All of our properties owned or leased are used for office space. We own two buildings located in St. Petersburg, Florida. Our principal location contains approximately 40,000 square feet of commercial office space and associated property for use as our principal executive offices. Our second building contains approximately 7,800 square feet of commercial office space and is currently unoccupied but is being renovated for future use.
We lease in total approximately 16,500 square feet of office space located in Florida, New York, and Hawaii. These leases are generally short-term to medium-term leases of commercial office space.
United Insurance Holding Corp. is a holding company primarily engaged in residential and commercial property and casualty insurance in the United States. We conduct our business principally through four wholly-owned insurance subsidiaries: UPC, ACIC, FSIC, and IIC. Collectively, we refer to the holding company and all our subsidiaries, including non-insurance subsidiaries, as “UPC Insurance,” which is the preferred brand identification for our Company.
(1) Loss ratio, net is calculated as losses and loss adjustment expenses (LAE) relative to net premiums earned.
(3) Combined ratio is the sum of the loss ratio, net and expense ratio, net.
We believe that investors’ understanding of UPC Insurance’s performance is enhanced by our disclosure of the following non-GAAP measures. Our methods for calculating these measures may differ from those used by other companies and therefore comparability may be limited.
Operating Expenses excluding the effects of ceding commission income earned, merger expenses, and amortization of intangible assets (underlying expense) is a non-GAAP measure which is computed by subtracting ceding income earned related to our quota share reinsurance agreement, merger expenses and amortization of intangibles. Ceding commission income compensates the Company for expenses it incurs in generating the premium ceded under our quota share reinsurance agreement. Merger expenses are directly related to past mergers and are not reflective of current period operating performance. Similarly, amortization expense is related to the amortization of intangible assets acquired through merger and therefore the expense does not arise through normal operations. We believe it is useful for investors to evaluate these components separately and in the aggregate when reviewing our performance. The most direct comparable GAAP measure is operating expenses. The underlying expense measure should not be considered a substitute for the expense ratio and does not reflect the overall profitability of our business.
Net Income excluding the effects of merger expenses, non-cash amortization of intangible assets and realized gains (losses), net of tax (core income) is a non-GAAP measure which is computed by adding merger expenses, net of tax, and amortization, net of tax, to net income and subtracting realized gains (losses) on our investment portfolio net of tax, from net income. Merger expenses are directly related to past mergers and are not reflective of current period operating performance. Similarly, amortization expense is related to the amortization of intangible assets acquired through mergers and therefore the expense does not arise through normal operations. Investment portfolio gains (losses) vary independent of the Company's operations. We believe it is useful for investors to evaluate these components separately and in the aggregate when reviewing our performance. The most direct comparable GAAP measure is net income. The core income measure should not be considered a substitute for net income and does not reflect the overall profitability of our business.
Net income for the year ended December 31, 2017 was $10,145,000, or $0.27 per diluted share, compared to net income of $5,698,000, or $0.26 per diluted share, for the year ended December 31, 2016. The increase in net income was primarily due to an increase in gross premiums earned and improvement in our underlying loss ratio, as well as the favorable impact of U.S. Tax Reform.
Our total gross written premium increased by $332,692,000, or 47.0%, to $1,040,848,000 for the year ended December 31, 2017 from $708,156,000 for the year ended December 31, 2016, primarily reflecting our merger with AmCo on April 3, 2017, as well as strong organic growth in new and renewal business generated in our Gulf and Northeast regions. The breakdown of the year-over-year changes in both direct written and assumed premiums by region and gross written premium by line of business is shown in the table below.
(2) “Gulf” is comprised of Hawaii, Louisiana and Texas; “Northeast” is comprised of Connecticut, Massachusetts, New Jersey, New York and Rhode Island; and “Southeast” is comprised of Georgia, North Carolina and South Carolina.
(1) Underlying Loss and LAE is a non-GAAP financial measure and is reconciled above to Loss and LAE, the most directly comparable GAAP measure. Additional information regarding non-GAAP financial measures presented in this Form 10-K can be found in the “Definitions of Non-GAAP Measures” section, above.
Operating and underwriting expenses increased by $7,151,000, or 34.8%, to $27,675,000 for the year ended December 31, 2017 from $20,524,000 for the year ended December 31, 2016, primarily due to increased costs related to our ongoing growth, incurred expenses related to software improvements and costs related to the increase in underwriting reports.
