We use an aggregate of approximately 2.4 million square feet in approximately 60 office locations and approximately 490 store fronts. We have an ownership interest in the entities that own the buildings in which we lease space at two of these locations, which represent an aggregate of approximately 0.3 million square feet.
We manage our business through two segments: Property and Casualty (“P&C”) and Accident and Health (“A&H”). We transact business primarily through our twenty-two regulated domestic insurance subsidiaries:
Our insurance subsidiaries have an “A-” (Excellent) group rating by A.M. Best Company, Inc. (“A.M. Best”). On September 5, 2019, A.M. Best affirmed our A- rating including our subsidiary National Farmers Union Property
and Casualty Company, which we acquired on August 1, 2019. We currently conduct a limited amount of business outside the United States, primarily in Bermuda.
On December 2, 2019, we sold our Euro Accident Health and Care Insurance Sweden operation to a Swedish investment company focused on Nordic healthcare investments.
Two of our wholly-owned subsidiaries are management companies that act as attorneys-in-fact for Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the “Reciprocal Exchanges” or “Exchanges”). We do not own the Reciprocal Exchanges but are paid a fee to manage their business operations through our wholly-owned management companies. The Reciprocal Exchanges are included in our P&C segment.
The operating results of insurance companies are subject to quarterly and yearly fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The industry has been highly cyclical with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. While these cycles can have a large impact on a company’s ability to grow and retain business, we have sought to focus on niche markets and regions where we are able to maintain premium rates at generally consistent levels and maintain underwriting discipline throughout these cycles. We believe that the nature of our insurance products, including their relatively low limits, the relatively short duration of time between when claims are reported and when they are settled, and the broad geographic distribution of our customers, have allowed us to grow and retain our business throughout these cycles. In addition, we have limited our exposure to catastrophe losses through reinsurance. With regard to seasonality, we tend to experience higher claims and claims expense in our P&C segment during periods of severe or inclement weather. Our operating results for the year ended December 31, 2019 have been negatively impacted by losses resulting from severe weather-related events.
estimates, such changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.
Loss reserves include statistical reserves and case estimates for individual claims that have been reported and estimates for claims that have been incurred but not reported at the balance sheet date as well as estimates of the expenses associated with processing and settling all reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Estimates are based upon past loss experience modified for current trends as well as economic, legal and social conditions. Loss reserves, except life reserves, are not discounted to present value, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income.
In establishing these estimates, we make various assumptions regarding a number of factors, including frequency and severity of claims, the length of time needed to achieve ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may be different from our original estimates. On a quarterly basis, we review our reserves for loss and LAE to determine whether further adjustments are required. Any resulting adjustments are included in the period in which adjustments are determined. Additional information regarding the judgments and uncertainties surrounding our estimated reserves for loss and LAE can be found in Item 1, “Business-Loss Reserves.”
Reinsurance premiums, losses and LAE ceded to other companies are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Earned premiums and losses and LAE incurred ceded to other companies have been recorded as a reduction of premium revenue and losses and LAE. Commissions allowed by reinsurers on business ceded have been recorded as ceding commission revenue to the extent the ceding commission exceeds acquisition costs. Reinsurance recoverable is reported based on the portion of reserves and paid losses and LAE that are ceded to other companies. Assessing whether or not a reinsurance contract meets the condition for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums and losses, and is based, in part, on the use of actuarial and pricing models and assumptions. If we determine that a reinsurance contract does not transfer sufficient risk, we account for the contract under deposit accounting.
Investments. We account for our investments in debt securities in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, “Investments - Debt Securities,” and certain equity investments with ASC 321, “Investments - Equity Securities.” In accordance with ASC 320, our debt securities are classified as available for sale and are measured at fair value with unrealized gains and losses reported as a separate component of comprehensive income. Equity investments (except those accounted for under the equity method, and those that result in consolidation of the investee and certain other investments) are measured at fair value with all gains and losses reported in net income in accordance with ASC 321. We may sell our available-for-sale and equity securities in response to changes in interest rates, risk/reward characteristics, liquidity needs or other factors. Available-for-sale and equity securities are reported at their estimated fair values based on quoted market prices or recognized pricing services.
Goodwill and intangible assets. We account for goodwill and intangible assets in accordance with ASC 350, “Intangibles - Goodwill and Other.” A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset and is not amortized. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if changes
Intangible assets that have finite lives, including but not limited to, agent and customer relationships and trademarks, are amortized over the estimated useful life of the asset. For intangible assets with finite lives, impairment is recognized if the carrying amount is not recoverable and exceeds the fair value of the intangible asset. Generally intangible assets with finite lives are only tested for impairment if there are indicators of impairment (“triggers”) identified. Triggers include, but are not limited to, a significant adverse change in the extent, manner or length of time in which the intangible asset is being used or a significant adverse change in legal factors or in the business climate that could affect the value of the other intangible asset.
Business combinations. We account for business combinations under the acquisition method of accounting, which requires us to record assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their respective fair values as of the acquisition date. We account for the insurance and reinsurance contracts under the acquisition method as new contracts, which requires us to record assets and liabilities at fair value. We adjust the fair value of loss and LAE reserves by recording the acquired loss reserves based on our existing accounting policies and then discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk-free interest rate is then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and our best estimate of the fair value of such reserves at the acquisition date is recorded as either an intangible asset or another liability, as applicable and is amortized proportionately to the reduction in the related loss reserves (e.g., over the estimated payout period of the acquired loss and LAE reserves). We assign fair values to intangible assets acquired based on valuation techniques including the income and market approaches. We record contingent consideration at fair value based on the terms of the purchase agreement with subsequent changes in fair value recorded through earnings. The purchase price is the fair value of the total consideration conveyed to the seller and we record the excess (deficiency) of the purchase price over the fair value of the acquired net assets, where applicable, as goodwill or bargain purchase gain. We expense costs associated with the acquisition of a business in the period incurred.
Noncontrolling Interest. Non-redeemable noncontrolling interest is the portion of equity (net assets) not attributable, directly or indirectly, to a parent. We have no ownership interest in the Reciprocal Exchanges. Therefore, the difference between the value of their assets and liabilities represent the value of the noncontrolling interest.
Fair value of financial instruments. Our estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820, “Fair Value Measurements and Disclosures.” The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the ASC 820 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions.
Income taxes. We join our subsidiaries in the filing of a consolidated federal income tax return and are party to federal income tax allocation agreement. The Reciprocal Exchanges are not party to federal income tax allocation agreement but file separate tax returns annually. Deferred income taxes reflect the impact of temporary differences between the amount of our assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset and liability primarily consists of book versus tax differences for earned premiums, loss and LAE reserve discounting, deferred acquisition costs, earned but unbilled premiums, and unrealized holding gains and losses on debt securities.
premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The costs associated with generating fee income are not separately tracked.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses consist of policy acquisition and marketing expenses, salaries and benefits expenses. Policy acquisition expenses comprise commissions attributable to those agents, wholesalers or brokers that produce premiums written on our behalf and promotional fees attributable to our affinity relationships. Acquisition costs also include costs that are related to the successful acquisition of new or renewal insurance contracts including comprehensive loss underwriting exchange reports, motor vehicle reports, credit score checks, and policy issuance costs.
Net combined ratio (non-GAAP). The net combined ratio (non-GAAP) is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss ratio and net operating expense ratio (non-GAAP). If the net combined ratio (non-GAAP) is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. Our definition of net loss ratio and net operating expense ratio are as follows:
On August 1, 2019, we completed the acquisition of National Farmers Union Property and Casualty Company (“Farmers Union Insurance”). The purchase price for the transaction was approximately $52.8 million.
In 2017, we entered into a Homeowners Quota Share Agreement (the “HO Quota Share Agreement”) covering our homeowners line of business. On July 1, 2019, we renewed our HO Quota Share Agreement for a one-year term. Effective July 1, 2019, we cede 40.0% of net liability and receive a 36.0% ceding commission on new and renewal business and a portion of the in-force business. A portion of the in-force business is being run-off under the prior agreements. The weighted average expected ceding commission for all in-force business and new and renewal homeowners business is 37.5% over the contract term.
On December 2, 2019, we sold our Euro Accident Health and Care Insurance Sweden operation (“Euroaccident”) to an investor group focused on Nordic healthcare investments. The sale price for this transaction was $139.0 million and resulted in a $26.4 million gain recorded in other income.
Farmers Union Insurance, and the Auto Quota Share and the HO Quota Share Agreements (collectively, the “Quota Shares”) impacted our P&C segment. The sale of Euroaccident impacted our A&H segment. As a result of these transactions, comparisons between the 2019 and 2018 results will be less meaningful.
Consolidated Results of Operations for the Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018
Gross premium written. Gross premium written increased by $166.2 million, or 3.1%, from $5,416.8 million for the year ended December 31, 2018 to $5,583.1 million for the year ended December 31, 2019, due to an increase of $95.7 million from the P&C segment, primarily driven by the acquisition of Farmers Union Insurance ($77.3 million); and an increase of $70.5 million from the A&H segment primarily as a result of growth in our small group self-funded and individual products ($81.4 million), partially offset by the fourth quarter sale of our international business.
Net earned premium. Net earned premium increased by $385.8 million, or 10.3%, from $3,732.2 million for the year ended December 31, 2018 to $4,118.0 million for the year ended December 31, 2019. The change by segment was: P&C increased by $339.2 million and A&H increased by $46.6 million. The increase in the P&C segment was attributable to organic growth ($185.1 million), decreased ceded earned premium to the Quota Shares ($57.2 million), the acquisition of Farmers Union Insurance ($73.4 million), and an increase in the Reciprocal Exchanges ($23.5 million). The increase in the A&H segment was primarily due to growth in our small group self-funded and individual products ($66.3 million), partially offset by the fourth quarter sale of our international business.
Ceding commission income. Ceding commission income increased by $13.8 million, from $224.7 million for the year ended December 31, 2018 to $238.5 million for the year ended December 31, 2019.
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $192.2 million, or 7.2%, from $2,662.2 million for the year ended December 31, 2018 to $2,854.5 million for the year ended December 31, 2019, primarily reflecting decreased ceded losses to the Quota Shares ($94.2 million), the acquisition of Farmers Union Insurance ($54.1 million) and unfavorable prior year loss development. The changes by segment were: P&C increased by $202.9 million and A&H decreased by $10.7 million. Losses related to P&C weather-related events, excluding the Reciprocal Exchanges, were $51.2 million in 2019 compared to $128.7 million in 2018, a decrease of $77.5 million year over year.
Loss and LAE for the year ended December 31, 2019 included $5.2 million of unfavorable development on prior accident year loss and LAE reserves. The development was composed of $50.5 million of unfavorable development in the P&C segment (including $3.9 million of unfavorable development for the Reciprocal Exchanges) primarily driven by the small business auto product line, and $45.4 million of favorable development in the A&H segment primarily driven by overall improvement in loss ratio estimates. Loss and LAE for the year ended December 31, 2018 included $34.0 million of favorable development on prior accident year loss and LAE reserves. The development was composed of $3.1 million of favorable development in the P&C segment (including $1.7 million of unfavorable development for the Reciprocal Exchanges), and $31.0 million of favorable development in the A&H segment primarily driven by favorable development in the domestic A&H stop loss and short-term medical products.
Our consolidated net loss ratio decreased from 71.3% for the year ended December 31, 2018 to 69.3% for the year ended December 31, 2019.
General and administrative expenses. General and administrative expenses increased by $103.7 million, or 11.1%, from $938.0 million for the year ended December 31, 2018 to $1,041.8 million for the year ended December 31, 2019, primarily due to an increase of $47.1 million in the P&C segment, and an increase of $52.4 million in the A&H segment. The increase in the P&C segment was primarily driven by the acquisition of Farmers Union Insurance, while the increase in the A&H segment was primarily due to domestic organic growth.
Net operating expense (non-GAAP); net operating expense ratio (non-GAAP). Net operating expense increased by $97.4 million, or 11.1%, from $877.0 million for the year ended December 31, 2018 to $974.4 million for the year ended December 31, 2019, due to an increase of $74.8 million from the P&C segment and an increase of $22.6 million from the A&H segment. The increase in the P&C segment was primarily driven by increased general and administrative expenses, the acquisition of Farmers Union Insurance and decreased cession to the Quota Shares in 2019.
Net investment income. Net investment income increased by $22.2 million, or 18.6%, from $119.0 million for the year ended December 31, 2018 to $141.2 million for the year ended December 31, 2019. The increase was primarily due to increased income from our debt securities.
P&C Segment Results of Operations for the Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018
Gross premium written. Gross premium written increased by $95.7 million, or 2.0%, from $4,718.7 million for the year ended December 31, 2018 to $4,814.5 million for the year ended December 31, 2019, primarily driven by the acquisition of Farmers Union Insurance ($77.3 million).
Net earned premium. Net earned premium increased by $339.2 million, or 10.9%, from $3,115.8 million for the year ended December 31, 2018 to $3,455.0 million for the year ended December 31, 2019, attributable to organic growth ($185.1 million), decreased ceded earned premium to the Quota Shares ($57.2 million), the acquisition of Farmers Union Insurance ($73.4 million), and an increase in the Reciprocal Exchanges ($23.5 million).
Ceding commission income. Ceding commission income increased by $9.8 million, from $217.7 million for the year ended December 31, 2018 to $227.5 million for the year ended December 31, 2019.
General and administrative expenses. General and administrative expenses increased by $47.1 million, from $726.2 million for the year ended December 31, 2018 to $773.3 million for the year ended December 31, 2019. The increase was primarily driven by organic growth and the acquisition of Farmers Union Insurance.
Net operating expense (non-GAAP); net operating expense ratio (non-GAAP). Net operating expense increased by $74.8 million, or 10.9%, from $683.5 million for the year ended December 31, 2018 to $758.3 million for the year ended December 31, 2019. The increase was primarily driven by increased general and administrative expenses, the acquisition of Farmers Union Insurance and decreased cession to the Quota Shares in 2019. Our P&C segment net operating expense ratio was 21.9% for the year ended December 31, 2018 compared to 21.9% for the year ended December 31, 2019.
A&H Segment Results of Operations for the Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018
Net earned premium. Net earned premium increased by $46.6 million, or 7.6%, from $616.4 million for the year ended December 31, 2018 to $663.0 million for the year ended December 31, 2019, primarily due to growth in our small group self-funded and individual products ($66.3 million), partially offset by the fourth quarter sale of our international business.
Loss and loss adjustment expense; net loss ratio. Loss and LAE decreased by $10.7 million, from $321.3 million for the year ended December 31, 2018 to $310.7 million for the year ended December 31, 2019. Our A&H net loss ratio decreased from 52.1% for the year ended December 31, 2018 to 46.9% for the year ended December 31, 2019. The loss ratio decrease was primarily as a result of favorable prior year loss development of $45.4 million in 2019, compared to a $31.0 million favorable prior year loss development in 2018.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $37.6 million, or 20.4%, from $184.7 million for the year ended December 31, 2018 to $222.3 million for the year ended December 31, 2019, primarily from domestic organic growth.
General and administrative expenses. General and administrative expenses increased by $52.4 million, or 26.0%, from $201.8 million for the year ended December 31, 2018 to $254.2 million for the year ended December 31, 2019, primarily from domestic organic growth.
Our investment strategy emphasizes, first, the preservation of capital and, second, maximization of an appropriate risk-adjusted return. We seek to maximize investment returns using investment guidelines that stress prudent allocation among cash and cash equivalents, debt securities and, to a lesser extent, other investments. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our debt securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of local governments, U.S. denominated corporate obligations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, commercial mortgage obligations, and structured securities primarily consisting of collateralized loan and debt obligations.
We are organized as a holding company with twenty-two domestic insurance company subsidiaries and various foreign insurance and reinsurance subsidiaries, as well as various other non-insurance subsidiaries. Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in debt securities and, to a lesser extent, other investments. Except as set forth below, we expect that projected cash flows from operations, as well as the net proceeds from our debt and equity issuances, will provide us with sufficient liquidity to fund our anticipated growth by providing capital to increase the surplus of our insurance subsidiaries, as well as to pay claims and operating expenses, and to pay interest and principal on debt and debt facilities and other holding company expenses for the foreseeable future. However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected. To support our current and future policy writings, we have raised capital using a combination of debt and equity, and entered into third party quota share reinsurance agreements. We may raise additional capital over the next twelve months or obtain additional capital support in the form of third party quota share reinsurance.
Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their place of domicile which limit the amount of cash dividends or distributions that they may pay to us unless special permission is received from the insurance regulator of the relevant domicile. The aggregate limit imposed by the various domiciliary regulatory authorities of our insurance subsidiaries was approximately $403.0 million and $287.9 million as of December 31, 2019 and 2018, respectively, taking into account dividends paid in the prior twelve month periods. During the years ended December 31, 2019, 2018 and 2017, there were $7.0 million, $156.7 million and $339.4 million, respectively, of dividends or return of capital paid by our insurance subsidiaries.
We forecast claim payments based on our historical experience. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on both a short-term and long-term basis. Cash payments for claims were $2.8 billion, $2.5 billion and $2.5 billion in the years ended December 31, 2019, 2018 and 2017,
Net cash used in investing activities decreased by $292.5 million, primarily due to increased cash received from sales of investments and sale of a business in 2019 compared to 2018.
For more information about our reinsurance agreements, see Note 9 “Reinsurance” in the notes to our consolidated financial statements.
For more information about our debt, including other outstanding debt, ranking and restrictive covenants, refer to Note 11, “Debt” in the notes to our consolidated financial statements.
The loss and LAE payments due by period in the table above are based upon the loss and LAE estimates as of December 31, 2019, and actuarial estimates of expected payout patterns and are not contractual liabilities with finite maturities. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and LAE payments due by period is subject to the same uncertainties associated with determining the level of loss and LAE generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and LAE estimate process, see Item 1, “Business - Loss Reserves.” Actual payments of loss and LAE by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and LAE vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See Item 1A, “Risk Factors - Risks Relating to Our Business - If we are unable to establish and maintain accurate loss reserves, our business, financial condition
and results of operations may be materially adversely affected” for a discussion of the uncertainties associated with estimating loss and LAE.
The interest related to our debt by period as of December 31, 2019 was as follows: $40.8 million - less than 1 year, $81.0 million - 1 - 3 years, $56.7 million - 3 - 5 years and $281.4 million - more than 5 years.