We are a specialty personal lines insurance holding company. Through our subsidiaries, we provide a variety of insurance products, including personal and commercial automobile, homeowners and umbrella, supplemental health, lender-placed and other niche insurance products. We sell insurance products with a focus on underwriting profitability through a combination of our customized and predictive analytics and our technology driven low cost infrastructure.
The operating results of property and casualty insurance companies are subject to quarterly and yearly fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. While these cycles can have a large impact on a company’s ability to grow and retain business, we have sought to focus on niche markets and regions where we are able to maintain premium rates at generally consistent levels and maintain underwriting discipline throughout these cycles. We believe that the nature of our P&C insurance products, including their relatively low limits, the relatively short duration of time between when claims are reported and when they are settled, and the broad geographic distribution of our customers, have allowed us to grow and retain our business throughout these cycles. In addition, we have limited our exposure to catastrophe losses through reinsurance. With regard to seasonality, we tend to experience higher claims and claims expense in our P&C segment during periods of severe or inclement weather.
We evaluate our operations by monitoring key measures of growth and profitability, including net loss ratio, net combined ratio (non-GAAP) and operating leverage. We target a net combined ratio (non-GAAP) between 90% and 95% while seeking to maintain optimal operating leverage in our insurance subsidiaries commensurate with our A.M. Best rating objectives. To achieve our targeted net combined ratio (non-GAAP) we continually seek ways to reduce our operating costs and lower our expense ratio. For the year ended December 31, 2015, our operating leverage (the ratio of net earned premium to average total stockholders’ equity) was 1.6x, which was within our planned target operating leverage of between 1.5x and 2.0x.
Investment income is also an important part of our business. Because we often do not settle claims until several months or longer after we receive the original policy premiums, we are able to invest cash from premiums for significant periods of time. We invest our capital and surplus in accordance with state and regulatory guidelines. Our net investment income was $75.3 million, $52.4 million and $30.8 million for the years ended December 31, 2015, 2014 and 2013, respectively. We held 9.6% and 6.6%, of total invested assets in cash and cash equivalents as of December 31, 2015 and 2014, respectively.
ultimate settlement of claims, inflation of medical costs, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.
In April 2014, we purchased Personal Express Insurance Company (“Personal Express”), a California domiciled personal auto and home insurer from Sequoia Insurance Company, an affiliate of AmTrust. The purchase price was approximately $21.5 million, subject to certain adjustments.
In June 2014, we purchased certain assets of Imperial Management Corporation ("Imperial"), including its underwriting subsidiaries Imperial Fire & Casualty Insurance Company and National Automotive Insurance Company, its retail agency subsidiary ABC Insurance Agencies, and its managing general agency subsidiary RAC Insurance Partners. The purchase price was approximately $20.0 million. In connection with the Imperial transaction, we assumed certain debt of Imperial and Imperial Fire & Casualty Insurance Company (see Note 15, "Debt" in the notes to our consolidated financial statements).
In April 2015, we closed on the acquisition of Assigned Risk Solutions Ltd. ("ARS"), a New Jersey based managing general agency that services assigned risk, personal auto, and commercial lines of business, for a purchase price of approximately $48.0 million in cash and potential future earnout payments ("ARS Contingent Payments"). The fair value of the ARS Contingent Payments was estimated to be $4.1 million at December 31, 2015.
In November 2012, we acquired National Health Insurance Company (“NHIC”), a Texas-domiciled life and health insurer currently licensed in 48 states and the District of Columbia, to write our A&H risks. NHIC was established as a life and health insurer in 1979. NHIC offers a significant number of A&H insurance products for individuals and groups, which include life, accident, limited medical/hospital indemnity, short-term medical, cancer/critical illness, stop loss, travel accident/trip cancellation and dental/vision coverages.
In February 2012, we acquired VelaPoint, LLC ("VelaPoint"), a general agency that operates a call center with approximately 127 licensed agents selling a full range of supplemental medical insurance products, as well as individual major medical policies underwritten through a wide range of third-party insurance companies. For the year ended December 31, 2015, VelaPoint produced approximately $183.0 million in premium on behalf of third parties.
In February 2012, we acquired America’s HealthCare Plan (“AHCP”), a managing general agent/program manager. AHCP works with over 4,300 independent agents and general agents across the country to provide an array of insurance products, including those offered by third-party insurers, and serves as a significant method of distribution for NHIC’s products.
In September 2012, we acquired from the Coca-Cola Bottlers’ Association a health insurance administration company that administers specialty self-insurance arrangements, offering ERISA qualified self-insured plans to employers in affinity associations or trade groups and selling medical stop loss coverage to employers (collectively, the “TABS” companies). We believe the TABS companies, which wrote approximately $34.6 million in stop loss premium in 2015, have significant growth potential.
In January 2015, we closed on the acquisition of Healthcare Solutions Team, LLC (“HST”), an Illinois-based healthcare insurance general agency. We paid approximately $15.0 million on the acquisition date and agreed to pay potential future earnout payments ("HST Contingent Payments") based on the overall profitability of HST and the business underwritten by our insurance subsidiaries which is produced by HST. The fair value of the HST Contingent Payments was estimated to be $4.5 million at December 31, 2015.
In October 2015, we closed our acquisition of certain business lines and assets from Assurant Health, which is a business segment of Assurant, Inc. As part of the transaction, we acquired the small group self-funded and supplemental product lines, as well as North Star Marketing, a proprietary small group sales channel. The purchase price was an aggregate cash payment of $14.0 million.
In January 2014, in connection with the agreement by ACP Re to acquire Tower, Integon National Insurance Company, our wholly-owned subsidiary (“Integon National”), entered into a reinsurance agreement (the “Cut-Through Reinsurance Agreement”) with several Tower subsidiaries. Under the Cut-Through Reinsurance Agreement, Integon National reinsured on a 100% quota share basis with a cut-through endorsement all of Tower’s new and renewal personal lines business and assumed 100% of Tower’s unearned premium reserves with respect to in-force personal lines policies, in each case, net of reinsurance already in effect. The agreement was effective solely with respect to losses occurring on or after January 1, 2014. We paid a 20% ceding commission with respect to unearned premium assumed and a 22% ceding commission with respect to new and renewal business after January 1, 2014 and up to a 4% claims handling expense reimbursement to Tower on all Tower premium subject to the Cut-Through Reinsurance Agreement. This Agreement remained in effect until the closing of the Tower Transaction on September 15, 2014, and is currently in run-off.
Integon National entered into the Personal Lines Quota Share Reinsurance Agreement (the "PL Reinsurance Agreement"), with Tower’s ten statutory insurance companies (collectively, the “Tower Companies”), pursuant to which Integon National reinsures 100% of all losses under the Tower Companies’ new and renewal personal lines business written after September 15, 2014. The ceding commission payable by Integon National under the PL Reinsurance Agreement is equal to the sum of (i) reimbursement of the Tower Companies’ acquisition costs in respect of the business covered, including commission payable to National General Insurance Marketing, Inc., a subsidiary of the Company (“NGIM”), pursuant to the PL MGA Agreement (as defined below), and premium taxes and (ii) 2% of gross written premium (net of cancellations and return premiums) collected pursuant to the PL MGA Agreement.
NGIM produces and manages all new and renewal personal lines business of the Tower Companies pursuant to a Personal Lines Managing General Agency Agreement (the "PL MGA Agreement"). As described above, all post-September 15, 2014 personal lines business written by the Tower Companies is reinsured by Integon National pursuant to the PL Reinsurance Agreement. The Tower Companies pay NGIM a 10% commission on all business written pursuant to the PL MGA Agreement. All payments by the Tower Companies to NGIM pursuant to the PL MGA Agreement are netted out of the ceding commission payable by Integon National to the Tower Companies pursuant to the PL Reinsurance Agreement.
entered into an Aggregate Stop Loss Retrocession Contract (the "Retrocession Agreement") with ACP Re pursuant to which ACP Re is obligated to reinsure the full amount of any payments that NG Re Ltd. and AII are obligated to make to CP Re under the Stop-Loss Agreement. Pursuant to the Stop-Loss Agreement, each of NG Re Ltd. and AII provide, severally, $125.0 million of stop loss coverage with respect to the run-off of the Tower business written on or before September 15, 2014. The reinsurers’ obligation to indemnify CP Re under the Stop-Loss Agreement will be triggered only at such time as CP Re’s ultimate paid net loss related to the run-off of the pre-September 15, 2014 Tower business exceeds a retention equal to the Tower Companies’ loss and loss adjustment reserves and unearned premium reserves as of September 15, 2014, which, the parties to the Loss Portfolio Transfer Agreement have agreed will be established upon reevaluation as of December 31, 2015. CP Re will pay AII and NG Re Ltd. total premium of $56.0 million on the five-year anniversary of the Stop-Loss Agreement. The premium payable by NG Re Ltd. and AII to ACP Re pursuant to the Retrocession Agreement will be $56.0 million in the aggregate, less a ceding commission of 5.5% to be retained by NG Re Ltd. and AII.
All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is cancelled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. A non-sufficient fund fee is recognized when the customer’s payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked.
Net investment income and realized gains and (losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed-maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment loss. We classify equity securities and our fixed-maturity securities as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within other comprehensive income.
LAE less the provisional ceding commission for the quarter. The adjustment to the provisional ceding commission is calculated at the end of, and with respect to, each calendar year during the term of the Quota Share (an “adjustment period”), with the final adjustment period following termination of the Quota Share ending at the end of the run-off period. The adjusted commission rate, which is calculated and reported by the reinsurers to the Company within 30 days after the end of each adjustment period, is calculated by first determining the “actual loss ratio” for the adjustment period, which loss ratio is calculated in the same manner as the net loss ratio as disclosed in this filing. The adjusted commission rate is set based on the actual loss ratio within a range between 30.0% and 34.5%, and varies inversely with a range of actual loss ratios between 60.0% and 64.5%, such that the adjusted commission rate will be higher than 32.0% if the actual loss ratio is lower than 62.5%, and lower than 32.0% if the actual loss ratio is higher than 62.5%, subject to the caps described above. The Company accrues any adjustments to the provisional ceding commission based on the loss experience of the ceded business on a quarterly basis. Remittance of any positive difference between the adjusted commission rate over the provisional ceding commission is paid by the reinsurer to the Company, and any negative difference is paid by the Company to the reinsurer within 12 months after the end of the final adjustment period (other than with respect to the initial year of the agreement with respect to which initial remittance was made 24 months after the end of the first adjustment period).
It is important to understand our accounting policies in order to understand our financial statements. These policies require us to make estimates and assumptions. Our management has reviewed our financial policies and results. These reviews affect the reported amounts of our assets, liabilities, revenues and expenses and the related disclosures. Some of the estimates result from judgments that can be subjective and complex, and, consequently, actual results in future periods might differ significantly from these estimates.
All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is cancelled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. A non-sufficient fund fee is recognized when the customer’s payment is returned by the
financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance premium; however, the amounts of fees charged are not dependent on the amount or period of insurance coverage provided and do not entail any obligation to return any portion of those funds. The direct and indirect costs associated with generating fee income are not separately tracked. The Company estimates an allowance for doubtful accounts based on a percentage of fee income.
Management fees earned by the management companies for services provided to the Reciprocal Exchanges are eliminated in consolidation.
Reinsurance. We account for reinsurance premiums, losses and LAE ceded to other companies on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Earned premiums and losses and LAE incurred ceded to other companies have been recorded as a reduction of premium revenue and losses and LAE. Commissions allowed by reinsurers on business ceded have been recorded as ceding commission revenue. Ceding commission is a commission we receive based on the earned premium ceded to third party reinsurers to reimburse us for our unallocated LAE and other operating expenses. We earn commissions on reinsurance premiums ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, on a pro rata basis over the terms of the policies reinsured. In connection with the Personal Lines Quota Share, the amount we received is based on a contractual formula contained in the reinsurance agreements and is based on the ceded losses as a percentage of ceded premium. Reinsurance recoverables are reported based on the portion of reserves and paid losses and LAE that are ceded to other companies. Assessing whether or not a reinsurance contract meets the condition for risk transfer requires judgment. The determination of risk transfer is critical to reporting premiums and losses, and is based, in part, on the use of actuarial and pricing models and assumptions. If we determine that a reinsurance contract does not transfer sufficient risk, we account for the contract under deposit accounting.
For investments that have quoted market prices in active markets, we use the quoted market prices as fair value and include these prices in the amounts disclosed in the Level 1 hierarchy. We receive the quoted market prices from nationally recognized third-party pricing services (“pricing service”). When quoted market prices are unavailable, we utilize the pricing service to determine an estimate of fair value. This pricing method is used, primarily, for fixed maturities. The fair value estimates provided by the pricing services are included in the Level 2 hierarchy. The pricing service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information and for structured securities, cash flow and, when available, loan performance data. The pricing service’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing, to prepare evaluations. In addition, the pricing service uses model processes, such as the Option Adjusted Spread model, to assess interest rate impact and develop prepayment scenarios. The market inputs that the pricing service normally seeks for evaluations of securities, listed in approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications.
determine if the estimate is Level 2 or Level 3 hierarchy. In the past we have not adjusted any pricing provided by the pricing services based on the review performed by our investment managers.
The following describes the valuation techniques we used to determine the fair value of financial instruments held as of December 31, 2015:
•States and Political Subdivision Bonds - These investments are comprised of bonds and auction rate securities issued by U.S. state and municipal entities or agencies. The fair values of municipal bonds are generally priced by pricing services. The pricing services typically use spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipal bonds are observable market inputs, these are classified within Level 2 of the fair value hierarchy. Municipal auction rate securities are reported in our consolidated balance sheets at cost, which approximates their fair value.
•Foreign Government - Comprised of bonds issued by foreign governments, and are generally priced by pricing services. As the significant inputs used to price foreign government bonds are observable market inputs, the fair values of foreign government bonds are included in the Level 2 fair value hierarchy.
•Mortgage, Asset-backed and Structured Securities - These securities are comprised of commercial and residential mortgage-backed and structured securities. These securities are priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment spreads, yield curves and credit spreads to the valuation. As the significant inputs used to price these securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.
Stock Compensation Expense. We recognize compensation expense for our share-based awards over the estimated vesting period based on estimated grant date fair value. Share-based payments include stock option grants and restricted stock units ("RSU") under our 2010 Equity Incentive Plan and our 2013 Equity Incentive Plan.
Earnings per Share. Basic earnings per share are computed based on the weighted-average number of shares of common stock outstanding. Dilutive earnings per share are computed using the weighted-average number of shares of common stock outstanding during the period adjusted for the dilutive impact of share options and convertible preferred stock using the treasury stock method.
Deferred income taxes reflect the impact of temporary differences between the amount of our assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset and liability primarily consists of book versus tax differences for earned premiums, loss and LAE reserve discounting, deferred acquisition costs, earned but unbilled premiums, and unrealized holding gains and losses on fixed maturities. We record changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income, primarily unrealized investment gains and losses, directly to other comprehensive income. We include changes in deferred income tax assets and liabilities as a component of income tax expense.
During 2013, we terminated the Personal Lines Quota Share on a run-off basis (the "Quota Share Runoff") pursuant to which we historically ceded 50% of our P&C gross premium written and related losses (excluding premium ceded to state-run reinsurance facilities) to our quota share reinsurers. Effective July 31, 2014, no additional premium is being ceded under the Personal Lines Quota Share.
On October 1, 2015, we closed on a master transaction agreement with QBE Investments (North America), Inc. (“QBE Parent”) and its subsidiary, QBE Holdings, Inc. (together with QBE Parent, “QBE”), pursuant to which we acquired QBE’s lender-placed insurance business (“LPI Business”), including certain of QBE’s affiliates engaged in the LPI Business.
Gross premium written. Gross premium written increased by $454.6 million from $2,135.1 million for the year ended December 31, 2014 to $2,589.7 million for the year ended December 31, 2015 due to an increase of $343.1 million in premiums received from the P&C segment primarily as a result of an increase in Imperial premium (increase of $61.0 million), the consolidation of the Reciprocal Exchanges (increase of $209.9 million), acquisition of our LPI Business (increase of $126.6 million) and organic growth (increase of $75.5 million), partially offset by a decrease in our Tower business (decrease of $131.9 million) which included a large one-time unearned premium reserve assumption of $158.8 million in 2014. Premiums received from the A&H segment increased $111.5 million primarily as a result of premium from the Assurant Transaction (increase of $55.7 million) and organic growth (increase of $66.6 million), partially offset by a decrease in our EHC business (decrease of $10.8 million) which included a one-time unearned premium reserve assumption of $15.2 million in 2014.