(1) Underlying Net Loss Ratio is a non-GAAP measure and is reconciled above to the Consolidated Net Loss Ratio, the most directly comparable GAAP measure. Additional information regarding non-GAAP financial measures presented in this Form 10-K can be found in the “Definitions of Non-GAAP Measures” section, above.
Net Income for the year ended December 31, 2016 was $5,698,000, or $0.26 per diluted share, compared to $27,358,000, or $1.28 per diluted share, for the year ended December 31, 2015. The decrease in net income was primarily due to increases in losses and LAE during 2016 as compared to 2015.
Our gross written premium increased by $138,420,000, or 24.3%, to $708,156,000 year ended December 31, 2016 from $569,736,000 the year ended December 31, 2015, primarily due to strong organic growth in new and renewal business generated in our Gulf and Northeast regions. Increases in direct written premium of over $159,335,000 were partially offset by reductions in assumed premium as we sharply curtailed our takeout activity in 2016 compared to the prior year. The breakdown of the year-over-year changes in both direct written and assumed premiums by region and gross written premium by line of business is shown in the following table:
(1) “Gulf” is comprised of Hawaii, Louisiana and Texas; “Northeast” is comprised of Connecticut, Massachusetts, New Jersey, New York and Rhode Island; and “Southeast” is comprised of Georgia, North Carolina and South Carolina.
(1) Only includes new and renewal homeowner, commercial and dwelling fire policies written during the year.
Expenses for the year ended December 31, 2016 increased $164,211,000, or 52.0%, to $480,214,000 for the year ended December 31, 2016 from $316,003,000 for 2015, primarily due to increased losses, policy acquisition costs, operating costs and general and administrative expenses. The calculation of our combined and underlying loss ratios is shown below:
The calculations of the Company’s expense ratio and underlying expense ratios are shown below.
General and administrative expenses increased $13,104,000, or 43.9%, to $42,956,000 for the year ended December 31, 2016 from $29,852,000 for the year ended December 31, 2015, primarily due to increases in personnel costs related to our continued growth and higher depreciation and amortization costs resulting from the acquisition of IIC during the second quarter of 2016.
reviewed all of our securities and determined that we did not need to record impairment charges at December 31, 2017. Similarly, we did not record impairment charges at December 31, 2016.
During the second quarter of 2017 we placed our reinsurance program for the 2017 hurricane season. We purchased catastrophe excess of loss reinsurance protection of $2,747,500,000. The contracts reinsure for personal lines property excess catastrophe losses caused by multiple perils including hurricanes, tropical storms, and tornadoes. The agreements were effective as of June 1, 2017, for a one-year term and incorporate the mandatory coverage required by and placed with the Florida Hurricane Catastrophe Fund. The private agreements provide coverage against severe weather events such as hurricanes, tropical storms and tornadoes. The cost for this program increased by $122,669,000 to $314,169,000 in 2017 as a result of increasing our protection by 81.3% and including ACIC under the program.
Excluding our flood business, for which we cede 100% of the risk of loss, reinsurance costs for 2017 were 38.6% of gross premiums earned compared to 28.7% of gross premiums earned for 2016. The increase in this ratio was driven primarily by our quota share reinsurance program, which was in effect for eleven months during 2017, but for only one month during 2016.
On December 13, 2017, we issued $150,000,000 of senior notes that will mature on December 15, 2027 and bear interest at a rate equal to 6.250% per annum payable semi-annually on each June 15 and December 15, commencing June 15, 2018. The senior notes are senior unsecured obligations of the Company. We may redeem the senior notes at our option, at any time and from time to time in whole or in part, at a redemption price equal to the greater of (i) 100% of the principal amount of the senior notes to be redeemed and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon from the date of redemption to the date that is three months prior to maturity. On and after that date, we may redeem the senior notes at par.
On April 3, 2017, the Company successfully completed its merger with AmCo. The acquisition was completed through a series of mergers that ultimately resulted in the Company issuing 20,956,355 shares of its common stock as merger consideration to the equity holders of RDX Holding, LLC, the former parent company of AmCo. As a result of the mergers, AmCo merged with and into a wholly-owned subsidiary of the Company. We incurred $7,000,000 of merger-related expenses. Please refer to Note 4 in the Notes to Consolidated Financial Statements for additional information on the merger transaction.
On April 29, 2016, we acquired all of the outstanding common stock of IIC for $60,471,000. We paid $48,450,000 in cash at closing and issued an $8,550,000 promissory note to Interboro, LLC, the former parent company of IIC, which matured and was paid in October 2017. The purchase price also included the assumption of an accrued liability of $3,471,000 which was paid during July 2016. We incurred $224,000 of merger-related expenses. Please refer to Note 11 in the Notes to Consolidated Financial Statements for a discussion of the additional terms associated with this note.
greater than 0.3:1, determined on a pro forma basis as if the additional indebtedness and all other indebtedness incurred since the immediately preceding Balance Sheet Date had been incurred and the proceeds therefrom applied as of such day. The Company and its subsidiaries also may not create, assume, incur or permit to exist any indebtedness for borrowed money that is secured by a lien on the voting stock of any significant subsidiary without selling the senior notes equally. The Company may not issue, sell, assign, transfer or otherwise dispose of, directly or indirectly, any of the capital stock of the Company’s significant subsidiaries as of the issue date of the notes (except to the Company or to one or more of the Company’s other subsidiaries, or for the purpose of qualifying directors or as may be required by law or regulation), subject to certain exceptions. At December 31, 2017, we were in compliance with the covenants as specified in the senior notes.
BB&T Term Note Payable (BB&T Note) - The BB&T Note requires that at all times while there has been no “Non-Recurring Losses”, the Company will maintain a minimum Cash Flow Coverage ratio of 1.2:1. The Cash Flow Coverage ratio is defined as UPC Insurance’s cash flow to our debt services. “Cash flow” is defined as earnings before taxes, plus depreciation and amortization and interest. “Debt service” is defined as the prior year’s current maturities of long term debt plus interest expense. This ratio will be tested annually, based on UPC Insurance’s audited financial statements. For the one-year period following a "Non-Recurring Loss", UPC Insurance is required to maintain a minimum Cash Flow Coverage ratio of 1.0:1. "Non-Recurring Losses" is defined as losses from our insurance subsidiaries' operations, as determined from time to time in the bank's sole discretion. This covenant will only be effective if the Pre-Non-Recurring Losses (as defined in the BB&T Note) test is failed, and is only available and effective for one (1) annual test period. Thereafter, the Non-Recurring Loss Cash Flow Coverage Ratio (as defined in the BB&T Note) of 1.2:1 will immediately apply. At the time of the most recent annual test period, December 31, 2017, we were in compliance with the covenants as specified in the BB&T Note.
In addition, the BB&T Note requires that we establish and maintain with BB&T a noninterest bearing demand deposit account with a minimum balance of $500,000, and an interest-bearing account with a minimum balance of $1,500,000, at all times during the term of the loan. In the event of default, BB&T may, among other things, declare its loan immediately due and payable, require us to pledge additional collateral to the bank, and take possession of and foreclose upon our corporate headquarters, which has been pledged to the bank as security for the loan. At December 31, 2017, we were in compliance with the covenants as specified in the BB&T Note.
If we have not made the decision to sell the fixed income security and it is not more likely than not we will be required to sell the fixed income security before recovery of its amortized cost basis, we evaluate whether we expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. We use our best estimate of future cash flows expected to be collected from the fixed income security, discounted at the security’s original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists. The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security. All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected. That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, the financial condition and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements. Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered. The estimated fair value of collateral will be used to estimate
The determination of the amount of other-than-temporary impairment is an inherently subjective process based on periodic evaluations of the factors described above. Such evaluations and assessments are revised as conditions change and new information becomes available. We update our evaluations quarterly and reflect changes in other-than-temporary impairments in results of operations as such evaluations are revised. The use of different methodologies and assumptions in the determination of the amount of other-than-temporary impairments may have a material effect on the amounts presented within the consolidated financial statements.
Represents repayment of $150,000,000 senior notes payable on December 15, 2027, principal payments totaling $10,000,000 over the remaining life of the SBA Note debt, and principal payments totaling $4,651,000 over the remaining life of the term note payable to BB&T. All future payments are shown net of amortization of debt issuance costs. See Note 11 in our Notes to Consolidated Financial Statements for additional information regarding our long-term debt.
