Direct Auto leases office space at 515 North State Street, Chicago, Illinois. Direct Auto employees at this location administer their non-standard auto business. This lease will expire on March 31, 2020, and the Company is evaluating its options to renew or relocate.
We believe that the offices currently occupied by each of our subsidiaries are sufficient for their needs and any expected growth in the near future.
You should read the selected financial data set forth below in conjunction with our historical Consolidated Financial Statements and related notes and with “
· Nodak Agency, Inc. - a wholly-owned subsidiary of Nodak Insurance;
· Battle Creek - an affiliated company of Nodak Insurance; and
The property and casualty insurance industry is affected by recurring industry cycles known as “hard” and “soft” markets. A soft cycle is characterized by intense competition resulting in lower pricing in order to compete for business. A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing. We believe that the market is generally in a stable phase as different portions of the market respond to higher frequency and severity of weather-related events.
The Company derives its revenue primarily from net premiums earned, net investment income, and net realized capital gain (loss) on investments.
Premiums earned is the earned portion of net premiums written. Gross premiums written include all premiums recorded by an insurance company during a specified policy period. Insurance premiums on property and casualty policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies or, in the case of crop insurance, over the period of risk to the Company. At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and is realized as revenue in subsequent periods over the remaining term of the policy or period of risk. NI Holdings’ property and casualty policies typically have a term of twelve months. For example, for an annual policy that is written on July 1, 2018, one-half of the premiums would be earned in 2018 and the other half would be earned in 2019.
Amortization of deferred policy acquisition costs and other underwriting and general expenses
NI Holdings uses the asset and liability method of accounting for deferred income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of its assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred income tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.
Premiums written represent a measure of business volume most relevant on an annual basis for the Company’s business model. This measure includes the amount of premium purchased by policyholders as of the policy’s effective date, whereas premiums earned
as presented in the statement of operations matches the amount of premium to the period of risk for those insurance policies. The Company’s insurance policies are sold with a variety of effective periods, including annual, semi-annual, and monthly.
The net premiums written to statutory surplus ratio represents the ratio of net premiums written to statutory surplus. This ratio is designed to measure the ability of the Company to absorb above-average losses and the Company’s financial strength. In general, a low premium to surplus ratio is considered a sign of financial strength because the Company is theoretically using its capacity to write more policies. Statutory surplus is determined using accounting principles prescribed or permitted by the insurance subsidiaries’ state of domicile and differs from GAAP equity.
When a catastrophe occurs, which in the Company’s case mostly involves the weather perils of wind and hail, NI Holdings utilizes mapping technology through geographic coding of its property risks to overlay the path of the storm. This enables the Company to establish estimated damage amounts based on the wind speed and size of the hail for case or per claim loss amounts. This process allows the Company to determine within a reasonable time (5 - 7 days) an estimated number of claims and estimated losses from the storm. If the Company estimates the damages to be in excess of its retained catastrophe amount, reinsurers are notified immediately of a potential loss so that the Company can quickly recover reinsurance payments once the retention is exceeded.
NI Holdings utilizes an independent actuary to assist with the estimation of its liability for unpaid losses and LAE. This actuary prepares estimates by first deriving an actuarially based estimate of the ultimate cost of total losses and LAE incurred as of the financial statement date based on established actuarial methods as described below. The Company then reduces the estimated ultimate loss and LAE by loss and LAE payments and case reserves carried as of the financial statement date. The actuarially determined estimate is based upon indications from one of the following actuarial methodologies or uses a weighted average of these results. The specific method used to estimate the ultimate losses would vary depending on the judgment of the actuary as to what is the most appropriate method for the property and casualty business. The Company’s management reviews these estimates and supplements the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and internal company processes. NI Holdings may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the Consolidated Financial Statements.
Other factors that have or can have an impact on the Company’s case and IBNR reserves include but are not limited to those described below.
Laws governing liability claims and judicial interpretations thereof can change over time, which can expand the scope of coverage anticipated by insurers when initially establishing reserves for claims. In addition, public attitudes regarding damage awards can result in judges and juries granting higher recoveries for damages than expected by claims personnel when claims are presented. In addition, these changes can result in both increased claim frequency and severity as both plaintiffs and their legal counsel perceive the opportunity for higher damage awards. Reserves established for claims that occurred in prior years would not have anticipated these legal changes and, therefore, could prove to be inadequate for the ultimate losses paid by the Company, causing the Company to experience adverse development and higher loss payments in future years.
Factors exist that can drive the cost to settle claims for reasons other than standard inflation. For example, demand surge caused by a very large catastrophe (as in the case of Hurricane Katrina) has an impact on not only the availability and cost of building materials such as roofing and other materials, but also on the availability and cost of labor. Other factors such as increased vehicle traffic in an area not designed to handle the increased congestion and increased speed limits on busy roads are examples of changes that could cause claim severity to increase beyond what the Company’s historic reserves would reflect. In addition, unexpected increases in the labor costs and healthcare costs that underlie insured risks, changes in costs of building materials, or changes in commodity prices for insured crops may cause fluctuations in the ultimate development of the case reserves.
As discussed above, NI Holdings and its actuary utilize historical patterns to provide an accurate estimate of what will take place in the future. Should we experience an unexpected delay in reporting time (claims are slower to be reported than in the past), our actuary or we may underestimate the anticipated number of future claims, which could cause the ultimate loss we may experience to be underestimated. A lag in reporting may be caused by changes in how claims are reported (online vs. through company personnel), the type of business or lines of business the Company is writing, the Company’s distribution system (direct writer, independent agent, or captive agent), and the geographic area where the Company chooses to insure risk.
As of December 31, 2018, the impact of a 1% change in our estimate for unpaid losses and LAE, net of reinsurance recoverables, on our net income, after income taxes of 21%, would be approximately $671.
When a claim is reported, claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. It is possible that the level of adequacy in the case reserve may differ from historical levels and/or the claims reporting pattern may change. The following table displays the impact on net income, after income taxes of 21%, which results from various changes to the level of case reserves as of December 31, 2018. This variance in future IBNR emergence could occur in one year or over multiple years, depending when the change is recognized.
NI Holdings evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis. NI Holdings assesses whether OTTI is present when the fair value of a security is less than its amortized cost. OTTI is considered to have occurred with respect to fixed income securities if (1) an entity intends to sell the security, (2) it is more likely than not an entity will be required to sell the security before recovery of its amortized cost basis, or (3) the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. When assessing whether the cost or amortized cost basis of the security will be recovered, the Company compares the present value of the expected cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the cost or amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the cost of amortized cost basis is referred to as the “credit loss”. If there is a credit loss, the impairment is considered to be other-than-temporary. If NI Holdings identifies that an other-than-temporary impairment loss has occurred, it then determines whether it intends to sell the security, or if it is more likely than not that the Company will be required to sell the security prior to recovering the cost or amortized cost basis less any current-period credit
losses. If NI Holdings determines that it does not intend to sell, and it is not more likely than not that it will be required to sell the security, the amount of the impairment loss related to the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of income taxes. If NI Holdings determines that it intends to sell the security, or that it is more likely than not that it will be required to sell the security prior to recovering its cost or amortized cost basis less any current-period credit losses, the full amount of the other-than-temporary impairment will be recognized in earnings.
For the year ended December 31, 2018, NI Holdings recognized $382 of other-than-temporary impairments of its investment securities. For the year ended December 31, 2017, NI Holdings recognized $330 of other-than-temporary impairments of its investment securities. For the year ended December 31, 2016, NI Holdings recognized no other-than-temporary impairments of its investment securities. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
For more information on the Company’s investments, see Note 6 to the Consolidated Financial Statements, included elsewhere in this Report.
The fair value estimates of NI Holdings’ investments provided by the independent pricing service at each period-end were utilized, among other resources, in reaching a conclusion as to the fair value of its investments.
Management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. Management reviews all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in common sectors, durations, and credit ratings. This review will also include all fixed income securities rated lower than “A” by Moody’s or Standard & Poor’s. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service. In its review, management did not identify any such discrepancies, and no adjustments were made to the estimates provided by the pricing service, for the years ended December 31, 2018 or December 31, 2017. The classification within the fair value hierarchy is then confirmed based on the final conclusions from the pricing review.
For more information on the Company’s fair value measurements, see Note 7 to the Unaudited Consolidated Financial Statements, included elsewhere in this Report.
No deferred policy acquisition costs (“DAC”) were recorded in the acquisition for Direct Auto in accordance with purchase accounting guidance. Rather, a separate intangible asset representing the value of business acquired (”VOBA”) was valued at $5,134
and established at the closing date. This VOBA intangible asset will be amortized into expense as the acquired unearned premiums are reported into income, in the same way as DAC. Policy acquisition costs relating to new business written by Direct Auto will be deferred following the closing date. The release of the VOBA asset and the establishment of new DAC will generally offset each other over the twelve months following the acquisition of Direct Auto.
At December 31, 2018 and 2017, deferred policy acquisition costs, the VOBA intangible asset, and the related liability for unearned premiums were as follows:
NI Holdings had gross deferred income tax liabilities of $5,865 at December 31, 2018 and $6,190 at December 31, 2017, arising primarily from deferred policy acquisition costs, intangible assets, and net unrealized capital gains on investments.
NI Holdings exercises significant judgment in evaluating the amount and timing of recognition of the resulting income tax liabilities and assets. These judgments require NI Holdings to make projections of future taxable income. The judgments and estimates the Company makes in determining its deferred income tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against its deferred income tax assets.
The effect of a change in income tax rates is recognized in the period of the enactment date. The TCJA enacted on December 22, 2017 changed the corporate income tax rate from 35% in 2017 and prior years, to 21% in 2018 and beyond. Although current income taxes payable for 2017 were not impacted, accounting guidance requires that deferred income tax assets and liabilities are re-valued upon date of enactment with the impact recorded in current year income tax expense. The impact to the Company’s deferred income taxes during 2017 was to reduce the Company’s net deferred income tax liability by $1,274, which is reflected as a reduction of income tax expense in the Consolidated Statement of Operations for the year ended December 31, 2017.
For more information on the Company’s results of operations by segment, see Note 21 to the Consolidated Financial Statements, included elsewhere in this Report.
The consolidated net income for NI Holdings was $31,244 for the year ended December 31, 2018 compared to $15,612 a year ago. The major components of NI Holdings’ operating revenues and net income for the two years were as follows:
NI Holdings’ net premiums earned for the year ended December 31, 2018 increased 9.1% to $195,720 compared to $179,464 a year ago.
Direct premiums earned for the year ended December 31, 2018 increased $30,182, or 15.9%, to $219,600 from $189,418 a year ago. Assumed premiums earned decreased slightly. Ceded premiums earned were $13,729 more in 2018 compared to 2017 due to increased ceding of 2018 crop insurance premiums back to the FCIC under the gain-sharing provision of the federal crop insurance program. The addition of the Direct Auto non-standard auto business contributed $14,516 to the net year-over-year increase of $16,256 in net premiums earned.
Our personal lines of business (private passenger auto, home and farm) continued to grow outside of North Dakota. Our non-standard auto business also grew year-over-year due to rate increases in Nevada and the addition of Direct Auto. Our crop business decreased $1,507 on a direct basis in 2018 compared to last year due to a combination of reduced acreage insured and lower commodity prices. On a net basis, crop premiums decreased $15,127 from increased ceding of premiums due to gain-sharing of favorable loss experience.
NI Holdings’ net losses and LAE for the year ended December 31, 2018 decreased 3.0% to $119,088 compared to $122,711 for the year ended December 31, 2017. The Company’s loss and LAE ratio decreased to 60.8% for 2018, compared to 68.4% for 2017.
Expense deferrals were $8,196 higher in 2018 than 2017 due to the increase in direct premiums written in 2018, whereas amortization of those costs was $4,106 higher in 2018 due to the increase in direct premiums earned in 2018. The net increase in deferrals is primarily due to the establishment of deferred policy acquisition costs on new business for Direct Auto after the acquisition.
Rate increases and other underwriting actions on our Primero non-standard auto business reduced the underwriting loss considerably from a year ago. Fee income attributable to this segment is a key component in measuring its profitability. The new Direct Auto non-standard auto business is expected to experience a lower loss and LAE ratio while generating only minimal fee income. Fee income on the non-standard auto business was $1,406 and $1,087 for the years ended December 31, 2018 and 2017, respectively.
Investment income, net of investment expense, increased $1,149 for the year ended December 31, 2018 compared to 2017. This increase is attributable to an increase in invested assets caused the timing of the investment actions taken with respect to the receipt of the proceeds of over $90 million from the Company’s initial public offering in March 2017. Cash and invested assets also increased a net $53,533 in September 2018 from the acquisition of Direct Auto. The majority of Direct Auto cash and invested assets was in short term cash and cash equivalents at the closing date. The weighted average gross yield on invested assets remained level of 2.5% in 2018 compared to 2017.
NI Holdings has evaluated each security in a loss position and taken into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. NI Holdings believes that the foregoing declines in fair value in its existing portfolio are most likely attributable to short-term market trends and there is no evidence that the Company will not recover the entire amortized cost basis.
For the year ended December 31, 2018, NI Holdings had pre-tax income of $38,572 compared to pre-tax income of $22,006 for the year ended December 31, 2017. The increase in pre-tax income was largely attributable to favorable loss experience in our crop business and our all other segment, the gain realized as a result of the purchase accounting afforded the acquisition of Direct Auto, and favorable operating results from Direct Auto.
NI Holdings recorded income tax expense of $7,328 for the year ended December 31, 2018, compared to $6,394 of income tax expense for the year ended December 31, 2017. Our effective tax rate for 2018 was 19.0% compared to an effective tax rate of 29.1% for 2017. Reported tax expense in 2017 included $568 of additional income tax expense related to the handling of expenses associated with the Company’s mutual to stock conversion and initial public offering and a $1,274 reduction of income tax expense due to a new corporate income tax rate of 21% for tax years 2018 and beyond, enacted on December 22, 2017. The previous tax rate was 35% for 2017 and prior.
For the year ended December 31, 2018, NI Holdings had net income before non-controlling interest of $31,244 compared to net income before non-controlling interest of $15,612 for 2017. This increase in net income was primarily attributable to favorable loss experience in our crop business and our all other segment, the gain realized as a result of the purchase accounting afforded the acquisition of Direct Auto, and favorable operating results from Direct Auto.
The consolidated net income for NI Holdings was $15,612 for the year ended December 31, 2017 compared to $4,638 a year ago. The major components of NI Holdings’ operating revenues and net income for the two years were as follows:
Private passenger auto, as well as home and farm, continued to grow outside of North Dakota. Both segments were favorably impacted by lower ceding of premiums due to a higher retention amount in our catastrophe reinsurance program in 2017. Our non-standard auto business was relatively flat year-over-year as rate increases were needed in Nevada to cover the higher losses experienced in this business. Our crop business experienced higher losses in 2017, which reduced the level of premium sharing required with the federal government on relatively flat direct premiums earned.
The underwriting results for our both our private passenger auto business and our home and farm business improved significantly year-over-year. The year ended December 31, 2016 included a high number of weather related events that generated underwriting losses. Strategic rating and underwriting actions across the personal lines of business, along with an average year of weather related losses, helped to bring those lines back to profitability.
The following table sets forth our average cash and invested assets, investment income, and return on average cash and invested assets for the reported periods:
Investment income, net of investment expense, increased $1,387 for the year ended December 31, 2017 compared to 2016. This increase is attributable to an increase in invested assets, as cash and invested assets increased to $313,885 at December 31, 2017 from $207,677 at December 31, 2016, primarily as a result of the proceeds from the Company’s IPO. The weighted average gross yield on invested assets decreased to 2.5% in 2017 compared to 2.7% in 2017.
The Company’s fixed income securities and equity securities are classified as available for sale because it will, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies. At December 31, 2017, the Company had net unrealized gains on fixed income securities of $1,780 and net unrealized gains on equity securities of $18,533. At December 31, 2016, the Company had net unrealized gains on fixed income securities of $1,210 and net unrealized gains on equity securities of $14,406.
For the year ended December 31, 2017, NI Holdings had pre-tax income of $22,006 compared to pre-tax income of $6,117 for the year ended December 31, 2016. The increase in pre-tax income was largely attributable to the decrease in losses and LAE on the private passenger auto and home and farm lines of business when compared to the higher level of weather related losses in 2016.
NI Holdings recorded income tax expense of $6,394 for the year ended December 31, 2017, compared to $1,479 of income tax expense for the year ended December 31, 2016. Income tax expense for 2017 included $568 of additional income tax expense related to the handling of expenses associated with the Company’s mutual to stock conversion and initial public offering and a reduction of $1,274 to income tax expense due to a new corporate income tax rate of 21% for tax years 2018 and beyond, enacted on December 22, 2017. Accounting guidance requires that companies re-measure existing deferred tax assets (including loss carryforwards) and liabilities and record an offset for the net amount as a component of income tax expense from continuing operations in the period of enactment. Any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforward should also be reflected as a component of income tax expense from continuing operations. In addition, the valuation allowance against certain deferred income tax assets decreased by $394 to $628 at December 31, 2017 from $1,022 at December 31, 2016.
For the year ended December 31, 2017, NI Holdings had annualized return on average equity, after non-controlling interest, of 7.9% compared to annualized return on average equity, after non-controlling interest, of 3.1% for the year ended December 31, 2016. Average equity is calculated as the average between beginning and ending equity excluding non-controlling interest for the year.
At December 31, 2018, total liabilities were $182,739, an increase of $61,324, or 50.5%, from December 31, 2017. The acquisition of Direct Auto on August 31, 2018 added $40,967 of unpaid losses and LAE as well as $15,955 of unearned premiums.
For the year ended December 31, 2018, net cash provided by operating activities totaled $20,955 compared to $18,425 a year ago. Consolidated net income of $31,244 for the year ended December 31, 2018 compared to $15,612 for the same period a year ago. Excluding the amounts directly attributed to the acquisition of Direct Auto, changes to the receivable from FCIC and federal income tax recoverable/payable offset the change to net income to result in only a modest change in cash flows provided by operating activities between 2018 and 2017.
Net cash provided by investing activities totaled $23,397 for the year ended December 31, 2018, compared to $91,857 net cash used in investing activities a year ago. The net cash provided in 2018 primarily relates to the acquisition of Direct Auto as the purchase price of $17,000 was more than offset by the cash and cash equivalents acquired in connection with the purchase ($44,485). The net cash used in 2017 primarily resulted from the opportunity to invest the excess cash raised from our initial public offering.
As a standalone entity, and outside of the net proceeds from the recent initial public offering, NI Holdings’ principal source of long-term liquidity will be dividend payments from Nodak Insurance and Direct Auto.
As a public company, NI Holdings is subject to the proxy solicitation, periodic reporting, insider trading, and other requirements of the Exchange Act and to most of the provisions of the Sarbanes-Oxley Act of 2002. As a result, NI Holdings anticipates incurring higher levels of expenses related to accounting and legal services that will be necessary to comply with such requirements.
The following table summarizes, as of December 31, 2018, NI Holdings’ future payments and estimated claims and claims related payments for continuing operations.
We have audited the accompanying consolidated balance sheets of NI Holdings, Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, changes in equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and the schedule listed in Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
The Company paid $10,300, $4,550, and $3,800 in federal income taxes during 2018, 2017, and 2016, respectively.
Our consolidated financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), include our accounts and those of our wholly-owned subsidiaries, as well as Battle Creek, an entity we control via contract. We have eliminated all significant inter-company accounts and transactions in consolidation. The terms “we”, “us”, “our”, or “the Company” as used herein refer to the consolidated entity.
We classify each fair value measurement at the appropriate level in the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted market price in active markets for identical assets or liabilities (Level I measurements) and the lowest priority to unobservable inputs (Level III measurements). An asset’s or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation.
We defer our policy acquisition costs, consisting primarily of commissions, premium taxes, and certain other underwriting costs, reduced by ceding commissions, which vary with and relate directly to the production of business. We amortize these deferred policy acquisition costs over the period in which we earn the premiums. The method we follow in computing deferred
policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs we expect to incur as we earn the premium.
We report property and equipment at cost less accumulated depreciation. Depreciation is computed using the straight-line method based upon estimated useful lives of the assets.
We maintain liabilities for unpaid losses and loss adjustment expenses with respect to both reported and unreported claims. We establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. We base the amount of our liability for reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim, and the insurance policy provisions relating to the type of loss our policyholder incurred. We determine the amount of our liability for unreported losses and loss adjustment expenses on the basis of historical information by line of insurance. Inflation is not explicitly selected in the loss reserve analysis. However, historical inflation is embedded in the estimated loss reserving function through analysis of costs and trends and reviews of historical reserving results. We closely monitor our liabilities and update them periodically using new information on reported claims and a variety of statistical techniques. We do not discount our liabilities for unpaid losses and loss adjustment expenses.
We account for deferred income taxes using the asset and liability method. The objective of the asset and liability method is to establish deferred income tax assets and liabilities for the temporary differences between the financial reporting basis and the income tax basis of our assets and liabilities at enacted tax rates expected to be in effect when we realize or settle such amounts.
Accounting guidance requires that companies re-measure existing deferred income tax assets (including loss carryforwards) and liabilities when a change in tax rate occurs, and record an offset for the net amount of the change as a component of income tax expense from continuing operations in the period of enactment. The guidance also requires any change to a previously recorded valuation allowance as a result of re-measuring existing temporary differences and loss carryforwards to be reflected as a component of income tax expense from continuing operations.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. In the event that all or any of the reinsuring companies might be unable to meet their obligations under existing reinsurance agreements, the Company would be liable for such defaulted amounts.
Goodwill represents the excess of the purchase price over the underlying fair value of acquired entities. When completing acquisitions, we seek also to identify separately identifiable intangible assets that we have acquired. We assess goodwill and other intangibles with an indefinite useful life for impairment annually. We also assess goodwill and other intangibles for impairment upon the occurrence of certain events. In making our assessment, we consider a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and current market data. Inherent uncertainties exist with respect to these factors and to our judgment in applying them when we make our assessment. Impairment of goodwill and other intangibles could result from changes in economic and operating conditions in future periods. We did not record any impairments of goodwill or other intangibles during the years ended December 31, 2018 or 2017.
Goodwill arising from the acquisition of Primero in 2014 represents the excess of the purchase price over the fair value of the net assets acquired. The purchase price in excess of the fair value of net assets acquired was negotiated at arms-length with an unrelated party and was based upon the strategic decision by Company management to expand both the geographic footprint and product lines of the Company. The nature of the business acquired was such that there were limited intangibles not reflected in the net assets acquired. The purchase price was paid with a combination of cash and cancellation of obligations owed to the acquired company by the sellers. The goodwill that arose from this transaction is included in the basis of the net assets acquired and is not deductible for income tax purposes.
We account for business acquisitions in accordance with the acquisition method of accounting, which requires, among other things, that most assets acquired, liabilities assumed, and contingent consideration be recognized at their fair values as of the acquisition date, which is the closing date for the Direct Auto transaction. During the measurement period, adjustments to provisional purchase price allocations are recognized if new information is obtained about the facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends as soon as it is determined that no more information is obtainable, but in no case shall the measurement period exceed one year from the acquisition date. The Company does not expect any adjustments during this period.
In 2018, the Company incurred $118 of acquisition-related costs. These expenses are included in other underwriting and general expenses in the Company’s Consolidated Statements of Operations for the year ended December 31, 2018. These expenses are reflected in pro forma earnings for the year ended December 31, 2017 in the table above.
The gain realized on bargain purchase of $4,578 from the Direct Auto acquisition is included in fee and other income in the Company’s Consolidated Statements of Operations for the year ended December 31, 2018.
As an emerging growth company, we have elected to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. The following discussion includes effective dates for both public business entities and emerging growth companies, as well as whether specific guidance may be adopted early.
In March 2016, the FASB issued amended guidance to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the Consolidated Statement of Cash Flows. All excess income tax benefits and income tax deficiencies should be recognized as income tax expense or benefit in the Consolidated Statement of Operations, instead of affecting additional paid-in-capital on the Consolidated Balance Sheet. These discrete income tax items should be classified along with other income tax cash flows as an operating activity on the Consolidated Statement of Cash Flows. In addition, cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity. This guidance is effective for annual periods beginning after December 15, 2016 for public business entities. For private companies and emerging growth companies, this guidance is effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Early adoption is permitted for all entities in any period. An entity that elects early adoption must adopt all amendments in the same period. Amendments requiring recognition of excess income tax benefits and income tax deficiencies in the Consolidated Statement of Operations should be applied prospectively. The Company early adopted this guidance on a prospective basis for the year ended December 31, 2017. At the date of adoption, there was an immaterial impact to the computation of diluted earnings per share, but no impact to the Company’s financial position or results of operations.
In January 2016, the FASB issued amended guidance that generally requires entities to measure equity securities at fair value and recognize changes in fair value in their results of operations. The FASB issued other impairment, disclosure, and presentation improvements related to financial instruments within the guidance. This guidance is to be applied through a cumulative-effect adjustment to beginning retained earnings that results in no impact to the Company’s results of operations at the date of adoption. We will adopt this standard on its effective date of January 1, 2019 for emerging growth companies. The most significant anticipated impact relates to the change in accounting for equity securities, where $8,184 of after-tax unrealized net capital gains will be reclassified from accumulated other comprehensive income to retained earnings as of January 1, 2019. The after-tax change in accounting for equity securities will not likely affect the Company’s total equity; however, this amount of unrealized net capital gains reclassified at the transition date to retained earnings will never be recognized in net income. Going forward, the accounting used for equity securities will record the market fluctuations attributed to equity securities through our results of operations rather than as a component of Other Comprehensive Income, which will add a level of volatility to our net income.
In May 2014, the FASB issued guidance that establishes the manner in which an entity recognizes the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. While the guidance will replace most existing GAAP revenue recognition guidance, the scope of the guidance excludes insurance contracts. The Company has reviewed its sources of revenues, and has determined that no material revenues are derived from non-insurance contracts and thus subject to the new revenue recognition guidance. This guidance is effective for annual and interim reporting periods beginning after December 15, 2017 for public business entities. For private companies and emerging growth companies, this guidance is effective for annual reporting periods beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted for all entities. We currently believe that this guidance will have no impact on our financial position, results of operations, or cash flows when we adopt this guidance for the year ended December 31, 2019.
In June 2016, the FASB issued a new standard that will require timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The guidance will require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better form their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Additionally, the guidance requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Finally, the guidance amends the accounting for credit losses on available-for-sale fixed income securities and purchased financial assets with credit deterioration. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 for public business entities which are SEC filers. For private companies and emerging growth companies, this guidance is effective for annual reporting periods beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021. Early adoption is permitted for all entities as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are evaluating the impact this new guidance will have on our financial position, results of operations, and cash flows.
Fixed income securities with a fair value of $4,900 at December 31, 2018 and $3,493 at December 31, 2017 were deposited with various state regulatory agencies as required by law. The increase was primarily due to the Direct Auto acquisition. The Company has not pledged any assets to secure any obligations.
The investment category and duration of the Company’s gross unrealized losses on fixed income securities and equity securities were as follows:
We frequently review our investment portfolio for declines in fair value. Our process for identifying declines in the fair value of investments that are other than temporary involves consideration of several factors. These factors include (i) the time period in which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects, and overall financial condition of the issuer, (iii) the significance of the decline, and (iv) our intent and ability to hold the investment for a sufficient period of time for the value to recover. When our analysis of the above factors results in the conclusion that declines in fair values are other than temporary, the cost of the securities is written down to fair value and the previously unrealized loss is therefore reflected as a realized capital loss on investment.
The Company recorded impairments of $382 in the year ended December 31, 2018. The Company recorded impairments of $330 in the year ended December 31, 2017. The Company did not record any impairments in 2016.
We maximize the use of observable inputs in our valuation techniques and apply unobservable inputs only to the extent that observable inputs are unavailable. The largest class of assets and liabilities carried at fair value by the Company at December 31, 2018 and 2017 were fixed income securities.
Our available-for-sale investments are comprised of a variety of different securities, which are classified into levels based on the valuation technique and inputs used in their valuation. The valuation of cash equivalents and equity securities are generally based on Level I inputs, which use the market-approach valuation technique. The valuation of our fixed income securities generally incorporates significant Level II inputs using the market and income approach techniques. We may assign a lower level to inputs typically considered to be Level II based on our assessment of liquidity and relative level of uncertainty surrounding inputs. There were no assets or liabilities classified at Level III at December 31, 2018 or 2017.
As a group, during the years ended December 31, 2018 and 2017, the Company retained the first $10,000 of weather-related losses from catastrophic events and had reinsurance under various reinsurance agreements up to $74,600 in excess of its $10,000 retained risk. For 2019, the catastrophe retention amount remains at $10,000 while the catastrophic reinsurance increased to $78,600. Prior to January 1, 2017, the group collectively retained the first $5,000 of weather-related losses.
The Company actively monitors and evaluates the financial condition of the reinsurers and develops estimates of the uncollectible amounts due from reinsurers. Such estimates are made based on periodic evaluation of balances due from reinsurers, judgments regarding reinsurers’ solvency, known disputes, reporting characteristics of the underlying reinsured business, historical experience, current economic conditions, and the state of reinsurer relations in general. Collection risk is mitigated from reinsurers by entering into reinsurance arrangements only with reinsurers that have strong credit ratings and statutory surplus above certain levels. The Company’s largest reinsurance recoverables on paid and unpaid losses were due from reinsurance companies with A.M. Best ratings of “A-” or higher, except for one reinsurer with a rating of “B++”, with a receiveable of $315 at December 31, 2018. This reinsurer was replaced during 2019, primarily due to the 2018 downgrade.
A reconciliation of direct to net losses and loss adjustment expenses is as follows:
If 100% of our ceded reinsurance was cancelled as of December 31, 2018, no ceded commissions would need to be returned to the reinsurers. Reinsurance contracts are typically effective from January 1 through December 31 each year.
The following table presents required supplementary information about average historical claims duration as of December 31, 2018:
Depreciation expense was $492, $500, and $441 during the years ended December 31, 2018, 2017 and 2016, respectively.
Total statutory revenues of Battle Creek, after intercompany eliminations, which is limited to net investment income, were $159, $153, and $174 during the year ended December 31, 2018, 2017, and 2016, respectively. There were no statutory-basis expenses reported, after intercompany eliminations, during the years ended December 31, 2018, 2017, and 2016.
The Company sponsors a money purchase plan that covers all eligible employees. Plan costs are funded annually as they are earned. The Company’s contributions expense to the money purchase plan totaled $598, $854, and $762 during the years ended December 31, 2018, 2017, and 2016, respectively.
Effective April 28, 2016, the Board of Directors authorized a non-qualified deferred compensation plan covering key executives of the Company as designated by the Board of Directors. The Company’s policy is to fund the plan in a given calendar year by amounts that exceed the maximum contribution allowed by the Employee Retirement Income Security Act (“ERISA”), beginning in 2017. The Company’s expenses included $451 and $183 for the years ended December 31, 2018 and 2017, respectively.
It is anticipated that the only assets held by the ESOP will be shares of the Company’s common stock. Participants in the ESOP cannot direct the investment of any assets allocated to their accounts. The initial ESOP participants are employees of Nodak Insurance. The employees of Primero and Direct Auto will not participate in the ESOP. American West and Battle Creek have no employees.
The Company recognized compensation expense of $400 and $401 during the years ended December 31, 2018 and 2017, respectively.
At December 31, 2018 and 2017, the Company, other than Battle Creek, had no income tax related carryovers for net operating losses, alternative minimum tax credits, or capital losses. Battle Creek, which files its income tax returns on a stand-alone basis, had net operating loss carryovers of $4,786 and $4,951 at December 31, 2018 and 2017, respectively. The net operating loss carryforward expires beginning in 2021 through 2030.
Our Primero subsidiary leases a facility in Spearfish, South Dakota under a non-cancellable operating lease expiring in 2023. Our Direct Auto subsidiary leases a facility in Chicago, Illinois under a non-cancellable operating lease expiring in 2020. We leased equipment and software under non-cancellable operating leases expiring at various times through 2017. There were expenses of $140, $80, and $74 related to these leases during the years ended December 31, 2018, 2017, and 2016, respectively.
As of December 31, 2018, we have minimum future commitments under non-cancellable leases as follows:
On February 28, 2018, our Board of Directors approved an authorization for the repurchase of up to approximately $10 million of the Company’s outstanding common stock. We completed the repurchase of 191,265 shares of our common stock for $2,996 during the three months ended December 31, 2018, and reflected the cost of this treasury stock as a reduction of Equity within our Consolidated Balance Sheet as of December 31, 2018.
On December 1, 2017, the Compensation Committee awarded RSUs to non-employee directors and select executives. RSUs are promises to issue actual shares of common stock at the end of a vesting period. The RSUs granted to executives under the Plan were based on salary and generally vest 20% per year over a five-year period, while RSUs granted to non-employee directors vested in May 2018. Dividend equivalents on RSUs are accrued during the vesting period and paid in cash at the end of the vesting period, but are subject to forfeiture until the underlying shares become vested. Participants do not have voting rights with respect to RSUs. On March 1, 2018, the first tranche of executive RSUs vested.
At December 31, 2018, there was $664 of unrecognized compensation cost related to outstanding RSUs. That cost is expected to be recognized over a weighted-average period of 3.31 years.
A summary of the Company’s outstanding PSUs for the year ended December 31, 2018, is presented below:
As described in Note 1, the conversion of the mutual company to a stock company resulted in the issuance of NI Holdings common shares on March 13, 2017. Earnings per share is computed by dividing net income available to common shareholders for the period by the weighted average number of common shares outstanding for the same period. The weighted average number of common shares outstanding was 22,358,858 and 22,512,401 for the years ended December 31, 2018 and 2017, respectively. For the period prior to the date of the conversion, we assumed that the net common shares issued in the initial public offering of 22,760,000 shares were outstanding since January 1, 2017.
The loss and LAE ratio equals losses and loss adjustment expenses divided by net premiums earned. The expense ratio equals amortization of deferred policy acquisition costs and other underwriting and general expenses, divided by net premiums earned. The combined ratio equals losses and loss adjustment expenses, amortization of deferred policy acquisition costs, and other underwriting and general expenses, divided by net premiums earned.
We do not assign or allocate all Consolidated Statement of Operations or Consolidated Balance Sheet line items to our operating segments. Those line items include investment income, net realized capital gain on investments, other income excluding non-standard auto insurance fees, and income taxes within the Consolidated Statement of Operations. For the Consolidated Balance Sheet, those items include cash and investments, property and equipment, other assets, accrued expenses, federal income taxes recoverable or payable, and equity.
The following table presents selected information, as filed with insurance regulatory authorities, for our insurance subsidiaries as determined in accordance with accounting practices prescribed or permitted by such insurance regulatory authorities as of and for the years ended December 31, 2018, 2017 and 2016: