
The Company performed an evaluation of subsequent events through the date the financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the consolidated financial statements as of December 31, 2020.