As of December 31, 2017, UPC, FSIC, IIC, ACIC and Blue Line had unpaid loss and LAE of $482,232,000. The specific amounts and timing of obligations related to known and unknown reserves and related LAE reserves are not set contractually, and the amounts and timing of these obligations are unknown. Nonetheless, based upon our cumulative claims paid over the last 18 years, we estimate that the loss and LAE reserves will be paid in the periods shown above. While we believe that historical performance of loss payment patterns is a reasonable source for projecting future claims payments, there is inherent uncertainty in this estimated projected settlement of loss and LAE reserves, and as a result these estimates will differ, perhaps significantly, from actual future payments.
We have audited the accompanying consolidated balance sheets of United Insurance Holdings Corp. and its subsidiaries (the Company) as of December 31, 2017 and 2016, the related consolidated statements of comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes to the consolidated financial statements and schedules (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We currently classify all of our investments in fixed maturities, equity securities, other investments and short-term investments as available-for-sale, and report them at fair value. Subsequent to our acquisition of available-for-sale securities, we record changes in value through the date of disposition as unrealized holding gains and losses, net of tax effects, and include them as a component of comprehensive income. We include realized gains and losses, which we calculate using the specific-identification method for determining the cost of securities sold, in net income. We amortize any premium or discount on fixed maturities over the remaining maturity period of the related securities using the effective interest method, and we report the amortization in net investment income. We recognize dividends and interest income when earned.
possibility exists that our estimate may vary significantly in the near term from the estimated amounts included in our consolidated financial statements.
Our policy fees consist of the managing general agent (MGA) fee and a pay-plan fee. We defer MGA fees as unearned revenue and recognize revenue on a pro rata basis over the term of the underlying policies. We record pay-plan fees, which are charged to all policyholders that pay premium in more than one installment, as income when collected. We report all policy-related fees as other revenue on our Consolidated Statements of Comprehensive Income.
We follow industry practice of reinsuring a portion of our risks. Reinsurance involves transferring, or “ceding”, all or a portion of the risk exposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss.
Where permitted by law or regulatory authority, we collect assessments imposed upon policyholders as a policy surcharge and we record the amounts collected as a liability until we remit the amounts to the regulatory agency that imposed the assessment. During 2017, we did not receive any significant assessments from regulatory authorities in the states in which our insurance subsidiaries operate.
We expense all advertising costs when we incur those costs. For the years ended December 31, 2017, 2016 and 2015, we incurred advertising costs of $1,013,000, $907,000, and $2,630,000, respectively.
We report both basic earnings per share and diluted earnings per share. To calculate basic earnings per share, we divide net income attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period. We calculate diluted earnings per share by dividing net income attributable to common stockholders by the weighted-average number of shares of common stock, common stock equivalents, and restricted shares outstanding during the period.
a geographic concentration resulting from the fact that, though we now operate in 12 states, we still wrote approximately 52% of our gross written premium in Florida
a group concentration of credit risk with regard to our reinsurance recoverable, since all of our reinsurers engage in similar activities and have similar economic characteristics that could cause their ability to repay us to be similarly affected by changes in economic or other conditions; and
When testing goodwill for impairment, we also consider our market capitalization in relation to the aggregate estimated fair value of our reporting unit. We apply significant judgment when determining the estimated fair value of our reporting unit and when assessing the relationship of market capitalization to the aggregate estimated fair value of our reporting unit.
Loan receivables that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at the principal balance outstanding, net of the allowance for loan losses.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). This update was intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 became effective for annual periods beginning after December 15, 2016. The new guidance did not impact the way in which we account for share-based payment transactions, and therefore the adoption as of January 1, 2017 had no impact on our results of operations or financial position.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04). This update simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. ASU 2017-07 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods, with early adoption permitted for certain requirements. We do not intend to early adopt and are assessing the impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.
and note that the standard is not applicable to our insurance contracts or other revenue streams. The adoption of this new accounting standard does not have a material impact on our consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). This update is intended to replace existing lease guidance by requiring a lessee to recognize substantially all leases (whether operating or finance leases) on the balance sheet as a right-of-use asset and an associated least liability. Short-term leases of 12 months or less are excluded from this amendment. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We do not intend to early adopt and are assessing the impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.
The following table details fixed maturity and equity securities available for sale, by major investment category, at December 31, 2017 and 2016:
For each fixed income security in an unrealized loss position, we determine if the loss is temporary or other-than-temporary. If our management decides to sell the security or determines that it is more likely than not that we will be required to sell the security before recovery of the cost or amortized cost basis for reasons such as liquidity needs, contractual or regulatory requirements, then the security’s decline in fair value is considered other-than-temporary and is recorded in earnings.
During our quarterly evaluations of our securities for impairment, we determined that none of our investments in debt and equity securities or limited partnership investments that reflected an unrealized loss position were other-than-temporarily impaired. The issuers of debt securities held by us continue to make interest payments on a timely basis. We do not intend to sell nor is it likely that we would be required to sell the debt securities before we recover our amortized cost basis. The near-term prospects of all the issuers of the equity securities we own indicate we could recover our cost basis, and we also do not intend to sell these securities until their value equals or exceeds their cost. The limited partnership was in an unrealized loss position at December 31, 2016, but was continuing to make interest payments on a timely basis and we did not intend to sell at that time. The investment was liquidated in 2017 and we recovered our amortized cost.
We estimate the fair value of our investments using the closing prices on the last business day of the reporting period, obtained from active markets such as the NYSE, Nasdaq, and NYSE MKT. For securities for which quoted prices in active markets are unavailable, we use a third-party pricing service that utilizes quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs to estimate the fair value of those securities for which quoted prices are unavailable. Our estimates of fair value reflect the interest rate environment that existed as of the close of business on December 31, 2017 and 2016. Changes in interest rates subsequent to December 31, 2017 may affect the fair value of our investments.
We acquired investments in limited partnerships, recorded in the other investments line of our Consolidated Balance Sheets, that are currently being accounted for at fair value utilizing a discounted cash flow methodology. The estimated fair value of our investments in the limited partnership interests was $8,081,000. We have fully funded two investments and are still obligated to fund an additional $1,365,000 for the remaining three investments.
The information presented in the table below is as of December 31, 2017.
The following table summarizes the quantitative impact that the significant unobservable inputs used to estimate the fair value of our Level 3 investments has on the estimated fair value of our investments shown in the tables above. Those limited partnership investments being carried at cost are excluded from the table below. Our investment in DCR Mortgage Partners VI, L.P. (DCR VI) was valued using a duration of 60 months for both periods presented below. Our investment in RCH Mortgage Fund VI Investors, L.P. was valued using a duration of 60 months when held at December 31, 2016.
For the year ended December 31, 2017, AmCo recorded $134,386,000 of revenues and $12,579,000 of pre-tax net income. These amounts are included in our results of operations for the year ended December 31, 2017.
On April 29, 2016, we completed the acquisition of IIC. The purchase price for IIC consisted of $48,450,000 in cash, $8,550,000 in a note payable that matured during October 2017 and an accrued liability for $3,471,000 paid during July 2016. The acquisition of IIC supported the Company's growth strategy and further strengthened the Company's overall position in the property and casualty insurance market in the state of New York.
For the year ended December 31, 2016, IIC recorded $28,573,000 of revenues and $14,202,000 of pre-tax net income. These amounts are included in our results of operations for the year ended December 31, 2016.
The operations of IIC are included in our Consolidated Statements of Comprehensive Income effective April 29, 2016. The final purchase price allocation is as follows:
The unaudited pro forma financial information for 2016 has been prepared as if the IIC acquisition had taken place on January 1, 2016. The unaudited pro forma information is not necessarily indicative of the results that we would have achieved had the transaction taken place on January 1, 2016, and the unaudited pro forma information does not purport to be indicative of future financial operating results.
In connection with the acquisition, we paid an investment advisory fee of $224,000. This amount was included in general and administrative expenses on the Company’s Consolidated Statements of Operations during the year ended December 31, 2016.
No impairment loss in the value of goodwill was recognized during the years ended December 31, 2017 and 2016. Additionally, there was no accumulated impairment related to goodwill at December 31, 2017 or 2016.
No impairment in the value of amortizing or non-amortizing intangible assets was recognized during the years ended December 31, 2017 and 2016.
Amortization expense of our intangible assets was $31,200,000, $10,910,000 and $3,090,000 for the years ended December 31, 2017, 2016 and 2015, respectively. The large increase in amortization expense in 2017 was primarily due to the amortization of intangible assets and Value of Business Acquired acquired as part of the AmCo acquisition.
