As a result of the Company’s conversion to a C Corporation, the deferred tax asset increased by approximately $14.3 million primarily due to the effects of eliminating deferred tax balances on the insurance subsidiaries related to intercompany transactions. This excludes the tax effect related to contract modification expense as discussed in note (8) below.
Founder special compensation, offering-related expenses, and contract modification expense are shown net of the estimated tax benefit for each period presented. The estimated tax was calculated assuming the Company’s blended statutory federal and state income tax rates of 37.5%, 38.1%, 37.2% and 35.7% for the years ended December 31, 2014, 2013, 2012 and 2011, respectively.
Our Program Services segment generates significant fee income, in the form of ceding fees, by offering issuing carrier (“fronting”) capacity to both specialty general agents and other producers (“GAs”), who sell, control, and administer books of insurance business that are supported by third parties that assume reinsurance risk. These reinsurers are domestic and foreign insurers and institutional risk investors (“capacity providers”) that want to access specific lines of U.S. property and casualty insurance business. Issuing carrier arrangements refer to our business in which we write insurance on behalf of a capacity provider and then reinsure the risk under these policies with the capacity provider in
On February 8, 2016, the Company announced that Matthew Freeman was appointed President of State National Companies, Inc. Mr. Freeman oversees the sales and service operations for both the Program Services and Lender Services segments and reports to Terry Ledbetter, Chairman and Chief Executive Officer.
Trending Market Opportunities. We believe that macroeconomic conditions will provide us with growth opportunities in each of our business segments. Increasing automobile sales and credit availability should expand
lenders’ loan portfolios to improve our Lender Services results. Increased capital in the reinsurance market, coupled with a decline in reinsurance rates is causing reinsurers to review options for accessing the primary market, should create demand for our fronting services in our Program Services segment.
In our Lender Services business, we believe that organic growth from our existing lender clients will be driven by overall growth in lenders’ portfolios as a result of rising automobile sales, higher average auto loan sizes and increasing credit availability resulting in increased premium writings. We expect that new sales from our alliance with CUNA Mutual and potential new business from banks and specialty finance companies will produce additional premiums.
Founder Special Compensation. Prior to the completion of the private placement in 2014, we paid special compensation to our co-founders in recognition of their service to our Company. We refer to these payments as “founder special compensation.” Founder special compensation payments were discretionary and determined by the Company’s owners in the first or second quarter of the year in which they were made, based on current period considerations including capital position, estimated capital needs and liquidity, and earnings for the prior year. We paid founder special compensation in the aggregate amount of $17.9 million and $10.2 million for the years ended December 31, 2014 and 2013, respectively. Following the completion of the private placement in 2014, we ceased paying founder special compensation.
Premiums earned. Premiums earned are the earned portion of our net premiums written, which are predominately CPI premiums. As the CPI product is not a traditional insurance product, the premium recognition is likewise different. First, we do not record premiums until we collect them from our accounts since they have the right to waive the placement of insurance on any of their loans. Our standard premium notice cycles range from 42 to 84 days. Therefore, we earn premiums for such notice periods at the time they are written. Next, there is a high level of policy cancellations since borrowers often purchase insurance at the traditional rates that provides protection for them in addition to their lender. Due to this high level of policy cancellations, we split the premium into two pieces: (1) an allowance for future cancellations and (2) premiums that we expect to earn, which we refer to as “stick premiums.” We earn stick premiums on a pro rata basis over the terms of the policies. The CPI premiums written as presented in this document reflect the effects of the allowance for policy cancellations including any adjustments related to re-estimation of the allowance. As such, our recorded CPI premiums written are those that we expect to earn while those that are expected to cancel are included in the allowance for policy cancellations. At the end of each reporting period, stick premium written that is not earned is classified as unearned premium, which is earned in subsequent periods over the remaining terms of the policies. Our policies typically have a term of one year, although the average duration of our CPI policies is typically less than six months due to policy cancellations.
General and administrative expense. General and administrative expense is composed of all other operating expenses, including various departmental salaries and benefits expenses for employees. General and administrative expenses also include expenses related to our office space, postage, telephone and information technology charges, as well as legal and auditing fees and corporate travel. In addition, general and administrative expense includes those charges that are related to the amortization of tangible and intangible assets.
Net combined ratio. The net combined ratio is a measure of the overall profitability of our Lender Services segment. This is the sum of the net loss ratio and the net expense ratio. For the years ended December 31, 2015, 2014 and 2013, our net combined ratio was 86.5%, 89.3% and 85.1%, respectively. Our objective is to price our products to achieve a net combined ratio between 85% to 90%.
The Company evaluates its investment portfolio for impairments of individual securities that are deemed to be other-than-temporary. Fixed maturity securities that are determined to have other-than-temporary impairment and it is more likely than not the Company will sell before recovery of their amortized cost, are written down to fair value and the entire amount of the write-down is included in net income, net of realized investment gains. For all other impaired fixed-maturity securities, the impairment loss is separated into the amount representing the credit loss and the amount representing all other factors. The amount of impairment loss that represents the credit loss is included in net income, net of realized investment gains. The amount of the impairment loss that relates to all other factors is included in other comprehensive income. Equity securities that are determined to have other-than-temporary impairment are recognized in net income, net of realized investment gains.
Minimum ceding fees are fees the Company receives pursuant to contractual minimum premium requirements for certain programs where either significant premium capacity is reserved for that program or where the expected premium volume is not reasonably assured. For those programs where a minimum applies, the ceding fees are considered as two distinct pieces: 1) “premium related fees,” which are earned as the associated gross written premium is earned, typically pro rata on an annual basis; and (2) “capacity fees,” which are determined based on the shortfall, if any, between the program’s contractual annual premium minimum and the amount of premium estimated to be written in the contract year, which fees are earned over the contract year.
Prior to the completion of the private placement in June 2014, we made special compensation payments to our co-founders in recognition of their service to our Company. We refer to these as “founder special compensation.” Following the completion of the private placement in 2014, we ceased paying founder special compensation.
Upon the completion of the private placement in 2014, our parent company’s status as a Subchapter S corporation terminated and our consolidated income became fully subject to U.S. federal income taxes. This adjustment represents estimated income taxes as if the Company had been treated as a C Corporation for each period presented. The estimated tax was calculated assuming the Company’s blended statutory federal and state income tax rates of 37.5% and 38.1% for the periods ended December 31, 2014 and 2013, respectively.
General and administrative expense. General and administrative expense increased by $4.1 million or 6.9%, from $58.9 million for the year ended December 31, 2014 to $63.0 million for the year ended December 31, 2015, primarily due to stock-based compensation, employee group insurance and expenses associated with being a public company.
Contract modification expense. Contract modification expense decreased by $17.8 million. In connection with the 2014 amendment to the alliance agreement with CUNA Mutual, we paid CUNA Mutual $17.8 million. As a result, we recorded non-recurring contract modification expense of $17.8 million for the year ended December 31, 2014.
Commission income. Commission income decreased by $0.5 million, or 24.5%, from $2.0 million for the year ended December 31, 2013 to $1.5 million for the year ended December 31, 2014 primarily due to cancellation of an ancillary line program.
Other income. Other income increased by $1.9 million, or 76.2%, from $2.5 million for the year ended December 31, 2013 to $4.4 million for the year ended December 31, 2014. This increase consists primarily of an early termination fee related to an operating lease. In November 2013, the Company received an early termination notice from an unaffiliated third party relating to the operating lease between the parties. The Company recognized $1.5 million in lease termination fees in 2014 due to the early termination of the lease. In addition, we recognized a gain of $0.6 million for the year ended December 31, 2014 related to the auction and repurchase of one of the Company’s subordinated debentures. The Company repurchased a $7.5 million subordinated debenture for $6.8 million. This transaction resulted in a $0.6 million gain after deducting the unamortized portion of the initial issuance costs from the difference in the par value and the purchase price.
Losses and loss adjustment expenses. Losses and LAE increased by $8.7 million, or 27.2%, from $32.1 million for the year ended December 31, 2013 to $40.8 million for the year ended December 31, 2014, which is partly the result of higher premiums earned. A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to an increase in vehicle sales, resulting in higher loan balances which are the bases upon which we pay claims. In addition, the net loss ratio on the Lender Services segment increased from 37.3% to 42.0% for the years ended December 31, 2013 and December 31, 2014, respectively. This increase is primarily due to an increase in claims frequency and severity.
Founder special compensation. Founder special compensation increased by $7.7 million or 75.6% from $10.2 million for the year ended December 31, 2013 compared to $17.9 million for the year ended December 31, 2014. The increase in founder special compensation was primarily due to the favorable capital position and liquidity during the period as well as our expected liquidity needs prior to the completion of the private placement in 2014. This favorable position was partly due to the increased earnings achieved for 2013 as compared to 2012. The assessment was made by the Company’s owners in the first and second quarters and was considered along with the capital needs for the coming periods.
Offering-related expenses. Offering-related expenses of $8.8 million at December 31, 2014 are non-recurring expenses associated with the private placement of the Company’s stock.
Program Services Segment Results of Operations for the Year Ended December 31, 2015 compared to the Year Ended December 31, 2014
Ceding fees. Ceding fees increased by $12.8 million, or 39.0%, from $32.9 million for the year ended December 31, 2013 to $45.7 million for the year ended December 31, 2014, primarily due to an increase in Program Services gross
In connection with the amendment to the alliance agreements with CUNA Mutual, we paid CUNA Mutual $17.8 million. As a result, we recorded non-recurring contract modification expense of $17.8 million.
General and administrative expense. General and administrative expense increased by $0.8 million or 2.2%, from $39.0 million for the year ended December 31, 2014 to $39.8 million for the year ended December 31, 2015. The increase in general and administrative expenses was minimal in relation to our increased premium retention from the Alliance quota share agreement due to our ability to effectively leverage our fixed costs. This contributed to a decrease in our net expense ratio to 41.0% in 2015 compared to 47.3% in 2014.
Losses and loss adjustment expenses. Losses and LAE increased by $9.0 million, or 28.4%, from $31.6 million for the year ended December 31, 2013 to $40.6 million for the year ended December 31, 2014, which is partly the result of higher premiums earned. A strengthening economy, an aging automobile fleet, and easier access to credit have contributed to an increase in vehicle sales, resulting in higher loan balances which are the bases upon which we pay claims. The net loss ratio increased from 37.3% to 42.0% for the years ended December 31, 2013 and December 31, 2014, respectively. This increase is also due to an increase in claims frequency and severity.
General and administrative expense. General and administrative expense increased by $3.0 million, or 8.3%, from $36.0 million for the year ended December 31, 2013 to $39.0 million for the year ended December 31, 2014 primarily due to an increase in personnel cost.
Contract modification expense. Contract modification expense of $17.8 million at December 31, 2014 is associated with the modification of the CUNA Mutual alliance agreement. The Company accrued the expense as of June 30, 2014 and paid the expense on July 8, 2014.
Other income. Other income increased by $1.8 million, or 123.8%, from $1.4 million for the year ended December 31, 2013 to $3.2 million for the year ended December 31, 2014. This increase consists primarily of an early termination fee related to an operating lease. In November 2013, the Company received an early termination notice from an unaffiliated third party relating to the operating lease between the parties. The Company recognized $1.5 million in lease termination fees in 2014 due to the early termination of the lease. In addition, we recognized a gain of $0.6 million for the year ended December 31, 2014 related to the auction and repurchase of one of the Company’s subordinated debentures. The Company repurchased a $7.5 million subordinated debenture for $6.8 million. This transaction resulted in a $0.6 million gain after deducting the unamortized portion of the initial issuance costs from the difference in the par value and the purchase price.
General and administrative expense. General and administrative expense increased by $2.6 million, or 41.5%, from $6.4 million for the year ended December 31, 2013 to $9.0 million for the year ended December 31, 2014. This is primarily due to stock-based compensation expense incurred in 2014. The Company did not have stock-based compensation expense in 2013.
Income tax expense (benefit). Income taxes decreased by $12.5 million from a $2.8 million expense for the year ended December 31, 2013 to a $9.7 million benefit for the year ended December 31, 2014 from the conversion of the Company’s tax status to a C Corporation.
Our investment strategy emphasizes, first, the preservation of capital and, second, the generation of an appropriate risk-adjusted return. We seek to generate 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 and short-term money market funds. As of December 31, 2015, the tax adjusted yield on our fixed maturity and equity securities was 2.7%. Convertible securities represent 12.3% of the portfolio at December 31, 2015, an increase from 5.3% at December 31, 2014. Management increased the convertible portfolio because convertible securities offer the potential for participation in the growth of the equity markets with greater down side protection. The average duration, excluding convertible securities, was 4 years and included 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 and common stock of U.S. corporations. Our investment portfolio is managed by Asset Allocation & Management Company, LLC and AAM Advisors, Inc. (collectively, “AAM”). AAM operates under written investment guidelines approved by our board of directors. We pay AAM an investment management fee based on the market value of assets under management.
The table below summarizes the credit quality of our fixed-maturity securities as of December 31, 2015, as rated by Standard and Poor’s.
We are required to maintain deposits in various states where the insurance subsidiaries are licensed to operate. These deposits are fixed maturity securities at fair values totaling $53.5 million and $36.9 million at December 31, 2015 and December 31, 2014, respectively. The increase in the amounts on deposit at December 31, 2015 is primarily due to an increase in the required deposits for workers’ compensation business.
Our insurance subsidiaries are subject to statutory and regulatory restrictions imposed on insurance companies by their states 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 domiciliary state. The aggregate limit imposed by the various domiciliary states of our insurance subsidiaries was approximately $23.0 million and $21.6 million as of December 31, 2015 and 2014, respectively. In addition, we are able to generate substantial cash flow outside of our regulated insurance company subsidiaries through intercompany agency and management agreements between our insurance subsidiaries and our agency, TBA. TBA functions as a managing general agent for SNIC and NSIC in connection with the Lender Services segment. In addition, under the management agreement TBA provides business development, financial monitoring and other oversight functions to our insurance subsidiaries.
Net cash provided by operating activities was approximately $23.2 million for the year ended December 31, 2014, compared with $33.9 million provided by operating activities for the same period in 2013. On July 8, we made payments totaling $17.8 million to CUNA Mutual pursuant to the 2014 amendment of the alliance agreement. In addition, the Company paid offering-related expenses of $8.8 million and had an increase in founder special compensation of $7.7 million as of December 31, 2014. These increases in cash outflows are partially offset by increases in cash inflows related to premium and ceding fee growth through December 31, 2014.
rates range from 3.80% to 4.10% plus the 3-month LIBOR. The three month LIBOR at December 31, 2015, was 0.61%. All of the debentures mature between 2032 and 2034.
The interest related to the debt by period as of December 31, 2014 was as follows: $2.0 million-less than 1 year, $4.3 million-1 - 3 years, $4.3 million-3 - 5 years and $ 28.8 million-more than 5 years.