NI Holdings is a North Dakota business corporation that is the stock holding company of Nodak Insurance and became such in connection with the conversion of Nodak Mutual from a mutual to stock form of organization and the creation of a mutual holding company. The conversion was consummated on March 13, 2017. Immediately following the conversion, all of the outstanding shares of common stock of Nodak Insurance were issued to Nodak Mutual Group, which then contributed the shares to NI Holdings in exchange for 55% of the outstanding shares of common stock of NI Holdings. Nodak Insurance then became a wholly-owned stock subsidiary of NI Holdings. Prior to completion of the conversion, NI Holdings conducted no business and had no assets or liabilities. As a result of the conversion, NI Holdings became the holding company for Nodak Insurance and its existing subsidiaries.
On August 31, 2018, NI Holdings completed the acquisition of 100% of the common stock of Direct Auto from private shareholders and Direct Auto became a consolidated subsidiary of the Company. Direct Auto is a property and casualty insurance company specializing in non-standard automobile insurance in the state of Illinois. Direct Auto remains headquartered in Chicago, Illinois and continues to be led by its president and other key management in place at the time of the acquisition. The results of Direct Auto are included as part of the Company’s non-standard auto business segment following the closing date.
On January 1, 2020, NI Holdings completed the acquisition of 100% of the common stock of Westminster from the private shareholder of Westminster and Westminster became a consolidated subsidiary of the Company. Westminster is a property and casualty insurance company specializing in commercial multi-peril insurance in the states of Delaware, Georgia, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Virginia, West Virginia, and the District of Columbia. Westminster remains headquartered in Owings Mills, Maryland and continues to be led by its president and other key management in place at the time of the acquisition. The results of Westminster are included as part of the Company’s commercial business segment following the closing date.
Nodak Insurance offers property and casualty insurance, crop hail, and multi-peril crop insurance to members of the North Dakota Farm Bureau through captive agents in North Dakota. American West and Battle Creek offer similar insurance coverage through independent agents in South Dakota and Minnesota, and Nebraska, respectively. Primero offers limited nonstandard auto insurance coverage in Arizona, Nevada, North Dakota, and South Dakota. Direct Auto offers limited nonstandard auto insurance coverage in Illinois. Westminster offers commercial multi-peril insurance in the Mid-Atlantic region of the United States. All of the Company’s insurance subsidiary and affiliate companies are rated “A” Excellent by A.M. Best, which is the third highest out of a possible 15 ratings.
We monitor the marketplace both on a regional and line of business basis. The private passenger marketplace continues to be a very competitive and challenging pricing environment, due to improved results and increased competitive pressure in the market. Rates for private passenger auto remain competitive across the country. The non-standard auto market also remains competitive with companies seeking to grow this line of business. Two large acquisitions took place in the non-standard auto segment during the third quarter, indicating that others in the marketplace are recognizing profitable opportunities associated with this segment. As opposed to most personal lines, the commercial multi-peril market in which we participate continued to harden, with accelerating positive rate changes in both liability and especially property during 2020.
The Company derives its revenue primarily from net premiums earned, net investment income, and net capital gain on investments.
Due to the nature of the crop planting and harvesting cycle and the deadlines for filing and processing claims under the federal crop insurance program, insurance premiums for crop insurance are recognized and earned during the period of risk, which usually begins in spring and ends with harvest in the fall. In the case of prevented planting claims, the period of risk is shortened to the date a valid prevented planting claim is filed, as the Company believes the period of risk has ended. Under the federal crop insurance program, farmers must purchase crop insurance with respect to spring planted crops by March 15. By July 15, the farmer must report the number of acres he has planted in each crop. On September 1, the insurer bills the farmer for the insurance premium, which is due and payable by the farmer by October 1. If the farmer does not pay the premium by such date, the insurer must essentially provide a loan to the farmer in an amount equal to the premium at an annual interest rate of 15% because the insurer is required to pay the farmer’s portion of the premium to the FCIC by November 15, regardless of whether the farmer pays the premium to the insurer. Except for claims occurring in the spring (primarily for prevented planting and required replanting claims), claims are required to be filed with the FCIC by December 15. A different cycle exists for crops planted in the fall, such as winter wheat, but the vast majority of crop insurance written by NI Holdings covers crops planted in the spring.
Beginning in 2019, in accordance with a change in accounting principle, changes in unrealized gains and losses on the Company’s investments in equity securities are included in net income as a part of net capital gains and losses on investments. These gains and losses may be significant given the size of the equity securities holdings and the inherent volatility in equity securities prices. Prior to 2019, the changes in unrealized gains and losses pertaining to such investments were recorded in other comprehensive income. The changes in unrealized gains and losses on fixed income securities continue to be recorded in other comprehensive income, net of income taxes. The new accounting treatment has no effect on total shareholders’ equity.
NI Holdings’ portfolio of investments is managed by Conning, Inc., Disciplined Growth Investors, and CIBC Personal Wealth Management. These investment managers have discretion to buy and sell securities in accordance with the investment policy approved by our Board of Directors.