Estimated amortization expense to be recognized by the Company over the next five years is as follows:
Our reinsurance program is designed, utilizing our risk management methodology, to address our exposure to catastrophes. According to the Insurance Service Office (ISO), a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25,000,000 or more in U.S. industry-wide direct insured losses to property and that affect a significant number of policyholders and insurers (ISO catastrophes). In addition to ISO catastrophes, we also include as catastrophes those events (non-ISO catastrophes), which may include losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made.
More frequency and severity protection than in any prior year, with an overall program exhaustion point of $2,747,500,000;
Sufficient coverage for a single 1-in-400-year event (AIR Touchstone v3.1 Standard Event Set);
Coverage expanded to include the entire life of a hurricane in lieu of an hours clause.
For the FHCF reimbursement contracts effective June 1, 2017, UPC Insurance has elected a 45% coverage for all its insurance subsidiaries with Florida exposure. We estimate the mandatory FHCF layer will provide approximately $789,000,000 of aggregate coverage with varying retentions and limits among the three FHCF contracts that all inure to the benefit of the open market coverage secured from private reinsurers.
The $1,928,000,000 of aggregate open market catastrophe reinsurance coverage is structured into multiple layers with a cascading feature that all layers drop down as layers below them are exhausted. Any remaining unused layer protection drops down for subsequent events until exhausted, ensuring there are no potential gaps in coverage up to the $2,747,500,000 program exhaustion point.
Effective December 31, 2017, UPC Insurance, through our wholly-owned insurance subsidiary UPC, replaced our 15% quota share agreement that expired on November 30, 2017 and our 5% quota share agreement that was set to renew on December 1, 2017 with the quota share agreement with private reinsurers. The quota share agreement has a term of 12 months and a cession rate of 20% for all subject business. The quota share agreement provides coverage for all catastrophe perils and attritional losses. For all catastrophe perils, the quota share agreement provides ground-up protection effectively reducing our retention for catastrophe losses. Quota share reinsurers’ participation in paying attritional losses is subject to an attritional loss ratio cap.
Effective January 1, 2018, UPC Insurance, through its wholly-owned insurance subsidiaries UPC, ACIC, IIC and FSIC, renewed the aggregate excess of loss agreement with a private reinsurer. The treaty provides coverage for all catastrophe perils other than hurricanes, tropical storms, tropical depressions and earthquakes. Under this agreement, we will retain, in the aggregate, 100% of those losses up to 4.75% of the covered companies’ gross earned premium. The reinsurer will then be liable
Ceded losses incurred increased by $518,293,000 during the year ended December 31, 2017, compared to the year ended December 31, 2016, primarily because we incurred more ceded losses in 2017 than in 2016 as a result of Hurricanes Harvey and Irma which occurred during 2017. A portion of the losses we incurred in 2017, 2016 and 2015 exceeded our retained loss
Reserves for losses incurred but not reported (IBNR reserves) - Our IBNR reserves include true IBNR reserves plus “bulk” reserves. Bulk reserves represent additional amounts that cannot be allocated to particular claims, but which are necessary to estimate ultimate losses on reported and unreported claims. We estimate our IBNR reserves by projecting the ultimate losses using the methods discussed below and then deducting actual loss payments and case reserves from the projected ultimate losses. We review and adjust our IBNR reserves on a quarterly basis based on information available to us at the balance sheet date.
We calculate our estimate of ultimate losses by using the following actuarial methods. We separately calculate the methods using paid loss data and incurred loss data. In the versions of these methods based on incurred loss data, the incurred losses are defined as paid losses plus case reserves. For this discussion of our loss reserving process, the word “segment” refers to a subgrouping of our claims data, such as by geographic area and/or by particular line of business; it does not refer to operating segments.
