Battle Creek owns the building in which its offices are located at 603 South Preece Street, Battle Creek, Nebraska. Primero owns the building at 2640 South Jones Blvd, Suite 2, Las Vegas, Nevada, and Tri-State Ltd. leases the building at 506 5th Street, Spearfish, South Dakota. Primero employees at these two locations administer the non-standard auto business. We believe that the offices currently occupied by each of our subsidiaries are sufficient for their needs and any expected growth in the near future.
NI Holdings derives its revenue primarily from premiums earned, net investment income, and net realized capital gain (loss) on investments.
Net investment income and net realized capital gain (loss) on investments
NI Holdings’ expenses consist primarily of loss and LAE, amortization of deferred policy acquisition costs, other underwriting and general expenses, and income taxes.
NI Holdings uses the asset and liability method of accounting for deferred income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of its assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred income tax asset will not be realized. At December 31, 2017, 2016 and 2015, NI Holdings had recorded valuation allowances with respect to its deferred income tax assets of $628, $1,022, and $1,084, respectively. The effect of a change in tax rates is recognized in the period of the enactment date, which is the primary reason for the change in valuation allowance in 2017, as a result of the TCJA enacted on December 22, 2017.
NI Holdings evaluates its insurance operations by monitoring certain key measures of growth and profitability. In addition to reviewing its financial performance based on results determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”), NI Holdings utilizes certain non-GAAP financial measures that are used widely in the property and casualty insurance industry and which it believes are valuable in managing its business and for comparison to its peers. These non-GAAP measures are the expense ratio, loss and LAE ratio, combined ratio, written premiums, ratio of net written premiums to statutory surplus, underwriting gain, return on average equity, and risk-based capital.
The expense ratio is the ratio (expressed as a percentage) of amortization of deferred policy acquisition costs and other underwriting and general expenses (attributable to insurance operations) to premiums earned, and measures our operational efficiency in producing, underwriting, and administering the Company’s insurance business.
The Company’s combined ratio is the sum of the loss and LAE ratio and the expense ratio, and measures its overall underwriting gain. If the combined ratio is below 100%, NI Holdings is making an underwriting gain. If its combined ratio is at or above 100%, it is not profitable without investment income and may not be profitable if investment income is insufficient.
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. NI Holdings is required to make estimates and assumptions in certain circumstances that affect amounts reported in its financial statements and related footnotes. NI Holdings evaluates these estimates and assumptions on an ongoing basis based on historical developments, market conditions, industry trends, and other information that it believes to be reasonable under the circumstances. There can be no assurance that actual results will conform to these estimates and assumptions and that reported results of operations would not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. NI Holdings believes the following policies are the most sensitive to estimates and judgments.
When a claim is reported to NI Holdings, its claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. The amount of the loss reserve for the reported claim is based primarily upon an evaluation of coverage, liability, damages suffered, and any other information considered pertinent to estimating the exposure presented by the claim. Each claim is contested or settled individually based upon its merits and some property and casualty claims may take years to resolve, especially if legal action is involved. Case reserves are reviewed on a regular basis and are updated as new information becomes available.
period by a selected a priori (i.e. deductive) loss ratio. The resulting dollars are then multiplied by the expected percentage of unpaid (or unreported) losses described above. This provides an estimate of future paid (or reported) losses that is then added to actual paid (or incurred) loss data to produce the estimated ultimate loss.
Paid and Case Incurred Loss Method - The Paid and Case Incurred Loss Development Method utilizes ratios of cumulative paid or case incurred loss or LAE at each age of development as a percent of the preceding development age. Selected ratios are then multiplied together to produce a set of loss development factors which when applied to the most current data value, by accident year, develop estimated ultimate losses or LAE. Ultimate losses or LAE are then selected for each accident year from the various methods employed.
Ratio of Paid ALAE to Paid Loss Method - This method utilizes the ratio of paid adjusted loss adjustment expense (“ALAE”) to paid losses and is similar to the Paid and Case Incurred Method described above, except that the data projected are the ratios of paid ALAE to paid losses. The projected ultimate ratio is then multiplied by the selected ultimate losses, by accident year, to yield ultimate ALAE. ALAE reserves are calculated by subtracting paid losses from ultimate ALAE.