Current income taxes represent amounts paid to the federal government and certain states whose payment is based upon net income (subject to regulatory adjustments) generated by the Company. As noted above, it does not include state premium taxes that are based purely on the collection of policyholder premiums.
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 income 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. The effect of a change in tax rates is recognized in the period of the enactment date. Total income taxes reflect both current income taxes and the change in the net deferred income tax asset or liability, excluding amounts attributed to accumulated other comprehensive income.
NI Holdings measures growth by monitoring changes in gross premiums written and net premiums written. The Company measures underwriting profitability by examining its loss and LAE ratio, expense ratio, and combined ratio. It also measures profitability by evaluating underwriting gain (loss), net income (loss), and return on average equity.
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 in the unusual situation that legal action is involved. Case reserves are reviewed on a regular basis and are updated as new information becomes available.
The Company estimates multi-peril crop insurance losses on a quarterly basis based upon historical loss patterns, current crop conditions, current weather patterns, and input from crop loss adjusters. These estimates have proven to be reasonably accurate indicators of the Company’s anticipated losses for this line of business.
Bornhuetter-Ferguson Method - The Bornhuetter-Ferguson Method is a blended method that explicitly takes into account both actual loss development to date and expected future loss emergence. This method is applied on both a paid loss basis and an incurred loss basis. This method uses selected loss development patterns to calculate the expected percentage of losses unpaid (or unreported). The expected future loss component of the method is calculated by multiplying earned premium for the given exposure 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.
The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, inflation, legal trends, increases in the state-dictated minimum liability limits in the recent case of nonstandard auto insurance, and legislative changes, among others. The impact of many of these items on ultimate costs for losses and loss adjustment expenses is difficult to estimate. Loss reserve estimation is also affected by the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. NI Holdings continually refines its estimates of unpaid losses and LAE in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. NI Holdings considers all significant facts and circumstances known at the time the liabilities for unpaid losses and LAE are established.
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 a hurricane, has an impact on not only the availability and cost of building materials such as roofing and other 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. During 2018, the state of Nevada mandated the incorporation of higher minimum liabilities for nonstandard auto insurance policies written in the state. Similar mandates became effective in July 2020 in the state of Arizona. While it is certain that these actions increase the average claim cost experienced in the state, the actual amount is subject to judgement until further claim experience is obtained.
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 federal income taxes of 21%, resulting from various changes from the inflation factor implicitly embedded in the estimated payment pattern as of December 31, 2020. 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.
When a claim is reported, claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. It is possible that the level of adequacy in the case reserve may differ from historical levels and/or the claims reporting pattern may change. The following table displays the impact on net income, after federal income taxes of 21%, which results from various changes to the level of case reserves as of December 31, 2020. This variance in future IBNR emergence could occur in one year or over multiple years, depending when the change is recognized.
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 fixed income securities, and on equity securities through December 31, 2018, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of other comprehensive income (loss) and, accordingly, have no effect on net income (loss). Effective January 1, 2019, changes in unrealized investments gains or losses on equity securities began to be reported in net income (loss), rather than as a component of other comprehensive income (loss). Investment income is recognized when earned, and realized capital gains and losses on investments are recognized when investments are sold, or an other-than-temporary impairment is recognized.
For the year ended December 31, 2020, NI Holdings’ investment portfolio experienced an increase in net unrealized gains of $15,117.
The strong recovery in the financial markets led to a substantial increase in the Company’s net unrealized gains from equity securities for the year ended December 31, 2020. The net increase of $5,853 is included in net capital gain on investments on the Company’s Consolidated Statements of Operations for the year ended December 31, 2020.
For the years ended December 31, 2020 and 2019, NI Holdings did not recognize any OTTIs of its investment securities. For the year ended December 31, 2018, NI Holdings recognized $382 of OTTIs of its investment securities. Adverse investment market conditions, in addition to poor operating results of underlying investments, could result in impairment charges in the future.
NI Holdings uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, NI Holdings may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Accounting guidance on fair value measurements and disclosures establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy are as follows:
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 would 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 provides 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.
As in the case of previous acquisitions, no deferred policy acquisition costs (“DAC”) were recorded in the acquisition of Westminster in accordance with purchase accounting guidance. Rather, a separate intangible asset representing the value of business acquired (“VOBA”) was valued at $4,750 and established at the closing date. This VOBA intangible asset was amortized into expense as the acquired unearned premiums were reported into income, in the same way as DAC, and is fully amortized at December 31, 2020. Policy acquisition costs relating to new business written by Westminster were deferred following the closing date. The release of the VOBA asset and the establishment of new DAC generally offset each other over the twelve months following the acquisition of Westminster.
At December 31, 2020 and 2019, deferred policy acquisition costs, the VOBA intangible asset, and the related liability for unearned premiums were as follows:
NI Holdings had gross deferred income tax liabilities of $16,429 at December 31, 2020 and $10,290 at December 31, 2019, arising primarily from deferred policy acquisition costs, net unrealized capital gains on investments, and other intangible assets.
