Our headquarters is located at 1101 First Avenue North, Fargo, North Dakota, which is also the headquarters of Nodak Mutual. Nodak Mutual owns this building and leases a portion of the building to the North Dakota Farm Bureau and to American Farm Bureau Insurance Services, Inc.
You should read the selected financial data set forth below in conjunction with our historical consolidated financial statements and related notes and with “
For the year ended December 31, 2016, Nodak Mutual had consolidated direct premiums written of $180.9 million, consolidated net premiums earned of $152.8 million, and consolidated net income of $4.6 million. For the year ended December 31, 2015, Nodak Mutual had consolidated direct premiums written of $172.8 million, consolidated net premiums earned of $139.5 million, and consolidated net income of $17.5 million. For the year ended December 31, 2014, Nodak Mutual had consolidated direct premiums written of $156.0 million, consolidated net premiums earned of $131.9 million, and consolidated net income of $13.8 million. At December 31, 2016, Nodak Mutual had total assets of $278.7 million and equity of $153.4 million.
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. Nodak Mutual believes that the market is in transition toward a hard market after remaining moderately stable since 2010.
Nodak Mutual derives its revenue primarily from premiums earned, net investment income, and net realized gains (losses) from 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. 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. Nodak Mutual’s property and casualty policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2016, one-half of the premiums would be earned in 2016 and the other half would be earned in 2017.
Nodak Mutual invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expenses) in cash, cash equivalents, equities and debt securities. Investment income includes interest and dividends earned on invested assets. Net realized gains and losses on invested assets are reported separately from net investment income. Nodak Mutual recognizes realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost, as applicable. Nodak Mutual’s portfolio of investment securities is managed by Conning, Inc., who has discretion to buy and sell securities in accordance with the investment policy approved by our board of directors.
Loss and LAE represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims, including legal fees.
Amortization of deferred policy acquisition costs and underwriting and administrative expenses
Nodak Mutual evaluates its insurance operations by monitoring certain key measures of growth and profitability. In addition to reviewing its financial performance based on results determined in accordance with GAAP, Nodak Mutual utilizes certain non-GAAP financial measures that are used widely in the property and casualty insurance industry and which it believes are valuable in managing its business and for comparison to its peers. These non-GAAP measures are the expense ratio, loss and LAE ratio, combined ratio, written premiums, ratio of net written premiums to statutory surplus, underwriting income, return on average equity, and risk based capital.
Nodak Mutual uses net income (loss) to measure its profit and return on average equity to measure its effectiveness in utilizing equity to generate net income. In determining return on average equity for a given year, net income (loss) is divided by the average of the beginning and ending equity for that year.
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. Nodak Mutual is required to make estimates and assumptions in certain circumstances that affect amounts reported in its financial statements and related footnotes. Nodak Mutual evaluates these estimates and assumptions on an ongoing basis based on historical developments, market conditions, industry trends, and other information that
it believes to be reasonable under the circumstances. There can be no assurance that actual results will conform to its estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. Nodak Mutual believes the following policies are the most sensitive to estimates and judgments.
As multi-peril crop insurance claims must be reported within a specified time period established by the Federal Crop Insurance Corporation, this line of business is not impacted by IBNR loss or LAE reserves. The Company estimates losses on a quarterly basis based upon historical loss patterns, current crop conditions, current weather patterns, and input from crop loss adjusters. These estimates have proven to be a very good indicator of the Company’s anticipated losses for this line of business.
Nodak Mutual utilizes an independent actuary to assist with the estimation of its loss and LAE reserves in September and December of each year. This actuary prepares estimates of the ultimate liability for unpaid losses and LAE based on established actuarial methods described below. Nodak Mutual’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 changes in internal company processes and strategy. Nodak Mutual may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the financial statements.
Ratio of Paid ALAE to Paid Loss Method - This method utilizes the ratio of paid adjusted loss adjustment expense to paid losses and is similar to the Paid and Case Incurred Methods described above, except that the data projected are the ratios of paid adjusted loss adjustment expense to paid losses. The projected ultimate ratio is then multiplied by the selected ultimate losses, by accident year, to yield ultimate adjusted loss adjustment expense. Adjusted loss adjustment expense reserves are calculated by subtracting paid losses from ultimate adjusted loss adjustment expense.
There is an inherent amount of uncertainty in the establishment of insurance liabilities. This uncertainty is greatest in the current and most recent accident years due to the relative newness of the claims being reported and the relatively small percentage of these claims that have been reported, investigated, and adjusted by the company’s claims staff. Therefore, the reserves carried in these more recent accident years are generally more conservative than those carried for older accident years. As the company has the opportunity to investigate and adjust the reported claims, both the case and IBNR reserves are adjusted to more closely reflect the ultimate expected loss.
Changes in company personnel and/or the approach to how claims are reported, adjusted, and reserved may affect the reserves established by a company. As discussed above, the setting of IBNR reserves is not an exact science and involves the expert judgment of an actuary. One actuary’s reserve opinion may differ slightly from another actuary’s opinion. This is the primary reason why the IBNR reserve estimate is customarily reported as a range by a company’s actuary, which provides the company with an acceptable “range” to use in establishing its estimate for IBNR reserves.
company’s IBNR reserves. Should the economic inflation rate increase significantly, it is likely that a company may not anticipate the need to adjust the IBNR reserves accordingly, which could lead to the company being deficient in its IBNR reserves.
When establishing IBNR reserves, Nodak Mutual’s actuary takes into account many of the factors discussed above. One of the more important factors that is considered when setting reserves is the past or historical claim settlement experience. Our actuary considers factors such as the number of files entering litigation, payment patterns, length of time it takes company claims personnel to settle the claims, and average payment amounts when estimating reserve amounts. Should future settlement patterns change due to legal environment, company claims handling philosophy, or personnel, it may have an impact on the future claims payments, which could cause existing reserves to either be redundant (excessive) or deficient (below) compared to the actual loss amount.
As discussed above, Nodak Mutual and its actuary utilize historical patterns to provide an accurate estimate of what will take place in the future. Should we experience a change in reporting time (claims are slower to be reported than in the past), we or our actuary may underestimate the anticipated number of future claims, which could cause us and our actuary to underestimate the ultimate loss we may experience. 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 geographic area where the company chooses to insure risk.
Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for loss and loss adjustment expenses may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. Nodak Mutual reflects adjustments to loss reserves in the results of operations in the period the estimates are changed.
Nodak Mutual’s actuary is required to exercise a considerable degree of judgment in the evaluation of all of these and other factors in the analysis of Nodak Mutual’s loss and LAE reserves and the related range of anticipated losses. The method of determining the loss reserves has not changed and the reserve generated by Nodak Mutual’s actuary is consistent with the observed development of Nodak Mutual’s loss reserves over the last few years.
Specifically, the following factors could impact the frequency and severity of claims, and therefore, the ultimate amount of loss and LAE paid:
The following table provides case and IBNR reserves for losses and loss adjustment expenses as of December 31, 2016, 2015 and 2014.
The projections make no provision for extraordinary future emergence of new classes of losses or types of losses not sufficiently represented in the Company’s historical data base or which are not yet quantifiable. Also, there may be a change in the
Management has identified the impact on earnings of various factors used in establishing loss reserves so that users of the Company’s financial statements can better understand how development on prior years’ reserves might impact the Company’s results of operations.
Inflation includes actual inflation as well as social inflation which includes future emergence of new classes of losses or types of losses, change in judicial awards, and any other changes beyond assumed levels that impact the cost of claims.
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 tax that results from various changes from the historical inflation factor that is implicitly embedded in the estimated payment pattern to develop the reserves as of December 31, 2016. This variance in future IBNR emergence could occur in one year or over multiple years, depending when the change is recognized.
relationship or ratio, between ULAE and losses paid. This ratio is used to estimate the required ULAE reserve. Consequently, this component of the loss expense reserve has a proportional relationship to the overall loss reserves excluding loss adjustment expense. This method assumes that the underlying claims process and mix of business do not change materially from period to period.
The fair value and unrealized losses for Nodak Mutual’s securities that were temporarily impaired as of December 31, 2016, 2015 and 2014 are as follows:
For the year ended December 31, 2016, Nodak Mutual’s fixed income portfolio experienced gross unrealized losses of $1.2 million due to decreases in fair values. Most of the decrease in fair value in our fixed maturity portfolio was in industrial and miscellaneous fixed maturity investments as a result of increases in prevailing interest rates.
Nodak Mutual has evaluated each security and taken into account the severity and duration of any impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. Nodak Mutual’s fixed maturity portfolio is managed by Conning Asset Management, which specializes in the handling of insurance company assets.
For the year ended December 31, 2016, Nodak Mutual recognized no other-than-temporarily impairments of its investment securities. For the year ended December 31, 2015, Nodak Mutual recognized impairments totaling $0.1 million. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
Nodak Mutual uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, Nodak Mutual may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy under ASC Topic 820 are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 includes debt securities with quoted prices that are traded less frequently then exchange traded instruments. Valuation techniques include matrix pricing which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).
Should the independent pricing service be unable to provide a fair value estimate, Nodak Mutual attempts to obtain a non-binding fair value estimate from a number of broker-dealers and reviews this estimate in conjunction with a fair value estimate reported by an independent business news service or other sources. In instances where only one broker-dealer provides a fair value for a fixed maturity security, Nodak Mutual uses that estimate. In instances where Nodak Mutual is able to obtain fair value estimates from more than one broker-dealer, Nodak Mutual reviews the range of estimates and selects the most appropriate value based on the facts and circumstances. Should neither the independent pricing service nor a broker-dealer provide a fair value estimate, Nodak Mutual develops a fair value estimate based on cash flow analyses and other valuation techniques that utilize certain unobservable inputs. Accordingly, Nodak Mutual classifies such a security as a Level 3 investment.
Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. At December 31, 2016 and 2015, deferred acquisition costs and the related unearned premium reserves were as follows (dollars in thousands):
The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, loss and LAE, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected loss and LAE, may require adjustments to deferred acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off or a premium deficiency reserve would be established.
Nodak Mutual had gross deferred income tax assets of $6.6 million at December 31, 2016. A valuation allowance is required to be established for any portion of the deferred income tax asset for which Nodak Mutual believes it is more likely than not that it will not be realized. Valuation allowances of $1.0 million, $1.1 million, and $1.1 million had been established at December 31, 2016, 2015, and 2014, respectively.
Nodak Mutual exercises significant judgment in evaluating the amount and timing of recognition of the resulting income tax liabilities and assets. These judgments require Nodak Mutual to make projections of future taxable income. The judgments and estimates Nodak Mutual 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 Nodak Mutual to record a valuation allowance against its deferred income tax assets.
As of December 31, 2016, Nodak Mutual had no material unrecognized tax benefits or accrued interest and penalties. Federal tax years 2013 through 2016 are open for examination.
Nodak Mutual premium levels and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle and makes it difficult to attract and retain properly priced commercial business. The markets Nodak Mutual serves and national property and casualty insurance markets are currently in transition from moderate stability to a hard market. Therefore, it is generally likely that insurers will be able to increase their rates or profit margins. A hard market typically has a positive effect on premium growth.
Nodak Mutual’s premiums earned increased 9.5% for the year ended December 31, 2016 compared to the year ended December 31, 2015 primarily due to growth in our personal lines business outside of North Dakota.
Investment income, net of investment expense, increased approximately $62,000 for the year ended December 31, 2016 compared to 2015. This increase is attributable to an increase in invested assets, as cash and invested assets increased from $197.8 million at December 31, 2015 to $207.7 million at December 31, 2016. This increase more than offset a decrease in the weighted average yield on invested assets from 2.2% in 2015 to 2.1% in 2016 as higher yielding fixed maturity securities matured and were replaced with lower yielding securities.
Underwriting income (loss) measures the pretax profitability of a company’s insurance business. It is derived by subtracting loss and loss adjustment expenses, amortization of deferred acquisition costs, and underwriting and administrative expenses from earned premiums. Each of these captions is presented in our statements of operations but not subtotaled. The sections below provide more insight into the variances in the categories of loss and loss adjustment expenses and amortization of deferred policy acquisition costs and underwriting and administrative expense, which impact underwriting profitability.
Total underwriting and administrative expenses, including amortization of deferred acquisition costs, increased $3.1 million in 2016, or 8.5% higher than in 2015. This increase is due to an increase of $1.8 million in amortization of deferred acquisition costs and an increase of $1.3 million in other underwriting and general expenses.
Nodak Mutual’s results of operations are influenced by factors affecting the property and casualty insurance and crop insurance industries in general. The operating results of the United States property and casualty industry and crop insurance industry are subject to significant variations due to competition, weather, catastrophic events, changes in regulation, general economic conditions, rising medical expenses, judicial trends, fluctuations in interest rates and other changes in the investment environment.
Premiums in the crop insurance business are mainly influenced by the number of acres planted and types of crops insured because the pricing is set by the RMA.
As discussed above, Nodak Mutual evaluates its insurance operations by monitoring certain key measures of growth and profitability. In addition to using GAAP based performance measurements, Nodak Mutual also utilizes certain non-GAAP financial measures that are used widely in the property and casualty insurance industry and that it believes are valuable in managing its business and for comparison to its peers. These non-GAAP measures are underwriting income (loss), expense ratio, loss and LAE ratio, combined ratio, written premiums, net written premiums to statutory surplus ratio, and return on average equity.
Nodak Mutual’s loss and LAE ratio decreased to 60.1% in 2015, compared to 67.7% for the same period in 2014, primarily due to loss and loss adjustment expenses decreasing 6.1% in 2015 compared to 2014, due primarily to decreased losses on its crop insurance products in 2015.
For the year ended December 31, 2015, Nodak Mutual had pre-tax income of $25.9 million compared to pre-tax income of $20.2 million for the year ended December 31, 2014. The increase in pre-tax income was largely attributable to the decrease in loss and loss adjustment expense in the crop insurance line.
For the year ended December 31, 2015, Nodak Mutual had net income after noncontrolling interest of $17.5 million compared to net income after noncontrolling interest of $13.8 million for 2014. This increase in net income is primarily attributable to reduced loss and loss adjustment expense in the company’s crop insurance business.
At December 31, 2016, Nodak Mutual had total assets of $278.7 million, compared to total assets of $258.6 million at December 31, 2015. At December 31, 2016, total liabilities were $125.3 million, compared to $108.7 million at December 31, 2015. The $16.6 million increase was primarily due to the increase of approximately $4.0 million in unearned premiums and an increase of $14.3 million in the reserve for unpaid loss and LAE. The reserve for unpaid loss and LAE was $59.6 million at December 31, 2016, compared to $45.3 million at December 31, 2015. This increase was due primarily to a significant increase in weather related losses incurred during the second quarter of 2016 as a result of multiple weather events.
At December 31, 2015, total liabilities were $108.7 million, compared to $111.5 million at December 31, 2014. The $2.8 million decrease was primarily due to a decline in reserves for unpaid loss and LAE. The reserve for unpaid loss and LAE was $45.3 million at December 31, 2015, compared to $50.5 million at December 31, 2014. This decrease was due primarily to crop and weather related losses in 2014.
Nodak Mutual generates sufficient funds from its operations and maintains a high degree of liquidity in its investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of funds are premium collections, investment earnings and maturing investments. In addition, we raised $93.4 million in net proceeds from our initial public offering, which we are able to use to meet the demands of claim settlements and operating expenses.
Nodak Mutual maintains investment and reinsurance programs that are intended to provide sufficient funds to meet its obligations without forced sales of investments. Nodak Mutual maintains a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.
The following table summarizes, as of December 31, 2016, Nodak Mutual’s future payments and estimated claims and claims related payments for continuing operations.
In February 2015, the FASB issued a new standard that amends the current consolidation guidance affecting both the variable interest entity (“VIE”) and voting interest entity (“VOE”) consolidation models. The standard does not add or remove any of the characteristics in determining if an entity is a VIE or a VOE, but rather, the standard enhances assessment of some of these characteristics. The new standard was effective on December 15, 2015. The adoption of this new guidance did not have a significant impact on our financial position, results of operations or cash flows.
In May 2015, the FASB issued guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The guidance also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. The guidance instead limits disclosure to investments for which the entity has elected to measure fair value using that practical expedient. The guidance was effective for annual reporting periods beginning after December 15, 2015, and interim reporting periods within those annual reporting periods. The adoption of this new guidance did not have a significant impact on our financial position, results of operations or cash flows.
We have audited the accompanying consolidated balance sheets of Nodak Mutual Insurance Company and Subsidiaries (collectively, the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, change in equity, and cash flows for each of the years in the three-year period ended December 31, 2016. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
Primero Insurance Company is a wholly owned subsidiary of Tri-State, Ltd. Tri-State, Ltd. is a non-active shell corporation 100% owned by Nodak Mutual. Primero is a property/casualty insurance company solely writing non-standard automobile coverage in the states of Nevada, Arizona, North Dakota and South Dakota.
Battle Creek is controlled by Nodak Mutual via a surplus note and 100% quota share agreement. The terms of the surplus note and quota share allow Nodak Mutual to appoint two-thirds of the Board of Directors. Battle Creek is a property/casualty insurance company writing personal auto, homeowners, and farm coverages solely in the state of Nebraska.
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 evaluate whether we are the primary beneficiary of each VIE and we consolidate the VIE if we have both (1) the power to direct the economically significant activities of the entity and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity. We consider the contractual agreements that define the ownership structure, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights and board representation of the respective parties in determining whether we qualify as the primary beneficiary. Our assessment of whether we are the primary beneficiary of a VIE is performed at least annually.
We control Battle Creek via a 100% quota share reinsurance agreement between Nodak Mutual and Battle Creek, as well as the ability to control a majority of the Board of Directors of Battle Creek. Through the effects of the 100% quota share agreement with Battle Creek, we are considered the primarily beneficiary of Battle Creek’s operating results excluding investment income, bad debt expense, and income taxes. Therefore, we consolidate Battle Creek and Battle Creek’s policyholders’ interest in Battle Creek is reflected as non-controlling interests in equity in our consolidated balance sheet.
Cash and cash equivalents include certain investments in highly liquid debt instruments with original maturities of three months or less. Cost approximates fair value for these short term investments.
We review our investments each quarter to determine whether a decline in fair value below the amortized cost basis is other than temporary. Accordingly, we assess whether we intend to sell or it is more likely than not that we will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as a loss in the consolidated statement of operations, but is recognized in other comprehensive income.
We must establish the appropriate level in the fair value hierarchy for each fair value measurement. 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.
Certain amounts in 2015 and 2014 have been reclassified to conform to the 2016 presentation.
We record premiums written at policy inception and recognize them as revenue on a pro rata basis over the policy term. The portion of premiums that could be earned in the future is deferred and reported as unearned premiums. When policies lapse, the Company reverses the unearned portion of the written premium and removes the applicable unearned premium. Policy-related fee income is recognized when collected.
The Company uses the direct write-off method for recognizing bad debts. Accounts are deemed to be delinquent after 60 days except for those accounts associated with amounts due from insureds for premiums, in which case policy cancellation procedures are commenced in accordance with state insurance regulations. Any earned but uncollected premiums are written off immediately upon the effective date of policy cancellation.
Liabilities for losses and loss adjustment expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to policyholder claims based on facts and circumstances then known. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss adjustment expenses will exceed or be less than such estimates. We base our estimates of liabilities for losses and loss adjustment expenses on assumptions as to future loss trends and expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, we may learn additional facts regarding certain claims, and consequently, it often becomes necessary for us to refine and adjust our estimates of liability. We reflect any adjustments to our liabilities for losses and loss adjustment expenses in our operating results in the period in which we determine the need for a change in the estimates.
We maintain liabilities for the payment of 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 claims and loss adjustment expenses on the basis of historical information by line of insurance. We account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. We closely monitor our liabilities and re-compute 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.
With the exception of Battle Creek, which files a stand-alone federal income tax return, we currently file a consolidated federal income tax return.
The Company reports any tax related interest and penalties, if incurred in its income tax expense, in the year such amounts are determinable.
Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolio of fixed income securities and, to a lesser extent, short-term investments is subject to credit risk. We define this risk as the potential loss in fair value resulting from adverse changes in the borrower’s ability to repay the debt. We manage this risk by performing an analysis of prospective investments and through regular reviews of our portfolio by our investment staff and advisors. We also limit the amount of our total investment portfolio that we invest in any one security.
We maintain cash balances primarily at one bank, which are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250. During the normal course of business, balances are maintained above the FDIC insurance limit. The Company maintains short-term investment balances in investment grade money market accounts that are insured by the Securities Investor Protection Corporation (“SIPC”) up to $500. On occasion, balances for these accounts are maintained in excess of the SIPC insurance limit.
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.
Advertising costs are expensed as they are incurred. Advertising expense was $846, $983 and $905 for the years ended December 31, 2016, 2015 and 2014, respectively.
Goodwill, representing the excess of the purchase price over the fair value of the net assets acquired, is reported separately in the consolidated balance sheet. 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 intangible assets 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 which arose from this transaction is included in the basis of the net assets acquired and this is not deductible for tax purposes.
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued guidance that requires an entity to recognize 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 new standard is effective on January 1, 2018. The standard permits the use of either the retrospective or the cumulative effect transition method. We do not expect the adoption of this new guidance to have a significant impact on our financial position, results of operations or cash flows.
In May 2015, the FASB issued guidance that requires entities to provide additional disclosures about their liability for unpaid losses and loss adjustment expenses to increase the transparency of significant estimates. The guidance also requires entities to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid losses and loss adjustment expenses, including the reasons for the changes and the effects on the entities’ financial statements, and the losses, frequency and severity of claims. The guidance also requires entities to disclose a rollforward of the liability for unpaid losses and loss adjustment expenses for annual and interim reporting periods. The guidance was effective for annual reporting periods beginning after December 15, 2015, and interim reporting periods within annual reporting periods beginning after December 15, 2016. The adoption of this new guidance did not have a significant impact on our financial position, results of operations or cash flows but changes to our disclosures were required.
In January 2016, the FASB issued guidance that generally requires entities to measure equity investments at fair value and recognize changes in fair value in their results of operations. The guidance also simplifies the impairment assessment of equity investments, without readily determinable fair values by requiring entities to perform a qualitative assessment to identify impairment. The FASB issued other disclosure and presentation improvements related to financial instruments within the guidance. The guidance is effective for annual and interim reporting periods beginning after December 15, 2017. As a result of this guidance, we will reflect changes in the fair value of our equity investments in our results of operations beginning January 1, 2018.
The purchase price of $12,025 was based on a negotiated price comprised of $10,295 in cash proceeds at closing, with subsequent settlement of affiliated balances of $1,730.
The assets acquired and liabilities assumed were adjusted to their estimated fair values as of the Tri-State Acquisition Date. The excess of purchase price over the estimated fair value of net assets created goodwill in the amount of $2,628.
The following table summarizes, for all securities in an unrealized loss position at December 31, 2016 and 2015, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position:
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 loss. The Company did not record any impairments in 2016 and recorded $139 of impairments on four equity securities in 2015. As of December 31, 2016, 129 fixed maturities have unrealized losses. In conjunction with our outside investment advisors, we analyzed the credit ratings of the securities as well as the historical monthly amortized cost to fair value ratio of securities in an unrealized loss position. This analysis yielded no fixed maturities which had amortized cost values less than 80% of fair value for the entire 12-month period of 2016.
The components of net realized capital gain (loss) on investments consisted of the following for the years ended December 31, 2016, 2015 and 2014:
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 1 inputs, which use the market approach valuation technique. The valuation of our fixed income securities, generally incorporate significant Level 2 inputs using the market and income approach techniques. We may assign a lower level to inputs typically considered to be Level 2 based on our assessment of liquidity and relative level of uncertainty surrounding inputs. There were no assets or liabilities classified at Level 3 at December 31, 2016 and 2015.
The following table sets forth our assets, which are measured on a recurring basis by the level within the fair value hierarchy in which fair value measurements fall as of December 31, 2016 and 2015:
A reconciliation of direct to net premiums on both a written and an earned basis is as follows for the years ended December 31, 2016, 2015 and 2014:
A reconciliation of direct to net losses and loss adjustment expenses is as follows for the years ended December 31, 2016, 2015 and 2014:
Activity with regards to our deferred policy acquisition costs during the years ended December 31, 2016, 2015 and 2014 is as follows:
The prior years’ provision for unpaid losses and loss adjustment expenses decreased by $4,756 and $8,888 during 2016 and 2015, respectively. The decrease is generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims.
The following tables present information about incurred and paid claims development as of December 31, 2016, net of reinsurance, as well as cumulative claim frequency and the total of IBNR reserves plus expected development on reported claims. The tables include unaudited information about incurred and paid claims development for the years ended December 31, 2007 through 2015, which we present as supplementary information.
The following table presents required supplementary information about average historical claims duration as of December 31, 2016:
The Company sponsors a money purchase plan that covers all eligible employees. Plan costs are fully funded as they accrue. The Company’s total contribution to the money purchase plan totaled $762, $701 and $778 for 2016, 2015 and 2014, respectively. The Company also sponsors a 401(k) plan with an automatic contribution to all eligible employees and a matching contribution for eligible employees of 50% up to 3% of eligible compensation. The Company’s total contributions to the 401(k) plan totaled $423, $390 and $432 for 2016, 2015 and 2014, respectively. All fees associated with both plans are deducted from the eligible employee accounts.
Nodak Mutual has a line of credit with Wells Fargo, N.A. for $3,000, of which there were no outstanding amounts as of December 31, 2016 and 2015. The line of credit expires on October 31, 2017.
The components of our provision for income taxes for the years ended December 31, 2016 and 2015 are as follows:
The provision for income taxes differs from the amount that would be computed by applying the statutory federal rate to income before provision for income taxes for the years ended December 31, 2016 and 2015 as a result of the following:
The tax effects of temporary differences that give rise to significant portions of our deferred income tax assets and deferred income tax liabilities at December 31, 2016 and 2015 are as follows:
At December 31, 2016 and 2015, 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 $5,171 and $5,349 of net operating loss carryover at December 31, 2016 and 2015, respectively, and $247 of net capital loss carryovers at December 31, 2015. The net operating loss carryforward expires beginning in 2021 through 2030. In 2016, the $247 capital loss carryover expired and none of the capital loss carryover was utilized against realized capital gains. In 2015, $202 of capital loss carryover expired and none of the capital loss carryover was utilized against capital gains.
State insurance laws require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance subsidiaries are subject to regulations that restrict the payment of dividends from statutory surplus and may require prior approval from their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk based capital (“RBC”) requirements that may further impact their ability to pay dividends. Our insurance subsidiaries statutory capital and surplus at December 31, 2016 and 2015 exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements, by a significant margin. Amounts available for distribution to Nodak Mutual as dividends from its insurance subsidiaries without prior approval of insurance regulatory authorities are $1,180 in 2017 and $1,119 in 2016 from American West. No amounts were available from Primero Insurance Company in 2017 or 2016.
Reconciliations of statutory net income and capital and surplus, as determined using SAP, to the amounts included in the accompanying GAAP-basis financial statements are as follows as of and for the years ended December 31, 2016, 2015 and 2014:
We have three primary insurance product lines, which consist of multi-peril crop and hail, non-standard auto and other property and casualty coverages. We do not allocate assets, underwriting expenses or fee and other income to the individual product
lines and generally review the products in the aggregate for purposes of managerial decision making. We operate only in the United States, and no single customer or agent provides 10 percent or more of our revenues. The table below outlines revenue by insurance product line for the years ended December 31, 2016, 2015 and 2014.
The following table provides a summary of unaudited quarterly results for the periods presented (in thousands). Earnings per share data is not available for the quarterly periods presented as they occurred prior to the conversion and sale of stock.