Net earned premium. Net earned premium increased by $496.6 million, or 30.4%, from $1,633.2 million for the year ended December 31, 2014 to $2,129.8 million for the year ended December 31, 2015. The increase by segment was: P&C - $405.8 million and A&H - $90.8 million. The increase in the P&C segment was primarily attributable to an increase in Tower premium retention (increase of $39.0 million), the Quota Share Runoff (increase of $42.8 million), Imperial premium (increase of $50.8 million), the consolidation of the Reciprocal Exchanges (increase of $87.1 million), acquisition of our LPI Business (increase of $123.3 million) and organic growth (increase of $62.8 million). The increase in the A&H segment was primarily due to earned premium from the Assurant Transaction (increase of $55.8 million) and organic growth (increase of $34.9 million).
Ceding commission income. Ceding commission income increased from $12.4 million for the year ended December 31, 2014 to $43.8 million for the year ended December 31, 2015, reflecting the consolidation of the Reciprocal Exchanges, partially offset by a decrease from the Quota Share Runoff (including a sliding scale adjustment to our terminated third party quota share in 2015). Our consolidated ceding commission ratio, which includes the Reciprocal Exchanges, increased from 0.8% to 2.1%. Excluding the Reciprocal Exchanges, the ceding commission ratio was (0.1)% and 0.5% for the years ended December 31, 2015 and 2014, respectively. The Reciprocal Exchanges' ceding commission ratio was 34.4% and 10.1% for the year ended December 31, 2015 and for the period ended December 31, 2014, respectively.
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $328.6 million, or 31.2%, from $1,053.1 million for the year ended December 31, 2014 to $1,381.6 million for the year ended December 31, 2015, primarily reflecting the Quota Share Runoff, the Imperial acquisition, the consolidation of the Reciprocal Exchanges, the LPI Business acquisition, the Assurant Transaction and loss experience in our domestic stop loss programs. The changes by segment were: P&C - increased $243.1 million and A&H - increased $85.4 million. Loss and LAE for the year ended December 31, 2015 included $15.7 million of unfavorable development on prior accident year loss and LAE reserves ($18.4 million excluding $2.7 million of favorable development for the Reciprocal Exchanges) primarily caused by $17.2 million of A&H reserve strengthening predominantly with respect to business subject to the EHC Reinsurance Agreement and $1.2 million of unfavorable development in the P&C segment predominantly with respect to higher than expected loss emergence from commercial auto liability combined single limit insurance policies. Our consolidated net loss ratio, which includes the Reciprocal Exchanges, increased from 64.5% for the year ended December 31, 2014 to 64.9% for the year ended December 31, 2015 with a higher A&H segment net loss ratio resulting from higher loss experience in our domestic stop loss programs, partially offset by a lower P&C segment net loss ratio driven by product mix changes. Excluding the Reciprocal Exchanges, the net loss ratio was 64.4% and 64.7% for the years ended December 31, 2015 and 2014, respectively. The Reciprocal Exchanges' net loss ratio was 72.4% and 56.1% for the year ended December 31, 2015 and for the period ended December 31, 2014, respectively, including $2.7 million of favorable development on prior accident year loss and LAE reserves for the year ended December 31, 2015 and $1.3 million of unfavorable development on prior accident year loss and LAE reserves for the period ended December 31, 2014.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $90.8 million, or 28.8% from $315.1 million for the year ended December 31, 2014 to $405.9 million for the year ended December 31,
General and administrative expenses. General and administrative expenses increased by $181.6 million, or 52.1%, from $348.8 million for the year ended December 31, 2014 to $530.3 million for the year ended December 31, 2015 primarily as a result of an increase in Tower premium retention, the consolidation of the Reciprocal Exchanges, an increase resulting from the LPI Business acquisition, an increase resulting from the Assurant Transaction and higher organic growth.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $136.1 million, or 28.2% from $482.9 million for the year ended December 31, 2014 to $618.9 million for the year ended December 31, 2015. The consolidated net operating expense ratio (non-GAAP), which includes the Reciprocal Exchanges, decreased to 29.1% in the year ended December 31, 2015 from 29.6% in the year ended December 31, 2014 primarily as a result of increased service and fee income and maturation of the A&H business, partially offset by increased general and administrative expenses, and increased acquisition costs and other underwriting expenses.
Excluding the Reciprocal Exchanges, the net operating expense ratio was 29.3% and 29.6% for the years ended December 31, 2015 and 2014, respectively. The Reciprocal Exchanges' net operating expense ratio was 25.1% and 27.9% for the year ended December 31, 2015 and for the period ended December 31, 2014, respectively.
Net realized gain (loss) on investments. Net realized losses on investments increased by $7.4 million from a loss of $2.9 million for the year ended December 31, 2014 to a $10.3 million loss for the year ended December 31, 2015 primarily due to the recognition of a $15.2 million OTTI charge in the year ended December 31, 2015 relating to certain investments in the energy and natural resources sectors based on our qualitative and quantitative OTTI review as compared to a $2.2 million OTTI charge in the year ended December 31, 2014. These losses resulting from OTTI charges were partially offset by net realized gains on the sale of investments of $4.9 million for the year ended December 31, 2015 compared to net realized losses on the sale of investments of $0.6 million for the year ended December 31, 2014.
Equity in earnings (losses) of unconsolidated subsidiaries. Equity in earnings of unconsolidated subsidiaries, which primarily relates to our 50% interest in life settlement entities, increased $9.5 million, from $1.2 million in earnings for the year ended December 31, 2014 to $10.6 million in earnings for the year ended December 31, 2015, due to the change in fair market value of the life settlement contracts.
The Reciprocal Exchanges had pre-tax income of $7.9 million for the year ended December 31, 2015 and pre-tax income of $3.7 million for the period ended December 31, 2014, respectively. A full valuation allowance is recorded on the Reciprocal Exchanges. The Reciprocal Exchanges' valuation allowance as of December 31, 2015 and 2014 was $17.3 million and $21.5 million, respectively.
Service and fee income. Service and fee income increased by $41.0 million, or 32.2%, from $127.5 million for the year ended December 31, 2013 to $168.6 million for the year ended December 31, 2014. The increase was primarily attributable to the increase of $13.7 million in service and fee income related to our A&H segment as a result of organic growth and the EHC Business and an increase of $27.4 million related to our P&C segment as a result of higher general agent fees and organic P&C segment growth.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $180.2 million, or 133.6%, from $134.9 million for the year ended December 31, 2013 to $315.1 million for the year ended December 31, 2014 primarily due to the Tower Reinsurance Agreements, Quota Share Runoff, A&H growth expenses and the EHC Business.
Provision for income taxes. Consolidated income tax expense, which includes the Reciprocal Exchanges, increased by $12.7 million, or 114.3%, from $11.1 million for the year ended December 31, 2013, reflecting an effective tax rate of 21.3%, to $23.9 million for the year ended December 31, 2014, reflecting an effective tax rate of 18.7%. Income tax expense included a tax benefit of $21.2 million attributable to the reduction of the deferred tax liability associated with the equalization reserves of our Luxembourg reinsurers. The effect of this tax benefit reduced the effective tax rate for the year ended December 31, 2014 by 16.7%.
Gross premium written. Gross premium written increased by $343.1 million, or 17.2%, from $1,994.7 million for the year ended December 31, 2014 to $2,337.8 million for the year ended December 31, 2015 primarily as a result of an increase in Imperial premium (increase of $61.0 million), the consolidation of the Reciprocal Exchanges (increase of $209.9 million), acquisition of the LPI Business (increase of $126.6 million) and organic growth (increase of $75.5 million), partially offset by a decrease in our Tower business (decrease of $131.9 million) which included a large one-time unearned premium reserve assumption of $158.8 million in 2014.
Net earned premium. Net earned premium increased by $405.8 million, or 26.8%, from $1,512.7 million for the year ended December 31, 2014 to $1,918.5 million for the year ended December 31, 2015 primarily as a result of an increase in Tower premium retention (increase of $39.0 million), the Quota Share Runoff (increase of $42.8 million), Imperial premium (increase of $50.8 million), the consolidation of the Reciprocal Exchanges (increase of $87.1 million), acquisition of the LPI Business (increase of $123.3 million) and organic growth (increase of $62.8 million).
General and administrative expenses. General and administrative expenses increased by $156.1 million from $292.1 million for the year ended December 31, 2014 to $448.2 million for the year ended December 31, 2015 primarily as a result of an increase in Tower premium retention, the consolidation of the Reciprocal Exchanges, an increase resulting from our LPI Business and higher organic growth.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $140.7 million, or 32.7%, from $430.0 million for the year ended December 31, 2014 to $570.7 million for the year ended December 31, 2015. The P&C segment net operating expense ratio (non-GAAP), which includes the Reciprocal Exchanges, increased from 28.4% for the year ended December 31, 2014 to 29.7% for the year ended December 31, 2015 primarily as a result of increased general and administrative expenses, and increased acquisition costs and other underwriting expenses, partially offset by increased service and fee income. Excluding the Reciprocal Exchanges, the net operating expense ratio was 30.1% and 28.4% for the years ended December 31, 2015 and 2014, respectively. The Reciprocal Exchanges' net operating expense ratio was 25.1% and 27.9% for the year ended December 31, 2015 and for the period ended December 31, 2014, respectively.
Net earned premium. Net earned premium increased by $857.9 million, or 131.0%, from $654.8 million for the year ended December 31, 2013 to $1,512.7 million for the year ended December 31, 2014 primarily as a result of the Tower Reinsurance Agreements (increase of $272.0 million), the Quota Share Runoff (increase of $457.0 million), the Imperial acquisition (increase of $66.9 million) and the consolidation of the Reciprocal Exchanges (increase of $47.6 million).
Service and fee income. Service and fee income increased by $27.4 million, or 33.1%, from $82.8 million for the year ended December 31, 2013 to $110.1 million for the year ended December 31, 2014 as a result of higher general agent fees and organic P&C segment growth.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $237.0 million, or 122.8%, from $193.0 million for the year ended December 31, 2013 to $430.0 million for the year ended December 31, 2014. The P&C segment net operating expense ratio (non-GAAP), which includes the Reciprocal Exchanges, decreased from 29.5% for the year ended December 31, 2013 to 28.4% for the year ended December 31, 2014 primarily due to the lower expense ratio on policies reinsured under the Tower Reinsurance Agreements. Excluding the Reciprocal Exchanges, the net operating expense ratio was 28.4% for the year ended December 31, 2014. The Reciprocal Exchanges' net operating expense ratio was 27.9% for the period ended December 31, 2014.
Underwriting income. Underwriting income increased from $25.9 million for the year ended December 31, 2013 to $115.6 million for the year ended December 31, 2014 primarily as a result of the Tower Reinsurance Agreements and the Quota Share Runoff. The P&C segment combined ratio, which includes the Reciprocal Exchanges, for the year ended December 31, 2014 decreased to 92.3% compared to 96.1% for the same period in 2013 primarily as the result of our lower net loss ratio and net operating expense ratio experienced on policies reinsured under the Tower Reinsurance Agreements. Excluding the Reciprocal
General and administrative expenses. General and administrative expenses increased by $25.5 million from $56.6 million for the year ended December 31, 2014 to $82.1 million for the year ended December 31, 2015 as a result of an increase resulting from the Assurant Transaction and higher organic growth.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense decreased $4.6 million from $52.9 million for the year ended December 31, 2014 to $48.2 million for the year ended December 31, 2015. The net operating expense ratio (non-GAAP) decreased from 43.9% for the year ended December 31, 2014 to 22.8% for the year ended December 31, 2015 primarily as a result of increased A&H premiums and higher service and fee income.
Gross premium written. Gross premium written increased by $106.9 million, from $33.5 million for the year ended December 31, 2013 to $140.4 million for the year ended December 31, 2014 primarily as a result of the EHC Business.
Net premium written. Net premium written increased by $106.8 million, from $33.2 million for the year ended December 31, 2013 to $140.0 million for the year ended December 31, 2014 primarily as a result of the EHC Business.
Net earned premium. Net earned premium increased by $87.3 million, from $33.2 million for the year ended December 31, 2013 to $120.5 million for the year ended December 31, 2014 primarily as a result of the EHC Business.
Service and fee income. Service and fee income increased by $13.7 million, or 30.5%, from $44.8 million for the year ended December 31, 2013 to $58.5 million for the year ended December 31, 2014 as a result of the EHC Business and organic growth.
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $59.8 million, from $26.1 million for the year ended December 31, 2013 to $85.9 million for the year ended December 31, 2014. Our net loss ratio decreased from 78.7% for the year ended December 31, 2013 to 71.3% for the year ended December 31, 2014. The loss ratio in the year ended December 31, 2014 was positively affected by the EHC Business.
General and administrative expenses. General and administrative expenses increased by $28.4 million from $28.2 million for the year ended December 31, 2013 to $56.6 million for the year ended December 31, 2014 primarily as a result of A&H expansion expenses and the EHC Business.
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $45.1 million from $7.8 million for the year ended December 31, 2013 to $52.9 million for the year ended December 31, 2014. The net operating expense ratio (non-GAAP) increased from 23.5% for the year ended December 31, 2013 to 43.9% for the year ended December 31, 2014 primarily as a result of the A&H expansion expenses.
Our investment strategy emphasizes, first, the preservation of capital and, second, maximization of an appropriate risk-adjusted return. We seek to maximize investment returns using investment guidelines that stress prudent allocation among cash and cash equivalents, fixed-maturity securities and, to a lesser extent, equity securities. Cash and cash equivalents include cash on deposit, commercial paper, pooled short-term money market funds and certificates of deposit with an original maturity of 90 days or less. Our fixed-maturity securities include obligations of the U.S. Treasury or U.S. government agencies, obligations of U.S. and Canadian corporations, mortgages guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, Federal Farm Credit entities, and asset-backed securities and commercial mortgage obligations. Our equity securities include preferred stock of U.S. and Canadian corporations.
The increase in gross unrealized losses from $17.4 million at December 31, 2014 to $64.8 million at December 31, 2015 resulted primarily from fluctuations in market interest rates.
The tables below summarize the credit quality of our fixed maturities, securities pledged and preferred securities as of December 31, 2015 and 2014, as rated by Standard & Poor’s.
The tables below summarize the investment quality of our corporate bond holdings and industry concentrations as of December 31, 2015 and 2014.
Gross Unrealized Losses. The tables below summarize the gross unrealized losses on equity securities and fixed maturities by the length of time the security had continuously been in an unrealized loss position as of December 31, 2015 and 2014:
As of December 31, 2015, of the $10.4 million of unrealized losses related to securities in unrealized loss positions for a period of twelve or more consecutive months, $8.5 million of those unrealized losses were related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost. Those unrealized losses were evaluated based on factors such as discounted cash flows and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations.
During the years ended December 31, 2015, 2014 and 2013, we recognized an OTTI loss of $15.2 million, $2.2 million and $2.9 million, respectively, on investments based on our qualitative and quantitative review. For the year ended December 31, 2015, the OTTI loss of $15.2 million related to certain investments in the energy and natural resources sectors and was based on the severity of the decline in relation to their amortized cost or cost.
A life settlement contract is a contract between the owner of a life insurance policy and a third party who obtains the ownership and beneficiary rights of the underlying life insurance policy. During 2010, we formed Tiger Capital LLC (“Tiger”) with a subsidiary of AmTrust for the purpose of acquiring certain life settlement contracts. In 2011, we formed AMT Capital Alpha, LLC (“AMT Alpha”) with a subsidiary of AmTrust for the purpose of acquiring additional life settlement contracts. In the first quarter of 2013, we acquired a 50% interest in AMT Capital Holdings, S.A. (“AMTCH”), the other 50% of which is owned by AmTrust. Additionally, in December 2013, we formed AMT Capital Holdings II, S.A. ("AMTCH II") with AmTrust for the purpose of acquiring additional life settlement contracts. We have a 50% ownership interest in each of Tiger, AMT Alpha, AMTCH and AMTCH II (collectively, the “LSC Entities”). The LSC Entities may also acquire premium finance loans made in connection with the borrowers’ purchase of life insurance policies that are secured by the policies. The LSC Entities acquire the underlying policies securing the loan through the borrowers’ voluntary surrender of the policy in satisfaction of the loan or foreclosure. A third party serves as the administrator for two of the life settlement contract portfolios, for which it receives an administrative fee. The third-party administrator is eligible to receive a percentage of profits after certain time and performance thresholds have been met.
As of December 31, 2015, the face value amounts of the 255 life insurance policies disclosed in the table below was approximately $1.6 billion. As of December 31, 2015, the LSC Entities owned no premium finance loans.
The following table describes details of our investment in LSC Entities as of December 31, 2015. This table shows the gross amounts for the portfolio of life insurance policies owned by the LSC Entities, in which we and AmTrust each own a 50% interest.
We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof. During 2015, we issued 6,000,000 depositary shares, each representing a 1/40th interest in a share of our 7.50% Non-Cumulative Preferred Stock, Series B (equivalent to 165,000 shares of Series B Preferred Stock). The total net proceeds we received from the issuance was approximately $159.6 million, after deducting the issuance expenses payable by us. In addition, during 2015, we issued 11,500,000 shares of common stock in a public offering at $19.00 per share. The total net proceeds we received from the issuance was approximately $210.6 million, after deducting the issuance expenses payable by us. Also, during 2015, we sold $100.0 million aggregate principal amount of our 7.625% Notes in a public offering. The net proceeds we received from the issuance was approximately $96.9 million, after deducting the underwriting discount and commissions, but before expenses. Further, during 2015, we sold an additional $100.0 million aggregate principal amount of our 6.75% Notes to certain purchasers in a private placement. The net proceeds we received from the issuance was approximately $98.9 million, after deducting the estimated issuance expenses payable by us. We also had a $135.0 million credit agreement under which there were no amounts outstanding as of December 31, 2015. The proceeds of borrowings under the credit agreement may be used for working capital, acquisitions and general corporate purposes. See "7.625% Subordinated Notes due 2055", "Common Stock", "Preferred Stock", "6.75% Notes due 2024" and "Revolving Credit Agreement" below.
Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their place of domicile which limit the amount of cash dividends or distributions that they may pay to us unless special permission is received from the insurance regulator of the relevant domicile. The aggregate limit imposed by the various domiciliary regulatory authorities of our insurance subsidiaries was approximately $360.1 million and $286.3 million as of December 31, 2015 and 2014, respectively, taking into account dividends paid in the prior twelve month periods. During the years ended December 31, 2015, 2014 and 2013, there were $23.8 million, $12.0 million and $24.0 million, respectively, of dividends and return of capital paid by the insurance subsidiaries to National General Management Corp. ("Management Corp.") or the Company.
We forecast claim payments based on our historical experience. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on both a short-term and long-term basis. Cash payments for claims were $1,276.3 million, $866.0 million and $448.8 million in the years ended December 31, 2015, 2014 and 2013, respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and investment portfolio has increased from $1,116.7 million at December 31, 2013 to $1,998.7 million at December 31, 2014 and increased to $2,950.0 million at December 31, 2015. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods.
Net cash provided by financing activities was $324.8 million for the year ended December 31, 2014, compared with net cash provided by financing activities of $176.7 million for the year ended December 31, 2013. For the year ended December 31, 2014, cash provided by financing activities increased versus the comparable period in 2013 primarily due to: (i) the May 2014 sale of our $250.0 million aggregate principal amount of 6.75% Notes; and (ii) the June 2014 issuance of 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock, partially offset by a lower amount of proceeds from the issuance of common stock in 2014 as compared to 2013.
The following tables present the consolidating balance sheets as of December 31, 2015 and December 31, 2014 (amounts in thousands):
During the year ended December 31, 2015, premiums and other receivables, net increased $111.2 million compared to December 31, 2014 primarily due to the increase in Tower premium retention, the LPI Business acquisition and the Assurant Transaction. Deferred acquisition costs increased $34.5 million compared to December 31, 2014 primarily due to the increase in Tower premium retention and the LPI Business acquisition. Prepaid reinsurance premiums increased $25.6 million compared to December 31, 2014 primarily due to the consolidation of the Reciprocal Exchanges. Goodwill and Intangible assets, net increased $141.7 million compared to December 31, 2014 primarily due to the LPI Business acquisition, the Assurant Transaction, and our HST and ARS acquisitions.
We assume and cede insurance risks under various reinsurance agreements, on both a pro rata basis and an excess of loss basis. We purchase reinsurance to mitigate the volatility of direct and assumed business, which may be caused by the aggregate value or the concentration of written exposures in a particular geographic area or business segment and may arise from catastrophes or other events. As part of our overall risk and capacity management strategy, we purchase excess of loss catastrophic and casualty reinsurance for protection against catastrophic events and other large losses. The property catastrophe program provides a total of $450 million in coverage in excess of a $50 million retention, with one reinstatement. We also purchased drop-down coverage to reduce the retention to $35 million for Texas and Louisiana. The casualty program provides $45 million in coverage in excess of a $5 million retention. We pay a premium as consideration for ceding the risk.
risk. Prepaid reinsurance premiums are earned on a pro rata basis over the period of risk, based on a daily earnings convention, which is consistent with premiums written.
The following is a summary of premium and related losses ceded to the MCCA for the years ended December 31, 2015, 2014 and 2013:
Reinsurance recoverables from the NCRF as of December 31, 2015 and 2014 are as follows:
We have a concentration of credit risk associated with the MCCA, the NCRF and the reinsurance under the Personal Lines Quota Share arrangement. Reinsurance recoverables on unpaid losses from these entities at December 31, 2015 and 2014 are as follows:
The indenture contains customary covenants, such as reporting of annual and quarterly financial results, and restrictions on certain mergers and consolidations. The indenture also includes covenants relating to the incurrence of debt if our consolidated leverage ratio would exceed 0.35 to 1.00, a limitation on liens, a limitation on the disposition of stock of certain of our subsidiaries and a limitation on transactions with certain of our affiliates. We were in compliance with all of the covenants contained in the indenture as of December 31, 2015.
As of December 31, 2015 and 2014, there was no outstanding balance on the line of credit. Interest expense for our existing and repaid lines of credit for the years ended December 31, 2015, 2014 and 2013 was $0.0 million, $1.2 million and $1.3 million, respectively.
See also Note 28, "Subsequent Events" in the notes to our consolidated financial statements for information on the New Credit Agreement.
On August 18, 2015, we issued 11,500,000 shares of common stock in a public offering, including 1,500,000 shares issued pursuant to the underwriters' over-allotment option. The common stock offering was priced to the public at $19.00 per share, resulting in net proceeds of $210.9 million, after deducting underwriting discount, but before expenses. The cost of issuance of stock of approximately $7.9 million was charged directly to additional paid-in capital. The net proceeds to us after underwriting discount, commissions and expenses were approximately $210.6 million.
On June 25, 2014, we issued 2,200,000 shares of 7.50% Non-Cumulative Preferred Stock ("Series A Preferred Stock") in a public offering. Dividends on the Series A Preferred Stock when, as and if declared by the Company's Board of Directors (the "Board") or a duly authorized committee of the Board, will be payable on the liquidation preference amount of $25.00 per share, on a non-cumulative basis, quarterly in arrears on the 15th day of January, April, July and October of each year (each, a "dividend payment date"), commencing on October 15, 2014, at an annual rate of 7.50%. Dividends on the Series A Preferred Stock are not cumulative. Accordingly, in the event dividends are not declared on the Series A Preferred Stock for payment on any dividend payment date, then those dividends will not accumulate and will not be payable. If the Company has not declared a dividend before the dividend payment date for any dividend period, the Company will have no obligation to pay dividends for that dividend period, whether or not dividends on the Series A Preferred Stock are declared for any future dividend payment. The net proceeds we received from the issuance was approximately $53.2 million, after deducting the underwriting discount and issuance expenses.
As of December 31, 2015 and 2014, we had no collateralized lending transaction principal outstanding. Interest income associated with lending agreements for the years ended December 31, 2015, 2014 and 2013 was $0.0 million, $0.0 million and $0.1 million, respectively.
As of December 31, 2015, we had collateralized borrowing transaction principal outstanding of $52.5 million at an interest rate of 0.80%. As of December 31, 2014, we had collateralized borrowing transaction principal outstanding of $46.8 million at interest rates between 0.30% and 0.35%. Interest expense associated with the repurchase borrowing agreements for the years ended December 31, 2015, 2014 and 2013 was $0.2 million, $0.2 million and $0.3 million, respectively. We had approximately $55.4 million and $49.5 million of collateral pledged in support for these agreements as of December 31, 2015 and 2014, respectively.
The following table sets forth certain of our contractual obligations as of December 31, 2015:
The loss and LAE payments due by period in the table above are based upon the loss and LAE estimates as of December 31, 2015 and actuarial estimates of expected payout patterns and are not contractual liabilities with finite maturities. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and LAE payments due by period is subject to the same uncertainties associated with determining the level of loss and LAE generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and LAE estimate process, see Item 1, “Business-Loss Reserves.” Actual payments of loss and LAE by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and LAE vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See Item 1A, “Risk Factors-Risks Relating to Our Business Generally-If we are unable to establish and maintain accurate loss reserves, our business, financial condition and results of operations may be materially adversely affected” for a discussion of the uncertainties associated with estimating loss and LAE.
As of December 31, 2015, we had a 50% ownership interest in the LSC Entities which in turn owned 255 life settlement contracts with a carrying value of $264.0 million. In order to derive the economic benefit of the face value of these policies, the LSCs are required to make these premium payments.
On July 23, 2014, we and ACP Re entered into the Amended and Restated Personal Lines Master Agreement (the "Master Agreement"). The Master Agreement provides for the implementation of the various transactions associated with the acquisition of Tower by ACP Re. In addition, the Master Agreement requires us to pay ACP Re contingent consideration in the form of a three-year earnout (the "ACP Re Contingent Payments") of 3% of gross premium written of the Tower personal lines business written or assumed by us following the Merger. The ACP Re Contingent Payments are subject to a maximum of $30.0 million, in the aggregate, over the three-year period. The expected remaining ACP Re Contingent Payments as of December 31, 2015 are $17.6 million. (See Note 16, "Related Party Transactions" in the notes to our consolidated financial statements).
On April 1, 2015, we closed on the acquisition of ARS, a New Jersey-based managing general agency that services assigned risk, personal auto, and commercial lines of business, for a purchase price of approximately $48.0 million in cash and potential future earnout payments ("ARS Contingent Payments"). The fair value of the ARS Contingent Payments was estimated to be $4.1 million at December 31, 2015.