Premiums in the multi-peril crop insurance business are primarily influenced by the number of acres 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 earned premiums and losses due to the risk-sharing arrangement with the federal government. Multi-peril crop insurance premiums are generally written in the second quarter, and earned ratably over the period of risk, which extends into the fourth quarter. However, as was the case in 2020, if the Company experiences a higher than average number of prevented planting claims early in the season, additional earned premiums may be recognized in the second quarter due to the shortened risk period.
Premiums in the commercial lines of business are generally written and earned throughout the year. Losses on this business are also incurred throughout the year, but generally are more frequent during the first and second quarters.
Beginning in March 2020, the global pandemic associated with COVID-19 and related economic conditions began to impact the Company’s results. The Company’s underwriting results were impacted by reduced net premiums earned in our non-standard auto segment. The Company also experienced volatility in net unrealized investment gains and losses driven by the impact of changes in fair value on the Company’s equity investments, attributable to the recent disruption in global financial markets. For further discussion regarding the potential impacts of COVID-19 and related economic conditions of the Company, see “Part II - Item 1A - Risk Factors”.
NI Holdings’ net premiums earned for the year ended December 31, 2020 increased $37,223, or 15.1%, to $283,661 compared to $246,438 for the year ended December 31, 2019.
Direct premiums earned for 2020 increased $43,400, or 16.9%, from 2019. The addition of the Westminster commercial business contributed $40,742 in direct premiums earned during 2020.
Our personal lines of business (private passenger auto, home and farm) continued to grow significantly in South Dakota, while premiums in these lines remained relatively flat in North Dakota and Nebraska due to the impact of both COVID-19 and increased competition in our markets. Non-standard auto premiums earned decreased approximately 6% year-over-year due to the impact of COVID-19, reduced policy counts as a result of rate actions taken in Primero’s primary markets which were driven by increased minimum liability limits, and competitive challenges in Direct Auto’s market. Direct premiums for crop business were lower in 2020 compared to 2019, primarily due to lower commodity prices for multi-peril crop and fewer acres insured under the crop hail line of business.
The 2019 multi-peril crop insurance business ended the year with less than 50% of the corn in North Dakota harvested and we carried a significant number of open claims into 2020. All of those claims have been settled, but produced unfavorable loss development of $3,831 on a net basis. For the 2020 crop season, a higher than normal number of prevented planting claims were submitted due to fields not harvested from the prior year, resulting in an elevated loss and LAE ratio.
During the year ended December 31, 2020, reported losses and LAE included $3,292 of net unfavorable development on prior accident years, compared to $6,509 of net favorable development on prior accident years during the year ended December 31, 2019. Net favorable development is the result of prior years’ claims settling for less than originally estimated, while net unfavorable development is the result of prior years’ claims settling for more 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. The net unfavorable development reported in 2020 is primarily related to the 2019 multi-peril crop business.
The expense ratio of 30.0% for the year ended December 31, 2020 was 2.7 percentage points higher than the expense ratio in 2019. This increase in the ratio is reflective of the higher expense ratio of the Westminster business and increased compensation expenses.
The underwriting profitability of the Company for the year ended December 31, 2020 increased year-over-year. As discussed above, loss experience (as reflected in the loss and LAE ratio) decreased in the private passenger auto, non-standard auto, home and farm, and all other segments.
The combined ratio for the home and farm segment improved substantially as we experienced a lower number of weather-related events in 2020. The favorable impact from fewer weather-related losses combined with modest rate adjustments resulted in a profitable year.
For the commercial segment, the results of Westminster are now combined with the commercial business of Nodak Insurance and American West. The 2019 results reflected high loss experience. During 2020, the addition of Westminster decreased the loss and LAE ratio, although a higher expense load led to a higher combined ratio. Underwriting expenses for Westminster were adversely impacted by amortization of its VOBA intangible asset in 2020.
For the crop segment, the combined ratio was elevated due to the high percentage of unharvested corn that remained in the field from the 2019 season. As those fields were harvested, the losses were higher than anticipated, resulting in adverse development. The 2020 multi-peril crop ratio was also elevated due to the large number of prevented planting claims submitted during second quarter. The high combined ratio for multi-peril crop was partially offset by favorable loss experience in our crop hail business.
NI Holdings had fee and other income of $1,801 for the year ended December 31, 2020, compared to $2,125 for the year ended December 31, 2019. Fee income attributable to Primero’s non-standard auto business is a key component in measuring its profitability. Fee income on this business decreased to $1,337 for 2020 from $1,638 for 2019, driven by a reduction in policy count. Primero also temporarily waived some of its policy maintenance fees as a response to the COVID-19 pandemic.
Investment income, net of investment expense, decreased $162 for the year ended December 31, 2020 compared to a year ago. This decrease is partly attributable to lower market yields on the acquired Westminster’s fixed income securities and additional investment expenses from Westminster. The weighted average gross yield on invested assets decreased to 2.3% in 2020 from 2.5% in 2019, driven by lower reinvestment yields on fixed income securities.
As of December 31, 2020, our overall book yield for our combined fixed income and equity portfolio was 2.6%. The average duration of our fixed income securities was 3.6 years at December 31, 2020.
Effective January 1, 2019, in accordance with a change in accounting principle, market fluctuations on our equity securities began to be reported in the Company’s results of operations. NI Holdings reported a net gain of $5,853 attributed to the change in unrealized appreciation of its equity securities for the year ended December 31, 2020, compared to a net gain of $11,537 for the year ended December 31, 2019.
The Company recorded no OTTIs in the years ended December 31, 2020 and 2019.
For the year ended December 31, 2020, NI Holdings had pre-tax income of $52,816 compared to $33,811 for the year ended December 31, 2019. The increase in pre-tax results was largely attributable to the significant improvement in loss experience during 2020.
NI Holdings recorded income tax expense of $11,472 for the year ended December 31, 2020, compared to $7,311 for the year ended December 31, 2019. A portion of income tax expense relates to state income taxes primarily for the state of Illinois. Our effective tax rate for 2020 was 21.7% compared to an effective tax rate of 21.6% for 2019.
The valuation allowance against certain deferred income tax assets was $931 as of December 31, 2020, compared to $594 as of December 31, 2019.
Our personal lines of business (private passenger auto, home and farm) continued their strong growth in South Dakota. Our non-standard auto premiums also increased year-over-year due to the acquisition of Direct Auto. Direct premiums for crop business are lower in 2019 compared to 2018 due in part to lower commodity prices, although 2019 net premiums are higher than 2018 net premiums due to more ceding of 2018 premiums under the gain-sharing provisions of the federal crop insurance program based on our more favorable loss ratio for 2018.
NI Holdings’ net losses and LAE for the year ended December 31, 2019 increased 42.5% to $169,710 compared to $119,088 for the year ended December 31, 2018. The Company’s loss and LAE ratio increased to 68.9% for 2019, compared to 60.8% for 2018.
Our loss experience was above average levels for both our multi-peril crop business and crop hail business for 2019, compared to favorable loss experience during 2018. The wet spring and cool summer across North Dakota resulted in a delay for some crops to mature, while a wet fall delayed the harvest of those crops. A substantial number of multi-peril crop claims remained open at year-end.
Underlying expenses were $11,667 higher in the year ended December 31, 2019 compared to the prior year. The new Direct Auto subsidiary contributed $16,792 of underlying expenses during 2019, compared to $5,981 for the prior year. Policy acquisition costs have increased due to higher written premiums.
The underwriting results of the Company for the year ended December 31, 2019 decreased year-over-year. As discussed above, loss experience (as reflected in the loss and LAE ratio) increased in the private passenger auto, non-standard auto, crop, and commercial segments.
The non-standard auto results decreased from last year, as the increase in underwriting gain from the new Direct Auto business was offset by the deterioration of the Primero business. The underwriting gain on crop insurance decreased, due to higher loss ratios for the multi-peril crop business and the crop hail line.
The Company recorded no other-than-temporary impairments in the year ended December 31, 2019, and $382 of other-than-temporary impairments in the year ended December 31, 2018.
NI Holdings has evaluated each fixed income security in a loss position and taken into account the severity and duration of the impairment, the current rating on the security (if any), and the outlook for the issuer according to independent analysts. NI Holdings believes that any declines in fair value of individual securities in its existing portfolio are most likely attributable to short-term market trends and there is no evidence that the Company will not recover the entire amortized cost basis.
For the year ended December 31, 2019, NI Holdings had pre-tax income of $33,811 compared to $39,165 for the year ended December 31, 2018. The decrease in pre-tax income was largely attributable to increased loss experience in our private passenger auto and crop segments in 2019 and the elimination of the 2018 purchase accounting gain associated with the acquisition of Direct Auto, offset by the net gain attributed to the favorable change in unrealized gain of equity securities.
NI Holdings recorded income tax expense of $7,311 for the year ended December 31, 2019, compared to $7,921 for the year ended December 31, 2018. A portion of income tax expense relates to state income taxes primarily for the state of Illinois. Our effective tax rate for 2019 was 21.6% compared to an effective tax rate of 20.2% for 2018.
At December 31, 2020, NI Holdings’ total assets increased $109,444, or 21.5%, from December 31, 2019. Cash and investments increased due to positive earnings in the business, unrealized appreciation in equity securities, and the acquired Westminster assets. Premiums and agents’ balances receivable also increased due to the acquired Westminster receivables. Deferred policy acquisition costs increased due partly to the Westminster commercial business and growth in other segments. The receivable from the FCIC decreased due to a partial collection of past year amounts, partially offset by 2020 activity. Goodwill and other intangibles recognized in the Westminster acquisition was $20,506, less amortization expense during 2020. Other assets increased as a result of higher reinsurance recoverables from the Westminster commercial business.
Total equity increased by $39,069, or 12.6%, during the year ended December 31, 2020. The increase in equity primarily reflects consolidated net income of $41,344 for the year and other comprehensive income of $7,319, due to higher fair values within our fixed income securities portfolio, partially offset by share repurchases of $12,234.
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 2017, we raised $93,145 in net proceeds from our IPO, which we planned to use for strategic acquisitions.
In 2018, we used $17,000 for the acquisition of Direct Auto. On January 1, 2020, we acquired Westminster for $40,000. We paid $20,000 at the time of closing. We will pay the remaining $20,000, subject to certain adjustments, in three equal installments on each of the first and second anniversaries of the closing, and on the first business day of the month preceding the third anniversary of the closing.
We currently anticipate that cash generated from our operations and available from our investment portfolio, along with the remaining IPO net proceeds, will be sufficient to fund our operations.
The changes in cash and cash equivalents for the years ended December 31, 2020, 2019, and 2018 were as follows:
For the year ended December 31, 2020, net cash provided by operating activities totaled $51,010 compared to $25,665 a year ago. The consolidated net income of $41,344 for the year ended December 31, 2020 compared to consolidated net income of $26,500 for the same period a year ago. The increase in cash flows from operating activities also reflected differences in the activity between the Company and the FCIC during 2020 and 2019, growth in unearned premiums due to increasing sales of the Westminster commercial business, and lower levels of loss and loss adjustment expenses. During 2019, unrealized gains on investments were offset by increases in unpaid losses and LAE and unearned premiums to serve as the primary reconciling items between net income and net cash flows from operating activities.
For the year ended December 31, 2020, net cash used by financing activities totaled $12,265 compared to $2,025 a year ago. The Company repurchased shares of its own common stock for $12,234 and $2,006 during 2020 and 2019, respectively.
As a standalone entity, and outside of the net proceeds from the IPO, NI Holdings’ principal source of long-term liquidity will be dividend payments from its directly-owned subsidiaries.
The following table summarizes, as of December 31, 2020, NI Holdings’ future payments and estimated claims and claims related payments.
Westminster was acquired on January 1, 2020 for a purchase price of $40,000, subject to certain adjustments. The Company paid $20,000 from the net proceeds from the IPO at time of closing, with another $20,000 payable in three equal installments. The Company paid the first installment on the first anniversary of the closing. The Company will pay the remaining two installments, plus or minus any adjustments, on the second anniversary of the closing and on the first business day of the month preceding the third anniversary of the closing.
To the Shareholders and Board of Directors of NI Holdings, Inc.
Nodak Insurance Company (“Nodak Insurance”, formerly Nodak Mutual Insurance Company prior to the conversion);
Direct Auto, a wholly-owned subsidiary of NI Holdings, is a property and casualty company licensed in Illinois. Direct Auto began writing non-standard automobile coverage in 2007, and was acquired by NI Holdings on August 31, 2018 via a stock purchase agreement. The financial results of Direct Auto have been included in the Consolidated Financial Statements herein since August 31, 2018. See Note 4.
Westminster, a wholly-owned subsidiary of NI Holdings, is a property and casualty insurance company licensed in seventeen states and the District of Columbia. Westminster is headquartered in Owings Mills, Maryland and underwrites multi-peril commercial insurance in the states of Delaware, Georgia, Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina, Virginia, West Virginia, and the District of Columbia. Westminster was acquired by NI Holdings on January 1, 2020 via a stock purchase agreement. The financial results of Westminster have been included in the Consolidated Financial Statements herein since January 1, 2020. See Note 4.
The same executive management team provides oversight and strategic direction for the entire organization. Nodak Insurance provides common product oversight, pricing practices, and underwriting standards, as well as underwriting and claims administration, to itself, American West, and Battle Creek. Primero, Direct Auto, and Westminster personnel manage the day-to-day operations of their respective companies. The insurance companies share a combined business plan to achieve market penetration and underwriting profitability objectives. Distinctions within the products of the insurance companies generally relate to the states in which the risk is located and specific risk profiles targeted within similar classes of business.
Any company deemed to be a variable interest entity (“VIE”) is required to be consolidated by the primary beneficiary of the VIE.
We evaluate whether we are the primary beneficiary of each VIE and we consolidate the VIE if we have both (1) the power to direct the economically significant activities of the entity and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity. We consider the contractual agreements that define the ownership structure, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights, and board representation of the respective parties in determining whether we qualify as the primary beneficiary. Our assessment of whether we are the primary beneficiary of a VIE is performed at least annually.
Level I - Quoted price in active markets for identical assets and liabilities.
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, which approximates fair value. All other invested assets have been assessed for impairment. The carrying value of these other invested assets was $2,924 at December 31, 2020 and $1,914 at December 31, 2019.
Effective in the first quarter of 2020, the Company’s results began to be reported in our Consolidated Financial Statements in the following five primary operating segments - private passenger auto insurance, non-standard auto insurance, home and farm insurance, crop insurance, and commercial insurance. A sixth “all other” segment captures all other insurance business, including our assumed reinsurance lines of business.