Laws governing liability claims and judicial interpretations thereof can change over time, which can expand the scope of coverage anticipated by insurers when initially establishing reserves for claims. In addition, public attitudes regarding damage awards can result in judges and juries granting higher recoveries for damages than expected by claims personnel when claims are presented. In addition, these changes can result in both increased claim frequency and severity, as both plaintiffs and their legal counsel perceive the opportunity for higher damage awards. Reserves established for claims that occurred in prior years would not have anticipated these legal changes and, therefore, could prove to be inadequate for the ultimate losses paid by the Company, causing the Company to experience adverse development and higher loss payments in future years.
Changes in Company personnel and/or the approach to how claims are reported, adjusted, and reserved may affect the reserves established by the Company. As discussed above, the setting of IBNR reserves is not an exact science and involves the expert judgment of an actuary. One actuary’s reserve opinion may differ slightly from another actuary’s opinion. This is the primary reason why the IBNR reserve estimate is customarily reported as a range by a company’s actuary, which provides a company with an acceptable “range” to use in establishing its best estimate for IBNR reserves.
Increases or decreases in claim severity for reasons other than inflation
Factors exist that can drive the cost to settle claims for reasons other than standard inflation. For example, demand surge caused by a very large catastrophe (as in the case of Hurricane Katrina) has an impact on not only the availability and cost of building materials such as roofing and other such materials, but also on the availability and cost of labor. Other factors such as increased vehicle traffic in an area not designed to handle the increased congestion and increased speed limits on busy roads are examples of changes that could cause claim severity to increase beyond what the Company’s historic reserves would reflect. In addition, unexpected increases in the labor costs and healthcare costs that underlie insured risks, changes in costs of building materials, or changes in commodity prices for insured crops may cause fluctuations in the ultimate development of the case reserves.
Management has identified the impact on earnings of various factors used in establishing loss reserves so that users of the Company’s financial statements can better understand how development on prior years’ reserves might affect the Company’s results of operations.
Inflation is not explicitly selected in the loss reserve analysis. However, historical inflation is embedded in the estimated loss development factors. The following table displays the impact on net income after income taxes of 21% resulting from various changes from the inflation factor implicitly embedded in the estimated payment pattern as of December 31, 2017. A change in inflation may or may not fully affect loss payments in the future because some of the underlying expenses have already been paid. The table below assumes that any change in inflation will be fully reflected in future loss payments. This variance in future IBNR emergence could occur in one year or over multiple years, depending when the change is recognized.
Inflation includes actual inflation as well as social inflation that includes future emergence of new classes of losses or types of losses, change in judicial awards, and any other changes beyond assumed levels that affect the cost of claims.
NI Holdings’ fixed income securities and equity securities are classified as available-for-sale and carried at estimated fair value as determined by management based upon quoted market prices or a recognized pricing service at the reporting date for those or similar investments. Changes in unrealized investment gains or losses on the Company’s investments, net of applicable income taxes, are reflected directly in equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income (loss). Investment income is recognized when earned, and capital gains and losses are recognized when investments are sold, or an other-than-temporarily impairment is recognized.
For the year ended December 31, 2017, NI Holdings recognized $330 of other-than-temporary impairments of its investment securities. For the year ended December 31, 2016, NI Holdings recognized no other-than-temporary impairments of its investment securities. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
For more information on the Company’s investments, see Note 5 to the Consolidated Financial Statements, included elsewhere in this Report.
NI Holdings bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the estimates of NI Holdings or other third parties, are often calculated based on the characteristics of the asset, the economic and competitive environment, and other such factors. Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts that NI Holdings could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of our financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different from the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.
