Our executive offices and insurance operations are located in Richmond, Virginia, which occupy approximately 42,000 square feet of office space for annual rent of approximately $0.5 million. The lease for this space expires in 2020. During 2019, we purchased land in anticipation of developing a new corporate headquarters.
The following tables present our selected consolidated financial and other data, at the dates and for the periods indicated. The selected consolidated financial and other data set forth below as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements for those years.
(1) Prior to our IPO in 2016, a significant amount of our business was reinsured through our MLQS with third-party reinsurers. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Our Results of Operations - The MLQS" and Note 8 to the Consolidated Financial Statements.
(2) Effective January 1, 2018, we adopted ASU 2016-01, which eliminated the available-for-sale classification for equity securities and required changes in unrealized gains and losses in fair value of these investments to be recognized in net income.
of underwriting capacity (known as a hard market), the E&S market may grow significantly more rapidly than the standard insurance market as business may shift from the standard market to the E&S market dramatically.
During 2016, the ceding percentage was 15% and the provisional ceding commission rate was 41%. We reduced the ceding percentage due to strong growth in Kinsale Insurance’s capital position as a result of the profitability of the business relative to the growth rate of its gross written premiums. As a result of the successful completion of our IPO in August 2016, we terminated and commuted the MLQS contract on October 1, 2016, which covered the period January 1, 2016 through September 30, 2016. The MLQS was not renewed for the 2017 or the 2018 calendar years and there are no remaining MLQS contracts outstanding.
Our results of operations may be difficult to compare historically in light of the impact of the MLQS on our results of operations. During the year in which the MLQS was employed, management internally evaluated our financial performance both including and excluding the effects of the MLQS.
Adjusted loss ratio is a non-GAAP financial measure. We define adjusted loss ratio as the loss ratio, excluding the effects of the MLQS. For additional detail on the impact of the MLQS on our results of operations, see "-Factors Affecting Our Results of Operations - The MLQS."
Adjusted combined ratio is a non-GAAP financial measure. We define adjusted combined ratio as the loss ratio, excluding the effects of the MLQS. For additional detail on the impact of the MLQS on our results of operations, see "-Factors Affecting Our Results of Operations - The MLQS."
Net retention ratio is the ratio of net written premiums to gross written premiums.
Gross written premiums were $275.5 million for the year ended December 31, 2018 compared to $223.2 million for the year ended December 31, 2017, an increase of $52.3 million, or 23.5%. The increase in gross written premiums for the for the year ended December 31, 2018 over the prior year was due to higher submission activity from brokers across most lines of business. The average premium per policy written by us was $7,800 in 2018 compared to $8,200 in 2017. Excluding our personal lines insurance, which has a relatively low premium per policy written, the average premium per policy written was approximately $10,400 in 2018 compared to $10,700 in 2017. The decrease in the average premium per policy written was due to changes in the mix of business during 2018 compared to the prior year. The changes in gross written premiums were most notable in the following lines of business:
Small business, which represented approximately 16.1% of our gross written premiums in 2018, increased by $9.5 million, or 27.1%, for the year ended December 31, 2018 over the prior year;
Excess casualty, which represented approximately 9.6% of our gross written premiums in 2018, increased by $6.2 million, or 30.6%, for the year ended December 31, 2018 over the prior year;
Allied health care, which represented approximately 6.1% of our gross written premiums in 2018, increased by $6.2 million, or 58.0%, for the year ended December 31, 2018 over the prior year,
Management liability, which represented approximately 3.0% of our gross written premiums in 2018, increased by $4.0 million, or 97.9%, for the year ended December 31, 2018 over the prior year.
Our loss ratio was 60.2% for the year ended December 31, 2018 compared to 58.9% for the year ended December 31, 2017. The increase in the loss ratio for the year ended December 31, 2018 was due to lower net favorable development of loss reserves for prior accident years, offset in part by lower catastrophe losses, net of reinsurance, in 2018 compared to 2017.
For each year of 2018 and 2017, the overall favorable development of loss reserves for prior accident years was primarily due to reported losses emerging at lower levels than expected. During the year ended December 31, 2018, prior accident years developed favorably by $7.0 million, of which $10.6 million was attributable to accident years 2016 and 2017. This favorable development was offset in part by adverse development from accident years 2011 through 2015 of $3.6 million. During the year ended December 31, 2017, loss reserves for prior accident years developed favorably by $11.3 million, which was largely attributable to accident years 2014 through 2016 of $15.4 million. This favorable development was offset in part by adverse development in the accident years 2011 through 2013 of $4.1 million. On an inception-to-date basis, all accident years have developed favorably, with the exception of the 2011 accident year.
