Our corporate headquarters, Standard Commercial P&C operating unit and Workers Compensation operating unit are located at 777 Main Street, Suite 1000, Fort Worth, Texas. The suite is located in a high-rise office building and contains 27,808 square feet of space. The rent is currently $49,823 per month pursuant to a lease which expires June 30, 2022.
· Standard Commercial Segment. The Standard Commercial Segment includes the standard lines commercial property/casualty and occupational accident insurance products and services handled by our Standard Commercial P&C operating unit and the workers compensation insurance products handled by our Workers Compensation operating unit. Effective July 1, 2015, the Workers Compensation operating unit no longer retains any risk on new or renewal policies. Our Standard Commercial P&C operating unit is comprised of our American Hallmark Insurance Services and ECM subsidiaries. Our Workers Compensation operating unit is comprised of our TBIC Holdings, TBIC and TBICRM subsidiaries.
· Specialty Commercial Segment. Our Specialty Commercial Segment includes the excess and surplus lines commercial property/casualty insurance products and services handled by our MGA Commercial Products operating unit and the general aviation, satellite launch, commercial umbrella and primary/excess liability, medical professional liability and primary/excess commercial property insurance products and services handled by our Specialty Commercial operating unit, as well as certain specialty risk programs which are managed at the parent level. Our MGA Commercial Products operating unit is comprised of our HSU, PAAC and TGASRI subsidiaries. Our Specialty Commercial operating unit is comprised of our Aerospace Insurance Managers, ASRI, ACMG, HXS and HDS subsidiaries.
· Personal Segment. Our Personal Segment includes the non-standard personal automobile and renters insurance products and services handled by our Specialty Personal Lines operating unit. During the fourth quarter of 2014, our Specialty Personal Lines operating unit discontinued the low value dwelling/homeowners and manufactured homes insurance products it previously offered. Our Specialty Personal Lines operating unit is comprised of our AHGA and HCS subsidiaries.
· Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument; and
The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. A premium deficiency exists if the sum of expected claim costs and claim adjustment expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and expected investment income on those unearned premiums, as computed on a product line basis. We routinely evaluate the realizability of deferred policy acquisition costs. At December 31, 2015 and 2014, there was no premium deficiency related to deferred policy acquisition costs.
The market capitalization of Hallmark’s common stock has been below book value during 2015. We consider our market capitalization in assessing the reasonableness of the fair values estimated for our operating units in connection with our goodwill impairment testing. We believe the current financial market conditions, as well as the limited daily trading volume of Hallmark shares has resulted in a decrease in our market capitalization that is not representative of a long-term decrease in value. The valuation analysis discussed above supports our view that goodwill was not impaired at October 1, 2015. Through December 31, 2015, there were no indicators of impairment.
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2015 was $465.4 million to $376.1 million. Our best estimate of unpaid losses and LAE as of December 31, 2015 is $450.9 million. Our carried reserve for unpaid losses and LAE as of December 31, 2015 is comprised of $227.1 million in case reserves and $223.8 million in incurred but not reported reserves. In setting this estimate of unpaid losses and LAE, we have assumed, among other things, that current trends in loss frequency and severity will continue and that the actuarial analysis was empirically valid. We have established a best estimate of unpaid losses and LAE which is $30.1 million higher than the midpoint, or 96.9% of the high end, of the actuarial range at December 31, 2015 as compared to $18.0 million above the midpoint, or 94.8% of the high end, of the actuarial range at December 31, 2014. We expect our best estimate to move within the actuarial range from year to year due to changes in our operations and changes within the marketplace. Due to the inherent uncertainty in reserve estimates, there can be no assurance that the actual losses ultimately experienced will fall within the actuarial range. However, because of the breadth of the actuarial range, we believe that it is reasonably likely that actual losses will fall within such range.
Comparison of Years ended December 31, 2015 and December 31, 2014
The following is additional business segment information for the years ended December 31, 2015 and 2014 (in thousands):
Gross premiums written for the Standard Commercial Segment were $81.9 million for the year ended December 31, 2015, which was $2.8 million, or 3%, less than the $84.7 million reported for the same period in 2014. The decrease in gross premium was primarily due to lower premium production in our Workers Compensation operating unit due to a renewal rights agreement which ceded 100% of the unearned premium effective July 1, 2015. Net premiums written were $71.1 million for the year ended December 31, 2015 as compared to $76.9 million reported for the same period in 2014. The lower net premiums were primarily due to the workers compensation renewal rights agreement.
The net loss ratio for the year ended December 31, 2015 was 64.8% as compared to the 65.3% reported for the year ended December 31, 2014. The gross loss ratio before reinsurance was 63.4% for the year ended December 31, 2015 as compared to 71.7% for the prior year. The improvement in the gross and net loss ratios was driven primarily by lower net catastrophe losses. The gross and net loss ratios for the year ended December 31, 2015 included $7.8 million of net catastrophe related losses compared to $13.4 million of net catastrophe related losses for the same period the prior year. During the year ended December 31, 2015 the Standard Commercial Segment reported $7.4 million of favorable loss development as compared to $6.0 million reported for the same period of 2014.
Gross premiums written for the Specialty Commercial Segment were $351.0 million for the year ended December 31, 2015, which was $26.5 million, or 8%, more than the $324.5 million reported for the same period in 2014. Net premiums written were $241.8 million for the year ended December 31, 2015 as compared to $230.6 million reported for the same period in 2014. The increase in gross and net premiums written was due to increased premium production in both our MGA Commercial Products and our Specialty Commercial operating units.
Our MGA Commercial Products operating unit reported a $0.4 million decrease in loss and LAE due primarily to $0.2 million of favorable prior year loss reserve development recognized during the year ended December 31, 2015 as compared to $4.7 million of adverse prior year loss reserve development recognized for the same period the prior year. Our Specialty Commercial operating unit reported a $0.9 million decrease in loss and LAE which consisted of (a) a $2.3 million decrease in loss and LAE in our general aviation and satellite launch insurance products due primarily to $0.9 million of favorable prior year loss reserve development recognized during the year ended December 31, 2015 as compared to $0.3 million of adverse prior year loss reserve development recognized for the same period the prior year, (b) a $0.5 million increase in loss and LAE due primarily to $0.6 million lower favorable prior year net loss reserve development recognized during the year ended December 31, 2015 as compared to the same period during 2014 in our commercial umbrella and primary/excess liability line of business, and (c) a $0.9 million increase in loss and LAE attributable to our medical professional liability insurance products. The increase of $3.3 million in operating expense was primarily the combined result of the year to date expenses to start up our primary/excess property coverage business of $1.9 million, increased salary and related expenses of $1.2 million, higher professional service fees of $0.3 million, increased travel related expenses of $0.1 million and higher other operating expenses of $0.2 million, partially offset by lower production related expense of $0.4 million primarily in our commercial umbrella and primary/excess liability line of business.
The Personal Segment reported a net loss ratio of 88.6% for the year ended December 31, 2015 as compared to 63.7% for 2014. The gross loss ratio before reinsurance was 80.8% for the year ended December 31, 2015 as compared to 70.1% for the same period in 2014. The higher gross and net loss ratios were primarily the result of unfavorable prior year net loss reserve development of $2.6 million for the year ended December 31, 2015 as compared to favorable prior year net loss reserve development of $2.9 million for the same period of 2014. The Personal Segment reported a net expense ratio of 19.0% for the year ended December 31, 2015 as compared to 43.3% for the same period of 2014. The decrease in the expense ratio was due predominately to the impact of the renewed quota share reinsurance agreement.
Corporate pre-tax loss was $14.2 million for the year ended December 31, 2015 as compared to a $21.3 million pre-tax loss for the same period the prior year. The improvement in pre-tax loss was primarily due to the increased revenue discussed above and lower interest expense of $0.7 million due to the lower floating interest rate effective June 15, 2015 on our Trust I subordinated debt securities. (See, “Liquidity and Capital Resources- Subordinated Debt Securities.”) This improvement in pre-tax loss was partially offset by higher operating expenses of $0.1 million primarily as a result of higher salary and related costs of $0.5 million due primarily to increased incentive compensation accruals compared to the prior period, partially offset by lower professional service fees of $0.3 million and lower other operating expenses of $0.1 million.
Comparison of Years ended December 31, 2014 and December 31, 2013
Management overview. During fiscal 2014, our total revenues were $337.4 million, representing a 13% decrease over the $389.4 million in total revenues for fiscal 2013. The decrease in revenue was primarily attributable to lower net earned premiums in our Personal Segment due to a new quota share reinsurance contract entered into during the fourth quarter of 2013 on our non-standard automobile risk produced in certain states. Further contributing to the decrease in revenue were significant realized gains recognized in our investment portfolio for the year ended December 31, 2013, lower net investment income and adverse profit share commission revenue adjustments in our Standard Commercial Segment for the year ended December 31, 2014.
We reported net income of $13.4 million for the year ended December 31, 2014, as compared to net income of $8.2 million for the year ended December 31, 2013. On a diluted per share basis, net income was $0.69 per share for fiscal 2014 as compared to net income of $0.43 per share for fiscal 2013.
The following is additional business segment information for the years ended December 31, 2014 and 2013 (in thousands):
Total revenue for the Personal Segment decreased 71% to $20.4 million for the year ended December 31, 2014 from $71.1 million the prior year. Lower net premiums earned of $49.7 million, lower net investment income of $0.4 million, decreased finance charges of $0.5 million and decreased other income of $0.1 million were the primary reasons for the decrease in revenue for the period.
Our Personal Segment reported pre-tax income of $1.2 million for the year ended December 31, 2014 as compared to a pre-tax loss of $3.4 million for the same period of 2013. The pre-tax income was the result of decreased losses and LAE of $43.7 million and lower operating expenses of $11.3 million, primarily due to lower production related expenses driven by increased ceding commission on the quota share agreements entered into during 2013, as well as lower amortization of intangible assets of $0.3 million. These increases in pre-tax income were partially offset by the decreased revenue discussed above.
The state insurance departments also regulate financial transactions between our insurance subsidiaries and their affiliated companies. Applicable regulations require approval of management fees, expense sharing contracts and similar transactions. The net amount paid in management fees by our insurance subsidiaries to Hallmark and our non-insurance company subsidiaries was $1.3 million, $1.1 million and $8.2 million during each of 2015, 2014 and 2013, respectively.
Comparison of Years Ended December 31, 2015 and December 31, 2014
Net cash provided by our consolidated operating activities was $52.9 million for the year ended December 31, 2015 compared to $33.7 million for the year ended December 31, 2014. The increase in operating cash flow was primarily due to increased premiums collected net of reinsurance due primarily to an increase in retained business, as well as lower net paid losses, partially offset by higher operating expenses and income taxes paid.
Cash provided by financing activities during the year ended December 31, 2015 was $26.8 million as a result of $29.9 million proceeds, net of debt issuance costs, from our Revolving Facility B during the fourth quarter of 2015 and $0.6 million related to proceeds from the exercise of employee stock options, partially offset by $2.5 million related to the repurchase of our common stock and $1.2 million related to the contingent purchase price payment to the sellers of TBIC Holding. Cash used in financing activities during the year ended December 31, 2014 was $2.1 million as a result of a $1.5 million repayment on our revolving credit facility and $1.8 million related to the repurchase of our common stock, partially offset by $1.2 million related to proceeds from the exercise of employee stock options.
Our Second Restated Credit Agreement with The Frost National Bank (“Frost”) dated June 30, 2015, reinstates the credit facility with Frost which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amends certain provisions of the credit facility and restates the agreement with Frost in its entirety. The Second Restated Credit Agreement provides a $15.0 million revolving credit facility, with a $5.0 million letter of credit sub-facility. The outstanding balance of the revolving credit facility bears interest at a rate equal to the prime rate or LIBOR plus 2.5%, at our election. We pay an annual fee of 0.25% of the average daily unused balance of the credit facility and letter of credit fees at the rate of 1.00% per annum. The revolving credit facility contains covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and organizational changes. As of December 31, 2015, we were in compliance with all of our covenants and had no outstanding borrowings under this revolving credit facility.
Set forth below is a summary of long-term contractual obligations as of December 31, 2015. Amounts represent estimates of gross undiscounted amounts payable over time. In addition, certain unpaid losses and LAE are ceded to others under reinsurance contracts and are, therefore, recoverable. Such potential recoverables are not reflected in the table.
(1) The payout pattern for unpaid losses and LAE is based upon historical payment patterns and does not represent actual contractual obligations. The timing and amount ultimately paid will likely vary from these estimates.
(2) Minimum payments have not been reduced by minimum sublease rentals of $0.6 million due in the future under noncancelable subleases.
Based on 2016 budgeted and year-to-date cash flow information, we believe that we have sufficient liquidity to meet our projected insurance obligations, operational expenses and capital expenditure requirements for the next 12 months.