NI Holdings uses quoted values and other data provided by independent pricing services in its process for determining fair values of its investments. The evaluations of such pricing services represent an exit price and a good faith opinion as to what a buyer in the marketplace would pay for a security in a current sale. This pricing service provides NI Holdings with one quote per instrument. For fixed income securities that have quoted prices in active markets, market quotations are provided. For fixed income securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of
Should the independent pricing service be unable to provide a fair value estimate, NI Holdings would attempt to obtain a non-binding fair value estimate from a number of broker-dealers and review this estimate in conjunction with a fair value estimate reported by an independent business news service or other sources. In instances where only one broker-dealer would provide a fair value for a fixed income security, NI Holdings would use that estimate. In instances where NI Holdings would be able to obtain fair value estimates from more than one broker-dealer, the Company would review the range of estimates and select the most appropriate value based on the facts and circumstances. Should neither the independent pricing service nor a broker-dealer provide a fair value estimate, NI Holdings would develop a fair value estimate based on cash flow analyses and other valuation techniques that utilize certain unobservable inputs. Accordingly, NI Holdings classifies such a security as a Level III investment.
Management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. Management reviews all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in common sectors, durations, and credit ratings. This review will also include all fixed income securities rated lower than “A” by Moody’s or S&P. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service. In its review, management did not identify any such discrepancies for the years ended December 31, 2017 and 2016, and no adjustments were made to the estimates provided by the pricing service for the years ended December 31, 2017 and 2016. The classification within the fair value hierarchy is then confirmed based on the final conclusions from the pricing review.
For more information on the Company’s fair value measurements, see Note 6 to the Consolidated Financial Statements, included elsewhere in this Report.
NI Holdings had gross deferred income tax assets of $4,279 at December 31, 2017 and $6,648 at December 31, 2016. A valuation allowance is required to be established for any portion of the deferred income tax asset for which the Company believes it is more likely than not that it will not be realized. Valuation allowances of $628 and $1,022 had been established at December 31, 2017 and 2016, respectively.
Premiums in the multi-peril crop insurance business are primarily influenced by the number of acres planted and types of crops insured because the pricing is set by the RMA rather than individual insurance carriers. The expected experience of this business for the calendar year may also significantly affect the reported net premiums earned and losses due to the risk-sharing arrangement with the federal government. Multi-peril crop insurance premiums are generally written in second quarter, and earned ratably over the period of risk, which extends into fourth quarter. Losses on this business are more heavily concentrated in the second and third quarters.
Premiums in the crop hail insurance business are also generally written in second quarter, but earned over a shorter period of risk than multi-peril crop insurance.
Our personal lines of business (private passenger auto, home and farm) continued to grow outside of North Dakota, and were favorably impacted by lower ceding of premiums due to a higher retention amount in our catastrophe reinsurance program in 2017. Our non-standard auto business was relatively flat year-over-year as rate increases were needed in Nevada to cover the higher losses experienced in this business. Our crop business experienced higher losses in 2017, which reduced the level of premium sharing required with the federal government on relatively flat direct premiums earned.
Our personal lines of business (private passenger auto, home and farm) experienced fewer weather related losses in 2017 compared to 2016, particularly in North Dakota. Our non-standard auto business improved from a year ago as a result of strategic pricing and underwriting actions.
Total underwriting and general expenses, including amortization of deferred policy acquisition costs, increased $5,301 in 2017, or 13.6%, compared to 2016. Expenses were higher in 2017 due to increased commissions and other policy acquisition costs as a result of increased premiums written. In addition, as a new public company, additional expenses were incurred due to increased salaries, legal and accounting costs, taxes and fees, and holding company costs. The expense ratio of 24.8% for the year ended December 31, 2017 was 0.8% less than the expense ratio in 2016, primarily due to higher net premiums earned in 2017.
The crop insurance business generated a lower underwriting gain for 2017 compared to 2016. While loss experience was higher for 2017, premium retention under the risk-sharing arrangement with the federal government was also higher to offset most of the increased loss experience.
Underwriting results for the all other segment increased in 2017 due to improvements in the commercial multi-peril and excess liability businesses, partially offset by the impacts of the hurricane and wildfire activity in our assumed reinsurance business.
NI Holdings had fee and other income of $1,648 for the year ended December 31, 2017, compared to $1,666 for the year ended December 31, 2016. The majority of fee income is attributable to the non-standard auto insurance business.
NI Holdings has evaluated each security in a loss position and taken into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. NI Holdings believes that the foregoing declines in fair value in its existing portfolio are most likely attributable to short-term market trends and there is no evidence that it will not recover the entire amortized cost basis.