The period of risk for our crop insurance program, which comprise primarily spring-planted crops, typically runs from April 1 (the approximate time when farmers can begin to work their fields) through December 15 (last date claims can be made for the most recent planting season). The crop insurance program provides indemnification for acreage that cannot be planted because of flood, drought, or other natural disaster (known as “prevented planting”). In cases where a valid prevented planting claim is made by an insured, the Company assumes that the risk period has ended as there will be no additional coverage under the policy, and the Company will immediately recognize the remaining unearned premium.
Direct Auto also provides for agency billing for a portion of their agents. Accounts billed to agents are due within 60 days of the statement date. The balances are carried as agents’ balances receivable until it is determined the amount is not collectible from the agent. At that time, the balance is written off as uncollectible. The agent is responsible for all past due balances. As part of its agent appointment, Direct Auto requires a personal guarantee for all balances due to Direct Auto from the principal of the contracted agency.
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 on the basis of historical information by line of insurance. Inflation is not explicitly selected in the loss reserve analysis. However, historical inflation is embedded in the estimated loss development factors. 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 expenses.
With the exception of Battle Creek, which files a stand-alone federal income tax return, we currently file a consolidated federal income tax return which includes NI Holdings and its wholly-owned subsidiaries. Direct Auto and Westminster became part of the consolidated federal income tax return as of their acquisition dates.
Insurance companies typically pay state premium taxes rather than state income taxes. However, Direct Auto is subject to state income taxes in the state of Illinois, in addition to state premium taxes. Additionally, NI Holdings, on a stand-alone basis, pays state income taxes to the state of North Dakota for income or losses generated as a separate financial entity. While state premium taxes are included as a part of amortization of deferred policy acquisition costs, state income taxes are combined with federal income taxes within the financial reporting category labeled income taxes.
We re-measure existing deferred income tax assets (including loss carryforwards) and liabilities when a change in tax rate occurs, and record an offset for the net amount of the change as a component of income tax expense from continuing operations in the period of enactment. We also record any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforwards as a component of income tax expense from continuing operations.
Property and liability insurance coverages are marketed through captive agents in North Dakota and through independent insurance agencies located throughout all other operating areas. All business, except for the majority of Direct Auto’s business, is billed directly to the policyholders.
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 other intangibles with an indefinite useful life for impairment annually. We also assess goodwill and other intangibles 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 intangibles could result from changes in economic and operating conditions in future periods. We did not record any impairments of goodwill or other intangibles during the years ended December 31, 2020, 2019, or 2018.
Goodwill arising from the acquisition of Westminster in January 2020 represents the excess of the purchase price over the fair value of the net assets acquired. The purchase price in excess of the fair value of net assets acquired was negotiated at arms-length with an unrelated party and was based upon the strategic decision by Company management to expand both the geographic footprint and commercial business product line of the Company. Other intangible assets arising from the acquisition of Westminster represent the estimated fair values of certain intangible assets, including state insurance licenses, the value of Westminster’s distribution network, the value of the Westminster trade name, and the VOBA. The state insurance license asset has an indefinite life, while the distribution networks asset, Westminster trade name, and VOBA assets will be amortized over twenty years, ten years, and twelve months, respectively, from the January 1, 2020 acquisition/valuation date.
Direct Auto remains headquartered in Chicago, Illinois and continues to be led by its president (who was also one of the principal shareholders) and other key management in place at the time of the acquisition. The results of Direct Auto are included as part of the Company’s non-standard auto business segment following the closing date.
During the year ended December 31, 2018, the acquired Direct Auto business contributed revenues of $14,178, and net income of $2,979, to the Company. The following unaudited pro forma summary presents consolidated information of the Company as if the business combination had occurred on January 1, 2018:
The Company did not reflect any material, nonrecurring pro forma adjustments directly attributable to the business combination to the above pro forma revenue and earnings.
The Company incurred acquisition-related costs of $828 during the year ended December 31, 2020, and $83 during the year ended December 31, 2019. These expenses were reclassified to occur in first quarter 2019 in the pro forma amounts presented above.
The Company paid $20,000 in cash consideration to the private shareholder of Westminster as of the closing date, and will pay
In January 2019, the Company adopted amended guidance from the Financial Accounting Standards Board (“FASB”) that generally requires entities to measure equity securities at fair value and recognize changes in fair value in their results of operations. The FASB issued other impairment, disclosure, and presentation improvements related to financial instruments within the guidance. Effective January 1, 2019, we applied this guidance, which resulted in a cumulative-effect reclassification of after-tax unrealized net capital gains aggregating $8,184, from accumulated other comprehensive income to retained earnings. This reclassification had no impact to the Company’s results of operations at the date of adoption. The after-tax change in accounting for equity securities did not affect the Company’s total shareholders’ equity; however, the unrealized net capital gains reclassified at the transition date to retained earnings will never be recognized in net income. Prior year financial statements were not restated. Going forward, the accounting used for equity securities will record the market fluctuations attributed to equity securities through our results of operations rather than as a component of other comprehensive income, which will add a level of volatility to our net income.
In December 2019, the FASB issued amended guidance to simplify the accounting for income taxes. The amended guidance is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years, for public business entities. For private companies and emerging growth companies, this amended guidance is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption is permitted, including adoption in an interim period. We are evaluating the impact this new guidance will have on our financial position, results of operations, and cash flows.
The amortized cost and estimated fair value of fixed income securities as of December 31, 2020 and 2019 were as follows:
The Company did not record any OTTI in 2020 or 2019. The Company recorded OTTI of $382 in the year ended December 31, 2018.
As a group, during the year ended December 31, 2020, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $97,000 in excess of its $10,000 retained risk. As a group, during the year ended December 31, 2019, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $78,600 in excess of its $10,000 retained risk. During the year ended December 31, 2018, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $74,600 in excess of its $10,000 retained risk. For 2021, the catastrophe retention amount remains at $10,000 while the overall catastrophic reinsurance program limit increased to $117,000 in excess of the $10,000 retention.
A reconciliation of direct to net premiums on both a written and an earned basis is as follows:
During the year ended December 31, 2020, the Company’s reported losses and LAE included $3,292 of net unfavorable development on prior accident years, compared to $6,509 of net favorable development on prior accident years during the year ended December 31, 2019. Increases and decreases are generally the result of ongoing analysis of recent loss development trends. As additional information becomes known regarding individual claims, original estimates are increased or decreased accordingly. The net unfavorable development reported for the year ended December 31, 2020 was primarily attributable to our 2019 multi-peril crop business.
Depreciation expense was $709, $538, and $492 during the years ended December 31, 2020, 2019 and 2018, respectively.
The following table presents the carrying amount of the Company’s goodwill by segment:
The following table presents the carrying amount of the Company’s other intangible assets:
Other intangible assets that have finite lives, including trade names and distribution networks, are amortized over their useful lives. The estimated amortization of other intangible assets with finite lives for the next five years and thereafter is as follows:
In connection with the pooling agreement, the quota share agreement between Battle Creek and Nodak Insurance was cancelled. As a result, the Company’s consolidated financial position and results of operations are impacted by the portion of Battle Creek’s underwriting results that are allocated to the policyholders of Battle Creek rather than the shareholders of NI Holdings.
State insurance laws require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance subsidiaries are subject to regulations that restrict the payment of dividends from statutory surplus and may require prior approval from their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital (“RBC”) requirements that may further affect their ability to pay dividends. Our insurance subsidiaries statutory capital and surplus at December 31, 2020 exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements, by a significant margin.
The Board of Directors has 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 by amounts that represent the excess of the maximum contribution allowed by the Employee Retirement Income Security Act (“ERISA”) over the key executives’ allowable 401(k) contribution. The plan also allows employee-directed deferral of key executive’s compensation or incentive payments. The Company reported expenses relating to this plan totaling $308, $458, and $451 for the years ended December 31, 2020, 2019, and 2018, respectively.
Each employee of Nodak Insurance will automatically become a participant in the ESOP if such employee is at least 21 years old, has completed a minimum of one thousand hours of service with Nodak Insurance, and has completed an Eligibility Computation Period. Employees are not permitted to make any contributions to the ESOP. Participants in the ESOP will receive annual reports from the Company showing the number of shares of common stock of the Company allocated to the participant’s account and the market value of those shares. The shares are allocated to participants based on compensation as provided for in the ESOP.
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.
Through December 31, 2020, 97,260 ESOP shares had been released and allocated to participants, with the remainder of 142,740 ESOP shares held in suspense at December 31, 2020. Using the Company’s year-end market price of $16.42, the fair value of the unearned ESOP shares was $2,344 at December 31, 2020.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted, implementing numerous changes to tax law including temporary changes regarding the prior and future utilization of net operating losses, temporary changes to the prior and future limitations on interest deductions, and the creation of certain refundable employee retention credits. There has been no impact to the Company’s income taxes due to this legislation.
We re-measure existing deferred income tax assets (including loss carryforwards) and liabilities when a change in tax rate occurs and record an offset for the net amount of the change as a component of income tax expense from continuing operations in the period of enactment. We record any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforwards as a component of income tax expense from continuing operations. The valuation allowance against certain deferred income tax assets was $931, $594, and $587 at December 31, 2020, 2019, and 2018, respectively.
The income tax effects of temporary differences that give rise to significant portions of our deferred income tax assets and deferred income tax liabilities at December 31, 2020 and 2019 are as follows:
At December 31, 2020 and 2019, we had no unrecognized tax benefits, no accrued interest and penalties, and no significant uncertain tax positions. No interest and penalties were recognized during the years ended December 31, 2020, 2019, or 2018.
At December 31, 2020 and 2019, the Company, other than Battle Creek and Westminster, had no income tax related carryovers for net operating losses, alternative minimum tax credits, or capital losses.
Battle Creek, which files its federal income tax returns on a stand-alone basis, had net operating loss carryovers of $3,390 and $4,652 at December 31, 2020 and 2019, respectively. The net operating loss carryforward expires beginning in 2021 through 2030, due to limitations on the use of this net operating loss carryforward.
Westminster, which became part of the Company’s consolidated federal income tax return beginning in 2020, had $2,559 of net operating loss carryover at December 31, 2020. This net operating loss carryforward expires beginning in 2021 through 2023, due to limitations on the use of this net operating loss carryforward.
Our Primero subsidiary leases a facility in Spearfish, South Dakota under a non-cancellable operating lease expiring in 2023. Our Direct Auto subsidiary leases a facility in Chicago, Illinois under a non-cancellable operating lease expiring in 2029. Our Nodak Insurance subsidiary leases a facility in Fargo, North Dakota under a non-cancellable operating lease expiring in 2024. There were expenses of $370, $316, and $140 related to these leases during the years ended December 31, 2020, 2019, and 2018, respectively.
We have been named as a defendant in various lawsuits relating to our insurance operations. Contingent liabilities arising from litigation, income taxes, and other matters are not considered to be material to our financial position.
The cost of this treasury stock is a reduction of shareholders’ equity within our Consolidated Balance Sheet.
The total aggregate number of shares of common stock that awards may be issued under all awards made under the Plan shall not exceed 1,000,000 shares of common stock, subject to adjustments as provided in the Plan. No eligible participant may be granted any awards for more than 100,000 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 $150 in any calendar year.
The Compensation Committee has awarded RSUs to non-employee directors and select executives. RSUs are promises to issue actual shares of common stock at the end of a vesting period. The RSUs granted to executives under the Plan were based on salary and vest 20% per year over a five-year period, while RSUs granted to non-employee directors vest 100% on the date of the next annual meeting of shareholders following the grant date. Dividend equivalents on RSUs are accrued during the vesting period and paid in cash at the end of the vesting period, but are subject to forfeiture until the underlying shares become vested. Participants do not have voting rights with respect to RSUs.
The Company recognizes stock-based compensation costs based on the grant date fair value. The compensation costs are normally expensed over the vesting periods to each vesting date; however, the cost of RSUs granted to executives are expensed immediately if the executive has met certain retirement criteria and the RSUs become non-forfeitable. Estimated forfeitures are included in the determination of compensation costs. No forfeitures are currently estimated.
The Compensation Committee has awarded PSUs to select executives. PSUs are promises to issue actual shares of common stock at the end of a vesting period, if certain performance conditions are met. The PSUs granted to employees under the Plan were based on salary and include a three-year book value cumulative growth target with threshold and stretch goals. They will vest on the third anniversary of the grant date, subject to the participant’s continuous employment through the vesting date and the level of performance achieved. Dividend equivalents on PSUs are accrued and paid in cash at the end of the performance period in accordance with the level of performance achieved, but are subject to forfeiture until the underlying shares become vested. Participants do not have voting rights with respect to PSUs.
At December 31, 2020, there was $1,090 of unrecognized compensation cost related to outstanding PSUs. That cost is expected to be recognized over a weighted-average period of 1.59 years.
For purposes of evaluating profitability of the non-standard auto segment, management combines the policy fees paid by the insured with the underwriting gain or loss as its primary measure. As a result, these fees are allocated to the non-standard auto segment (included in fee and other income) in the above tables. The remaining fee and other income amounts are not allocated to any segment, including the $4,578 gain realized on the bargain purchase of Direct Auto in 2018.
Beginning in March 2020, the global pandemic associated with novel coronavirus COVID-19 and related economic conditions began to impact the Company’s results. The Company’s underwriting results for 2020 were impacted by reduced net premiums earned in our non-standard auto segment, which decreased 6% from 2019. We anticipate additional pressure on premiums in this segment for 2021. Conversely, the pandemic favorably impacted loss frequency in our private passenger and non-standard auto segments during the second and third quarters of 2020, due to fewer miles driven by our insureds, resulting in improvements in our loss and LAE ratios.
The following table presents selected information, as filed with insurance regulatory authorities, for our insurance subsidiaries as determined in accordance with accounting practices prescribed or permitted by such insurance regulatory authorities as of and for the years ended December 31, 2020, 2019, and 2018:
Amounts available for distribution in 2021 to Nodak Insurance as dividends from its insurance subsidiaries without prior approval of insurance regulatory authorities are $1,837 from American West and $512 from Primero. No dividends were paid to Nodak Insurance from either entity during the years ended December 31, 2020, 2019, or 2018.
The amount available for payment of dividends from Nodak Insurance to NI Holdings during 2021 without the prior approval of the North Dakota Insurance Department is $21,628 based upon the policyholders’ surplus of Nodak Insurance at December 31, 2020. Prior to its payment of any extraordinary dividend, Nodak Insurance will be required to provide notice of the dividend to the North Dakota Insurance Department. This notice must be provided to the North Dakota Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The North Dakota Insurance Department has the power to limit or prohibit dividend payments if Nodak Insurance is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity. The Board of Directors of Nodak Insurance declared and paid a $6,000 dividend during the year ended December 31, 2020. No dividends were declared or paid in the years ended December 31, 2019 or 2018.