Our net investment income increased by 48.4% to $15.7 million for the year ended December 31, 2018 from $10.6 million for the year ended December 31, 2017, primarily due to growth in our investment portfolio balance generated from excess operating funds and higher gross investment returns, as a result a higher allocation of funds in asset-backed securities and preferred stock.
Other expenses for the full year of 2018 were comprised primarily of costs related to the new corporate headquarters development project. Other expenses for the full year of 2017 were comprised primarily of costs related to the Company's secondary common stock offering, which occurred during the second quarter of 2017.
Our effective tax rate for the year ended December 31, 2018 was approximately 16.5% compared to 35.4% for the year ended December 31, 2017. The decrease in the effective tax rate was principally due to the TCJA, which lowered the federal corporate tax rate from 35% to 21% starting January 1, 2018. In the fourth quarter of 2017, as a result of the TCJA enactment, we re-measured our deferred tax balances to reflect the lower rate as required by applicable accounting standards. The re-measurement resulted in an increase to our tax expense of $1.9 million for the year ended December 31, 2017. In addition, the effective tax rates for the year ended December 31, 2018 and 2017 reflected tax benefits from stock options exercised and the recognition of tax benefits related to tax-exempt interest income from municipal bonds.
The following table summarizes our results of operations for the years ended December 31, 2017 and 2016:
(2) Operating return on equity is net operating earnings, a non-GAAP financial measure, expressed as a percentage of average beginning and ending stockholders’ equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to operating income.
Net income was $24.9 million for the year ended December 31, 2017 compared to $26.2 million for the year ended December 31, 2016, a decrease of $1.3 million, or 4.8%. Our underwriting income was $28.2 million for the year ended December 31, 2017 compared to $34.3 million for the year ended December 31, 2016, a decrease of $6.1 million, or 17.7%. The corresponding combined ratio was 84.0% for the year ended December 31, 2017 compared to 74.3% for the year ended December 31, 2016. As previously discussed, the MLQS was not renewed for the 2017 calendar year. Excluding the effect of the 2016 MLQS, underwriting income was $35.0 million and the corresponding adjusted combined ratio was 76.8% for the year ended December 31, 2016. The decrease in our underwriting income, excluding the effect of the 2016 MLQS, was attributable to higher losses incurred from catastrophes and lower favorable development of reserves from prior accident years, offset in part by an increase in net earned premiums in 2017.
Our loss ratio was 58.9% for the year ended December 31, 2017 compared to 53.0% for the year ended December 31, 2016.Excluding the effects of the MLQS, our adjusted loss ratio was 50.0% for the year ended December 31, 2016. The increase in the loss ratio for the year ended December 31, 2017 was due to higher catastrophe losses, net of reinsurance, of $9.0 million, primarily from Hurricanes Harvey and Irma and lower favorable development of reserves from prior accident years.
The following tables summarize the effect of the factors indicated above on the loss ratios and adjusted loss ratios for the years ended December 31, 2017 and 2016:
Our combined ratio was 84.0% for the year ended December 31, 2017 compared to 74.3% for the year ended December 31, 2016. Excluding the effects of the MLQS, the adjusted combined ratio was 76.8% for the year ended December 31, 2016.
We perform quarterly reviews of all securities within our investment portfolio to determine whether any other-than-temporary impairment has occurred. Management concluded that there were no other-than-temporary impairments from fixed-maturity securities or equity securities with unrealized losses for the year ended December 31, 2017. We recognized an impairment loss of $0.3 million on our foreign market ETF for the year ended December 31, 2016. The impairment was based on our assessment of the security's prospect of recovery in the near term. Management concluded that none of the fixed-maturity securities with an unrealized loss at December 31, 2016 experienced an other-than-temporary impairment.
In 2016, our effective tax rate differed from the statutory tax rate of 35% primarily as a result favorable tax treatment on certain municipal bond interest income and dividends received from our equity investments.
Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends. We also use cash to pay commissions to brokers, as well as to pay for ongoing operating expenses such as salaries, rent and taxes. As described under "-Reinsurance" below, we use reinsurance to manage the risk that we take on our policies. We
Net cash used in investing activities increased by $64.1 million in 2018 from 2017. Net cash used in investing activities during the year ended December 31, 2018 reflected higher purchases of fixed-maturity securities, particularly other asset-backed securities and, to a lesser extent, corporate bonds and residential and commercial mortgage obligations. This was offset in part by lower purchases of equity securities during 2018, largely ETFs. Net cash used by investing activities decreased by $45.7 million in 2017 from 2016. Net cash used in investing activities for the year ended December 31, 2017 reflected lower purchases of fixed-maturity securities. During 2017, we were selective in our purchases of fixed income securities given current bond valuations, and held a significant portion of excess funds in cash equivalents. This was offset in part by higher purchases of equity securities during 2017, including $19.9 million of preferred stock.
For the year ended December 31, 2018, net cash used in financing activities was $4.1 million and reflected dividends paid of $0.28 per common share, or $5.9 million in the aggregate. During 2018, we received proceeds of $1.8 million from the exercise of vested stock options. For the year ended December 31, 2017, net cash used in financing activities was $4.0 million and reflected dividends paid of $0.24 per common share, or $5.0 million in the aggregate. During 2017, we received proceeds of $1.1 million from the exercise of vested stock options. For the year ended December 31, 2016, net cash provided by financing activities was $40.6 million and included proceeds from the IPO of $72.8 million, of which $40 million was contributed to our insurance subsidiary, Kinsale Insurance, and $30 million was used to paydown our debt facility. In addition, we paid dividends of $0.10 per common share, or $2.1 million in the aggregate.
The Company had a loan and security agreement (the "Credit Agreement") with the PrivateBank and Trust Company ("PrivateBank") with a five-year secured term loan in the amount of $30.0 million. Pursuant to the terms of the
Credit Agreement, the applicable interest rate on the term loan accrued daily at a rate equal to the 3-month LIBOR plus a margin, and was payable on the last day of each calendar quarter. The term loan had a maturity of December 4, 2020. Our wholly-owned subsidiaries, Kinsale Management and Aspera, were guarantors of the term loan. The assets of Kinsale Management and the stock of Kinsale Insurance were pledged as collateral to PrivateBank.
On December 8, 2016, we made a voluntary prepayment to PrivateBank of $27.7 million, the total amount outstanding under the Credit Agreement. As a result of the prepayment, the Credit Agreement was terminated early in accordance with the terms of the Credit Agreement.
The following table illustrates our contractual obligations and commercial commitments by due date as of December 31, 2018:
Tangible stockholders’ equity is a non-GAAP financial measure. We define tangible stockholders’ equity as stockholders’ equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders’ equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders’ equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
In addition, the amended and restated certificate of incorporation provided for automatic reclassification of our Class A Common Stock and Class B Common Stock into a single class of common stock. All shares of Class A Common Stock were reclassified into 14,682,671 shares of common stock, which were equal to the sum of:
option. All of the shares in the offering were offered by the selling stockholders. The Company did not receive any proceeds from the offering.
On July 27, 2016, the Kinsale Capital Group, Inc. 2016 Omnibus Incentive Plan (the "2016 Incentive Plan"), became effective. The 2016 Incentive Plan provides for grants of stock options, stock appreciation rights, restricted stock, other stock-based awards and other cash-based awards to directors, officers and other employees, as well as independent contractors or consultants providing consulting or advisory services to the Company. The number of shares of common stock available for issuance under the 2016 Incentive Plan may not exceed 2,073,832. On July 27, 2016, the Board of Directors approved, and we granted, 1,036,916 stock options with an exercise price equal to the IPO price of $16.00 per share. The stock options have a maximum contractual term of 10 years, and vest in 4 equal annual installments following the date of the grant.
On January 1, 2019, the Board of Directors granted 7,020 shares of restricted stock under the 2016 Incentive Plan to the Company’s non-employee directors. The restricted stock had a fair value on the date of grant of $55.56 per share and will vest over a 1 year period.
On February 12, 2018, the Company’s Board of Directors declared a cash dividend of $0.07 per share of common stock. This dividend was paid on March 15, 2018 to all stockholders of record on February 28, 2018.
On May 24, 2018, the Company’s Board of Directors declared a cash dividend of $0.07 per share of common stock. This dividend was paid on June 15, 2018 to all stockholders of record on June 4, 2018.
On February 14, 2019, the Company’s Board of Directors declared a cash dividend of $0.08 per share of common stock. This dividend is payable on March 14, 2019 to all stockholders of record on February 28, 2019.
At December 31, 2018, our cash and invested assets of $643.1 million consisted of fixed-maturity securities, cash and cash equivalents and equity securities. At December 31, 2018, the majority of the investment portfolio was comprised of fixed-maturity securities of $510.3 million that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on those securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. At December 31, 2018, we also held $75.1 million of cash and cash equivalents and $57.7 million of equity securities, which are comprised of ETFs and non-redeemable preferred stock. Effective January 1, 2018, we adopted a new accounting standard ASU 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities," which eliminated the available-for-sale classification for equity securities and required changes in unrealized gains and losses in fair value of these investments to be recognized in net income. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 3.9 years and an average rating of "AA" at December 31, 2018.
At December 31, 2018, the amortized cost and fair value of our investments were as follows:
The amortized cost and fair value of our available-for-sale investments in fixed-maturity securities summarized by contractual maturity as of December 31, 2018, were as follows:
In order to conduct business in certain states, we are required to maintain letters of credit or assets on deposit to support state-mandated insurance regulatory requirements and to comply with certain third-party agreements. Assets held on deposit or in trust accounts are primarily in the form of cash or certain high-grade securities. The fair value of our restricted assets was $6.9 million at December 31, 2018 compared to $7.1 million at December 31, 2017.
We do not have any material off-balance sheet arrangements as of December 31, 2018.
Net income for the years ended December 31, 2018, 2017, and 2016 reconcile to net operating earnings as follows:
IBNR reserves are determined using actuarial methods to estimate losses that have occurred but have not yet been reported to us. We principally use the incurred Bornhuetter-Ferguson actuarial method ("BF method") to arrive at our loss reserve estimates for each line of business. This method estimates the reserves based on our initial expected loss ratio and expected reporting patterns for losses. Because we have a limited number of years of loss experience compared to the period over which we expect losses to be reported, we use industry and peer-group data, in addition to our own data, as a basis for selecting our expected reporting patterns. Since the incurred BF method does not directly use reported losses in the estimation of IBNR, it is less sensitive to our level of reported losses than other actuarial methods. This method avoids some of the distortions that could result from a large loss development factor being applied to a small base of reported losses to calculate ultimate losses. However, this method will react more slowly than some other loss development methods if reported loss experience deviates significantly from our expected losses.
Our Reserve Committee consists of our Chief Actuary, Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. The Reserve Committee meets quarterly to review the actuarial recommendations made by the Chief Actuary. In establishing the actuarial recommendation for the reserves for losses and loss adjustment expenses, our actuary estimates an initial expected ultimate loss ratio for our statutory lines of business by accident year. Input from our underwriting and claims departments, including premium pricing assumptions and historical experience, is considered by our actuary in estimating the initial expected loss ratios. During each quarter, the Reserve Committee reviews the emergence of actual losses relative to expectations by line of business to assess whether the assumptions used in the reserving process continue to form a reasonable basis for the projection of liabilities for those product lines. Our reserving
The table below quantifies the impact of potential reserve deviations from our carried reserve at December 31, 2018. We applied sensitivity factors to incurred losses for the three most recent accident years and to the carried reserve for all prior accident years combined. We believe that potential changes such as these would not have a material impact on our liquidity.
During the year ended December 31, 2017, our net incurred losses for accident years 2016 and prior developed favorably by $11.3 million. This favorable development included $9.4 million for the 2016 accident year, $4.2 million for the 2015 accident year and $1.8 million for accident year 2014. This favorable development was primarily due to reported losses emerging at a lower level than expected, across most lines of business. The favorable development was offset in part by adverse development of $2.1 million for the 2013 accident year, $1.3 million for the 2012 accident year and $0.7 million for the 2011 accident year. The unfavorable development was primarily attributable to claims on the other liability occurrence statutory line of business.
Fair values of our investment portfolio are estimated using unadjusted prices obtained by our investment manager from nationally recognized third-party pricing services, where available. For securities where we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from our investment manager. We perform several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements at December 31, 2018, including (1) obtaining and reviewing the internal control report from our investment manager that obtain fair values from third party pricing services, (2) discussing with our investment manager their process for reviewing and validating pricing obtained from outside pricing services and (3) reviewing the security pricing received from our investment manager and monitoring changes in unrealized gains and losses at the individual security level.