NI Holdings recorded income tax expense of $6,394 for the year ended December 31, 2017, compared to $1,479 of income tax expense for the year ended December 31, 2016.
Income tax expense for 2017 included a reduction of $1,274 to income tax expense due to a new corporate income tax rate of 21% for tax years 2018 and beyond, enacted on December 22, 2017. Accounting guidance requires that companies re-measure
existing deferred tax assets (including loss carryforwards) and liabilities and record an offset for the net amount as a component of income tax expense from continuing operations in the period of enactment. Any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforward should also be reflected as a component of income tax expense from continuing operations. In addition, the valuation allowance against certain deferred income tax assets decreased by $394 to $628 at December 31, 2017 from $1,022 at December 31, 2016.
Our effective tax rate for 2017 was 29.1% compared to an effective tax rate of 24.2% for 2016. The increase in the effective tax rate was the result of a lesser impact of comparable permanent tax adjustments realized on a higher income before income taxes amount for 2017.
The major components of NI Holdings’ operating revenues and net income are as follows:
NI Holdings’ net losses and LAE for the year ended December 31, 2016 increased 41.3% to $118,508 compared to $83,876 for the year ended December 31, 2015. The Company’s loss and LAE ratio increased to 77.6% for 2016, compared to 60.1% for 2015.
In the all other segment, the assumed reinsurance book of business was adversely impacted by Canadian wildfires during the second quarter of 2016.
NI Holdings realized favorable development on prior accident years of $4,756 in 2016, compared to $8,888 of favorable development on prior accident years realized in 2015. Net favorable development is primarily the result of prior years’ claims settling for less than originally estimated. Adjustments to our original estimates resulting from claims are not made until the period in which there is reasonable evidence that an adjustment to the reserve is appropriate.
Total underwriting and general expenses, including amortization of deferred policy acquisition costs, increased $3,150 in 2016, or 8.8% higher than in 2015. This increase is due to an increase of $1,802 in amortization of deferred policy acquisition costs and an increase of $1,348 in other underwriting and general expenses.
NI Holdings’ fixed income securities and equity securities are classified as available for sale because it will, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies. At December 31, 2016, the Company had net unrealized gains on fixed income securities of $1,210 and net unrealized gains on equity securities of $14,406. At December 31, 2015, the Company had net unrealized gains on fixed income securities of $2,092 and net unrealized gains on equity securities of $15,453.
NI Holdings has evaluated each security and taken into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. NI Holdings believes that the foregoing declines in fair value in its existing portfolio are most likely attributable to short-term market trends and there is no evidence that it will not recover the entire amortized cost basis.
For the year ended December 31, 2016, NI Holdings had pre-tax income of $6,117 compared to pre-tax income of $25,873 for the year ended December 31, 2015. The decrease in pre-tax income was largely attributable to the increase in losses and LAE on the private passenger auto and home and farm lines of business due to a higher number of weather related losses in 2016.
NI Holdings recorded income tax expense of $1,479 for the year ended December 31, 2016, compared to $8,288 of income tax expense for the year ended December 31, 2015. Our effective tax rate for 2016 was 24.2% compared to an effective tax rate of 32.0% for 2015. The decrease in the effective tax rate was the result of a greater impact of comparable permanent tax adjustments realized on a lower income before income taxes amount for 2016.
For the year ended December 31, 2016, NI Holdings had net income after non-controlling interest of $4,551 compared to net income after non-controlling interest of $17,456 for 2015. This decrease in net income was primarily attributable to increased losses and LAE in the company’s private passenger auto and home and farm lines of business, due to a higher number of weather related losses in 2016.
For the year ended December 31, 2016, NI Holdings had annualized return on average equity, after non-controlling interest, of 3.1% compared to annualized return on average equity, after non-controlling interest, of 12.2% for the year ended December 31,
The major components of NI Holdings’ financial position are as follows:
At December 31, 2017, NI Holdings had total assets of $376,988, an increase of $98,285, or 35.3% over amounts reported at December 31, 2016. The increase was primarily attributable to net proceeds of $93,145 from issuance of NI Holdings common stock on March 13, 2017.
At December 31, 2017, total liabilities were $121,415, a decrease of $3,870, or 3.1% over amounts reported at December 31, 2016. The decrease was primarily due to lower levels of unpaid losses and loss adjustment expenses offset by higher levels of unearned premiums. Unpaid losses and loss adjustment expenses decreased due to lower levels of open case claims, partially offset by higher IBNR on our assumed reinsurance business. Unearned premiums increased from a year ago, reflecting the increase in direct premiums written in our private passenger auto and home and farm lines of business.
Total equity increased by $102,155, or 66.6% from December 31, 2016 to December 31, 2017. The increase in equity primarily reflects net proceeds of $93,145 from the issuance of NI Holdings common stock and net income of $15,612 for the year ended December 31, 2017, partially offset by the purchase of treasury stock of $8,037.
NI Holdings was formed on March 13, 2017 and became the holding company for Nodak Insurance and its existing subsidiaries. The increased capitalization from our initial public offering should (i) enhance investment income by increasing our investment portfolio, and (ii) provide capital to permit the Company to seek acquisitions and other diversification opportunities. The newly issued stock of NI Holdings was available for public trading on March 16, 2017.
NI Holdings generates sufficient funds from its operations and maintains a high degree of liquidity in its investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of funds are premium collections, investment earnings, and maturing investments. In addition, we raised $93,145 in net proceeds from our initial public offering, which are available if necessary to meet the demands of claim settlements and operating expenses.
NI Holdings’ philosophy is to provide sufficient cash flows from operations to meet its obligations in order to minimize the forced sales of investments. The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.
For the year ended December 31, 2017, net cash provided by operating activities totaled $18,425 compared to $7,307 for the year ended December 31, 2016. The Company reduced its levels of reinsurance receivables and collected more unearned premiums for the year ended December 31, 2017 compared to the year ended December 31, 2016, while net income increased significantly from 2016. Net cash used in investing activities totaled $91,857 for the year ended December 31, 2017, compared to net cash used of $3,510 in the year ended December 31, 2016, primarily reflecting the opportunity to invest the proceeds from the common stock offering in longer-term investments in 2017. Net cash provided by financing activities of $82,708 for the year ended December 31, 2017 reflect the net proceeds from our initial public offering, offset by the initial funding of our new employee stock option plan and the repurchase of treasury stock for $8,037.
For the year ended December 31, 2016, cash flows from operating activities totaled $7,307 compared to $17,177 for the year ended December 31, 2015. This decrease in cash flows from operating activities was primarily due to the increase in loss payments to insureds. Cash flows used in investing activities totaled $3,510 for the year ended December 31, 2016, compared to $24,385 in 2015, primarily reflecting the demand for cash due to higher weather related losses in 2016.
As a standalone entity, and outside of the net proceeds from the recent initial public offering, NI Holdings’ principal source of long-term liquidity will be dividend payments from Nodak Insurance. Nodak Insurance will be restricted by the insurance laws of North Dakota as to the amount of dividends or other distributions it may pay to NI Holdings. North Dakota law sets the maximum amount of dividends that may be paid by Nodak Insurance during any twelve-month period after notice to, but without prior approval of, the North Dakota Insurance Department. This amount cannot exceed the lesser of (i) 10% of the insurance company’s surplus as regards policyholders as of the preceding December 31, or (ii) the insurance company’s statutory net income for the preceding calendar year (excluding realized capital gains), less any prior dividends paid during such twelve-month period. In addition, any insurance company other than a life insurance company may carry forward net income from the preceding two calendar years, not including realized capital gains, less any dividends actually paid during those two calendar years. Dividends in excess of this amount are considered “extraordinary” and are subject to the approval of the North Dakota Insurance Department.
As a public company, NI Holdings is subject to the proxy solicitation, periodic reporting, insider trading, and other requirements of the Exchange Act and to most of the provisions of SOX. As a result, NI Holdings anticipates incurring higher levels of expenses related to accounting and legal services that will be necessary to comply with such requirements.
The following table summarizes, as of December 31, 2017, NI Holdings’ future payments and estimated claims and claims related payments for continuing operations.
NI Holdings has no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital reserves.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal controls over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Nodak Insurance is the largest domestic property and casualty insurance company in North Dakota. Nodak Insurance was incorporated on April 15, 1946 under the laws of North Dakota, and benefits from a strong marketing affiliation with the North Dakota Farm Bureau Federation (“NDFB”). Nodak Insurance is a leading writer of property and casualty insurance in North Dakota, specializing in providing private passenger auto, homeowners, farmowners, commercial, crop hail, and Federal multi-peril crop insurance coverages.
We make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our consolidated financial statements. The most significant estimates relate to our reserves for unpaid losses and loss adjustment expenses, valuation of investments, determination of other-than-temporary impairments, valuation allowances for deferred income tax assets, and deferred policy acquisition costs. While we believe our estimates are appropriate, the ultimate amounts may differ from the estimates provided. We regularly review our methods for making these estimates as well as the continuing appropriateness of the estimated amounts, and we reflect any adjustment we consider necessary in our current results of operations.
We have categorized our investment portfolio as “available-for-sale” and have reported the portfolio at fair value, with unrealized gains and losses, net of income taxes, reported in accumulated other comprehensive income. Fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Amortization of premium and accretion of discount are computed using an effective interest method. Realized gains and losses are determined using the specific identification method and included in the determination of net income. Net investment income includes interest and dividend income together with amortization of purchase premiums and discounts, and is net of investment management and custody fees.
Our other financial instruments, aside from investments, are cash and cash equivalents, premiums and agents’ balances receivable, and accrued expenses and accounts payable. The carrying amounts for cash and cash equivalents, premiums and agents’ balances receivable, and accrued expenses and accounts payable approximate their fair value based on their short-term nature. Other invested assets that do not have observable inputs and little or no market activity are carried on a cost basis. All other invested assets have been assessed for impairment. The carrying value of these other invested assets was $1,972 at both December 31, 2017 and 2016.
Certain amounts in the 2016 and 2015 consolidated financial statements have been reclassified to conform to the 2017 presentation. This includes a change in the Company’s reportable segments. The prior segments were non-standard auto, crop, and other property and casualty. The new segments used throughout this filing are private passenger auto, non-standard auto, home and farm, crop, and all other.
We record premiums written at policy inception and recognize them as revenue on a pro rata basis over the policy term or, in the case of crop insurance, over the period of risk. The portion of premiums that could be earned in the future is deferred and reported as unearned premiums. When policies lapse, the Company reverses the unearned portion of the written premium and removes the applicable unearned premium. Policy-related fee income is recognized when collected.
We maintain liabilities for unpaid losses and loss adjustment expenses with respect to both reported and unreported claims. We establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. We base the amount of our liability for reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim, and the insurance policy provisions relating to the type of loss our policyholder incurred. We determine the amount of our liability for unreported losses and loss adjustment expenses based on historical information by line of insurance. We account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. We closely monitor our liabilities and update them periodically using new information on reported claims and a variety of statistical techniques. We do not discount our liabilities for unpaid losses and loss adjustment expense.
New accounting guidance also allows companies to reclassify any tax effects stranded in accumulated other comprehensive income as a result of tax reform to retained earnings.
Goodwill represents the excess of the purchase price over the underlying fair value of acquired entities. When completing acquisitions, we seek also to identify separately identifiable intangible assets that we have acquired. We assess goodwill and intangible assets with an indefinite useful life for impairment annually. We also assess goodwill and other intangible assets for impairment upon the occurrence of certain events. In making our assessment, we consider a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and current market data. Inherent uncertainties exist with respect to these factors and to our judgment in applying them when we make our assessment. Impairment of goodwill and other intangible assets could result from changes in economic and operating conditions in future periods. We did not record any impairments of goodwill or other intangible assets during the years ended December 31, 2017, 2016, and 2015.
In March 2016, the FASB issued amended guidance 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
In March 2017, the FASB issued amended guidance to shorten the amortization period of premiums on certain purchased callable fixed income securities to the earliest call date. The amended guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For private companies and emerging growth companies, this amended guidance is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are evaluating the requirements of this guidance and the potential impact to our financial position, results of operations, and cash flows.
Fixed income securities with a fair value of $3,493 at December 31, 2017 and $3,530 at December 31, 2016 were deposited with various state regulatory agencies as required by law. The Company has not pledged any assets to secure any obligations.
As of December 31, 2017, we held 196 fixed income securities with unrealized losses. As of December 31, 2016, we held 129 fixed income securities with unrealized losses. In conjunction with our outside investment advisors, we analyzed the credit ratings of the securities as well as the historical monthly-amortized cost to fair value ratio of securities in an unrealized loss position. This analysis yielded no fixed income securities that had fair values less than 80% of amortized cost for the preceding 12-month period.
There were no liabilities measured at fair value on a recurring basis at December 31, 2017 or 2016.
The Company actively monitors and evaluates the financial condition of the reinsurers and develops estimates of the uncollectible amounts due from reinsurers. Such estimates are made based on periodic evaluation of balances due from reinsurers, judgments regarding reinsurers’ solvency, known disputes, reporting characteristics of the underlying reinsured business, historical experience, current economic conditions, and the state of reinsurer relations in general. Collection risk is mitigated from reinsurers by entering into reinsurance arrangements only with reinsurers that have strong credit ratings and statutory surplus above certain levels. The Company’s largest reinsurance recoverables on paid and unpaid losses were due from reinsurance companies with A.M. Best ratings of A or higher.
If 100% of our ceded reinsurance would be cancelled as of December 31, 2017, no ceded commissions would need to be returned to the reinsurers. Reinsurance contracts are typically effective from January 1 through December 31 each year.
The following tables present information, organized by our primary operating segments, about incurred and paid claims development as of December 31, 2017, net of reinsurance, as well as cumulative claim frequency and the total of IBNR reserves plus expected development on reported claims. The cumulative number of reported claims represents open claims, claims closed with payment, and claims closed without payment. It does not include an estimated amount for unreported claims. The number of claims is measured by claim event (such as a car accident or storm damage) and an individual claim event may result in more than one reported claim (such as a car accident with both property and liability damages). The Company considers a claim that does not result in a liability as a claim closed without payment. The tables include unaudited information about incurred and paid claims development for the years ended December 31, 2008 through 2015, which we present as supplementary information.
The following table presents required supplementary information about average historical claims duration as of December 31, 2017:
Depreciation expense was $500, $441, and $523 during the years ended December 31, 2017, 2016 and 2015, respectively.
Total statutory revenues and expenses of Battle Creek after intercompany eliminations, which is limited to net investment income and certain miscellaneous other income and expenses, were $153 and $0 during the year ended December 31, 2017, $174 and $0 during the year ended December 31, 2016, and $129 and $0 during the year ended December 31, 2015.
The Company also sponsors a 401(k) plan with an automatic contribution to all eligible employees and a matching contribution for eligible employees of 50% up to 3% of eligible compensation. The Company’s contributions expense to the 401(k) plan totaled $411, $422, and $390 for 2017, 2016 and 2015, respectively. All fees associated with both plans are deducted from the eligible employee accounts.
Effective April 28, 2016, the Board of Directors authorized a non-qualified deferred compensation plan covering key executives of the Company as designated by the Board of Directors. The Company’s policy is to fund the plan in a given calendar year by amounts that exceed the maximum contribution allowed by the Employee Retirement Income Security Act (“ERISA”), beginning in 2017. Funds deposited were $138 for the year ended December 31, 2017.
In connection with our initial public offering, Nodak Insurance loaned $2,400 to the ESOP’s related trust (the “ESOP Trust”). The ESOP loan will be for a period of ten years and bears interest at the long-term Applicable Federal Rate effective on the closing date of the offering (2.79% annually). The ESOP Trust used the proceeds of the loan to purchase shares in our initial public offering, which results in the ESOP Trust owning approximately 1.0% of the Company’s authorized shares. The ESOP has purchased the shares for investment and not for resale.
