The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our consolidated financial statements and accompanying notes in Part II, Item 8 below. The discussion below contains forward-looking statements that are based upon current expectations and are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations. See “Cautionary Note Regarding Forward-Looking Statements.”
Significant counties defined as greater than 2.5% of total in-force premium as of December 31, 2018.
The geographical distribution of our policies in-force, in-force premium and total insured value across all states were as follows, as of December 31, 2018, 2017 and 2016 (dollars in thousands, rounded to the nearest thousand):
We have used the model results noted above to stress test the completeness of the program by simulating a recurrence of the 2004 calendar year, in which four large catastrophic hurricanes made landfall in Florida. This season is considered to be the worst catastrophic year in Florida’s recorded history. Assuming the reoccurrence of the 2004 calendar year events, including the same geographic path of each such hurricane, the modeled estimated net loss to us in 2018 with the reinsurance coverage described herein would be approximately $110 million (after tax, net of all reinsurance recoveries). We estimate that, based on our portfolio of insured risks as of December 31, 2018 and 2017, a repeat of the four 2004 calendar year events would have exhausted approximately 20.0% and 27.0%, respectively, of our property catastrophe reinsurance coverage.
UPCIC has a net retention of $35 million per catastrophe event for losses incurred, in all states, up to a first event loss of $3.146 billion. UPCIC also purchases a separate underlying catastrophe program to further reduce its retention for all losses occurring in any state other than Florida (the “Other States Reinsurance Program”). UPCIC retains only $5 million under its Other States Reinsurance Program in the first event, $3 million in the second event and only $1 million under its Other States Reinsurance Program for the third through fifth events. These retention amounts are gross of any potential tax benefit we would receive in paying such losses.
Immediately above UPCIC’s net retention, we have reinsurance coverage from third-party reinsurers for up to four separate catastrophic events for all states. Specifically, we have purchased reinsurance coverage for the first and third catastrophic events, and each such coverage allows for one reinstatement upon the payment of reinstatement premiums, which would cover the second and fourth catastrophic events. This coverage has been obtained from four contracts as follows:
For the first three contracts above, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased reinstatement premium protection to pay the required premium necessary for the reinstatement of these coverages. All of these contracts extend coverage to all states.
Above the first layer, for losses exceeding $90 million and $111 million, we have purchased a second layer of coverage for losses up to $445 million-in other words, for the next $355 or $334 million of losses. This coverage has been obtained from three contracts as follows:
In these layers, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased reinstatement premium protection to pay the required premium necessary for the reinstatement of these coverages. All of these contracts extend coverage to all states.
Above the first and second layers, we have purchased a third layer of coverage for losses up to $529 million-in other words, for the next $84 million of losses. This coverage was obtained from two contracts as follows:
35% of $84 million in excess of $445 million provides coverage for the 2018-2019 period.
65% of $45 million in excess of $635 million provides coverage on a multi-year basis through May 31, 2021; and
35% of $45 million in excess of $635 million provides coverage for the 2018-2019 period.
In the sixth and seventh layers, we have purchased reinsurance for $218 million of coverage in excess of $680 million in losses incurred by us (net of the FHCF layer) and $140 million of coverage in excess of $898 million (net of the FHCF layer), respectively, for a total of $1.0 billion of coverage (net of the FHCF layer) by third-party reinsurers. In these layers, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased reinstatement premium protection to pay the required premium necessary for the reinstatement of these coverages. Both of these contracts extend coverage to all states.
UPCIC structures its reinsurance coverage into layers and utilizes a cascading feature such that the second, third, fourth, fifth, sixth and seventh reinsurance layers all attach at $111 million. Any layers above the $111 million attachment point are excess of loss over the immediately preceding layer. If the aggregate limit of the preceding layer is exhausted, the next layer cascades down in its place for future events. This means that, unless losses exhaust the top layer of our coverage, we are exposed to only $35 million in losses, pre-tax, per catastrophe for each of the first four events. In addition to tax benefits that could reduce our ultimate loss, we anticipate that certain fees paid to our subsidiary service providers by our Insurance Entities and, indirectly, our reinsurers would also increase during an active hurricane season.
Effective June 1, 2018 through June 1, 2019, under an excess catastrophe contract specifically covering risks located outside the state of Florida and intended to further reduce UPCIC’s $35 million net retention, as noted above, UPCIC has obtained catastrophe coverage of $30 million in excess of $5 million covering certain loss occurrences, including hurricanes, in states outside of Florida. This catastrophe coverage has a second full limit available with additional premium calculated pro rata as to amount and 100% as to time, as applicable. For this catastrophe coverage, which is placed in three layers, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased reinstatement premium protection to pay the required premium necessary for the reinstatement of this coverage. All catastrophe layers are placed with a cascading feature so that all capacity could be made available in excess of $5 million under certain loss scenarios. Further, UPCIC purchased subsequent catastrophe event excess of loss reinsurance specifically covering risks outside of Florida to cover certain levels of loss through five catastrophe events including hurricanes. Specifically, UPCIC obtained catastrophe coverage that covers 100% of $4,000,000 excess of $1,000,000 in excess of $6,000,000 otherwise recoverable. This coverage has two and a half free reinstatements and a total of $14,000,000 of coverage available to UPCIC.
In certain circumstances involving a first catastrophic event impacting both Florida and other states, UPCIC’s retention could result in pre-tax net liability as low as $5,000,000-the $35 million net retention under the all states reinsurance program could be offset by as much as $30 million in coverage under the Other States Reinsurance Program-or 1.7% of UPCIC’s statutory policyholders’ surplus as of December 31, 2018.
UPCIC’s third-party reinsurance program supplements the FHCF coverage we are required to purchase every year. The limit and retention of the FHCF coverage we receive each year is subject to upward or downward adjustment based on, among other things, submitted exposures to the FHCF by all participants. As of December 31, 2018, we estimate our FHCF coverage includes a maximum provisional limit of 90% of $2.33 billion, or $2.1 billion, in excess of $727 million. The estimated premium that UPCIC plans to cede to the FHCF for the 2018 hurricane season is $136.8 million.
Coverage purchased from third-party reinsurers, as described above, adjusts to provide coverage for certain losses not otherwise covered by the FHCF. The FHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events. The FHCF coverage extends only to losses to our Florida portfolio due to a land falling hurricane.
The total cost of APPCIC’s private catastrophe and multiple line excess reinsurance program, effective June 1, 2018 through May 31, 2019, is $2.27 million. In addition, APPCIC has purchased reinstatement premium protection as described below, the cost of which is $103,950. The largest private participants in APPCIC’s reinsurance program include leading reinsurance companies such as Everest Re, Chubb Tempest Re, Hiscox, Hannover Ruck and Lloyd’s of London syndicates.
APPCIC has a net retention of $2 million for all losses per catastrophe event for losses incurred up to a first event loss of $36.65 million. This retention amount is gross of any potential tax benefit we would receive in paying such losses.
APPCIC’s third-party reinsurance program is used to supplement the FHCF reinsurance we are required to purchase every year. The limit and retention of the FHCF coverage we receive each year is subject to upward or downward adjustment based on, among other things, submitted exposures to the FHCF by all participants. As of December 31, 2018, we estimate our FHCF coverage includes a maximum provisional limit of 90% of $20.5 million, or $18.5 million, in excess of $6.4 million. The estimated premium that APPCIC plans to cede to the FHCF for the 2018 hurricane season is $1.25 million. Factoring in our estimated coverage under the FHCF, we purchase coverage alongside our FHCF coverage from third-party reinsurers as described above, which adjusts to provide coverage for certain losses not otherwise covered by the FHCF. The FHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events. The FHCF coverage extends only to losses to our portfolio impacted by a land falling hurricane.
The third-party reinsurance we purchase for APPCIC is therefore net of FHCF recovery. When our FHCF and third-party reinsurance coverages are taken together, APPCIC has reinsurance coverage of up to $36.65 million, as illustrated by the graphic below. Should a catastrophic event occur, we would retain $2 million pre-tax for each catastrophic event, and would also be responsible for any additional losses that exceed our top layer of coverage.
Direct and ceded premiums are recognized as revenue on a pro rata basis over the policy term or over the term of the reinsurance agreement. The portion of direct premiums that will be earned in the future are deferred and reported as unearned premiums. The portion of ceded premiums that will be earned in the future is deferred and reported as prepaid reinsurance premiums.
Five-year accident year table on cumulative paid claims and allocated claim adjustment expenses, net of reinsurance,
Duration-a table of the average historical claims duration for the past five years, and
Adverse changes in loss cost trends, including inflationary pressures in home repair costs;
The estimation of claims and claims expense reserves for catastrophes also comprises estimates of losses from reported and unreported claims, primarily for damage to property. In general, estimates for catastrophe reserves are based on claim adjuster inspections and the application of historical loss development factors as described previously and in “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. However, depending on the nature of the catastrophe, as noted above, the estimation process can be further complicated. For example, for hurricanes, complications
In compliance with annual statutory reporting requirements, our appointed independent actuary provides a Statement of Actuarial Opinion (“SAO”) indicating that carried loss and LAE reserves recorded at each annual balance sheet date make a reasonable provision for all of the Insurance Entities’ unpaid loss and LAE obligations under the terms of contracts and agreements with our policyholders. Recorded reserves are compared to the indicated range provided in the actuary’s report accompanying the SAO. At December 31, 2018, the recorded amount for net loss and LAE falls within the range determined by the appointed independent actuaries and approximates their best estimate.
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 previous years, UPCIC experienced unanticipated unfavorable loss development on catastrophe losses from claims related to 2004 and 2005 being reopened and new claims being opened due to public adjusters encouraging policyholders to file new claims, and from homeowners’ association assessments related to condominium policies. 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.
We incur acquisition costs in connection with the production of new and renewal insurance policies which are deferred and recognized over the life of the underlying insurance policy. Acquisition costs not yet recognized are deferred and reported as “Deferred Policy Acquisition Costs.” Acquisition costs are commissions and state premium taxes incurred in acquiring insurance policies that related to the successful production of new and renewal business. As of December 31, 2018, deferred policy acquisition costs were $84.7 million compared to deferred policy acquisition costs of $73.1 million as of December 31, 2017.
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, 2018.
YEAR ENDED DECEMBER 31, 2018 COMPARED TO YEAR ENDED DECEMBER 31, 2017
Direct premiums written overall grew by $135.0 million, or 12.80%, to $1,190.9 million.
The Company achieved over $1 billion in-force premium for the state of Florida during 2018.
Although Hurricanes Michael and Florence caused substantial losses, our vertically integrated structure and comprehensive reinsurance program substantially limited the overall financial impact from these damaging storms.
Net income increased by $10.1 million, or 9.5%, to $117.1 million.
Increased our normal dividend 14% in the third quarter from $0.14 to $0.16 per share.
Offered Universal DirectSM in all 17 states in which the Company writes policies as of December 31, 2018.
organic growth from our existing agent force. We are now actively writing policies in 16 states other than our home state of Florida. Also contributing to growth in Florida and other states is growth in our online platform Universal DirectSM.
Direct premium earned increased by $122.4 million, or 12.3%, for the year ended December 31, 2018, reflecting the earning of premiums written over the past 12 months and changes in rates and policy count during that time.
Commission revenue is comprised principally of brokerage commissions we earn from reinsurers on reinsurance placed for the Insurance Entities. For the year ended December 31, 2018, commission revenue was $22.4 million, compared to $21.3 million for the year ended December 31, 2017. The increase in commission revenue of $1.2 million, or 5.6%, for the year ended December 31, 2018 was primarily the result of increased ceded premiums in 2018 compared to 2017 as a result of commissions earned from higher ceded premiums under the Company’s June 1, 2018 renewal of its 2018-2019 Reinsurance Program. Commission revenue from reinstatement premiums was $2.7 million in 2018 versus $2.6 million in 2017.
Losses and LAE, net of reinsurance were $414.5 million for the year ended December 31, 2018 compared to $350.4 million for the same period in 2017 as follows:
Net results during the year ended December 31, 2018 include: charges to losses and LAE of $14.8 million net ($395 million gross) due to the impact of two hurricanes, Hurricanes Florence and Michael; $99.5 million net allocated to strengthen prior accident year’s loss reserves. Prior years reserve strengthening resulted from Hurricane Irma companion claims, which propagated into non-cat systemic claims representation in Florida, resulting in an increase in prior year development. This strengthening resulted in an increase in the frequency (number of claims) and severity (cost of the claim) of non-catastrophe claims spanning several prior accident years, including reopened claims, newly reported claims, increased litigation and increased loss settlements of claims above carried values. Operational focus in the fourth quarter of 2018 was centered on accelerating the settlement of claims to reduce the number of claims outstanding. The increase in prior accident year claim severity and claim frequency reflects the trends and dynamics in the Florida market particularly AOB, systemic claims representation and solicitation of prior years’ claims in the post Irma environment. An AOB is a document signed by a policyholder that allows a third party to be paid for claim services performed for an insured homeowner who would be normally be reimbursed by the insurance company directly after making a claim. We have generally seen an increase in the use of AOBs by Florida policyholders. Claims paid under an AOB often involve unnecessary litigation and as a result cost significantly more than claims settled when an AOB is not involved, with most of the increase going to the attorneys or representatives of policyholders. In August 2018, the Company announced the appointment of a Chief Legal Officer to lead the legal efforts in response to the growing AOB claims and their related increase in litigated claims and costs. We continue to monitor assignment of benefits legislation in Florida and continue to take steps to address the Florida market dynamics. See “Item 8 - Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for five-year development data.
All other net losses and LAE were $300.2 million, or 39.1% of net earned premium, and $293.8 million, or 42.7% of net earned premium for the years ended December 31, 2018 and 2017, respectively. Our claims services entity generated a net benefit of
For the year ended December 31, 2018, general and administrative expenses were $256.5 million, compared to $231.0 million for the same period in 2017 as detailed below (dollars in thousands):
Although costs were up overall, general and administrative costs as a percentage of earned premiums decreased from 33.5% of earned premiums in 2017 to 33.4% of earned premiums in 2018. The increase in general and administrative expenses of $25.5 million was primarily the result of increases in policy acquisition costs of $18.5 million due to commissions associated with increased premium volume and continued premium growth in states that have higher commission rates compared to Florida, and to a lesser extent due to an increase in other operating costs of $7.0 million. Policy acquisition costs for the year ended December 31, 2018 included the receipt of a $6.5 million benefit related to a settlement of prior year premium tax audits with the Florida Department of Revenue. Other operating costs increased by $7.0 million in 2018, which was primarily driven by increases in salary, share-based compensation and a lower level of expenses recovered in 2018 from reinsurers compared to amounts recovered in 2017 related to Hurricane Irma. Other operating costs in 2018 reflected lower amounts spent on advertising and temporary employee expenses. Other operating costs as a percentage of earned premium reduced from 13.3% of earned premium in 2017 to 12.9% of earned premium in 2018.
Other comprehensive income (loss), net of taxes for the year ended December 31, 2018 was $4.7 million of net unrealized losses related to debt securities available-for-sale compared to other comprehensive income of $0.1 million related to net unrealized gains on debt securities available-for-sale and equity securities for 2017. On January 1, 2018 we adopted ASU 2016-01. See “Item 8 - Note 14 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income and loss for these periods and “Item 8 - Note 2 (Summary of Significant Accounting Policies-Recently Adopted Accounting Pronouncements)” for a discussion on the adoption.
For the year ended December 31, 2017, our growth in direct premiums written increased by 10.6% overall to $1,055.9 million, including an increase of 7.4% to $924.0 million within Florida and an increase of 40.4% to $131.9 million in our Other States book. Growth within Florida includes both continued organic growth and the positive effect of increased policyholder retention and the associated premium volume surrounding Hurricane Irma, while growth in our Other States book includes continued expansion within states where we already had a presence prior to 2017, as well as the addition of two new states during the year (New Jersey and New York).
Premiums earned, net increased by 8.9% to $688.8 million for the year ended December 31, 2017, compared to $632.4 million for the year ended December 31, 2016. The growth was the result of the increase in direct premium earned and was partially offset by the increase in ceded premium earned, both of which are discussed above.
yield while maintaining high credit quality. Total average investments were $666.3 million with an average credit rating of AA- during the year ended December 31, 2017 compared to $592.6 million with an average credit rating of AA- for the same period in 2016.
We periodically sell investment securities from our portfolio of securities available-for-sale when opportunities arise or when circumstances could result in greater losses if such securities continue to be held. We sold investment securities available-for-sale during the year ended December 31, 2017 resulting in a net realized gain of $2.6 million compared to a net realized gain of $2.3 million during the year ended December 31, 2016.
For the year ended December 31, 2017, general and administrative expenses increased by $9.8 million, or 4.4% to $231.0 million, driven by an increase in policy acquisition costs of $12.9 million, or 10.2%, and which was partially offset by a decrease in other operating costs of $3.0 million, or 3.2%. The increase in policy acquisition costs primarily reflects the growth in premium volume described above but also includes an increase in the amount of bonus commissions paid to independent agents for achieving certain levels of premium production and retention. Other operating costs decreased $3.0 million primarily driven by decrease in insurance cost, legal and consulting. The operating expense ratio improved as result of economies of scale.
Comprehensive income includes net income and other comprehensive income or loss. Other comprehensive income, net of taxes for the year ended December 31, 2017 was $0.1 million compared to a loss of $2.4 million for the same period in 2016. Other comprehensive income (loss) represents after tax changes to equity which are not recognized in net income, including changes in
the fair value of securities available-for-sale held in our investment portfolio and any reclassifications out of cumulative other comprehensive income for securities sold. See “Item 8 - Note 14 (Other Comprehensive Income (Loss)).”
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2018 COMPARED TO DECEMBER 31, 2017
Prepaid reinsurance premiums represent the portion of unearned ceded written premium that will be earned pro-rata over the remaining coverage period of our reinsurance program, which runs from June 1 to May 31 of the following year. The increase of $9.9 million to $142.8 million as of December 31, 2018 was due primarily to an increase in ceded written premium for the reinsurance costs relating to our 2018-2019 catastrophe reinsurance program beginning June 1, 2018, less amortization of those costs recorded during 2018.
Premiums receivable, net represents amounts receivable from policyholders. The increase in premiums receivable, net of $3.4 million to $59.9 million as of December 31, 2018 relates to both the growth in and seasonality of the Company’s business.
Deferred income taxes represent the estimated tax asset or tax liability caused by temporary differences between the tax return basis of certain assets and liabilities and amounts recorded in the financial statements. Deferred income taxes reverse in future years as the temporary differences between book and tax reverse. During the year ended December 31, 2018, the deferred income tax asset-net increased by $5.3 million to $14.6 million primarily due to an increase in the deferred tax benefit from increases in unrealized losses in investments.
Unearned premium represents the portion of direct premiums written that will be earned pro-rata in the future. The increase of $69.2 million to $601.7 million as of December 31, 2018 reflects both organic growth and seasonality of our business as described under “-Overview”.
Reinsurance payable, net principally represents the unpaid ceded written premiums owed to reinsurers in connection with the renewal of the Company’s 2018-2019 catastrophe reinsurance program on June 1, 2018, and to a lesser extent unpaid reinstatement premiums and cash advances received from reinsurers. The balance decreased by $17.1 million to $93.3 million as of December 31, 2018 as a result of reductions in cash advances received from reinsurers. Ceded premiums for the 2018-2019 catastrophe reinsurance program are paid in installments over the June 1 to May 31 policy term.
Other liabilities and accrued expenses increased by $0.3 million to $45.4 million as of December 31, 2018, primarily driven by an increase in other liabilities due to timing of payments.
The reduction in long-term debt was the result of principal payments on debt during 2018. See “-Liquidity and Capital Resources” and “Item 8 - Note 8 (Stockholders’ Equity)” for explanation of changes in treasury stock.
Additional paid-in-capital increased $0.2 million resulting from share-based compensation expense of $12.8 million and stock option exercises of $36.6 million for the year ended December 31, 2018. This was offset by the common stock value acquired through cashless stock option exercise and tax withholdings on the intrinsic value of stock option exercise, restricted stock and performance units vested for share-based payment transactions of $49.2 million for the year ended December 31, 2018.
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 to meet our liquidity requirements and we expect that, in the future, funds from operations will continue to meet such requirements.
During 2018, hurricanes were a significant liquidity event to the Company. The Company’s reinsurance program performed as expected providing sufficient liquidity in the form of cash advances for paid losses ceded to the reinsurers. During 2018, the Company collected substantially all of the amounts ceded to reinsurers and did not have to use funds in the Company’s investment portfolio.
Liquidity for UVE and its non-insurance subsidiaries is required to cover the payment of general operating expenses, dividends to shareholders (if and when authorized and declared by our Board of Directors), payment for the possible repurchase of our common stock (if and when authorized by our Board of Directors), payment of income taxes, and interest and principal payments on outstanding debt obligations, if any. The declaration and payment of future dividends by UVE to its shareholders, and any future repurchases of UVE common stock, will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, debt covenants and any regulatory constraints. Principal sources of liquidity for UVE and its non-insurance subsidiaries include revenues generated from fees paid by the Insurance Entities to affiliated companies for policy administration, inspections and claims adjusting services. Additional sources of liquidity include brokerage commissions earned on reinsurance contracts and policy fees. UVE also maintains investments, which are a source of ongoing interest and dividend income and would generate funds upon sale. As discussed in “Item 8 - Note 5 (Insurance Operations),” there are limitations on the dividends the Insurance Entities may pay to their immediate parent company, UVECF.
As noted above, the Tax Act has decreased the statutory corporate tax rate from 35.0% to 21.0% for tax years beginning after December 31, 2017. Going forward, the Company expects to see an overall benefit from the Act, primarily from lower statutory tax rates offset by certain other provisions, principally the provision limiting the deductibility of certain executive compensation.
In 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (the “SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (the “ICBUI”). The surplus note has a twenty-year term and accrues interest, adjusted quarterly based on the 10-year Constant Maturity Treasury Index. UPCIC is in compliance with each of the loan’s covenants as implemented by rules promulgated by the SBA. An event of default will occur under the surplus note, as amended, if UPCIC: (i) defaults in the payment of the surplus note; (ii) fails to submit quarterly filings to the FLOIR; (iii) fails to maintain at least $50 million of surplus during the term of the surplus note, except for certain situations; (iv) misuses proceeds of the surplus note; (v) makes any misrepresentations in the application for the program; (vi) pays any dividend when principal or interest payments are past due under the surplus note; or (vii) fails to maintain a level of surplus and reinsurance sufficient to cover in excess of UPCIC’s 1-in-100 year probable maximum loss as determined by a hurricane loss model accepted by the Florida Commission on Hurricane Loss Projection Methodology as certified by the FLOIR annually. To avoid a penalty rate, UPCIC must maintain either a ratio of net written premium to surplus of 2:1 or a ratio of gross written premium of 6:1 according to a calculation method set forth in the surplus note. As of December 31, 2018, UPCIC’s net written premium to surplus ratio and gross written premium to surplus ratio were in excess of the required minimums and, therefore, UPCIC is not subject to increases in interest rates. At December 31, 2018, UPCIC was in compliance with the terms of the surplus note. Total adjusted capital surplus, which includes the surplus note, was in excess of regulatory requirements for both UPCIC and APPCIC.
In December 2018, UVE announced that its Board of Directors authorized a share repurchase program under which UVE may repurchase shares in the open market up to $20 million of its outstanding shares of common stock through May 31, 2020. UVE repurchased 138,234 shares, at an aggregate price of approximately $5.5 million, pursuant to such repurchase program through December 31, 2018.
The following table summarizes the dividends declared and paid by the Company during the year ended December 31, 2018:
In November 2018, 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 loss adjustment expense 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 “Item 1A - Risk Factors-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 following table represents our contractual obligations for which cash flows are fixed or determinable as of December 31, 2018 (in thousands):
The 1-3 years amount represents the payment of reinsurance premiums payable under multi-year commitments. See “Item 8 - Note 15 (Commitments and Contingencies).”
In March 2017, FASB revised U.S. GAAP with the issuance of ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs, to amend the amortization period for certain purchased callable debt securities held at a premium. Current U.S. GAAP excludes certain callable debt securities from consideration of early repayment of principal even if the holder is certain that the call will be exercised. The new ASU shortens the amortization period of certain purchased callable debt securities to the earliest call date. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. Under the current U.S. GAAP, you could consider the call dates and estimate if you had a large number of similar securities and you were basing your judgment on actual experience. Our service provider (who processes the accounting for our investment transactions) has many similar securities on their system and can make that type of determination. As a result, we currently account for the amortization under the proposed ASU and there will be no impact to our results of operations, financial condition or liquidity.
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016
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, 2018 and 2017 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, 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, 2018, based on criteria established in the COSO framework.
Excess tax benefit (shortfall), net for the year ended December 31, 2016 were recognized in additional paid-in capital. For the years ended December 31, 2018 and 2017 excess tax benefit (shortfall) were recognized in income tax expense in the consolidated statements of income when the share-based awards vest or are settled. See “-Note 9 (Share-Based Compensation).”
The Company generates revenues primarily from the collection of premiums and invests funds in excess of those retained for claims-paying obligations and insurance operations. Other significant sources of revenue include brokerage commissions collected from reinsurers on certain reinsurance programs placed by the Insurance Entities, policy fees collected from policyholders by our wholly-owned managing general agent subsidiary and payment plan fees charged to policyholders who choose to pay their premiums in installments. Our 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.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of UVE and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
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 are in the recognition of liabilities for unpaid losses, loss adjustment expenses, and subrogation recoveries, and reinsurance recoveries. Actual results could differ from those estimates.
Investment, Equity Securities. The Company’s investment in equity securities are recorded at fair value on the consolidated balance sheet with changes in the fair value of equity securities reported in current period earnings on the consolidated statements of income within net change in unrealized gains (losses) of equity securities as they occur.
Premiums Receivable. Generally, premiums are collected prior to or during the policy period as permitted under the Insurance Entities payment plans. Credit risk is minimized through the effective administration of policy payment plans whereby rules governing policy cancellation minimize exposure to credit risk. The Company performs a policy level evaluation to determine the extent the premiums receivable balance exceeds the unearned premiums balance. The Company then ages this exposure to establish an allowance for doubtful accounts based on prior credit experience. As of December 31, 2018 and 2017, the Company recorded allowances for doubtful accounts in the amounts of $711 thousand and $680 thousand, respectively.
Provision for Premium Deficiency. It is the Company’s policy to evaluate and recognize losses on insurance contracts when estimated future claims, deferred policy acquisition costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums. No accruals for premium deficiency were considered necessary as of December 31, 2018 and 2017.
In August 2016, the FASB revised U.S. GAAP with the issuance of ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new ASU applies to: (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon debt instruments, (3) contingent consideration payments made after business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, (6) distributions received from equity method investments, (7) beneficial interests in securitization transactions and (8) separately identifiable cash flows and application of the predominance principle. Historically, the items outlined above have not been applicable to the Company. The Company adopted this ASU effective January 1, 2018 and the adoption did not have an impact on our Consolidated Statements of Cash Flows.
In November 2016, the FASB revised U.S. GAAP, Statement of Cash Flows (Topic 230): Restricted Cash with the issuance of the ASU 2016-18 to reduce diversity in the classification and presentation of changes in restricted cash in the statement of cash flows. The new ASU requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. The Company is required to reconcile such total to amounts on the Consolidated Balance Sheets and disclose the nature of the restrictions. The Company adopted this ASU effective January 1, 2018, which only resulted in a change in the presentation of the Consolidated Statements of Cash Flows.
In February 2018, the FASB revised U.S. GAAP, Comprehensive Income (Topic 220), with the issuance of ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, in response to the enactment of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) on December 22, 2017. The new ASU permits a company to reclassify the disproportionate income tax effects of the Tax Act on items within AOCI to retained earnings and requires certain new disclosures. The Company adopted this guidance effective January 1, 2018 and made an election to reclassify the income tax effects of the Tax Act from AOCI to retained earnings. Upon adoption, retained earnings were reduced by approximately $0.6 million due to this
reclassification. The reclassification represents the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances at the date of enactment of the Tax Act related to items remaining in AOCI. The Company follows an aggregate portfolio approach and considers that it had two portfolios, an available-for-sale debt portfolio and an available-for-sale equity portfolio, the disproportionate tax effects relating to the available-for-sale equity portfolio were included in the transition adjustment when adopting ASU 2016-01.
The following table provides the cost or amortized cost and fair value of debt and short-term securities available for sale as of the dates presented (in thousands):
The following table provides the credit quality of available-for-sale debt securities with contractual maturities as of the dates presented (in thousands):
Inc. and Fitch Ratings, Inc. The Company has presented the highest rating of the three rating agencies for each investment position.
The following table summarizes the fair value and gross unrealized losses on available-for-sale debt securities, aggregated by major investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates presented (in thousands):
As of December 31, 2018, the Company held available-for-sale debt securities that were in an unrealized loss position as presented in the table above. For available-for-sale debt securities with significant declines in value, the Company performs quarterly fundamental credit analysis on a security-by-security basis, which includes consideration of credit quality and credit ratings, review of relevant industry analyst reports and other available market data. For available-for-sale debt securities, the Company considers whether it has the intent and ability to hold the available-for-sale debt securities for a period of time sufficient to recover its cost basis. Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended, the security’s decline in fair value is considered other than temporary and is recorded in earnings. Based on our analysis, our fixed income portfolio is of high quality and we believe that we will recover the amortized cost basis of our available-for-sale debt securities. We continually monitor the credit quality of our investments in available-for-sale debt securities to assess if it is probable that we will receive our contractual or estimated cash flows in the form of principal and interest. Additionally, the Company considers management’s intent and ability to hold the available-for-sale debt securities until recovery and its credit analysis of the individual issuers of the securities. Based on this process and analysis, management has no reason to believe the unrealized losses of the available-for-sale debt securities as of December 31, 2018 are other than temporary.
All securities, except those with perpetual maturities, were categorized in the table above utilizing years to effective maturity. Effective maturity takes into consideration all forms of potential prepayment, such as call features or prepayment schedules, that shorten the lifespan of contractual maturity dates.
The following table provides certain information related to available-for-sale debt securities and equity securities during the periods presented (in thousands):
During the year ended December 31, 2018, the Company transferred $7.4 million from non-income producing investment real estate to income producing investment real estate.
The Company seeks to reduce its risk of loss by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers, generally as of the beginning of the hurricane season on June 1st of each year. The Company’s current reinsurance programs consist of catastrophe excess of loss reinsurance, subject to the terms and conditions of the applicable agreements. The Company is responsible for certain retained loss amounts before reinsurance attaches and insured losses related to catastrophes and other events that exceed coverage provided by the reinsurance programs. The Company remains responsible for the settlement of insured losses irrespective of whether any of the reinsurers fail to make payments otherwise due.
Amounts recoverable from reinsurers are estimated in a manner consistent with the terms of the reinsurance contracts. Reinsurance premiums, losses and loss adjustment expenses (“LAE”) are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.
The Company defers certain costs in connection with written policies, called Deferred Policy Acquisition Costs (“DPAC”). DPAC is amortized over the effective period of the related insurance and reinsurance policies.
In accordance with Florida Insurance Code, and based on the calculations performed by the Company as of December 31, 2018, UPCIC has the capacity to pay ordinary dividends of $14.0 million during 2019. APPCIC does not meet the earning’s or surplus regulatory requirements as of December 31, 2018 to pay ordinary dividends during 2019. For the year ended December 31, 2018, no dividends were paid from UPCIC to UVECF. For the year ended December 31, 2017, UPCIC paid dividends of $30.0 million to UVECF. No dividends were paid from APPCIC to UVECF for the years ended December 31, 2018 and 2017.
*UVECF made this contribution to APPCIC’s capital in conjunction with APPCIC’s request for FLOIR approval to transact commercial residential insurance products in Florida. The FLOIR granted APPCIC’s request.
UPCIC and APPCIC are required annually to comply with the NAIC risk-based capital (“RBC”) requirements. RBC requirements prescribe a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC RBC requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of a weak or deteriorating condition. As of December 31, 2018, based on calculations using the appropriate NAIC RBC formula, UPCIC’s and APPCIC’s reported total adjusted capital was in excess of the requirements.
Depreciation and amortization was $4.4 million, $3.9 million and $3.1 million for the years ended December 31, 2018, 2017 and 2016, respectively.
On November 9, 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (the “SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (the “ICBUI”). The surplus note has a twenty-year term and accrues interest, adjusted quarterly based on the 10-year Constant Maturity Treasury Index. The carrying amount of the surplus note is included in the statutory capital and surplus of UPCIC of approximately $11.4 million as of December 31, 2018.
The effective interest rate paid on the surplus note was 2.89%, 2.47% and 1.88% for the years ended December 31, 2018, 2017 and 2016, respectively. Any payment of principal or interest by UPCIC on the surplus note must be approved by the Florida Commissioner of the OIR. Quarterly principal payments of $368 thousand are due through 2026. Aggregate principal payments of approximately $1.5 million were made during each of the years ended December 31, 2018, 2017 and 2016.
UPCIC is in compliance with each of the loan’s covenants as implemented by rules promulgated by the SBA. An event of default will occur under the surplus note, as amended, if UPCIC: (i) defaults in the payment of the surplus note; (ii) fails to submit quarterly filings to the FLOIR; (iii) fails to maintain at least $50 million of surplus during the term of the surplus note, except for certain situations; (iv) misuses proceeds of the surplus note; (v) makes any misrepresentations in the application for the program; (vi) pays any dividend when principal or interest payments are past due under the surplus note; or (vii) fails to maintain a level of surplus and reinsurance sufficient to cover in excess of UPCIC’s 1-in-100 year probable maximum loss as determined by a hurricane loss
All shares acquired represent shares tendered to cover the strike price for options and tax withholdings on the intrinsic value of options exercised or performance share units or restricted stock (as defined in “-Note 9 (Share-Based Compensation)”) vested. These shares have been canceled by the Company.
In December 2018, UVE announced that its Board of Directors authorized a share repurchase program under which UVE may repurchase in the open market in compliance with Exchange Act Rule 10b-18 up to $20 million of its outstanding shares of common stock through May 31, 2020. UVE repurchased 138,234 shares, at an aggregate price of approximately $5.5 million, pursuant to such repurchase program through December 31, 2018.
During the year ended December 31, 2018, UVE repurchased an aggregate of 688,689 shares of its common stock in the open market in compliance with Exchange Act Rule 10b-18 at a total cost of $25.3 million.
Includes dividend equivalents due to certain employees who hold Performance Share Units which are subject to time-vesting conditions.
Under the Company’s 2009 Omnibus Incentive Plan, as amended (the “Incentive Plan”), 2,744,128 shares remained reserved for issuance and were available for new awards under the Incentive Plan as of December 31, 2018.
Awards under the Incentive Plan may include incentive stock options, non-qualified stock option awards (“Stock Option”), stock appreciation rights, non-vested shares of common stock, restricted stock units (“Restricted Stock”), performance share units (“PSUs”), other share-based awards and cash-based incentive awards. Awards under the Incentive Plan may be granted to employees, directors, consultants or other persons providing services to the Company or its affiliates.
The following table provides certain information related to Stock Options, Restricted Stock and PSUs during the year ended December 31, 2018 (in thousands, except per share data):
Unless otherwise specified, such as in the case of the exercise of Stock Options, the per share prices were determined using the closing price of the Company’s Common Stock as quoted on the exchanges on which the Company was listed. Shares issued upon exercise of options represent original issuances in private transactions pursuant to Section 4(2) of the Securities Act of 1933, as amended or issuances under the Company’s Incentive Plan.
Excess tax benefits (shortfalls) for the years ended December 31, 2018 and 2017 were recognized within income and within additional paid in capital for the year ended December 31, 2016.
Restricted Stock and Performance Share Units are awarded to certain employees in consideration for services rendered pursuant to terms of employment agreements or to provide those employees a continued incentive to share in the success of the Company. Restricted Stock generally vests over a one- to three-year service period commencing on the grant date. Each performance share unit has a value equal to one share of common stock and generally vests over a three-year service period commencing on the grant date.
The plan titled the “Universal Property & Casualty 401(K) Profit Sharing Plan and Trust” (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 loss. The 401(k) Plan includes a Company contribution of 100 percent of each eligible participant’s contribution that does not exceed five hundredths of their 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, 2018, 2017 and 2016.
There were no related party transactions for the years ended December 31, 2018, 2017 and 2016.
Significant components of the income tax provision are as follows for the periods presented (in thousands):
The following table reconciles the statutory federal income tax rate to the Company’s effective income tax rate for the periods presented:
The Company recognized excess income tax benefit of $5.4 million and $5.8 million from stock-based compensation awards that vested and/or were exercised during the years ended December 31, 2018 and 2017, respectively. Excess income tax benefits are reflected as an income tax benefit in the consolidated statements of income as a component of the provision for income taxes. Prior to the adoption of ASU 2016-09 on January 1, 2017, excess income tax benefits/(shortfalls) were reflected in additional paid-in capital in the consolidated statements of stockholders’ equity.
Recent changes in federal tax law have affected the Company’s balances of deferred income tax assets and liabilities. On December 22, 2017, the Tax Act of 2017 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.
Additional factors giving rise to the differences in the Company’s effective tax rate, when compared to statutory rates in the current and prior years, include non-deductible executive compensation, tax-exempt interest income, and the current expansion outside of Florida into non-income taxing state jurisdictions.
The Company accounts for income taxes using a balance sheet approach. As of December 31, 2018 and 2017, the significant components of the Company’s deferred income taxes consisted of the following (in thousands):
The Company has adopted Accounting for Uncertainty in Income Taxes (“ASC 740”) which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. ASC 740 provides a threshold for the financial statement recognition and measurement of an income tax position taken or expected to be taken in an income tax return. The Company’s policy is to classify interest and penalties related to unrecognized tax positions, if any, in its provision for income taxes. As of December 31, 2018, 2017 and 2016, the Company determined that no uncertain tax liabilities are required.
The Company filed a consolidated federal income tax return for the tax years ended December 31, 2017, 2016 and 2015 and intends to file the same for the tax year ended December 31, 2018. The tax allocation agreement between the Company and the Insurance Entities provides that they will incur income taxes based on a computation of taxes as if they were stand-alone taxpayers. The computations are made utilizing the financial statements of the Insurance Entities prepared on a statutory basis of accounting and prior to consolidating entries which include the conversion of certain balances and transactions of the statutory financial statements to a U.S. GAAP basis.
Represents the dilutive effect of unexercised Stock Options, unvested Performance Share Units and unvested Restricted Stock.
This amount represents reclassifications to retained earnings associated with the disproportional income tax effects of the Tax Act on items within AOCI and unrealized losses in AOCI relating to available-for-sale equity security investments. See “-Note 2 (Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements)” for more information.
We purchase reinsurance coverage to protect our capital and to limit our losses when major events occur. Our reinsurance commitments run from June 1 of the current year to May 31 of the following year. Certain of our 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” in the financial statements. 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) $82.3 million in 2019 and (2) $33.9 million in 2020.
Lawsuits are filed against the Company from time to time. Many of these lawsuits involve claims under policies that we underwrite and reserve for as an insurer. We are also involved in various other legal proceedings and litigation unrelated to claims under our 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 our financial condition or results of operations. The Company contests liability and/or the amount of damages as appropriate in each pending matter.
The Company utilizes third-party independent pricing services that provide a price quote for each available-for-sale debt security, equity security and available-for-sale short-term investment. Management reviews the methodology used by the pricing services. If management believes that the price used by the pricing service does not reflect an orderly transaction between participants, management will use an alternative valuation methodology. There were no adjustments made by the Company to the prices obtained from the independent pricing source for any available-for-sale debt security or equity securities included in the tables above.
Set forth in the following tables is information about unpaid losses and loss adjustment expenses as of December 31, 2018, net of reinsurance and estimated subrogation, as well as cumulative claim counts and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the liability for unpaid losses and LAE (in thousands).
The information about unpaid losses and loss adjustment expenses for the years ended December 31, 2014 to 2016, is presented as supplementary information and is unaudited.
Set forth is the following reconciliation of the net incurred and paid claims development tables to the liability for unpaid losses and LAE in the consolidated Balance Sheet as of December 31, 2018 (in thousands):
Set forth is the supplementary information about average historical claims duration as of December 31, 2018:
During 2018, the liability for unpaid losses and loss adjustment expenses, prior to reinsurance, increased by $224.4 million from $248.4 million as of December 31, 2017 to $472.8 million as of December 31, 2018. This increase was primarily a result of increased liabilities associated with Hurricanes Michael and Florence during 2018, and an increase in the expected liability associated with Hurricane Irma. Losses and loss adjustment expenses incurred during 2018 for Hurricane Irma were substantially ceded to reinsurers, and 2018 hurricanes Michael and Florence resulted in a net retention of $14.8 million after reinsurance. Other factors leading to the increase in incurred losses during 2018 include the increase in our underlying exposure due to increased writings in Florida and other states, as well as prior year adverse development as noted above of $99.5 million, net of reinsurance. As a result of changes in estimates of insured events in prior years, the loss and loss adjustment expense, net of reinsurance, increased by $99.5 million and $27.5 million during the year ended December 31, 2018 and 2017, respectively. Prior year development was primarily impacted by Hurricane Irma companion claims, which propagated into non-cat systemic claims representation in Florida, resulting in an increase in prior year development. This strengthening resulted from an increase in the frequency and severity of non-cat claims spanning several prior accident years, including reopened claims, newly reported claims, increased litigation and increased loss settlements of claims above carried values. This reflects the trends and dynamics in the Florida marketplace attributable to assignment of benefits and the increased solicitation of prior years’ claims in the post Irma environment. Total reserve re-estimates conducted in 2016 resulted in favorable development of $4.7 million in 2016. The favorable development in 2016 was principally the result of increases in estimated subrogation recoveries.
Reserves are estimated for both reported and unreported claims, and include estimates of all expenses associated with processing and settling all incurred claims, including consideration for anticipated subrogation recoveries that will offset future loss payments. The Company updates reserve estimates periodically as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Changes in prior year reserve estimates (reserve re-estimates), which may be material, are determined by comparing updated estimates of ultimate losses to prior estimates, and the differences are recorded as losses and LAE in the Consolidated Statements of Income in the period such changes are determined. Estimating the ultimate cost of losses and LAE is an inherently uncertain and complex process involving a high degree of subjective judgment and is subject to the interpretation and usage of numerous uncertain variables as discussed further below.
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 we implemented. The method is also utilized to evaluate segments impacted by the implementation of our 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.
hurricane Michael also recorded in the fourth quarter. Also during the fourth quarter unrealized losses on equity securities were $8 million. Net loss for the fourth quarter of 2018 was $6.5 million compared to net income of $36.4 million in the fourth quarter of 2017.