For fixed maturities where we intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost, a decline in fair value is considered to be other-than-temporary and is recognized in net loss based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security. If the decline in fair value of a fixed-maturity security below its amortized cost is considered to be other-than-temporary based upon other considerations, we compare the estimated present value of the cash flows expected to be collected to the amortized cost of the security. The extent to which the estimated present value of the cash flows expected to be collected is less than the amortized cost of the security represents the credit-related portion of the other-than-temporary impairment and is recognized in net loss, resulting in a new cost basis for the security. Any remaining decline in fair value represents the noncredit portion of the other-than-temporary impairment and is recognized in other comprehensive loss. For equity securities, a decline in fair value that is considered to be other-than-temporary is recognized in net loss based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security.
Reinsurance recoverables recorded on insurance losses ceded under reinsurance contracts are subject to judgments and uncertainties similar to those involved in estimating gross loss reserves. In addition to these uncertainties, our reinsurance recoverables may prove uncollectible if the reinsurers are unable or unwilling to perform under the reinsurance contracts. In establishing our reinsurance allowance for amounts deemed uncollectible, we evaluate the financial condition of our reinsurers and monitor concentration of credit risk arising from our exposure to individual reinsurers. To determine if an allowance is necessary, we consider, among other factors, published financial information, reports from rating agencies, payment history, collateral held and our legal right to offset balances recoverable against balances we may owe. Our reinsurance allowance for doubtful accounts is subject to uncertainty and volatility due to the time lag involved in collecting amounts recoverable from reinsurers. Over the period of time that losses occur, reinsurers are billed and amounts are ultimately collected, economic conditions, as well as the operational and financial performance of particular reinsurers may change and these changes may affect the reinsurers’ willingness and ability to meet their contractual obligations to us. It is difficult to fully evaluate the impact of major catastrophic events on the financial stability of reinsurers, as well as the access to capital that reinsurers may have when such events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear the collection risk if any reinsurer fails to meet its obligations under the reinsurance contracts. We target reinsurers with A.M. Best financial strength ratings of "A" (Excellent) or better. Based on our evaluation of the factors discussed above, we believe all of our recoverables are collectible and, therefore, no allowance for uncollectible reinsurance was provided for at December 31, 2018.
Management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors. Based on our evaluation, we have concluded that we maintained effective internal control over financial reporting as of December 31, 2018.
We have audited Kinsale Capital Group, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for recognizing changes in unrealized gains and losses in fair value of equity investments in 2018 due to the adoption of Accounting Standards Update 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
Fixed-maturity securities are classified as available-for-sale and reported at fair value. Unrealized gains and losses on these securities are excluded from net earnings but are recorded as a separate component of comprehensive income and stockholders’ equity, net of deferred income taxes.
The Company regularly evaluates its available-for-sale securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. See Note 2 for further discussion of other-than-temporary impairments ("OTTI").
Fair value disclosures for investments are included in Notes 2 and 3.
Stock-based compensation is expensed based upon the estimated fair value of employee stock awards. Compensation cost for awards of equity instruments to employees is measured based on the grant-date fair value of those awards and compensation expense is recognized over the service period that the awards vest. Forfeitures of stock-based compensation awards are recognized as they occur.
See Note 9 for further discussion and related disclosures regarding stock-based compensation.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)" to improve the financial reporting of leasing transactions. Under this ASU, lessees will recognize a right-of-use ("ROU") asset and corresponding liability on the balance sheet for all leases, except for leases covering a period of 12 months or less. The lessee’s income statement treatment for leases will vary depending on the nature and classification of the lease. This ASU is effective for annual and interim reporting periods beginning after December 15, 2018, and will therefore be effective for the Company beginning January 1, 2019.
For transition purposes, the Company will elect the package of practical expedients permitted under the adoption of the new standard, which will allow the Company to account for existing leases under their current classification, as well as omit any new costs classified as initial direct costs, under the new standard. This election will keep the existing agreements as operating leases. The Company will also elect the practical expedient allowing an accounting policy election by class of underlying asset, to account for separate lease and nonlease components as a single lease component. In addition, the Company has implemented the necessary internal controls relating to the adoption of the standard.
This ASU is effective for annual and interim reporting periods beginning after December 15, 2019. Early adoption is permitted beginning after December 15, 2018. Upon adoption, the update will be applied using the modified-retrospective approach, by which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period presented. The Company is currently evaluating the impact of the adoption on its consolidated financial statements.
