The following tables provide selected historical consolidated financial and operating data of the Company at the dates and for the periods indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the accompanying notes included in this report. We derived our selected historical consolidated financial data at December 31, 2017, and 2016 and for the years ended December 31, 2017, 2016, and 2015 from our consolidated financial statements included in this report. We derived our selected historical consolidated financial data at December 31, 2015, 2014 and 2013 and for the years ended December 31, 2014 and 2013 from our consolidated financial statements which are not included in this report. The results for past periods are not necessarily indicative of the results to be expected for any future period.
The actual results for the year ended December 31, 2015 reflect only the results of the Titan Agencies’ operations since the date of acquisition (July 1, 2015). The unaudited pro forma results for the year ended December 31, 2015 gives effect to the Titan acquisition and related transactions as if they had been consummated on January 1, 2015.
The unaudited pro forma results should not be considered indicative of actual results that would have been achieved had the Titan acquisition and related transactions been consummated on January 1, 2015 and do not purport to indicate results of operations for any future periods.
The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act makes broad changes to U.S. federal tax law including but not limited to a reduction in the federal corporate tax rate from 35% to 21%, and temporary differences related to the computation of tax loss and loss adjustment expense reserves and limitations on the interest expense deduction.
We are principally a retailer, servicer and underwriter of non-standard personal automobile insurance. Non-standard personal automobile insurance is made available to individuals because of their inability or unwillingness to obtain standard insurance coverage due to various factors, including payment history, payment preference, and failure in the past to maintain continuous insurance coverage, driving record and/or vehicle type. On May 4, 2016, we sold a tract of land at a gain of $1.2 million and as a result have only one single tract of land in San Antonio, Texas that remains for sale.
Our insurance operations generate revenue from selling non-standard personal automobile insurance products and related products in 16 states. We currently conduct our insurance servicing and underwriting operations in 13 states and operate only as an insurance agency in three states. We are also licensed as an insurance company in 13 states where we do not conduct any business. After obtaining a license in California, we began selling our non-standard personal automobile insurance product there in late June 2016 on a limited basis. In December 2016, we closed all of our retail locations and ceased writing new business in the state of Missouri.
At December 31, 2017, the majority of our 350 stores primarily sell non-standard personal automobile insurance products underwritten by us. The other retail locations primarily offer non-standard personal automobile insurance serviced and underwritten by other third-party insurance carriers for which we receive a commission.
The following table shows the number of our retail locations. Retail location counts are based upon the date that a location commenced or ceased writing business. Since December 31, 2015, 94 locations were closed which included 53 that were part of our recent actions to improve profitability, 24 in the Chicago-area whose leases expired in January 2016, and 17 others closed in the normal course of business. During 2016, four new locations were strategically selected to replace and consolidate the closed Chicago-area locations.
Strengthened our Product team and filed and received approval for substantial rate increases and structural changes in our rating programs in response to our increase in claim frequency. The magnitude and frequency of these rate increases have been unprecedented in our recent history;
At December 31, 2017, these actions have resulted in a 31% decrease in our policies in force since June 30, 2016, which has been partially offset by a 17% increase in our average in-force premium over this period. This premium increase was driven by an effective rate increase of 14% attained over the last eighteen months. We believe that our underwriting actions have contributed to a reduction of incoming claim volume across all coverages.
Collectively, we believe that these actions have contributed to the improved loss ratio for the current 2017 accident period, exclusive of the impact of the recent hurricanes.
As our business has stabilized, we have developed a long-term strategic plan with the goal of fully capitalizing on the strengths of our business model going forward. While our immediate objectives were returning to profitability and building team member morale, in the longer term we look to capitalize on our key internal capabilities and manage external risks. In this regard, we are evaluating the strengths of our agency model (i.e. retail locations, employee-agents, carrier relationships, technology and support staff) across our footprint so that we can deploy our capital and surplus wherever it will generate the highest return. This process may result in expanding the use of additional third-party insurance products in selected markets.
The following table presents gross premiums earned by state (in thousands). The effect of a 14% decrease in our year-over-year policies in force offset by a 10% year-over-year increase in our average in-force premium, resulted in net premiums earned for the year ended December 31, 2017 decreasing by 8.3% compared with the prior year.
Expense Ratio - Expense ratio is the ratio (expressed as a percentage) of insurance operating expenses (including depreciation and amortization) to net premiums earned. Insurance operating expenses are reduced by commission and fee income. This is a measurement that illustrates relative management efficiency in administering our operations.
Combined Ratio - Combined ratio is the sum of the loss ratio and the expense ratio. If the combined ratio is at or above 100%, our insurance segment cannot be profitable without sufficient investment income.
The invested assets of the insurance company subsidiaries consist substantially of marketable, investment grade debt securities, and include U.S. government securities, municipal bonds, corporate bonds, mutual funds, and collateralized mortgage obligations (“CMOs”), in addition to other alternative investments made into limited partnership interests and a real estate investment trust. Investment income is comprised primarily of interest earned on these securities, net of related investment expenses. Although investments are generally purchased with the intention to hold them until maturity, realized gains and losses could occur from time to time as changes are made to our holdings based upon changes in interest rates or the credit quality of specific securities, or as we did in 2016, to increase the statutory capital and surplus of the insurance company subsidiaries who carry fixed maturity securities at amortized cost.
The value of our other investments was $9.8 million at December 31, 2017 and consisted of two limited partnership interests carried at net asset value, which approximates fair value, with unrealized gains and losses reported as investment income, and a privately-held real estate investment trust carried at fair value, with unrealized gains and losses reported in a separate component of stockholders’ equity. At December 31, 2017, we had gross unrealized gains attributable to our privately-held real estate investment trust of $0.7 million in our consolidated other investments portfolio.
At December 31, 2017, 97% of the fair value of our fixed maturities portfolio was rated “investment grade” (a credit rating of AAA to BBB-) by nationally recognized statistical rating organizations. Investment grade securities generally bear lower yields and have lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate a stable and predictable investment return.
Revenues for the year ended December 31, 2017 decreased 11% to $347.5 million from $389.6 million in the prior year. Income before income taxes for the year ended December 31, 2017 was $6.6 million, compared with loss before income taxes of $45.1 million for the year ended December 31, 2016. Net loss for the year ended December 31, 2017 was $8.6 million, compared with $29.3 million for the year ended December 31, 2016. Basic and diluted net loss per share was $0.21, for the year ended December 31, 2017, compared with $0.71 for the year ended December 31, 2016.
Revenues from insurance operations were $347.4 million for the year ended December 31, 2017, compared with $388.3 million for the year ended December 31, 2016. Income before income taxes from insurance operations for the year ended December 31, 2017 was $12.5 million, compared with loss before income taxes from insurance operations of $40.7 million for the year ended December 31, 2016.
Premiums earned decreased by $25.1 million, or 8.3%, to $278.2 million for the year ended December 31, 2017, from $303.3 million for the year ended December 31, 2016. This decrease was the result of a targeted decline in new policies written through the closing of 53 poorly performing stores, increasing rates and the tightening of underwriting standards. These actions resulted in a 14% decrease in our year-over-year policies in force which was partially offset by a 10% year-over-year increase in our average in-force premium that was driven by our recent rate actions.
Investment income increased slightly to $4.7 million during the year ended December 31, 2017 from $4.6 million during the year ended December 31, 2016.
At December 31, 2017 and 2016, the book yields for our fixed maturities and cash equivalents portfolio were 1.9% and 1.5%, respectively, with effective durations of 2.48 and 2.52 years, respectively.
During the third quarter of 2017, Hurricanes Harvey and Irma impacted Texas and Florida, respectively. We received approximately 800 claims and incurred approximately $2.4 million in losses and LAE during the third quarter of 2017 from these events.
Overall, the combined ratio decreased to 97.2% for the year ended December 31, 2017 from 116.5% for the year ended December 31, 2016.
In assessing our ability to realize the DTA, both positive and negative evidence are used to evaluate the allowance. Although we incurred a pre-tax loss of $45.1 million in 2016 which is a source of negative evidence, we placed greater weight on our outlook for future taxable income over the allowable time period for realization of the DTA and concluded that it is more likely than not that the remaining DTA will be realized. Regarding the length of time available to realize the DTA, at December 31, 2017, $13.4 million of the DTA related to net operating loss carryforwards do not expire until 2032 through 2036 and $2.0 million in AMT (“Alternative Minimum Tax”) carryforwards are fully refundable by 2021 under the new tax legislation if not utilized. The DTA valuation allowance may be adjusted in future periods if management determines that it is more likely than not that some portion or all of the DTA will not be realized. In the event the DTA valuation allowance is adjusted, we would record an income tax expense for the adjustment.
Loss before income taxes from real estate and corporate operations for the year ended December 31, 2017 was $5.9 million, compared with $4.4 million for the year ended December 31, 2016. Segment losses consist of other operating expenses not directly related to our insurance operations, interest expense and stock-based compensation offset by offset by a $1.2 million gain on the sale of foreclosed real estate for the year ended December 31, 2016 and investment income on corporate invested assets.
For the year ended December 31, 2017, interest expense increased to $4.5 million from $4.3 million for the year ended December 31, 2016 as the result of an increase in LIBOR. Interest expense is from our debentures payable and the term loan from our principal stockholder to finance the July 1, 2015 Titan Agencies acquisition. For additional information, see “Liquidity and Capital Resources” in this report.
Revenues for the year ended December 31, 2016 increased 17% to $389.6 million from $331.9 million in the prior year. Loss before income taxes for the year ended December 31, 2016 was $45.1 million, compared with $2.6 million for the year ended December 31, 2015. Net loss for the year ended December 31, 2016 was $29.3 million, compared with $1.9 million for the year ended December 31, 2015. Basic and diluted net loss per share was $0.71, for the year ended December 31, 2016, compared with $0.05 for the year ended December 31, 2015.
Commission and fee income increased by $15.7 million, or 26%, to $75.6 million for the year ended December 31, 2016, from $59.9 million for the year ended December 31, 2015. Revenue from the former Titan retail locations acquired on July 1, 2015 accounted for the majority of this increase. The remaining increase in commission and fee income was a result of higher fee income related to commissionable ancillary products sold through our previously-existing retail locations.
Investment income decreased slightly to $4.6 million during the year ended December 31, 2016 from $5.0 million during the year ended December 31, 2015. This decrease in investment income was primarily a result of the lower returns on reinvested fixed maturities. At December 31, 2016 and 2015, the book yields for our fixed maturities and cash equivalents portfolio were 1.5% and 2.3%, respectively, with effective durations of 2.52 and 3.04 years, respectively.
The loss ratio was 101.9% for the year ended December 31, 2016, compared with 82.0% for the year ended December 31, 2015. We experienced unfavorable development related to prior fiscal years of $30.6 million for the year ended December 31, 2016,
Excluding the development related to prior fiscal years, the loss ratios for the years ended December 31, 2016 and 2015 were 91.8% and 81.7%, respectively. The year-over-year increase in the loss ratio was primarily due to higher than expected claim frequency across all major coverages and higher bodily injury severity. We believe that an increase in the number of miles driven by insured drivers as a result of lower gas prices and a favorable economy, along with an increase in distracted driving has been a contributing factor to an industry-wide increase in frequency. In response, the Company has continued to implement aggressive rate and underwriting actions as warranted at a state and coverage level and strengthen its claims organization and processes. These rate actions, as well as changes in coverage mix, the number of vehicles and vehicle type insured, have resulted in a 13.6% year-over-year increase in our average in-force premium.
Insurance operating expenses increased 10.6% to $116.5 million for the year ended December 31, 2016 from $105.3 million for the year ended December 31, 2015. This increase is primarily due to the addition of the former Titan retail locations which were not acquired until July 1, 2015.
Overall, the combined ratio increased to 116.5% for the year ended December 31, 2016 from 99.8% for the year ended December 31, 2015.
The holding company has debt service requirements related to the debentures payable and the term loan to a principal stockholder. The debentures are interest-only and mature in full in July 2037. The debentures accrue interest at a variable rate equal to Three-Month LIBOR plus 375 basis points, which resets quarterly. The interest rate related to the debentures for the year ended December 31, 2017 ranged from 4.637% to 5.128%. In January 2018 the interest rate reset to 5.517% through April 2018. The term loan is interest-only and matures in full in June 2025. The interest rate on the term loan is 8%.
State insurance laws limit the amount of dividends that may be paid from our insurance company subsidiaries. At December 31, 2017, our insurance company subsidiaries could not pay any dividends due to a negative unassigned surplus position.
On June 15, 2007, First Acceptance Statutory Trust I (“FAST I”), our wholly-owned unconsolidated subsidiary trust entity, completed a private placement whereby FAST I issued 40,000 shares of preferred securities at $1,000 per share to outside investors and 1,240 shares of common securities to us, also at $1,000 per share. FAST I used the proceeds from the sale of the preferred securities to purchase $41.2 million of junior subordinated debentures from us. The debentures will mature on July 30, 2037 and are currently redeemable by the Company in whole or in part and the preferred securities are callable. The debentures paid a fixed rate of 9.277% until July 30, 2012, after which the rate became variable (Three-Month LIBOR plus 375 basis points, resetting quarterly). During 2017, the interest rate related to the debentures ranged from 4.637% to 5.128%. The obligations of the Company under the junior subordinated debentures represent full and unconditional guarantees by the Company of FAST I’s obligations for the preferred securities. Dividends on the preferred securities are cumulative, payable quarterly in arrears and are deferrable at the Company’s option for up to five years. The dividends on these securities, which have not been deferred, are the same as the interest on the debentures. The Company cannot pay dividends on its common stock during any such deferments. FAST I does not meet the requirements for consolidation of FASB ASC 810, Consolidation.
Income taxes are accounted for under the liability method, whereby deferred income tax assets and liabilities result from temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and operating loss and tax credit carryforwards and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. Valuation of the deferred tax asset is considered a critical accounting estimate because the determination of our ability to utilize the asset involves a number of management assumptions relating to future operations and our ability to generate future taxable income. This could materially affect the determination of the ultimate value and, therefore, the carrying amount of our deferred tax asset.
In establishing a valuation allowance at December 31, 2017, both positive and negative evidence were used to evaluate the allowance and the greatest weight was placed on our outlook for future taxable income and the allowable time period for realization of the DTA. We estimated our future taxable income from our 2018 budget and the long-term forecasts we use to manage our business and concluded that it is more likely than not that the remaining DTA will be realized. A key consideration in our current analysis was the fact that no deferred tax assets have had expiration dates that we believed would be a factor in the timing of their ultimate realization. Regarding the length of time available to realize the DTA, at December 31, 2017, $13.4 million of the DTA related to net operating loss carryforwards that do not expire until 2032 through 2036 and $2.0 million in AMT (“Alternative Minimum Tax”) credit carryforwards are fully refundable by 2021 if not utilized.
In the event that facts and circumstances indicate that the goodwill or identifiable intangible assets may be impaired, quantitative impairment tests would be required. The valuation techniques utilized would include a discounted cash flow model using revenue and profit forecasts and an analysis of quoted market prices of our common stock for our goodwill. Other quantitative methods would be used for evaluating our acquired identifiable intangible assets: policy renewal rights and customer relationships, trademarks and trade names, and insurance licenses.
See “Business - Losses and Loss Adjustment Expense Reserves” in Item 1 of this report and Note 9 to our consolidated financial statements for additional information.
In reviewing our investment portfolio for impairment at December 31, 2017, we were able to rely upon the objective factor that the unrealized losses as of this date were related to the increase in market interest rates.
We have audited First Acceptance Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, First Acceptance Corporation and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive loss, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and financial statement schedule listed in the Index at Item 15(a)(2) and our report dated March 6, 2018 expressed an unqualified opinion thereon.
Investments, available-for-sale at fair value, include bonds with fixed principal payment schedules and mortgage-backed securities which are amortized using the retrospective method. These securities and investments in mutual funds are carried at fair value with the corresponding unrealized appreciation or depreciation, net of deferred income taxes, reported in other comprehensive loss.
Commission and fee income includes installment fees recognized when billed, commissions and fees from ancillary products recognized on a pro-rata basis over the respected terms of the contracts, and commissions and related policy fees, written for third-party insurance companies, recognized, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. A liability for returned commissions is established for the amount of commission income received that the Company estimates (based on historical experience) will be returned to third-party insurance companies as a result of policy cancellations.
Foreclosed real estate held for sale is recorded at the lower of cost or fair value less estimated costs to sell. The Company periodically reviews its portfolio of foreclosed real estate held for sale using current information including (i) independent appraisals, (ii) general economic factors affecting the area where the property is located, (iii) recent sales activity and asking prices for comparable properties and (iv) costs to sell and/or develop that would serve to lower the expected proceeds from the disposal of the real estate. Gains (losses) realized on liquidation are recorded directly to operations and included in revenues. Foreclosed real estate held for sale assets of $0.2 million are included within other assets in the accompanying consolidated balance sheets at both December 31, 2017 and 2016.
The Company follows the accounting guidelines, which allows companies to waive comparing the fair value of goodwill and intangible assets to their carrying amounts in assessing the recoverability of these assets if, based on qualitative factors, it is more likely than not that the fair value of the goodwill and intangible assets is greater than their carrying amounts. Based on a review of the relevant factors, the Company prepared a qualitative analysis for its annual impairment testing as of October 1, 2017, which did not indicate any impairment.
In May 2014, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) jointly issued a new revenue recognition standard, Accounting Standard Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” that will supersede virtually all revenue recognition guidance in GAAP and International Financial Reporting Standards (“IFRS”). This guidance had an effective date for public companies for annual and interim periods beginning after December 15, 2016, with early adoption not permitted. In July 2015, the FASB issued a one-year deferral of this effective date with the option for entities to early adopt at the original effective date. The standard is intended to increase comparability across industries and jurisdictions. The underlying principle of the new standard is that a business or other organization will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. The new standard will not change accounting guidance for insurance contracts. However, the Company has revenue from non-insurance arrangements and various types of fee income related to its insurance contracts which fall under this guidance, as would the sale of the Company’s tract of land that is held for sale.
During the years ended December 31, 2017, 2016 and 2015, the Company paid $0.4 million, $0.3 million and $0.7 million, respectively, in income taxes and $4.4 million, $4.2 million and $1.7 million, respectively, in interest.
The Company categorizes valuation methods used in both its identifiable intangible assets initial measurement and impairment tests as Level 3. To determine the fair value of acquired trademarks and trade names, the Company uses the relief-from-royalty method, which requires the Company to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital. To determine the fair value of the acquired policy renewal rights and customer relationships, the Company uses an “excess earnings” method that relied on projected future net cash flows and included key assumptions for the customer retention and renewal rates. The data used in these methods is not observable in the market.
The carrying values and fair values of certain of the Company’s financial instruments were as follows (in thousands).
since they were based on current market rates offered for debt with similar risks and maturities, an unobservable input categorized as Level 3. Carrying values of certain financial instruments, such as cash and cash equivalents and premiums, fees, and commissions receivable, approximate fair value due to the short-term nature of the instruments and are not required to be disclosed. Therefore, the aggregate of the fair values presented in the preceding table does not purport to represent the Company’s underlying value.
The following table represents the quantitative disclosure for those assets classified as Level 3 during the year ended December 31, 2017 (in thousands).
The components of net realized (losses) gains on investments, available-for-sale follow (in thousands).
The Company separates OTTI into the following two components: (i) the amount related to credit losses, which is recognized in the consolidated statement of operations and comprehensive loss and (ii) the amount related to all other factors, which is recorded in other comprehensive loss. The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge.
The issuer-specific factors considered in reaching the conclusion that securities with declines are not other-than-temporary include (i) the extent and duration of the decline in fair value, including the duration of any significant decline in value, (ii) whether the security is current as to payments of principal and interest, (iii) a valuation of any underlying collateral, (iv) current and future conditions and trends for both the business and its industry, (v) changes in cash flow assumptions for CMOs and (vi) rating agency
actions. Based on these factors, the Company makes a determination as to the probability of recovering principal and interest on the security.
The Company believes that the remaining securities having unrealized losses at December 31, 2017 were impacted by changes in interest rates and are not other-than-temporarily impaired. The Company also does not intend to sell any of these securities and it is more likely than not that the Company will not be required to sell any of these securities before the recovery of their amortized cost basis.
Assumed business represents private-passenger non-standard automobile insurance premiums in Texas written through a program with a county mutual insurance company and assumed by the Company through 100% quota-share reinsurance. The percentages of premiums assumed to net premiums written was 10%, 13%, and 13% for each of the years ended December 31, 2017, 2016 and 2015, respectively.
At December 31, 2017, the Insurance Companies had unsecured aggregate reinsurance receivables of $0.9 million.
The Company sponsors a defined contribution retirement plan (“401k Plan”) under Section 401(k) of the Internal Revenue Code. The 401k Plan covers substantially all employees who meet specified service requirements. Under the 401k Plan, the Company may, at its discretion, match 100% of the first 3% of an employee’s salary plus 50% of the next 2% up to the maximum allowed by the Internal Revenue Code. The Company’s contributions to the 401k Plan for the years ended December 31, 2017, 2016 and 2015 were $1.3 million, $1.1 million and $1.0 million, respectively, and are included within insurance operating expenses in the accompanying consolidated statements of operations and comprehensive loss.
The Company underwrites primarily a single product in the form of a non-standard personal automobile policy. Although this product can vary in terms of its coverages (liability and physical damage), disaggregation by these coverages is not considered meaningful due to the relative immateriality of the physical damage component which is only approximately 5% of the ending liability for unpaid losses and LAE. Additionally, the amount of renters coverage sold as an optional product is likewise immaterial. Information regarding the reserve for unpaid losses and loss adjustment expenses (“LAE”) is as follows (in thousands).
The average historical annual percentage payout of incurred losses by age, net of reinsurance is as follows. The amounts reflected below represent the average length of time between the occurrence of a loss and its payment.
In June 2007, First Acceptance Statutory Trust I (“FAST I”), a wholly-owned unconsolidated subsidiary trust of the Company, issued 40,000 shares of preferred securities at $1,000 per share to outside investors and 1,240 shares of common securities to the Company, also at $1,000 per share. FAST I used the proceeds from the sale of the preferred securities to purchase $41.2 million of junior subordinated debentures from the Company. The sole assets of FAST I are $41.2 million of junior subordinated debentures issued by the Company. The debentures will mature on July 30, 2037 and are currently redeemable by the Company in whole or in part and the preferred securities are callable. The debentures paid a fixed rate of 9.277% until July 30, 2012, after which the rate became variable (Three-Month LIBOR plus 375 basis points, resetting quarterly). The interest rate related to the debentures ranged from 4.637% to 5.128% during 2017. In January 2018, the interest rate reset to 5.517% through April 2018.
The debentures are classified as debentures payable in the Company’s consolidated balance sheets and the interest paid on these debentures is classified as interest expense in the consolidated statements of operations and comprehensive (loss) income. At December 31, 2017, the unamortized debt discount and issuance costs of $0.9 million are being amortized to interest expense over the term of the debentures.
The provision (benefit) for income taxes differs from the amounts computed by applying the statutory federal corporate tax rate of 21% to (loss) income before income taxes as a result of the following (in thousands).
Basic EPS are computed using the weighted average number of shares outstanding. Diluted EPS are computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding securities with a right to purchase or convert into common stock.
For the year ended December 31, 2016, the computation of diluted net loss per share did not include options to purchase approximately 750 thousand shares, a dilutive effect of 127 thousand shares, and restricted stock units convertible into 169 thousand shares, a dilutive effect of 17 thousand shares, since their inclusion would have been anti-dilutive. Options to purchase 220 thousand shares for the year ended December 31, 2016 were not included in the computation of diluted net loss per share as their exercise prices were in excess of the average stock prices for the year.
The statutory-basis financial statements of the Insurance Companies are prepared in accordance with accounting practices prescribed or permitted by the Department of Insurance in each respective state of domicile. Each state of domicile requires that insurance companies domiciled in the state prepare their statutory-basis financial statements in accordance with the National Association of Insurance Commissioners Accounting Practices and Procedures Manual subject to any deviations prescribed or permitted by the insurance commissioner in each state of domicile. The Insurance Companies are required to report their risk-based capital (“RBC”) each December 31. Failure to maintain an adequate RBC could subject the Insurance Companies to regulatory action and could restrict the payment of dividends. At December 31, 2017, the RBC levels of the Insurance Companies did not subject them to regulatory action.
At December 31, 2017 and 2016, on a consolidated statutory basis, the capital and surplus of the Insurance Companies was $66.1 million and $58.9 million, respectively. For the years ended December 31, 2017, 2016 and 2015, consolidated statutory net income (loss) of the Insurance Companies was $2.8 million, ($52.0) million and ($7.3) million, respectively.
In April 2016, the Company entered into standard agreements for Treasury and Custodial Services with a bank indirectly owned 15% by our principal stockholder. The fees under these agreements for the years ended December 31, 2017 and 2016 were $167 thousand and $112 thousand, respectively.
Income before income taxes for the quarter ended June 30, 2016 included unfavorable loss development of $25.8 million.