Incurred Development Method - The incurred development method is based upon the assumption that the relative change in a given year’s incurred loss estimates from one evaluation point to the next is similar to the relative change in prior years’ reported loss estimates at similar evaluation points. In utilizing this method, actual annual historical incurred loss data is evaluated. Successive years can be arranged to form a triangle of data. Loss development factors (LDFs) are calculated to measure the change in cumulative incurred costs from one evaluation point to the next. These historical LDFs and comparable industry benchmark factors form the basis for selecting the LDFs used in projecting the current valuation of losses to an ultimate basis. This method’s implicit assumption is that the relative adequacy of case reserves has been consistent over time, and that there have been no material changes in the rate at which claims have been reported. The paid development method is similar to the incurred development method. While the paid development method has the disadvantage of not recognizing the information by current case reserves, it has the advantage of avoiding potential distortions in the data due to changes in case reserving methodology. The paid development method’s implicit assumption is that the rate of payment of claims has been relatively consistent over time.
Expected Loss Method - In the expected loss method, ultimate loss projections are based upon some prior measure of the anticipated losses, usually relative to some measure of exposure (e.g., earned house years). An expected loss cost is applied to the measure of exposure to determine estimated ultimate losses for each year. Actual losses are not considered in this calculation. This method has the advantage of stability over time, because the ultimate loss estimates do not change unless the exposures or loss costs change. However, this advantage of stability is offset by a lack of responsiveness, since this method does not consider actual loss experience as it emerges. This method is based on the assumption that the loss cost per unit of exposure is a good indication of ultimate losses. It can be entirely dependent on pricing assumptions (e.g., historical experience adjusted for loss trend).
Bornhuetter-Ferguson Method - The incurred Bornhuetter-Ferguson (B-F) method is essentially a blend of two other methods. The first method is the loss development method whereby actual incurred losses are multiplied by an expected LDF. For slow reporting coverages, the loss development method can lead to erratic and unreliable projections because a relatively small swing in early reporting can result in a large swing in ultimate projections. The second method is the expected loss method whereby the IBNR estimate equals the difference between a predetermined estimate of expected losses and actual incurred losses. The incurred B-F method combines these two methods by setting ultimate losses equal to actual incurred losses plus expected unreported losses. As an experience year matures and expected unreported losses become smaller, the initial expected loss assumption becomes gradually less important. Two parameters are needed to apply the B-F method: the initial expected loss cost and the expected reporting pattern.
This method is often used for long-tail lines and in situations where the incurred loss experience is relatively immature or lacks sufficient credibility for the application of other methods. The paid B-F method is analogous to the incurred B-F method using paid losses and development patterns in place of incurred losses and patterns.
The following is information about incurred claims development and paid claims development as of December 31, 2017, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liability plus expected development on reported claims included within the net incurred claims amounts. The incurred claims development and paid claims development data reflect the acquisitions of FSIC, IIC, and AmCo in February 2015, April 2016, and April 2017, respectively, on a retrospective basis (includes FSIC, IIC and AmCo data for years prior to our acquisition of the insurance affiliates). The information about incurred claims development and paid claims development for the years ended December 31, 2008 to 2015 is presented as supplementary information.
(1) Acquired reserves, net of recoverables for 2017, 2016, and 2015 relate to our merges with AmCo, IIC, and FSH, respectively.
At December 31, 2017, the annual maturities of our long-term debt were as follows:
On April 29, 2016, we issued an $8,550,000 promissory note to Interboro, LLC, the former parent company of IIC, as part of the purchase price paid to acquire our insurance subsidiary. The note matured and was paid in October 2017.
On May 26, 2016, we issued a $5,200,000, 15-year term note payable to BB&T (the BB&T note) with the intent to use the funds to purchase, renovate, furnish and equip our home office. The note bears interest at 1.65% in excess of the one-month LIBOR. In the event of default, BB&T, may, among other things, declare its loan immediately due and payable, require us to pledge additional collateral to the bank, and take possession of and foreclose upon our home office which has been pledged to the bank as security for the loan.
The SBA note, BB&T note, and $150M senior notes contain representations and warranties, conditions and covenants. If these requirements are not met, all amounts outstanding or otherwise owed could become due and payable immediately and other limitations could be placed on our ability to use any available borrowing capacity. At December 31, 2017, we were in compliance with all covenants as specified in the notes. Refer to Part II; Item 7 for additional information regarding financial covenants.
The table below presents the rollforward of our debt issuance costs paid, in conjunction with the debt instruments described above, during the years ended December 31, 2017 and 2016:
See Note 11 for information regarding commitments related to long-term debt, and Note 14 for commitments related to regulatory actions.
Provisional estimate of income tax effects of the 2017 Tax Act to the extent accounting is incomplete but a reasonable estimate is determinable and
If a provisional estimate cannot be determined, ASC 740 should still be applied on the basis of tax law provisions that were in effect immediately before the enactment of the 2017 Tax Act.
We revalued all deferred tax assets and liabilities to recognize the tax rate that is expected to apply when the tax effects are ultimately recognized in future periods. The impact of revaluing the deferred tax assets and liabilities from 35% to 21% was a reduction to income tax expense of $6,777,000, as disclosed in the table above. This revaluation adjustment included a $1,549,000 reduction related to the deferred tax liability associated with the net unrealized gains on our investment portfolio, which was originally recorded as a component of other comprehensive income and not through the tax provision. The remainder was associated with our other deferred tax assets and liabilities identified in the table below.
Deferred income taxes, which are included in other assets or other liabilities as appropriate, reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. As noted above, the federal deferred tax assets and liabilities at December 31, 2017, have been revalued to reflect the new 21% federal corporate income tax rate under the 2017 Tax Act.
In assessing the net realizable value of deferred tax assets, we consider whether it is more likely than not that we will not realize some portion or all of the deferred tax assets. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider
Our insurance subsidiaries must maintain capital and surplus ratios or balances as determined by the regulatory authority of the states in which they are domiciled. The table below shows the minimum capital and surplus requirements, as well as the amount of surplus as regards policyholders for our regulated entities at December 31, 2017 and 2016.
(1) UPC and ACIC are required to maintain capital and surplus equal to the greater of 10% of its total liabilities or $5,000,000.
(2) There is not a reportable value for ACIC at December 31, 2016 as we did not own the company until April 2017.
The SBA note is considered a surplus note pursuant to statutory accounting principles. As a result, UPC is subject to the authority of the Insurance Commissioner of the State of Florida with regard to its ability to repay principal and interest on the SBA note. Any payment of principal or interest requires permission from the insurance regulatory authority.
Statutory accounting requires an additional admissibility test and the change in deferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP.
Our insurance subsidiaries must file with the various insurance regulatory authorities an “Annual Statement” which reports, among other items, statutory net income (loss) and surplus as regards policyholders, which is called stockholders’ equity under GAAP.
(1)Statutory net income acquired for 2017, 2016, and 2015 relates to the acquisitions of ACIC, IIC, and FSH, respectively.
We lease approximately 16,500 square feet of office space in Florida, New York, and Hawaii. These leases are generally short-term to medium-term leases of commercial office space. In addition to office space, we lease office equipment and a parking lot under operating leases. Lease expense amounted to $290,000, $205,000, and $922,000 for the years ended December 31, 2017, 2016, and 2015, respectively. At December 31, 2017, our minimum future lease payments under non-cancellable operating leases are:
One of our executive officers, Ms. Salmon, is a former partner at the law firm of Groelle & Salmon, PA, where her spouse remains partner and co-owner. Groelle & Salmon, PA provides legal representation to us related to our claims litigation, and also provided representation to us for several years prior to Ms. Salmon joining UPC Insurance in 2014. During the years ended December 31, 2017 and 2016, Groelle & Salmon, PA billed us approximately $3,188,000 and $2,892,000, respectively. Ms. Salmon’s spouse has a 50% interest in these billings, or approximately $1,594,000 and $1,446,000 for the years ended December 31, 2017 and 2016, respectively.
AmRisc, LLC (AmRisc), a managing general agent, handles the underwriting, claims processing, premium collection and reinsurance review for AmCo. R. Daniel Peed, Vice Chairman of our Board of Directors, beneficially owns approximately 7.7% of AmRisc and is also the Chief Executive Officer of AmRisc.
Net premiums receivable (net of commissions) of $29,913,000 were due from AmRisc as of December 31, 2017. These premiums were paid by AmRisc to our premium trust account by wire transfer within 15 days of collection pursuant to the underwriting contract with AmRisc.
Our Board of Directors declared dividends on our outstanding shares of common stock as follows for the periods presented (in thousands, except per share amounts):
We had approximately $1,140,000 of unrecognized stock compensation expense on December 31, 2017 related to non-vested stock-based compensation granted, that we expect to recognize over the next three years. We recognized $1,616,000, $877,000 and $808,000 of stock-based compensation expense during the twelve months ended December 31, 2017, 2016 and 2015, respectively.