On March 30, 2017, the FASB issued ASU 2017-08, "Premium Amortization on Purchased Callable Debt Securities," which shortens the amortization period of the premium for certain callable debt securities, from the contractual maturity date to the earliest call date. This ASU is effective in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including in an interim period. Upon adoption, the update will be applied on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the
For fixed maturities where a decline in fair value is considered to be other-than-temporary and the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost, an impairment is recognized in net income based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security. If the decline in fair value of a fixed-maturity security below its amortized cost is considered to be other-than-temporary based upon other considerations, the Company compares the estimated present value of the cash flows expected to be collected to the amortized cost of the security. The extent to which the estimated present value of the cash flows expected to be collected is less than the amortized cost of the security represents the credit-related portion of the OTTI, which is recognized in net income, resulting in a new cost basis for the security. Any remaining decline in fair value represents the noncredit portion of the OTTI, which is recognized in other comprehensive income. For equity securities prior to the adoption of ASU 2016-01, a decline in fair value that was considered to be other-than-temporary was recognized in net income based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security.
At December 31, 2017, the Company held 195 fixed-maturity securities with a total estimated fair value of $203.4 million and gross unrealized losses of $2.2 million. Of these securities, 126 were in a continuous unrealized loss position for greater than one year. Unrealized losses were caused by interest rate changes or other market factors and were not credit specific issues. At December 31, 2017, 91.1% of the Company’s fixed-maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities. At December 31, 2017, the Company held 13 securities in its equity portfolio with a total estimated fair value of $10.8 million and gross unrealized losses of $0.2 million. None of these securities were in a continuous unrealized loss position for greater than one year. Based on its review, the Company concluded that there were no other-than-temporary impairments from the fixed-maturity or equity securities with unrealized losses at December 31, 2017.
The Company had invested assets with a carrying value of $6.9 million and $7.1 million on deposit with state regulatory authorities at December 31, 2018 and 2017, respectively.
The three levels of the fair value hierarchy are defined as follows:
Fair values of the Company's investment portfolio are estimated using unadjusted prices obtained by its investment manager from nationally recognized third party pricing services, where available. For securities where the Company is unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from the Company's investment manager. Management performs several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements at December 31, 2018 and 2017, including 1) obtaining and reviewing internal control reports from the Company's investment manager that assess fair values from third party pricing services, 2) discussing with the Company's investment manager its process for reviewing and validating pricing obtained from third party pricing services and 3) reviewing the security pricing received from the Company's investment manager and monitoring changes in unrealized gains and losses at the individual security level. The Company has evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs.
There were no transfers into or out of Level 1 and Level 2 during the years ended December 31, 2018 or 2017. There were no assets or liabilities measured at fair value on a nonrecurring basis as of December 31, 2018 or 2017.
Due to the relatively short-term nature of cash, cash equivalents, receivables and payables, their carrying amounts are reasonable estimates of fair value.
The negative, or liability, balance at the beginning of the calendar year 2016 was due to the effect of deferred ceding commissions related to the MLQS. For the year ended December 31, 2016, the amortization of net policy acquisition costs included the impact of the commutation of the MLQS, which was effective October 1, 2016. The MLQS was not renewed for calendar year 2017 or 2018. See Note 8 for further details regarding the MLQS.
The Company’s subsidiaries file a consolidated U.S. federal income tax return. Under a tax sharing agreement, KCGI collects from or refunds to its subsidiaries the amount of taxes determined as if KCGI and the subsidiaries filed separate returns. The Company is no longer subject to income tax examination by tax authorities for the years ended before January 1, 2015.
Income tax expense includes the following components for the years ending December 31, 2018, 2017 and 2016:
During 2017, the Company measured its deferred tax assets and liabilities using enacted tax rates applicable in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35% to 21%, resulting in a $1.9 million increase in income tax expense and a corresponding decrease in net deferred tax assets as of the enactment date.
The Company did not have any uncertain tax positions in 2018. Management is not aware of any events that would give rise to any uncertain tax positions.
During the year ended December 31, 2018, our net incurred losses for accident years 2017 and prior developed favorably by $7.0 million. This favorable development included $6.8 million for the 2017 accident year and $3.8 million for accident year 2016. This favorable development was primarily due to reported losses emerging at a lower level than expected, across most lines of business. The favorable development was offset by adverse development of $3.6 million for the 2011 through 2015 accident years. The unfavorable development was primarily attributable to claims on the other liability occurrence line of business.
The following is information about incurred and paid claims development as of December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liabilities plus expected development on reported claims included within the net incurred claims amounts. The development and claims duration tables below exclude the commuted MLQS contracts, which
would distort development patterns related to those transactions. See Note 8 for further details regarding the commutation of the MLQS. Cumulative number of reported claims is reported on a per claim basis.
Prior to 2017, the Company participated in a MLQS treaty that transferred a proportion of the risk related to certain lines of business written by its subsidiary, Kinsale Insurance, to reinsurers that received a proportion of the direct written premiums on that business. The Company's MLQS contract also reduced the amount of capital required to
support the insurance operations of Kinsale Insurance. Under the terms of the MLQS contract, the Company received a provisional ceding commission and paid a reinsurance margin, as long as the reinsurers were not in a loss position on the contract. The MLQS contract included a sliding scale commission provision that reduced or increased the ceding commission based on the loss experience of the business ceded. Under the contract, the Company was entitled to an additional contingent profit commission up to an amount equal to all of the reinsurers’ profits above the margin based on the underwriting results of the business ceded, upon commutation of the contract. The contracts had a loss ratio cap of 110%, which restricted the Company from ceding any losses in excess of 110% of ceded earned premiums to the reinsurers. The Company maintained a funds-held account for the reinsurers who were a party to the MLQS contracts, which was credited with interest at a rate equal to the 10 year U.S. Treasury rate plus a spread. The funds-held account represented the excess of the ceded written premium and interest credited over ceded paid losses and LAE, the Company’s ceding commission and the reinsurers’ margin. As a result of the initial public offering, the Company terminated and commuted the MLQS contract effective October 1, 2016 and did not renew the MLQS contract for calendar year 2017 or 2018.
Under the terms of the MLQS covering calendar year 2016 (the "2016 MLQS"), the Company ceded 15% of the risk related to certain lines of business written, received a provisional ceding commission equal to 41% of ceded written premiums and paid a reinsurance margin equal to 4.00% of ceded written premium. The 2016 MLQS contract included a sliding scale commission provision that adjusted the ceding commissions within a range of 25% to 41% based on the loss experience of the business ceded.
Effective January 1, 2016, the Company commuted the 2014 MLQS, which reduced reinsurance recoverables on unpaid losses by and receivable from reinsurers by $34.2 million, with a corresponding reduction to funds held for reinsurers. Effective October 1, 2016, the Company terminated and commuted the 2016 MLQS. The commutation reduced reinsurance recoverables on unpaid losses and receivable from reinsurers by approximately $15.5 million with a corresponding reduction to funds held for reinsurers.
Effective January 1, 2017, the Company commuted the 2015 MLQS. The commutation reduced reinsurance recoverables on unpaid losses and receivable from reinsurers by approximately $36.5 million, with a corresponding reduction to funds held for reinsurers. There were no remaining MLQS contracts outstanding as of January 1, 2017.
At December 31, 2018, the net reinsurance receivable, defined as the sum of paid and unpaid reinsurance recoverables and ceded unearned premiums less reinsurance payables, from five reinsurers represented 92.7% of the total balance.
At January 1, 2016, the Company was authorized to issue 18,333,333 shares of Common Stock, $0.0001 par value per share ("Common Stock"), of which 15,000,000 shares were designated as Class A Common Voting Shares ("Class A Common Stock") and 3,333,333 were designated as Class B Common Non-Voting Shares ("Class B Common Stock"). On July 28, 2016, in connection with the IPO as discussed below, the Company amended and restated its certificate of incorporation to recapitalize the Company’s authorized capital stock to consist of 400,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share. There were no shares of preferred stock issued or outstanding at December 31, 2018 or December 31, 2017.
All shares of Class B Common Stock were reclassified into shares of common stock equal to a conversion ratio of 0.72095061, calculated based on the IPO price of $16.00 per share.
The Company recognized total equity-based compensation expense of $1.6 million, $0.7 million and $0.5 million for the years ended December 31, 2018, 2017 and 2016, respectively.
On July 27, 2016, the Board of Directors approved, and the Company granted, 1,036,916 stock options with an exercise price equal to the IPO price of $16.00 per share. The options have a maximum contractual term of 10 years and vest in 4 equal annual installments following the date of the grant. The weighted average grant date fair value of options granted during 2016 was $2.71 per share.
