The following tables set forth selected consolidated historical financial information of Conifer Holdings, Inc. and Subsidiaries as of the dates and for the periods indicated. The selected financial data for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 were derived from our audited consolidated financial statements and related notes thereto.
For our Insurance Company Subsidiaries, the excess of assets over liabilities are determined in accordance with statutory accounting principles as determined by the domiciliary state for each Insurance Company Subsidiary. In 2018, CIC issued a surplus note to WPIC for $10.0 million. The regulatory capital and surplus balance as of year ended December 31, 2018 eliminates the $10.0 million surplus note from the consolidated balance.
We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 45 states, including the District of Columbia. We are licensed to write insurance in 42 states, including the District of Columbia, as an admitted carrier and we offer our insurance products in all 50 states.
Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions, and other underwriting and administrative expenses. We organize our operations in two insurance businesses: commercial insurance lines and personal insurance lines.
Through our commercial insurance lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers’ compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis.
Through our personal insurance lines, we offer homeowners insurance and dwelling fire insurance products to individuals in several states. Our specialty homeowners insurance line is primarily comprised of either wind-exposed homeowners insurance providing hurricane and wind coverage to underserved homeowners in Texas, Hawaii and Florida or low-value dwelling insurance tailored for owners of lower valued homes, which we offer in Illinois, Indiana, Louisiana and Texas. Due to certain Florida-based industry events, we have deemphasized our Florida homeowners business and other wind-exposed business in Texas and Hawaii. We plan to continue to shift focus to low-value dwelling lines of business in order to bring personal lines premium levels back up and to maintain a strategic balance of commercial and personal lines of business.
• Incurred but not reported ("IBNR") reserves, which are (1) unpaid loss and LAE amounts that have been incurred but not yet reported; and (2) the expected development on case reserves.
• Expenses intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims, costs of outside adjusters and experts, and all other expenses which are identified to the case; and
• Expected initial loss and LAE ratio, which is the ratio of incurred losses and LAE to earned premiums; and
• Frequency/severity method-This method projects claim counts and average cost per claim on a paid or reported basis for high frequency, low severity products.
Our reserves consist entirely of reserves for property and liability losses, consistent with the coverages provided for in the insurance policies directly written or assumed by us under reinsurance contracts. Occasionally, several years may elapse
between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss. The level of IBNR reserves in relation to total reserves depends upon the characteristics of the specific line of business, particularly related to the speed with which claims are reported and outstanding claims are paid. Lines of business for which claims are reported slowly will have a higher percentage of IBNR reserves than lines of business that report and settle claims more quickly.
Fair values are measured in accordance with ASC 820, Fair Value Measurements. The guidance establishes a framework for measuring fair value and a three-level hierarchy based upon the quality of inputs used to measure fair value. The three levels of the fair value hierarchy are: (1) Level 1: inputs are based on quoted prices (unadjusted) in active markets for
identical assets or liabilities, (2) Level 2: inputs are other than quoted prices that are observable for the asset or liabilities, either directly or indirectly, for substantially the full term of the asset or liability and (3) Level 3: unobservable inputs that are supported by little or no market activity. The unobservable inputs represent the Company’s best assumption of how market participants would price the assets or liabilities.
The values for publicly-traded equity securities are generally based on Level 1 inputs which use the market approach valuation technique. The values for debt securities generally incorporate significant Level 2 inputs. The carrying value of cash and short-term investments approximate their fair values due to their short-term maturity.
In 2018, the Company recognized a measurement period adjustment of $42,735 related to loss reserve discounting, which reduced deferred tax expense. The Company also recognized a measurement period adjustment of $42,735 related to the loss reserve discounting transitional adjustment, which increased deferred tax expense. The measurement period adjustments were based upon obtaining additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts under the Act. The measurement period adjustments had no effect on the effective tax rate for the year ending December 31, 2018. The accounting for the income tax effects of the Act pursuant to SAB 118 has been completed as of the end of the December 22, 2018, measurement period and for the year ending December 31, 2018.
As of December 31, 2018, we have federal and state income tax net operating loss (“NOL”) carryforwards of $48.3 million and $11.9 million, respectively, which will expire at various dates from 2019 through 2038. Of the federal NOL amount, $14.1 million are subject to limitations under Section 382 of the Internal Revenue Code. These net NOL carryforwards are limited in the amount that can be utilized in any one year and may expire before they are realized. At this time we do not expect that any of the remaining NOL carryforwards will expire before utilized.
valuation allowance of $12.6 million and $9.9 million has been recorded against the gross deferred tax assets as of December 31, 2018 and 2017, respectively, as the Company has recognized a three-year cumulative loss as of December 31, 2018 which is significant negative evidence to support the lack of recoverability of those deferred tax assets in accordance with ASC 740, Income Taxes. If the $12.6 million valuation allowance as of December 31, 2018 was reversed in the future, it would increase book value by $1.49. The net deferred tax liability was $115,000 as of December 31, 2018 and 2017.
losses as a result of our market risk sensitive instruments, which primarily relate to fixed income securities that are available-for-sale and not held for trading purposes. Realized investment gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, adjusted operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying loss or profitability of our business. We believe that it is useful for investors to evaluate adjusted operating income and adjusted operating income per share, along with net income and net income per share, when reviewing and evaluating our performance.
For the year ended December 31, 2018, we continued to expand our commercial lines and reposition our personal lines of business. Our commercial lines gross written premiums grew by $5.6 million, or 6.1%, to $97.7 million in 2018, compared to $92.1 million in 2017. Personal lines gross written premiums decreased by $15.5 million, or 69.9%, to $6.7 million in 2018, compared to $22.2 million in 2017.
The Company reported a net loss of $9.2 million, or $1.08 per share, in 2018, compared to a net loss of $21.5 million, or $2.74 per share, in 2017.
The 2018 results were mainly driven by $9.0 million of adverse development. The largest difference between net loss and adjusted operating loss is related to the ADC (described below) in which $5.7 million of benefit from the ADC was included in the adjusted operating loss, but is deferred under retrospective accounting and will be recognized as a benefit over the next two years.
In 2018, there was $583,000 of loss development on Hurricane Harvey and $1.0 million of catastrophe reinsurance reinstatement costs relating to Hurricane Irma. The reinstatement costs, plus a short-term reduction in net earned premiums as we repositioned our business profile, contributed to a slightly higher expense ratio.
We purchased the ADC to greatly reduce our exposure to prior-year adverse development. The benefits of the ADC can be seen during 2018 wherein we ceded $10.3 million of adverse development to the ADC. Of the $10.3 million of ceded losses, $4.6 million was amortized in 2018, and reduced losses and LAE expense. The remaining $5.7 million was recognized as a deferred gain under retroactive reinsurance accounting rules and will be amortized over the next two years as a reduction in losses and LAE expense using the interest method. In 2017, we recorded $7.2 million in ceded premiums under the ADC, and ceded $7.2 million in losses. As of December 31, 2018, the ADC has been fully utilized.
Gross written premiums decreased by $9.9 million, or 8.7%, to $104.4 million for the year ended December 31, 2018, as compared to $114.3 million for the year ended December 31, 2017. These results reflect our continued execution of our growth initiatives in the niche commercial insurance markets and our strategic change in the mix of business of our personal lines.
Net written premiums decreased $2.2 million, or 2.4%, to $89.1 million for the year ended December 31, 2018, as compared to $91.2 million for the year ended December 31, 2017. The decrease was primarily due to the reduction in wind-exposed homeowners business.
Net losses and LAE decreased by $11.4 million, or 15.4%, for the year ended December 31, 2018, as compared to the same period in 2017. The calendar year loss ratios were 65.5% and 79.2% for the years ended December 31, 2018 and 2017, respectively. Before the impact of the ADC deferred gain and hurricane costs, the calendar year loss ratio was 58.3% in 2018. Before the impact of the ADC deferred gain and hurricane costs, the calendar year loss ratio was 74.8% in 2017.
The $9.5 million of adverse development in 2017 consisted of $7.2 million from commercial lines and $2.3 million from personal lines and mostly related to the 2016 and 2015 accident years. This development primarily consisted of $5.1 million from commercial liability business, $1.6 million from the commercial property, $1.7 million from Florida homeowners and $0.5 million from commercial auto business.
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased by 1.3 percentage points from 28.1% in 2017, to 26.8% in 2018.
There were no other gains in 2018. In 2017, we recognized a $750,000 gain on the sale of the renewal rights of a portion of the low-value dwelling book of business to another insurer.
For the year ended December 31, 2018, the Company reported $0 of current federal income tax expense and $52,000 of current state income tax expense. The Company also reported a deferred tax benefit of $0. For the year ended December 31, 2017, the Company reported $16,000 of current federal income tax benefit and $12,000 of current state income tax benefit. For the year ended December 31, 2017, the Company also reported a deferred tax benefit of $419,000 which was largely the result of changes in the net deferred tax asset valuation allowance related to changes in unrealized gains.
There is a $12.6 million valuation allowance against 100% of the net deferred tax assets at December 31, 2018, which would increase book value by $1.49 per share if reversed in the future. The valuation allowance was $9.9 million for 2017. As of December 31, 2018, the Company has net operating loss carryforwards for federal income tax purposes of $48.3 million, of which $43.3 million expire in tax years 2019 through 2038 and $5.0 million never expire. Of this amount, $14.1 million are limited in the amount that can be utilized in any one year and may expire before they are realized under Section 382 of the Internal Revenue Code. The Company has state net operating loss carryforwards of $11.9 million, which expire in tax years 2021 through 2038.
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings or policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the year December 31, 2017 increased $442,000, or 39.5%, to $1.5 million as compared to $1.1 million for the year ended December 31, 2016. The increase was due to continued expansion into lines of business in which various fees are charged to the policyholders.
The $9.5 million of adverse development in 2017 consisted of $7.2 million from commercial lines and $2.3 million from personal lines and mostly related to the 2016 and 2015 accident years. Substantially all of this development occurred in the first three quarters of 2017 and primarily consisted of $5.1 million from commercial liability business, $1.6 million from the commercial property, $1.7 million from Florida homeowners and $0.5 million from commercial auto business.
The portfolio’s average quality was AA at December 31, 2017 and 2016. The portfolio produced a tax equivalent book yield of 2.5% and 2.2% for the years ended December 31, 2017 and 2016, respectively. The duration-to-worst average of the debt securities portfolio was 3.2 years at December 31, 2017 and 2016.
Interest expense was $1.4 million and $647,000 for the years ended December 31, 2017 and 2016, respectively. Interest expense increased due to the increase in outstanding debt throughout the year. We issued $30.0 million of subordinated notes in the third quarter of 2017, with a current interest rate of 8.0% per annum. We paid off all of the senior debt facility from the proceeds of the subordinated notes. Interest expense includes the amortization of debt issuance costs relating to the new subordinated notes which is $66,000 per annum over the 15-year life of the notes.
We conduct our business operations primarily through our Insurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the holding company. Secondarily, the holding company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the holding company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the holding company under certain circumstances. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10% of statutory surplus at the end of the preceding year. No dividends were paid from our Insurance Company Subsidiaries in 2018 or 2017, and $5.5 million of dividends were paid from our Insurance Company Subsidiaries to the holding company in 2016.
Operating Activities. Cash used in operating activities for the year ended December 31, 2018, was $17.0 million as compared to cash provided by operating activities of $9.1 million for the year ended December 31, 2017. The $26.1 million fluctuation in cash from operations was due to a $10.0 million decrease in cash collected on gross premiums, mostly due to the reduction in wind-exposed homeowners premiums, a $2.8M increase in paid ceded premiums due to the ceded premiums paid on the ADC and reinstatement premiums, and a $10.1 million increase in net paid losses due, in part, to losses incurred from the 2017 hurricanes. Cash provided by operating activities for the years ended December 31, 2017 and 2016 were $9.1 million and $6.2 million, respectively. The increase in cash provided by operations was attributable to the overall growth of the business.
Net cash used in investing activities for the year ended December 31, 2016, was $10.8 million and was primarily attributable to net investments into debt securities of $23.9 million, offset by the sale of short-term investments of $10.3 million.
The carrying value of the Notes and Subordinated Notes are offset by $2.3 million of debt issuance costs that will be amortized through interest expense over the life of the loans. Refer to Note 7 ~ Debt of the Notes to the consolidated financial statements, for additional information regarding our outstanding debt.
Insurance operations are subject to various leverage tests (e.g., premium-to-statutory surplus ratios), which are evaluated by regulators and rating agencies. As of December 31, 2018, on a trailing twelve-month statutory combined basis, the gross written and net written premium leverage ratios were 1.6 to 1.0 and 1.4 to 1.0, respectively.
The NAIC’s Insurance Regulatory Information System (“IRIS”) was developed to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies “usual values” for each ratio. State insurance regulators review the IRIS ratio results to determine if an insurer is in need of further regulatory scrutiny or action. While the ratios, individually and collectively, are useful tools for identifying companies that may be experiencing financial difficulty, they are only a guide for regulators and should not be considered an absolute indicator of a Company's financial condition. While inquiries from regulators are not uncommon, our Insurance Company Subsidiaries have not experienced any regulatory actions due to their IRIS ratio results or otherwise.