In connection with the initial public offering, the Company created a contra-equity account on the Company’s consolidated balance sheet equal to the ESOP’s basis in the shares. The basis of those shares was set at $10.00 per share as part of the initial public offering. As shares are released from the ESOP suspense account, the contra-equity account will be credited, which shall reduce the impact of the contra-equity account on the Company’s Consolidated Balance Sheet. The Company shall record a compensation expense related to the shares released, which compensation expense is equal to the number of shares released from the suspense account multiplied by the average market value of the Company’s stock during the period.
The Company recognized compensation expense of $401 for the year ended December 31, 2017. At the end of 2017, 24,315 ESOP shares were released and allocated to participants, with a remainder of 215,685 ESOP shares in suspense at December 31, 2017. Using the Company’s year-end market price of $16.98, the fair value of the unearned ESOP shares was $3,662 at December 31, 2017.
Nodak Insurance has a $3,000 line of credit with Wells Fargo Bank, N.A., of which there were no outstanding amounts as of December 31, 2017 or 2016. This line of credit is scheduled to expire on November 30, 2018.
The provision for income taxes differs from the amount that would be computed by applying the statutory federal rate to income before provision for income taxes as a result of the following:
The income tax effects of temporary differences that give rise to significant portions of our deferred income tax assets and deferred income tax liabilities, valued at the new effective tax rate of 21% at December 31, 2017, are as follows:
At December 31, 2017 and 2016, the Company, other than Battle Creek, had no income tax related carryovers for net operating losses, alternative minimum tax credits, or capital losses. Battle Creek, which files its income tax returns on a stand-alone basis, had net operating loss carryovers of $4,951 and $5,159 at December 31, 2017 and 2016, respectively. The net operating loss carryforward expires beginning in 2021 through 2030. In 2016, a $247 capital loss carryover expired and none of the capital loss carryover was utilized against realized capital gains.
The Company does not have any unrecorded or potential contingent liabilities or material commitments requiring the use of assets as of December 31, 2017 and 2016.
The Company is authorized to issue 25,000,000 shares of common stock, with a par value of $0.01. In addition, 5,000,000 shares of preferred stock, without par value, are authorized but have not been issued.
The total aggregate number of shares of common stock that awards may be issued under all awards made under the Plan shall not exceed 500,000 shares of common stock, subject to adjustments as provided in the Plan. No eligible participant may be granted more than 100,000 shares from any stock options, stock appreciation rights, or performance awards denominated in shares, in the aggregate in any calendar year, subject to adjustment in accordance with the Plan. The aggregate amount payable pursuant to all performance awards denominated in cash to any eligible person in any calendar year is limited to $1,000 in value. Directors who are not also employees of the Company may not be granted awards denominated in shares that exceed $100 in any calendar year.
As described in Note 1, the conversion of the mutual company to a stock company resulted in the issuance of NI Holdings common shares on March 13, 2017. Earnings per share is computed by dividing net income available to common shareholders for the period by the weighted average number of common shares outstanding for the same period. The weighted average number of common shares outstanding was 22,512,401 for the year ended December 31, 2017. For the period prior to the date of the conversion, we assumed that the net common shares issued in the initial public offering of 22,760,000 shares were outstanding since January 1, 2017.
Unearned ESOP shares are not considered outstanding until they are released and allocated to plan participants. Unearned RSU shares are not considered outstanding until they are earned by award participants.
On May 23, 2017, our Board of Directors approved an authorization for the repurchase of up to $8 million of the Company’s outstanding common stock. We completed the repurchase of 446,671 shares of our common stock for $8,037 during the three months ended June 30, 2017, and reflected the cost of this treasury stock as a reduction of equity within our Consolidated Balance Sheet as of December 31, 2017.
We do not assign or allocate all Consolidated Statement of Operations or Consolidated Balance Sheet line items to our operating segments. Those line items include investment income, net realized capital gain on investments, other income excluding non-standard auto insurance fees, and income taxes for the Consolidated Statement of Operations statement. For the Consolidated Balance Sheet, those items include cash and investments, property and equipment, other assets, accrued expenses, federal income taxes recoverable or payable, and equity.
Reconciliations of statutory net income and capital and surplus, as determined using SAP, to the amounts included in the accompanying GAAP-basis financial statements are as follows as of and for the years ended December 31, 2017, 2016 and 2015: