Our corporate headquarters and Standard Commercial P&C business unit are located at 777 Main Street, Suite 1000, Fort Worth, Texas. The suite is located in a high-rise office building and contains 27,808 square feet of space. The rent is currently $48,664 per month pursuant to a lease which expires June 30, 2022.
Our Workers Compensation business unit is presently located at 11612 Bee Caves Road, Austin, Texas. The suite is located in a low-rise office building and contains 8,373 square feet of space of which 1,037 square feet is sub-leased. The gross rent is currently $17,269 per month pursuant to a lease which expires October 31, 2017.
Our Hallmark Select business unit is located at 15280 Addison Road, Suite 250, Addison, Texas. The suite is located in a low-rise office building and contains an aggregate of 8,219 square feet of space. The rent is currently $9,564 per month pursuant to a lease that expires July 31, 2018. Our Hallmark Select business unit also maintains branch offices in the following locations:
Our Personal Lines business unit is located at 6500 Pinecrest, Suite 100, Plano, Texas. The suite is located in a one story office building and contains 23,941 square feet of space. The rent is currently $27,931 per month pursuant to a lease that expires December 31, 2020.
Our insurance activities are organized by business units into the following reportable segments:
· Personal Segment. The Personal Segment includes the non-standard personal automobile, low value dwelling/homeowners, renters and manufactured homes, insurance products and services handled by our Personal Lines business unit that is comprised of American Hallmark General Agency, Inc. and Hallmark Claims Services, Inc., both of which do business as Hallmark Insurance Company.
The significant accounting policies requiring our estimates and judgments are discussed below. Such estimates and judgments are based on historical experience, changes in laws and regulations, observance of industry trends and information received from third parties. While the estimates and judgments associated with the application of these accounting policies may be affected by different assumptions or conditions, we believe the estimates and judgments associated with the reported consolidated financial statement amounts are appropriate in the circumstances. For additional discussion of our accounting policies, see Note 1 to the audited consolidated financial statements included in this report.
We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with ASC 820, we utilize the following fair value hierarchy:
In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value. This data may be internally developed and consider risk premiums that a market participant would require. Investment securities classified within Level 3 include other less liquid investment securities.
The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. A premium deficiency exists if the sum of expected claim costs and claim adjustment expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and expected investment income on those unearned premiums, as computed on a product line basis. We routinely evaluate the realizability of deferred policy acquisition costs. At December 31, 2014 and 2013, there was no premium deficiency related to deferred policy acquisition costs.
The income approach to determining fair value computed the projections of the cash flows that the reporting unit is expected to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach model include income projections, discount rates and terminal growth values. The income projections reflect an improved premium rate environment across most of our lines of business that continued throughout 2014. The income projections also include loss and LAE assumptions which reflect recent historical claim trends and the movement towards a more favorable pricing environment. The income projections also include assumptions for expense growth and investment yields which are based on business plans for each of our business units. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific company risk premium. The assumptions were based on historical experience, expectations of future performance, expected market conditions and other factors requiring judgment and estimates. While we believe the assumptions used in these models were reasonable, the inherent uncertainty in predicting future performance and market conditions may change over time and influence the outcome of future testing.
The fair values of each of our business units were in excess of their respective carrying values, including goodwill, as a result of our annual test for impairment during the fourth quarter 2014. However, a 7% decline in the fair value of our Standard Commercial P&C business unit, a 13% decline in the fair value of our E&S Commercial business unit, a 28% decline in the fair value of our Personal Lines business unit, a 52% decline in the fair value of our excess & umbrella component or a 12% decline in the fair value of our general aviation and satellite component would have caused the carrying value of the respective reporting unit to be in excess of its fair value, resulting in the need to perform the second step of impairment testing prescribed by ASC 350, which could have resulted in an impairment to our goodwill.
Our reserve requirements are also interrelated with product pricing and profitability. We must price our products at a level sufficient to fund our policyholder benefits and still remain profitable. Because claim expenses represent the single largest category of our expenses, inaccuracies in the assumptions used to estimate the amount of such benefits can result in our failing to price our products appropriately and to generate sufficient premiums to fund our operations.
Gross premiums written for the Specialty Commercial Segment were $324.5 million for the year ended December 31, 2014, which was $28.4 million, or approximately 10%, more than the $296.1 million reported for the same period in 2013. Net premiums written were $230.6 million for the year ended December 31, 2014 as compared to $235.7 million reported for the same period in 2013. The lower net premiums written was primarily due to a quota share reinsurance agreement entered into during the third quarter of 2013 in our Hallmark Select business unit on our general aviation line of business and a quota share agreement entered into during the second quarter of 2014 on business produced by a program underwriter in our E&S Commercial business unit.
The $241.9 million of total revenue for the year ended December 31, 2014 was $12.2 million higher than the $229.7 million reported for 2013. This 5% increase in revenue was due to higher net premiums earned of $10.3 million due predominately to increased production discussed above. Further contributing to this increased revenue was higher net investment income of $1.6 million and higher commissions and fees revenue of $0.3 million.
Pre-tax income for the Specialty Commercial Segment of $34.2 million for the year ended December 31, 2014 was $14.7 million higher than the $19.5 million reported for the same period in 2013. The increase in pre-tax income was primarily due to the increased revenue discussed above, lower loss and LAE expenses of $2.6 million and lower amortization of intangible assets of $0.3 million, partially offset by higher operating expenses of $0.4 million. Our E&S Commercial business unit reported a $0.2 million decrease in loss and LAE for the year ended December 31, 2014 as compared to the same period of 2013. In addition, our Hallmark Select business unit reported a $2.3 million decrease in loss and LAE which consisted of (a) a $7.1 million decrease in loss and LAE primarily due to increased reinsurance recoveries on the general aviation quota share agreement entered into during the third quarter of 2013, (b) a $2.1 million increase in loss and LAE due to increased premium production in our commercial umbrella and excess liability line of business, (c) a $0.8 million increase in loss and LAE attributable to our medical professional liability insurance products and (d) a $1.9 million increase in loss and LAE in our satellite insurance products due primarily to the increased occurrence of insured satellite losses during the year. The increase in operating expense was the combined result of higher salary and related expenses of $1.5 million due primarily to increased incentive compensation accruals and higher other operating expenses of $0.4 million partially offset by lower production related expenses of $1.3 million due to increased ceding commissions on the quota share reinsurance agreements discussed above and lower professional services of $0.2 million.
Total revenue for Corporate decreased by $11.7 million for the year ended December 31, 2014 as compared to the same period the prior year. This decrease in total revenue was due primarily to lower net realized gains on our investment portfolio of $10.4 million as compared to the same period of the prior year and lower net investment income of $1.3 million for the year ended December 31, 2014 as compared to the same period of the prior year.
Management overview. During fiscal 2013, our total revenues were $389.4 million, representing an approximately 14% increase over the $341.8 million in total revenues for fiscal 2012. The growth in revenue was primarily attributable to increased premium production and resulting earned premium driven largely from our Specialty Commercial Segment and our Standard Commercial Segment. Further contributing to the increase in revenue were higher net realized gains on our investment portfolio and a lower adverse profit share commission revenue adjustment in our Standard Commercial Segment. These increases in revenue were partially offset by lower net investment income and lower year to date earned premium in our Personal Segment due mostly to the impact of discontinued products and a reduction of premium written in underperforming states.
Our Standard Commercial Segment reported pre-tax income was $2.0 million for the year ended December 31, 2013 as compared to a pre-tax loss of $2.5 million for the same period of 2012. The increased revenue discussed above was the primary driver of the increased pre-tax income for the year ended December 31, 2013, partially offset by higher loss and LAE of $3.3 million and higher operating expenses of $2.4 million consisting primarily of higher production related expenses due to increased premium production.
Gross premiums written for the Specialty Commercial Segment were $296.1 million for the year ended December 31, 2013, which was $60.4 million, or 26%, more than the $235.7 million reported for the same period in 2012. Net premiums written were $235.7 million for the year ended December 31, 2013 as compared to $186.1 million reported for the same period in 2012. The increase in premium volume was due to increased premium production in both our E&S Commercial and Hallmark Select business units.
The Specialty Commercial Segment reported a net loss ratio of 69.8% for the year ended December 31, 2013 as compared to 61.6% for the same period during 2012. The gross loss ratio before reinsurance was 68.5% for the year ended December 31, 2013 as compared to 61.1% for the same period in 2012. The higher gross and net loss ratios included $13.4 million of unfavorable prior year loss reserve development for the year ended December 31, 2013 as compared to $3.6 million of favorable prior year loss reserve development for the same period during 2012. The Specialty Commercial Segment reported a net expense ratio of 26.6% for the year ended December 31, 2013 as compared to 28.3% reported for the same period the prior year. The decrease in the net expense ratio was due primarily to increased net premium volume.
Total revenue for Corporate was $5.3 million for the year ended December 31, 2013 as compared to $0.6 million for the same period of 2012. Net realized gains recognized on our investment portfolio were $10.5 million for the year ended December 31, 2013 as compared to $1.9 million during the same period during 2012. Net investment income decreased $3.7 million for the year ended December 31, 2013 as compared to the same period during 2012. Other income decreased $0.2 million for the year ended December 31, 2013 as compared to the same period during 2012.
Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), commissions and processing and service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to meet operating expenses and debt obligations. As of December 31, 2014, Hallmark had $11.8 million in unrestricted cash and cash equivalents. Unrestricted cash and cash equivalents of our non-insurance subsidiaries were $5.3 million as of December 31, 2014. As of that date, our insurance subsidiaries held $113.9 million of cash and cash equivalents as well as $450.8 million in debt securities with an average modified duration of 3.0 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.
AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-month period, without the prior written consent of the Texas Department of Insurance, to the greater of statutory net income for the prior calendar year or 10% of statutory policyholders’ surplus as of the prior year end. HIC and HNIC, both domiciled in Arizona, are limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year's net investment income, without prior written approval from the Arizona Department of Insurance. HSIC, domiciled in Oklahoma, is limited in the payment of dividends to the greater of 10% of prior year policyholders’ surplus or prior year’s statutory net income, not including realized capital gains, without prior written approval from the Oklahoma Insurance Department. For all our insurance companies, dividends may only be paid from unassigned surplus funds. During 2015, the aggregate ordinary dividend capacity of these subsidiaries is $24.3 million, of which $16.2 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the year ended December 31, 2014, our insurance company subsidiaries paid $8.0 million in dividends to Hallmark. None of our insurance company subsidiaries paid a dividend during the year ended December 31, 2013.
Statutory capital and surplus is calculated as statutory assets less statutory liabilities. The various state insurance departments that regulate our insurance company subsidiaries require us to maintain a minimum statutory capital and surplus. As of December 31, 2014, our insurance company subsidiaries reported statutory capital and surplus of $210.0 million, substantially greater than the minimum requirements for each state. Each of our insurance company subsidiaries is also required to satisfy certain risk-based capital requirements. (See, “Item 1. Business - Insurance Regulation - Risk-based Capital Requirements.”). As of December 31, 2014, the adjusted capital under the risk-based capital calculation of each of our insurance company subsidiaries substantially exceeded the minimum requirements. Our total statutory premium-to-surplus percentage for the years ended December 31, 2014 and 2013 was 154% and 184%, respectively.
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2014 were $638.2 million compared to $603.0 million at December 31, 2013. Cash flow from operations and an increase in investment fair values were the primary reasons for this increase.
Comparison of Years Ended December 31, 2014 and December 31, 2013
Our First Restated Credit Agreement with The Frost National Bank dated January 27, 2006, as amended to date, provides a revolving credit facility of $15.0 million. We pay interest on the outstanding balance at our election at a rate of the prime rate or LIBOR plus 2.5%. We pay an annual fee of 0.25% of the average daily unused balance of the credit facility. We pay letter of credit fees at the rate of 1.00% per annum. Our obligations under the revolving credit facility are secured by a security interest in the capital stock of all of our subsidiaries, guarantees of all of our subsidiaries and the pledge of all of our non-insurance company assets. The revolving credit facility contains covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with all of our covenants. As of December 31, 2014, we had no outstanding borrowings under this revolving credit facility.
Set forth below is a summary of long-term contractual obligations as of December 31, 2014. Amounts represent estimates of gross undiscounted amounts payable over time. In addition, certain unpaid losses and LAE are ceded to others under reinsurance contracts and are, therefore, recoverable. Such potential recoverables are not reflected in the table.