Our MGA Commercial Products operating unit is presently located at 7550 IH-10 West, San Antonio, Texas. These leased premises consist of a 16,599 square foot office suite and 800 square feet of storage space. The rent is currently $34,073 per month pursuant to a lease that expires November 30, 2020.
Our Specialty Commercial operating unit is located at 13727 Noel Road, Dallas, Texas. These leased premises consist of 15,072 square feet of office space. The rent is currently $28,574 per month pursuant to a lease that expires November 30, 2022. Our Specialty Commercial operating unit also maintains branch offices in the following locations:
(1) Amounts have been adjusted for the adoption of ASU 2015-03 which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, (See, “Simplifying the Presentation of Debt Issuance Costs” in Note 1 to the audited consolidated financial statements, included in this report.)
· 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 June 1, 2016, we no longer market new or renewal occupational accident policies. 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.
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, 2016 and 2015, there was no premium deficiency related to deferred policy acquisition costs.
Goodwill. Goodwill is tested for impairment at the reporting unit level (operating unit or one level below an operating unit) on an annual basis (October 1) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. For purposes of evaluating goodwill for impairment, we have determined that our reporting units are the same as our operating units except for the Specialty Commercial operating unit for which reporting units are at the component level (“one level below”). Our consolidated balance sheet as of December 31, 2016 includes goodwill of acquired businesses of $44.7 million that is assigned to our operating units as follows: Standard Commercial P&C operating unit - $2.1 million; MGA Commercial Products operating unit - $19.8 million; Specialty Commercial operating unit - $17.4 million (comprised of $7.7 million for the primary/excess & umbrella component and $9.7 million for the general aviation and satellite component); and Specialty Personal Lines operating unit - $5.4 million. This amount has been recorded as a result of prior business acquisitions accounted for under the acquisition method of accounting. Under ASC 350, “Intangibles - Goodwill and Other,” goodwill is tested for impairment annually. We completed our last annual test for impairment on the first day of the fourth quarter of 2016 and determined that there was no impairment.
The income approach to determining fair value computed the projections of the cash flows that the reporting unit is expected to generate converted into a present value equivalent through discounting. Significant assumptions in the income approach model include income projections, discount rates and terminal growth values. The income projections reflect an improved premium rate environment across most of our lines of business that continued throughout 2016. The income projections also include loss and LAE assumptions which reflect recent historical claim trends and the movement towards a more favorable pricing environment. The income projections also include assumptions for expense growth and investment yields which are based on business plans for each of our operating units. The discount rate was based on a risk free rate plus a beta adjusted equity risk premium and specific company risk premium. The assumptions were based on historical experience, expectations of future performance, expected market conditions and other factors requiring judgment and estimates. While we believe the assumptions used in these models were reasonable, the inherent uncertainty in predicting future performance and market conditions may change over time and influence the outcome of future testing.
The fair values of each of our operating units were in excess of their respective carrying values, including goodwill, as a result of our annual test for impairment during the fourth quarter 2016. However, a 10% decline in the fair value of our Standard Commercial P&C operating unit, a 7% decline in the fair value of our MGA Commercial Products operating unit, a 6% decline in the fair value of our Specialty Personal Lines operating unit, a 49% decline in the fair value of our excess & umbrella component or a 16% decline in the fair value of our general aviation and satellite component would have caused the carrying value of the respective reporting unit to be in excess of its fair value, resulting in the need to perform the second step of impairment testing prescribed by ASC 350, which could have resulted in an impairment to our goodwill.
The market capitalization of Hallmark’s common stock has been below book value during 2016. 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, 2016. Through December 31, 2016, there were no indicators of impairment.
The range of unpaid losses and LAE estimated by our actuary as of December 31, 2016 was $390.9 million to $498.7 million. Our best estimate of unpaid losses and LAE as of December 31, 2016 is $481.6 million. Our carried reserve for unpaid losses and LAE as of December 31, 2016 is comprised of $254.8 million in case reserves and $226.8 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 $36.8 million higher than the midpoint, or 96.6% of the high end, of the actuarial range at December 31, 2016 as compared to $30.1 million above the midpoint, or 96.9% of the high end, of the actuarial range at December 31, 2015. 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.
This increase in revenue was primarily attributable to higher net premiums earned, higher net investment income and higher commission and fee revenue, partially offset by realized losses recognized on our investment portfolio during the current period as compared to realized gains recognized during the same period the prior year and lower finance charges.
The following is additional business segment information for the years ended December 31, 2016 and 2015 (in thousands):
Total revenue for the Standard Commercial Segment of $72.0 million for the year ended December 31, 2016 was $4.9 million less than the $76.9 million reported during the year ended December 31, 2015. This 6% decrease in total revenue was mostly due to the Workers Compensation operating unit experiencing both a $0.6 million gain during the year ended December 31, 2015 in connection with the transfer of renewal rights and a $5.1 million decrease in net premiums earned during 2016 primarily as a result of ceding substantially all unearned premiums as of July 1, 2015 and lower net investment income of $0.2 million. These decreases in revenue were partially offset by a decreased adverse profit share commission revenue adjustment of $1.0 million.
The net loss ratio for the year ended December 31, 2016 was 61.0% as compared to the 64.8% reported for the year ended December 31, 2015. The gross loss ratio before reinsurance was 59.6% for the year ended December 31, 2016 as compared to 63.4% for the prior year. The lower gross and net loss ratios resulted primarily from lower premium volume, lower current accident year non-catastrophe loss trends and increased favorable net loss reserve development partially offset by higher current accident year catastrophe losses. The net loss ratios for the year ended December 31, 2016 include $8.4 million of catastrophe related losses. The net loss ratios for the year ended December 31, 2015 include $7.8 million of catastrophe related losses. During the year ended December 31, 2016 and 2015, the Standard Commercial Segment reported favorable prior year net loss reserve development of $9.9 million and $7.4 million, respectively. The Standard Commercial Segment reported a net expense ratio of 33.0% for the year ended December 31, 2016 as compared to 32.6% for the same period of 2015. The increase in the expense ratio was primarily due to the runoff of our Workers Compensation operating unit and the discontinued marketing of new and renewal occupational accident policies during 2016.
Our Personal Segment reported a pre-tax loss of $6.8 million for the year ended December 31, 2016 as compared to pre-tax loss of $0.9 million for the same period of 2015. The pre-tax loss was the result of increased losses and LAE of $9.0 million and increased operating expenses of $1.2 million, partially offset by the increased revenue discussed above.
The Personal Segment reported a net loss ratio of 98.7% for the year ended December 31, 2016 as compared to 88.6% for the same period in 2015. The gross loss ratio before reinsurance was 94.8% for the year ended December 31, 2016 as compared to 80.8% for the same period in 2015. The higher gross and net loss ratios were primarily the result of unfavorable prior year net loss reserve development of $5.0 million for the year ended December 31, 2016 as compared to unfavorable prior year net loss reserve development of $2.6 million for the same period of 2015, as well as higher current accident year loss trends. The increase in operating expenses of $1.2 million was the combined result of $0.4 million increase in other operating expenses driven by our investment in technology, a $0.3 million increase in production related expenses, a $0.4 million increase in salary and related expenses and a $0.1 million increase in professional service fees and occupancy expenses. The Personal Segment reported a net expense ratio of 21.5% for the year ended December 31, 2016 as compared to 19.0% for the same period of 2015.
Our MGA Commercial Products operating unit reported a $2.8 million increase in loss and LAE for the year ended December 31, 2015 as compared to the same period of 2014. Our MGA Commercial Products operating unit reported $1.2 million of unfavorable prior year loss reserve development during the year ended December 31, 2015 as compared to $5.3 million of unfavorable prior year loss reserve development reported 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. Our specialty programs reported a $3.2 million decrease in loss and LAE due primarily to $1.4 million of favorable prior year net loss reserve development recognized during the year ended December 31, 2015 as compared to $0.6 million of favorable prior year net loss reserve development recognized for the same period the prior year as well as the impact of a quota share agreement entered into during the second quarter of 2014. 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 Specialty Commercial Segment reported a net loss ratio of 62.6% for the year ended December 31, 2015 as compared to 65.5% for the same period during 2014. The gross loss ratio before reinsurance was 61.6% for the year ended December 31, 2015 as compared to 65.7% for the same period in 2014. The lower gross and net loss ratio included $2.1 million of favorable prior year loss reserve development for the year ended December 31, 2015 as compared to $3.7 million of unfavorable prior year loss reserve development for the same period during 2014.
Our Standard Commercial Segment reported pre-tax income of $6.7 million for the year ended December 31, 2015 which was $2.1 million higher than the $4.6 million reported for the same period of 2014. Lower loss and LAE of $4.1 million was the primary driver for the higher pre-tax income, as well as lower operating expenses of $2.6 million, partially offset by the decreased revenue discussed above.
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.
Total revenue for Corporate increased by $6.5 million for the year ended December 31, 2015 as compared to the same period the prior year. This increase in total revenue was due primarily to higher net investment income of $4.1 million as compared to the same period the prior year and higher net realized gains on our investment portfolio of $2.4 million recognized during the year ended December 31, 2015 as compared to the same period of 2014.
Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), commissions and processing and service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to meet operating expenses and debt obligations. As of December 31, 2016, Hallmark had $9.0 million in unrestricted cash and cash equivalents. Unrestricted cash and cash equivalents of our non-insurance subsidiaries were $6.1 million as of December 31, 2016. As of that date, our insurance subsidiaries held $64.5 million of cash and cash equivalents as well as $597.5 million in debt securities with an average modified duration of 3.0 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.
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 $1.1 million, $1.3 million and $1.1 million during each of 2016, 2015 and 2014, respectively.
Statutory capital and surplus is calculated as statutory assets less statutory liabilities. The various state insurance departments that regulate our insurance company subsidiaries require us to maintain a minimum statutory capital and surplus. As of December 31, 2016, our insurance company subsidiaries reported statutory capital and surplus of $248.4 million, substantially greater than the minimum requirements for each state. Each of our insurance company subsidiaries is also required to satisfy certain risk-based capital requirements. (See, “Item 1. Business - Insurance Regulation - Risk-based Capital Requirements.”) As of December 31, 2016, the adjusted capital under the risk-based capital calculation of each of our insurance company subsidiaries substantially exceeded the minimum requirements. Our total statutory premium-to-surplus percentage for the years ended December 31, 2016 and 2015 was 146% and 144%, respectively.
On a consolidated basis, our cash and investments, excluding restricted cash and investments, at December 31, 2016 were $733.8 million compared to $693.3 million at December 31, 2015. The primary reasons for this increase in unrestricted cash and investments were cash flow from operations, unsettled investment trades and an increase in investment fair values, partially offset by increase in capital expenditures, the repurchase of our common stock and a contingent purchase price payment to the sellers of TBIC Holding.
Comparison of Years Ended December 31, 2016 and December 31, 2015
Net cash provided by our consolidated operating activities was $30.9 million for the year ended December 31, 2016 compared to $52.9 million for the year ended December 31, 2015. The decrease in operating cash flow was primarily due to increased paid losses including timing of reinsurance claim settlements, partially offset by increased net collected premium, lower taxes paid, lower net paid operating expenses and higher collected net investment income.
Cash used in investing activities during the year ended December 31, 2016 was $58.2 million as compared to $96.3 million for the prior year. The decrease in cash used by investing activities during the year ended December 31, 2016 was comprised of a decrease in purchases of debt and equity securities of $24.1 million and an increase of $16.9 million in maturities, sales and redemptions of investment securities, partially offset by an increase in purchases of property and equipment of $0.7 million and a decrease in transfers from restricted cash of $2.2 million
Our Second Restated Credit Agreement with Frost Bank (“Frost”) dated June 30, 2015, reinstated the credit facility with Frost which expired by its terms on April 30, 2015. The Second Restated Credit Agreement also amended certain provisions of the credit facility and restated the agreement with Frost in its entirety. The Second Restated Credit Agreement provides a $15.0 million revolving credit facility (“Facility A”), with a $5.0 million letter of credit sub-facility. The outstanding balance of the Facility A 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 Facility A and letter of credit fees at the rate of 1.00% per annum. As of December 31, 2016, we had no outstanding borrowings under Facility A.
We may use Facility B loan proceeds solely for the purpose of making capital contributions to AHIC and HIC. As amended, we may borrow, repay and reborrow under Facility B until December 17, 2018, at which time all amounts outstanding under Facility B are converted to a term loan. Through December 17, 2018, we pay Frost a quarterly fee of 0.25% per annum of the average daily unused balance of Facility B. Facility B bears interest at a rate equal to the prime rate or LIBOR plus 3.00%, at our election. Until December 17, 2018, interest only on amounts from time to time outstanding under Facility B are payable quarterly. Any amounts outstanding on Facility B as of December 17, 2018 are converted to a term loan payable in quarterly installments over five years based on a seven year amortization of principal plus accrued interest. All remaining principal and accrued interest on Facility B become due and payable on December 17, 2023. As of December 31, 2016, we had $30.0 million outstanding under Facility B.
On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed a Delaware statutory trust, Hallmark Statutory Trust I (“Trust I”). Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated debt securities. The initial interest rate on our Trust I subordinated debt securities was 7.725% until June 15, 2015, after which interest adjusts quarterly to the three-month LIBOR rate plus 3.25 percentage points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of December 31, 2016, the principal balance of our Trust I subordinated debt was $30.9 million and the interest rate was 4.21% per annum.
(1) The subordinated debt securities excludes unamortized debt issuance costs of $1.0 million.
(2) 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.
(3) Minimum payments have not been reduced by minimum sublease rentals of $0.5 million due in the future under noncancelable subleases.
Based on 2017 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.