The following tables set forth our selected historical consolidated financial and operating information for the periods ended and as of the dates indicated. The income statement data for the years ended December 31, 2020, 2019, and 2018, and the balance sheet data as of December 31, 2020, and 2019, are derived from our audited financial statements included elsewhere in this annual report. These historical results are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information together with the other information contained in this annual report, including “
We are a specialty personal lines insurance holding company that, through our subsidiaries, provides a variety of insurance products, including personal and small business automobile, homeowners, umbrella, recreational vehicle, motorcycle, lender-placed, supplemental health and other niche insurance products. We sell insurance products with a focus on underwriting profitability through a combination of our customized and predictive analytics and our technology driven low cost infrastructure.
Investment income is also an important part of our business. Because we often do not settle claims until several months or longer after we receive the original policy premiums, we can invest cash from premiums for significant periods. We invest our capital and surplus following state and regulatory guidelines. Our net investment income was $118.3 million, $141.2 million and $119.0 million for the years ended December 31, 2020, 2019, and 2018, respectively. We held 12.3% and 3.3% of our total invested assets in cash, cash equivalents and restricted cash as of December 31, 2020, and 2019, respectively.
Our most significant balance sheet liability is our unpaid loss and LAE reserves. As of December 31, 2020, and 2019, our reserves, net of reinsurance recoverable on unpaid losses, were $1.9 billion and $1.8 billion, respectively. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual
losses. If we change our 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.
While we continue to closely monitor the impact of the COVID-19 pandemic and assess its potential effects on our business, the extent to which the COVID-19 outbreak will impact our operations or financial results is uncertain.
Premiums and other receivables are reported net of an allowance for expected credit losses. The allowance is based upon our ongoing review of amounts outstanding, historical loss data, including delinquencies and write-offs, current and forecasted economic conditions, and other relevant factors. We use a loss-rate method to estimate the
expected credit losses. Credit risk is partially mitigated by our ability to cancel the policy if the policyholder does not pay the premium.
Reserves for loss and loss adjustment expense. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any given point in time based on known facts and circumstances.
of risk with other insurance enterprises. We remain liable with respect to any insurance ceded if the assuming companies are unable to meet their obligations under these reinsurance agreements.
Deferred acquisition costs. Deferred acquisition costs include commissions, premium taxes, payments to affinity partners, and other direct sales costs that are directly related to the successful acquisition of insurance policies. These costs, net of ceding allowances, are deferred and amortized to the extent recoverable, over the policy period in which the related premiums are earned and/or over the expected life of the policy as applicable to A&H. Anticipated investment income is considered in determining the recoverability of these costs. We believe that these costs are recoverable.
Investments. 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. 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.
Beginning on January 1, 2020, credit losses on available-for-sale debt securities are recognized through an allowance account. The Company reports accrued investment income separately from debt securities in the Consolidated Balance Sheets, and has elected not to measure an allowance for credit losses. Accrued investment income is written-off by reversing interest income through net investment income at the time the issuer of the bond defaults or is expected to default on payments. Uncollectible debt securities are written-off to net gain (loss) on investments when the Company determines that no additional payments of principal or interest will be received.
Fair value of financial instruments. Our estimates of fair value for financial assets and financial liabilities are 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 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.
Ceding commission income. Ceding commission income is commission we receive based on the earned premium ceded to third-party reinsurers to reimburse us for our acquisition, underwriting and other operating expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission revenue which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition costs and other underwriting expenses.
Service and fee income. We also generate policy service and fee income from installment fees, late payment fees, and other finance and processing fees related to policy cancellation, policy reinstatement, and insufficient fund check returns. We also collect service fees in the form of commissions and general agent fees by selling policies issued by third-party insurance companies as well as fees generated through selling our technology products to third parties.
Net gains and losses on investments. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable; conversely, net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we establish a credit loss allowance on our debt securities as a result of specific credit concerns. For debt securities classified as available-for-sale, other than the allowance for credit losses, we report net unrealized gains and losses within accumulated other comprehensive income in our balance sheet. We report all gains and losses on equity securities within net gains (losses) on investments in our statement of income. Net gains and losses on investments also include foreign exchange gains and losses which are generated by the remeasurement of financial statement balances that are denominated or stated in another currency into the functional currency.
Other income (expense). Other income (expense) represents the bargain purchase gain or the gain on sale of a business.
Interest expense. Interest expense represents amounts we incur on our outstanding indebtedness and interest credited on funds held balances at the applicable interest rates.
Income tax expense. We incur federal, state, and local income tax expenses as well as income tax expenses in certain foreign jurisdictions in which we operate.
Underwriting income. Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense, and income taxes. Underwriting income is calculated as net earned premium plus ceding commission income and service and fee income less loss and LAE, acquisition costs and other underwriting expenses, and general and administrative expenses.
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 (non-GAAP) are as follows:
Gross premium written. Gross premium written increased by $51.5 million, from $5,583.1 million for the year ended December 31, 2019, to $5,634.5 million for the year ended December 31, 2020. The P&C segment increased by $43.2 million, primarily driven by the acquisition of Farmers Union Insurance ($102.7 million), partially offset by a decrease in the Reciprocal Exchanges ($73.8 million). The A&H segment increased by $8.3 million due to an increase in our small group self-funded and individual products ($147.8 million), offset by the sale of Euroaccident in 2019 ($139.3 million).
Net earned premium. Net earned premium increased by $376.6 million, or 9.1%, from $4,118.0 million for the year ended December 31, 2019, to $4,494.6 million for the year ended December 31, 2020. The change by segment was: P&C increased by $354.1 million and A&H increased by $22.4 million. The increase in the P&C segment was attributable to the increase in net premium written and a decrease in ceded earned premium to the Quota Shares ($301.0 million), and an increase in the Reciprocal Exchanges ($11.0 million). The increase in the A&H segment was attributable to an increase in our small group self-funded and individual products ($113.9 million), offset by the sale of Euroaccident in 2019 ($91.4 million).
Ceding commission income. Ceding commission income decreased by $86.0 million, or 36.1%, from $238.5 million for the year ended December 31, 2019, to $152.5 million for the year ended December 31, 2020, primarily driven by a decrease in ceded earned premium to the Quota Shares.
Service and fee income. Service and fee income increased by $118.4 million, or 18.4%, from $642.0 million for the year ended December 31, 2019, to $760.4 million for the year ended December 31, 2020, primarily due to an increase of $119.2 million in the A&H segment related to growth in group administration fees and third party technology fees; third party technology fees are included in other service and fee income.
Our consolidated net loss ratio decreased from 69.3% for the year ended December 31, 2019, to 62.8% for the year ended December 31, 2020.
Net operating expense (non-GAAP); net operating expense ratio (non-GAAP). Net operating expense increased by $138.5 million, or 14.2%, from $974.4 million for the year ended December 31, 2019, to $1,112.9 million for the year ended December 31, 2020, due to an increase of $171.5 million from the P&C segment, primarily offset by a decrease of $33.1 million from the A&H segment.
Interest expense. Interest expense for the years ended December 31, 2020, and 2019, was $33.8 million and $51.5 million, respectively.
Gross premium written. Gross premium written increased by $43.2 million, from $4,814.5 million for the year ended December 31, 2019, to $4,857.6 million for the year ended December 31, 2020, primarily driven by the acquisition of Farmers Union Insurance ($102.7 million), partially offset by a decrease in the Reciprocal Exchanges ($73.8 million).
Net premium written. Net premium written increased by $370.4 million, or 10.4%, from $3,564.0 million for the year ended December 31, 2019, to $3,934.5 million for the year ended December 31, 2020, due to the increase in gross premium written and a decrease in ceded written premium to the Quota Shares ($461.2 million), partially offset by a decrease in the Reciprocal Exchanges ($33.3 million).
Net earned premium. Net earned premium increased by $354.1 million, or 10.2%, from $3,455.0 million for the year ended December 31, 2019, to $3,809.2 million for the year ended December 31, 2020, attributable to the increase in net premium written, decrease in ceded earned premium to the Quota Shares ($301.0 million), and an increase in the Reciprocal Exchanges ($11.0 million).
Ceding commission income. Ceding commission income decreased by $74.8 million, or 32.9% from $227.5 million for the year ended December 31, 2019, to $152.7 million for the year ended December 31, 2020, primarily driven by a decrease in ceded earned premium to the Quota Shares.
Service and fee income. Service and fee income decreased by $0.8 million, from $392.5 million for the year ended December 31, 2019, to $391.7 million for the year ended December 31, 2020.
Loss and loss adjustment expense; net loss ratio. Loss and LAE decreased by $38.6 million, from $2,543.8 million for the year ended December 31, 2019, to $2,505.2 million for the year ended December 31, 2020, primarily reflecting lower claims frequency, as a result of less miles driven during the pandemic ($239.8 million) and the sale of Euroaccident in 2019 ($48.3 million), offset by a decrease in losses ceded to the Quota Shares ($180.3 million), and the acquisition of Farmers Union Insurance ($43.6 million). Losses related to weather-related events, excluding the Reciprocal Exchanges, were $150.2 million in 2020, compared to $51.2 million in 2019, an increase of $99.0 million year over year.
General and administrative expenses. General and administrative expenses increased by $19.6 million, from $773.3 million for the year ended December 31, 2019, to $792.9 million for the year ended December 31, 2020. The increase was primarily driven by organic growth.
A&H Segment Results of Operations for the Year Ended December 31, 2020, Compared to the Year Ended December 31, 2019
Gross premium written. Gross premium written increased by $8.3 million, from $768.6 million for the year ended December 31, 2019, to $776.9 million for the year ended December 31, 2020, primarily due to an increase in our small group self-funded and individual products ($147.8 million), offset by the sale of Euroaccident in 2019 ($139.3 million).
Net premium written. Net premium written increased by $25.8 million, from $660.6 million for the year ended December 31, 2019, to $686.4 million for the year ended December 31, 2020, primarily due to an increase in our small group self-funded and individual products ($115.1 million), offset by the sale of Euroaccident in 2019 ($89.2 million).
Service and fee income. Service and fee income increased by $119.2 million, or 47.8%, from $249.5 million for the year ended December 31, 2019, to $368.7 million for the year ended December 31, 2020, primarily driven by growth in commission revenue, group administration fees and third party technology fees; third party technology fees are included in other service and fee income.
General and administrative expenses. General and administrative expenses decreased by $12.0 million, from $254.2 million for the year ended December 31, 2019, to $242.2 million for the year ended December 31, 2020, primarily due to the sale of Euroaccident in 2019.
Underwriting income; net combined ratio (non-GAAP). Underwriting income increased by $47.3 million, or 34.7%, from $136.2 million for the year ended December 31, 2019, to $183.5 million for the year ended December 31, 2020. Our A&H net combined ratio decreased from 79.5% for the year ended December 31, 2019, to 73.2% for the year ended December 31, 2020.
Changes in Financial Position During the Year Ended December 31, 2020, Compared to December 31, 2019
Reinsurance recoverable decreased by $175,378, driven by a decrease in our P&C segment ($189,429), primarily due to a decrease in ceded premiums to the Quota Shares; and an increase in the A&H segment ($14,051), due to growth in the small group self-funded and individual products.
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, asset-backed securities, and structured securities consisting of collateralized loan and debt obligations.
The average yield on our investment portfolio was 2.7% and 3.1% for the years ended December 31, 2020, and 2019, respectively, and the average duration of the portfolio was 3.5 years and 4.2 years as of December 31, 2020, and 2019, respectively.
For more information related to our investments, see Note 4, “Investments” in the notes to our consolidated financial statements.
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 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 other holding company expenses for the foreseeable future. However, if our growth attributable to prior 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.
Net cash provided by investing activities increased by $512.4 million, primarily due to lower purchases of investments in 2020 compared to 2019.
For more information about our reinsurance agreements, see Note 10 “Reinsurance” in the notes to our consolidated financial statements.
For more information about our debt, including other outstanding debt, debt repayments, ranking and restrictive covenants, refer to Note 11, “Debt” in the notes to our consolidated financial statements.
For information about our preferred stock, refer to Note 14, “Stockholders’ Equity” in the notes to our consolidated financial statements.
(3) The interest related to our debt by period as of December 31, 2020, was as follows: $27.4 million - less than 1 year, $53.1 million - 1 - 3 years, $14.6 million - 3 - 5 years, and $30.4 million - more than 5 years.