The value of the options granted was estimated at the date of grant using the Black-Scholes pricing model using the following assumptions:
A summary of option activity under the employee share option plan as of December 31, 2018, and changes during the year then ended is presented below:
During 2018, the Board of Directors approved, and the Company granted, restricted stock awards under the 2016 Incentive Plan. The restricted stock awards were valued on the date of grant and will vest over a period of one to four years corresponding to the anniversary date of the grants. The fair value of restricted stock awards was determined based on the closing trading price of the Company’s shares on the grant date or, if no shares were traded on the grant date, the last preceding date for which there was a sale of shares. Except for restrictions placed on the transferability of restricted stock, holders of unvested restricted stock have full stockholder’s rights, including voting rights and the right to receive cash dividends. Unvested shares of restricted stock awards and accrued dividends, if any, are forfeited upon the termination of service to or employment with the Company.
As of December 31, 2018, the Company had $3.9 million of total unrecognized stock-based compensation expense expected to be charged to earnings over a weighted-average period of 3.4 years.
The Board of Directors granted 7,020 shares of restricted stock on January 1, 2019 under the 2016 Incentive Plan to the Company’s non-employee directors. The restricted stock had a fair value on the date of grant of $55.56 per share and will vest on a straight-line basis over a 1 year period.
There were approximately 86 thousand anti-dilutive stock awards for the year ended December 31, 2018. There were no anti-dilutive stock awards for the years ended December 31, 2017.
to Class B common stockholders equaled twenty-five percent of the Residual Proceeds. After the reclassification of common stock on July 28, 2016, all of the earnings of the Company were attributable to the single class of common stock.
Basic earnings per share for each class of common stock was computed by dividing the earnings attributable to the common stockholders by the weighted average number of shares of each respective class of common stock outstanding during the period. Diluted earnings per share attributable to each class of common stock was computed by dividing earnings attributable to common stockholders by the weighted average shares outstanding for each respective class of common stock outstanding during the period, including potentially dilutive shares of common stock for the period determined using the treasury stock method. There were no potentially dilutive shares attributable to Class A common stockholders. For purposes of the diluted earnings per share attributable to Class B common stockholders calculation, unvested restricted grants of common stock were considered to be potentially dilutive shares of common stock. There were no material anti-dilutive Class B shares for the year ended December 31, 2016. See Note 9, "Stockholders' Equity," for details regarding changes to the Company’s capital structure on July 28, 2016.
On September 30, 2016, the Company repaid $2.5 million of the term loan and, on December 8, 2016, repaid the total remaining amount outstanding of $27.5 million plus accrued interest of $0.2 million. In connection with the repayment of the term loan, the Company wrote off $0.3 million of debt issue costs, which was included in interest expense for the year ended December 31, 2016.
(1) Adoption of ASU 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets
and Financial Liabilities," which was effective January 1, 2018, eliminated the available-for-sale classification for
Construction underwrites commercial general liability coverage on contractors focusing on new residential construction, residential remodeling and renovation and commercial construction.
Energy underwrites commercial general liability, pollution liability, professional liability and excess liability on enterprises engaged in the business of energy production or distribution or mining including drillers, lease operators, contractors and product manufacturers.
General casualty underwrites general liability and liquor liability on hospitality, habitational and retail risks, among others, with similar premises liability loss exposures.
Health care underwrites medical professional liability for physicians, surgeons, dentists, chiropractors and podiatrists. Policies cover both individuals and small practice groups.
Commercial insurance underwrites commercial general liability on small accounts, through our wholly-owned broker, Aspera.
The Company does business with two unaffiliated insurance brokers that generated $32.7 million and $29.4 million of gross written premiums for the year ended December 31, 2018, representing 11.9% and 10.7% of gross written premiums, respectively. No other broker generated 10.0% or more of the gross written premiums for the year ended December 31, 2018.
Kinsale Insurance is subject to risk-based capital ("RBC") requirements. RBC is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of RBC is calculated using various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the RBC results, as determined by the formula. Companies that do not maintain statutory capital and surplus at a level in excess of the company action level RBC are required to take specified actions. At December 31, 2018 and 2017, actual statutory capital and surplus for Kinsale Insurance substantially exceeded the regulatory requirements.
Dividend payments to Kinsale from Kinsale Insurance are restricted by state insurance laws as to the amount that may be paid without prior approval of the regulatory authorities of Arkansas. The maximum dividend distribution is limited by Arkansas law to the greater of 10% of policyholder surplus as of December 31 of the previous year or statutory net income, not including realized capital gains, for the previous calendar year. Dividend payments are further limited to that part of available policyholder surplus which is derived from net profits on its business. The maximum dividend distribution that can be paid by Kinsale Insurance during 2019 without prior approval is $34.0 million.
The following is a summary of the unaudited quarterly results of operations: