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, umbrella, recreational vehicle, motorcycle, lender-placed, supplemental health 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.
We manage our business through two segments: Property and Casualty (“P&C”) and Accident and Health (“A&H”). We transact business primarily through our twenty-two regulated domestic insurance subsidiaries: Integon Casualty Insurance Company, Integon General Insurance Corporation, Integon Indemnity Corporation, Integon National Insurance Company (“Integon National”), Integon Preferred Insurance Company, New South Insurance Company, MIC General Insurance Corporation, National General Insurance Company, National General Assurance Company, National General Insurance Online, Inc., National Health Insurance Company, National General Premier Insurance Company, Imperial Fire and Casualty Insurance Company, Agent Alliance Insurance Company, Century-National Insurance Company, Standard Property and Casualty Insurance Company, Direct General Insurance Company, Direct General Insurance Company of Louisiana, Direct General Insurance Company of Mississippi, Direct General Life Insurance Company, Direct Insurance Company and Direct National Insurance Company. Our insurance subsidiaries that are part of our intercompany quota share agreement to Integon National, have an “A-” (Excellent) group rating by A.M. Best, subject to transition periods in the case of acquired companies. We currently conduct a limited amount of business outside the United States, primarily in Bermuda, Luxembourg and Sweden.
In June 2016, we closed on the acquisition of Century-National Insurance Company, a California domiciled property and casualty insurance company (“Century-National”), and Western General Agency, Inc., a California corporation (“Western General”), from Kramer-Wilson Company, Inc. This acquisition expands our standard and preferred product offering in both homeowners and personal auto in a key geographic area, enhancing our ability to bundle these products together and improve customer retention. The purchase price for the transaction was approximately $322.7 million.
In October 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, including certain of QBE’s affiliates engaged in the lender-placed insurance business (“LPI Business”). The transaction included the acquisition of certain assets, including loan-tracking systems and technology, client servicing accounts, intellectual property, and vendor relationships, as well as the assumption of the related insurance liabilities in a reinsurance transaction through which we received the loss reserves, unearned premium reserves, and invested assets. The aggregate consideration for the transaction was approximately $95.7 million.
Ceding commission income. Ceding commission income is a commission we receive based on the earned premium ceded to third-party reinsurers to reimburse us for our acquisition, underwriting and other operating expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, generally on a pro rata basis over the terms of the policies reinsured. The portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to acquisition and other underwriting expenses.
We also collect service fees in the form of commissions and general agent fees by selling policies issued by third-party insurance companies. We also collect management fees in connection with our management of the Reciprocal Exchanges. We do not bear insurance underwriting risk with respect to these policies. Commission income and general agent fees are recognized, net of an allowance for estimated policy cancellations, at the date the customer is initially billed or as of the effective date of the insurance policy, whichever is later. The allowance for estimated third-party cancellations is periodically evaluated and adjusted as necessary.
Net investment income and realized and unrealized gains and (losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturities 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 our fixed maturities and equity securities as available for sale. We report net unrealized gains (losses) on those securities classified as available for sale separately in other comprehensive income (loss). Additionally, we have a small portfolio of fixed
Net loss ratio. The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of loss and LAE incurred to net earned premium.
Use of estimates and assumptions. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our principal estimates include unpaid losses and LAE reserves; deferred acquisition costs; reinsurance recoverables, including the provision for uncollectible premiums; recording of impairment losses for other-than-temporary declines in fair value; determining the fair value of investments; determining the fair value of share-based awards for stock compensation; the valuation of intangibles and the determination of of goodwill and goodwill impairment; and income taxes. In developing the estimates and assumptions, management uses all available evidence. Because of uncertainties associated with estimating the amounts, timing and likelihood of possible outcomes, actual results could differ from 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 canceled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. An insufficient 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. We estimate an allowance for doubtful accounts based on a percentage of fee income.
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.
Assessments related to insurance premiums. We are subject to a variety of insurance-related assessments, such as assessments by state guaranty funds used by state insurance regulators to cover losses of policyholders of insolvent insurance companies and for the operating expenses of such agencies. A typical obligating event would be the issuance of an insurance policy or the occurrence of a claim. These assessments are accrued in the period in which they have been incurred. We use estimated assessment rates in determining the appropriate assessment expense and accrual. We use estimates derived from state regulators and/or National Association of Insurance Commissioners (“NAIC”) Tax and Assessments Guidelines.
Goodwill and intangible assets. We account for goodwill and intangible assets in accordance with ASC 350, “Intangibles - Goodwill and Other.” A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statements of income.
Business combinations. We account for business combinations under the acquisition method of accounting, which requires us to record assets acquired, liabilities assumed and any non-controlling interest in the acquiree at their respective fair values as of the acquisition date. We account for the insurance and reinsurance contracts under the acquisition method as new contracts, which requires us to record assets and liabilities at fair value. We adjust the fair value loss and LAE reserves by recording the acquired loss reserves based on our existing accounting policies and then discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk-free interest rate is then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties
We utilize the fair values received from the pricing service to estimate fair value measurements for all our fixed maturities and equity securities. The following describes the valuation techniques we used to determine the fair value of financial instruments held as of December 31, 2016 and December 31, 2015:
•Corporate Bonds - Comprised of bonds issued by corporations, public and privately placed. The fair values of short-term corporate bonds are priced using the spread above the London Interbank Offering Rate (“LIBOR”) yield curve, and the fair value of long-term corporate bonds are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, these are classified within Level 2 of the fair value hierarchy. We also hold certain structured notes and term loans that do not have an active market. These bonds are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and are classified as Level 3 in the fair value hierarchy.
•Equity Securities - The pricing service utilizes market quotations for equity securities that have quoted market prices in active markets and their respective quoted prices are provided as fair value. We classified the values of these equity securities as Level 1. The pricing service also provides fair value estimates for certain equity securities whose fair value is based on observable market information rather than market quotes. We classified the value of these equity securities as Level 2. From time to time, we also hold certain equity securities that are issued by privately-held entities or direct equity investments that do not have an active market. We estimate the fair value of these securities primarily based on inputs such as third-party broker quote, issuers’ book value, market multiples, and other inputs. These bonds are valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and are classified as Level 3 in the 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.
During 2016, 2015, and 2014, we entered into a number of acquisitions and other transactions, including the following: (i) in 2016, the Direct General and Century-National acquisitions, the Reciprocal Exchanges deconsolidation at January 1, 2016, and subsequent consolidation at March 31, 2016, and the increase in premium volume from our 2015 acquired company Assigned Risk Solutions Ltd. (“ARS”), which began being written on our paper on January 1, 2016; (ii) in 2015, the LPI Business acquisition and the Assurant Transaction; and (iii) in 2014, our personal lines reinsurance agreements with Tower Group International, Ltd. and its insurance subsidiaries (collectively, “Tower”), the Reciprocal Exchanges consolidation at September 14, 2014, and our purchase of certain assets from Imperial Management Corporation, including its underwriting subsidiaries, its retail agency and its managing general agency (“Imperial”). Additionally, in 2013, we terminated the Personal Lines Quota Share on a run-off basis (the “Quota Share Runoff”). Due to these transactions, comparisons in our results of operations between 2016 and 2015, and between 2015 and 2014, are less meaningful.
Consolidated Results of Operations for the Year Ended December 31, 2016 Compared with the Year Ended December 31, 2015
Net premium written. Net premium written increased by $885.1 million, or 40.5%, from $2,186.2 million for the year ended December 31, 2015 to $3,071.3 million for the year ended December 31, 2016. Net premium written for the P&C segment increased by $682.3 million for the year ended December 31, 2016 compared to the same period in 2015, primarily as a result of the acquisitions of Direct General ($58.5 million) and Century-National ($122.1 million), additional premiums from the LPI Business ($238.2 million) and ARS ($74.6 million), and organic growth ($182.3 million), partially offset by the first quarter deconsolidation of the Reciprocal Exchanges ($5.5 million). Net premium written for the A&H segment increased by $202.7 million, primarily as a result of additional premiums from the Assurant Transaction ($133.7 million) and organic growth ($67.4 million).
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $91.2 million, or 22.5%, from $405.9 million for the year ended December 31, 2015 to $497.2 million for the year ended December 31, 2016, primarily as a result of the Direct General ($1.9 million) and Century-National ($12.0 million) acquisitions, additional costs from the LPI Business ($33.3 million), ARS ($7.3 million) and the Assurant Transaction ($23.9 million), and organic growth and other ($25.6 million), partially offset by lower costs on the Reciprocal Exchanges ($12.7 million).
Net operating expense; net operating expense ratio (non-GAAP). Net operating expense increased by $295.9 million, or 47.8%, from $618.9 million for the year ended December 31, 2015 to $914.9 million for the year ended December 31, 2016. The consolidated net operating expense ratio, which includes the Reciprocal Exchanges, increased to 30.6% in the year ended December 31, 2016 from 29.1% in the year ended December 31, 2015. Excluding the Reciprocal Exchanges, the net operating expense ratio was 30.2% and 29.3% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges' net operating expense ratio was 41.2% and 25.1% for the years ended December 31, 2016 and 2015, respectively.
Net realized and unrealized gain (loss) on investments. Net realized and unrealized gain (loss) on investments increased by $14.2 million from a loss of $10.3 million for the year ended December 31, 2015 to a $3.9 million gain for the year ended December 31, 2016, primarily from our trading activities offset by higher other-than-temporary impairments in 2016.
Provision for income taxes. Income tax expense increased by $23.7 million, or 124.8%, from $19.0 million for the year ended December 31, 2015, reflecting an effective tax rate of 11.5%, to $42.6 million for the year ended December 31, 2016, reflecting an effective tax rate of 20.3%. The primary driver of the increase in consolidated income tax expense was the increase in pre-tax income period over period. Income tax expense included a tax benefit of $5.9 million and $27.1 million for the years ended December 31, 2016 and 2015, respectively, 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 years ended December 31, 2016 and 2015 by 2.81% and 16.5%, respectively.
Gross premium written. Gross premium written increased by $454.6 million, or 21.3%, 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 ($61.0 million), the consolidation of the Reciprocal Exchanges ($209.9 million), acquisition of our LPI Business ($126.6 million) and organic growth ($75.5 million), partially offset by a decrease in our Tower business ($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 ($55.7 million) and organic growth ($66.6 million), partially offset by a decrease in our European group life and health insurance managing general agent (“EHC”) business ($10.8 million) which included a one-time unearned premium reserve assumption of $15.2 million in 2014.
Net premium written. Net premium written increased by $316.2 million, or 16.9%, from $1,870.0 million for the year ended December 31, 2014 to $2,186.2 million for the year ended December 31, 2015. Net premium written for the P&C segment increased by $240.3 million for the year ended December 31, 2015 compared to the same period in 2014, primarily as a result of an increase in Imperial premium ($50.2 million), the Quota Share Runoff ($42.8 million), the consolidation of the Reciprocal Exchanges ($73.0 million), acquisition of our LPI Business ($125.7 million) and organic growth ($89.1 million), partially offset by a decrease in our Tower business ($140.6 million) which included a large one-time unearned premium reserve assumption of $158.8 million in 2014. Net premium written for the A&H segment increased by $76.0 million, primarily as a result of premium from the Assurant Transaction ($55.7 million) and organic growth ($31.0 million), partially offset by a decrease in our EHC business ($10.8 million) which included a one-time unearned premium reserve assumption of $15.2 million in 2014.
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, 2015, primarily due to 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 as a result of organic growth, partially
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 investment income. Net investment income increased by $22.9 million, or 43.7%, from $52.4 million for the year ended December 31, 2014 to $75.3 million for the year ended December 31, 2015, primarily due to an increase in average invested assets as a result of our (i) capital raising activities in the first half of 2014 and (ii) issuances of Series B preferred stock, debt and common stock during the year ended December 31, 2015.
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.
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.
Net premium written. Net premium written increased by $682.3 million, or 34.6%, from $1,970.3 million for the year ended December 31, 2015 to $2,652.6 million for the year ended December 31, 2016, primarily as a result of the acquisitions of Direct General ($58.5 million) and Century-National ($122.1 million), additional premiums from the LPI Business ($238.2 million) and ARS ($74.6 million), and organic growth ($182.3 million), partially offset by the first quarter deconsolidation of the Reciprocal Exchanges ($5.5 million).
ARS ($42.5 million), and organic growth ($140.4 million), partially offset by the first quarter deconsolidation of the Reciprocal Exchanges ($24.3 million).
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $448.9 million, or 37.1%, from $1,210.3 million for the year ended December 31, 2015 to $1,659.2 million for the year ended December 31, 2016, primarily reflecting the Direct General and Century-National acquisitions, additional losses from the LPI Business and ARS, catastrophe losses related to hail storms that occurred in Dallas and San Antonio, Texas; floods that occurred in Louisiana; and Hurricane Matthew in the Southeast; partially offset by the first quarter deconsolidation of the Reciprocal Exchanges. Our P&C segment net loss ratio, which includes the Reciprocal Exchanges, increased from 63.1% for the year ended December 31, 2015 to 64.3% for the year ended December 31, 2016, primarily due to catastrophe losses for the events that occurred during 2016. Excluding the Reciprocal Exchanges, the net loss ratio was 64.9% and 62.4% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges’ net loss ratio was 51.6% and 72.4% for the year ended December 31, 2016 and 2015, respectively.
Underwriting income. Underwriting income decreased from $137.5 million for the year ended December 31, 2015 to $99.2 million for the year ended December 31, 2016. Our P&C segment net combined ratio, which includes the Reciprocal Exchanges, for the year ended December 31, 2016 increased to 96.1% compared to 92.8% for the same period in 2015, primarily as a result of an increase in our net loss ratio due to catastrophe losses. Excluding the Reciprocal Exchanges, the combined ratio was 96.3% and 92.5% for the years ended December 31, 2016 and 2015, respectively. The Reciprocal Exchanges’ combined ratio was 92.8% and 97.5% for the years ended December 31, 2016 and 2015, respectively.
Net premium written. Net premium written increased by $240.3 million, or 13.9%, from $1,730.0 million for the year ended December 31, 2014 to $1,970.3 million for the year ended December 31, 2015, primarily as a result of an increase in Imperial
premium ($50.2 million), the Quota Share Runoff ($42.8 million), the consolidation of the Reciprocal Exchanges ($73.0 million), acquisition of the LPI Business ($125.7 million) and organic growth ($89.1 million), partially offset by a decrease in our Tower business ($140.6 million) which included a large one-time unearned premium reserve assumption of $158.8 million in 2014.
Ceding commission income. Our ceding commission income increased by $30.3 million from $12.4 million for the year ended December 31, 2014 to $42.7 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.
Service and fee income. Service and fee income increased by $64.6 million, or 58.7%, from $110.1 million for the year ended December 31, 2014 to $174.7 million for the year ended December 31, 2015, primarily resulting from the acquisition of the LPI Business and organic growth.
General and administrative expenses. General and administrative expenses increased by $156.1 million, or 53.4%, 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.
A&H Segment Results of Operations for the Year Ended December 31, 2016 Compared with the Year Ended December 31, 2015
Loss and loss adjustment expense; net loss ratio. Loss and LAE increased by $128.0 million, or 74.7%, from $171.3 million for the year ended December 31, 2015 to $299.4 million for the year ended December 31, 2016, primarily as a result of the Assurant Transaction and higher loss experience in our legacy domestic stop loss programs. Our net loss ratio decreased from 81.1% for
the year ended December 31, 2015 to 72.2% for the year ended December 31, 2016. The loss ratio decrease in the year ended December 31, 2016, was primarily driven by our international business.
Underwriting income (loss). Underwriting income increased from a loss of $8.2 million for the year ended December 31, 2015 to income of $21.2 million for the year ended December 31, 2016, as a result of the Assurant Transaction, partially offset by underwriting loss in our legacy domestic and international businesses. The net combined ratio for the year ended December 31, 2016 decreased to 94.9% compared to 103.9% for the same period in 2015.
Net premium written. Net premium written increased by $76.0 million, or 54.3%, from $140.0 million for the year ended December 31, 2014 to $216.0 million for the year ended December 31, 2015, primarily as a result of premium from the Assurant Transaction ($55.7 million) and organic growth ($31.0 million), partially offset by a decrease in our EHC business ($10.8 million) which included a one-time unearned premium reserve assumption of $15.2 million in 2014.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $11.3 million, or 20.7%, from $54.7 million for the year ended December 31, 2014 to $66.0 million for the year ended December 31, 2015, primarily due to an increase resulting from the Assurant Transaction and as a result of organic growth, partially offset by the consolidation of our EHC business as all new and renewal policies placed by EHC after April 1, 2014 are underwritten by our European insurance subsidiaries.
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.
The average yield on our investment portfolio was 3.1% and 3.3% and the average duration of the portfolio was 5.08 and 5.31 years for the years ended at December 31, 2016 and 2015, respectively.
Available-for-Sale Securities. The cost or amortized cost, gross unrealized gains and losses, and fair value on available-for-sale securities were as follows:
The amortized cost and fair value of available-for-sale fixed maturities held as of December 31, 2016, by contractual maturity, are shown in the table below. Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Gross Unrealized Losses. The tables below summarize the gross unrealized losses on fixed maturities and equity securities classified as available for sale, by the length of time the security had continuously been in an unrealized loss position as of December 31, 2016 and 2015.
As of December 31, 2016 and 2015, of the $2.1 million and $10.4 million, respectively, of unrealized losses related to securities in unrealized loss positions for a period of twelve or more consecutive months, none and $8.5 million, respectively, of those unrealized losses were related to securities in unrealized loss positions greater than or equal to 20% of its amortized cost or cost. The unrealized losses for securities greater than 20% 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, 2016, 2015 and 2014, we recognized an OTTI loss of $22.1 million, $15.2 million and $2.2 million, respectively, on investments based on our qualitative and quantitative review.
Credit Quality of Investments. The tables below summarize the credit quality of our fixed maturities, securities pledged and preferred securities as of December 31, 2016 and 2015, as rated by Standard & Poor’s.
Short-term Investments. We had short-term investments of $15.7 million and $3.5 million, as of December 31, 2016 and 2015, respectively. Short-term investments consisted of money market funds; these money market funds were rated by Standard & Poor’s as AAA.
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. We have a 50% ownership interest in each of Tiger, AMT Alpha and AMTCH (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.
The LSC Entities determined the fair value as of December 31, 2016 based on 236 policies out of 254 policies, as the LSC Entities assigned no value to 18 of the policies as of December 31, 2016. The LSC Entities estimated the fair value of a life insurance policy using a cash flow model with an appropriate discount rate. In some cases, the cash flow model calculates the value of an individual policy to be negative, and therefore the fair value of the policy is zero as no liability exists when a negative value is calculated. The LSC Entities are not contractually bound to pay the premium on its life settlement contracts and, therefore, would not pay a willing buyer to assume title of these contracts. Additionally, certain of the LSC Entities’ acquired policies were structured to have low premium payments at inception of the policy term, which later escalate greatly towards the tail end of the policy term. At the current time, the LSC Entities expense all premiums paid, even on policies with zero fair value. Once the premium payments escalate, the LSC Entities may allow the policies to lapse. In the event that death benefits are realized in the time frame between initial acquisition and premium escalation, it is a benefit to cash flow of the LSC Entities.
For additional information about the fair value of the life settlement contracts, see Note 6, “Equity Investments in Unconsolidated Subsidiaries” in the notes to our consolidated financial statements. For additional information about the risks inherent in determining the fair value of the portfolio of life insurance policies, see Item 1A, “Risk Factors-Risks Relating to Our Business Generally-A portion of our financial assets consists of life settlement contracts that are subject to certain risks.”
We are organized as a holding company with twenty-two domestic insurance company subsidiaries, various foreign insurance and reinsurance subsidiaries, as well as various other non-insurance subsidiaries. Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. The primary sources of cash for the management companies of the Reciprocal Exchanges are management fees for acting as the attorneys-in-fact for the exchanges. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed-maturity and, to a lesser extent, equity securities. Except as set forth below, we expect that projected cash flows from operations, as well as the net proceeds from our debt and equity issuances, will provide us with sufficient liquidity to fund our anticipated growth by providing capital to increase the surplus of our insurance subsidiaries, as well as to pay claims and operating expenses, and to pay interest and principal on debt and debt facilities and other holding company expenses for the foreseeable future. However, if our growth attributable to potential acquisitions, internally generated growth, or a combination of these factors, exceeds our expectations, we may have to raise additional capital. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected. To support our current and future policy writings, we have recently raised substantial capital using a combination of debt and equity, and we may raise additional capital over the next twelve months.
We may generate liquidity through the issuance of debt or equity securities or financing through borrowings under credit facilities, or a combination thereof. We also have a $225.0 million credit agreement, under which there was $50.0 million outstanding as of December 31, 2016. The proceeds of borrowings under the credit agreement may be used for working capital, acquisitions and general corporate purposes. See “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 $397.1 million and $360.1 million as of December 31, 2016 and 2015, respectively, taking into account dividends paid in the prior twelve month periods. During the years ended December 31, 2016, 2015 and 2014, there were $29.5 million, $23.8 million and $12.0 million, respectively, of dividends and return of capital paid by our insurance subsidiaries to their parent company or National General Holdings Corp.
The LSC Entities in which we own a 50% interest also purchase life settlement contracts that require the LSC Entities to make premium payments on individual life insurance policies in order to keep the policies in force. We presently expect to maintain sufficient cash flow to make future capital contributions to the LSC Entities to permit them to make future premium payments.
Net cash provided by operating activities was $315.4 million for the year ended December 31, 2016, compared with $316.1 million provided by operating activities for the same period in 2015. For the year ended December 31, 2016, net cash provided by operating activities decreased by $0.7 million.
Net cash provided by financing activities was $554.6 million for the year ended December 31, 2015, compared with net cash provided by financing activities of $324.8 million for the year ended December 31, 2014. For the year ended December 31, 2015, cash provided by financing activities increased versus the comparable period in 2014 primarily due to our: (a) issuance of 7.50% Non-Cumulative Series B Preferred Stock in the first half of 2015; (b) August 2015 sale of $100.0 million aggregate principal amount of 7.625% Notes; (c) August 2015 issuance of common stock; and (d) October 2015 sale of $100.0 million aggregate principal amount of additional 6.75% Notes, partially offset by (i) the issuance of common stock in our February 2014 private placement; (ii) the May 2014 sale of our $250.0 million aggregate principal amount of 6.75%Notes; and (iii) the June 2014 issuance of 2,200,000 shares of 7.50% Non-Cumulative Series A Preferred Stock.
During the year ended December 31, 2016, Premiums and other receivables, net increased $399.5 million compared to December 31, 2015, primarily due to the acquisitions of Direct General and Century-National, increased premium volume from our acquired company ARS, which is now written on our paper, and additional policies in our P&C and A&H segments, partially offset by a decrease in our LPI Business. Deferred acquisition costs increased $60.4 million compared to December 31, 2015, primarily due to the acquisition of Century-National, increased deferred acquisition costs in our P&C segment and the Reciprocal Exchanges. Prepaid reinsurance premiums increased $28.6 million compared to December 31, 2015, primarily due to the acquisition of Century-National, increased prepaid reinsurance premiums in our P&C segment and the Reciprocal Exchanges. Goodwill and Intangible assets, net increased $161.7 million compared to December 31, 2015, primarily due to the acquisitions of Direct General and Century-National, acquired renewal rights and the Reciprocal Exchanges.
During the year ended December 31, 2016, Unpaid loss and loss adjustment expense reserves increased by $509.4 million compared to December 31, 2015, primarily due to the acquisitions of Direct General and Century-National, increased ARS premium and catastrophe losses within our P&C segment, and the increase in incurred-but-not-reported claims in our A&H segment. Unearned premiums increased $443.1 million compared to December 31, 2015, primarily due to the acquisitions of Direct General, SPCIC and Century-National, increased ARS premium volume which is now written on our paper, increased organic growth and the Reciprocal Exchanges, partially offset by a decrease in our LPI Business. Debt increased by $260.5 million compared to December 31, 2015, due to borrowings under our credit facility loan, the promissory note issued in connection with our acquisition of Century-National, debt acquired from our recent acquisitions: Direct General and SPCIC, partially offset by our purchase of the Reciprocal Exchanges’ surplus notes. Other liabilities increased $57.5 million compared to December 31, 2015, primarily due to the acquisitions of Direct General and Century-National, increases in premium tax reserves and outstanding in process disbursements.
Our insurance subsidiaries utilize reinsurance agreements to transfer portions of the underlying risk of the business we write to various affiliated and third-party reinsurance companies. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of “A-” (Excellent) or are fully collateralized at the time we enter into our reinsurance agreements. We also enter reinsurance relationships with third-party captives formed by agents as a mechanism for sharing risk and profit. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account.
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 $475.0 million in coverage in excess of a $50.0 million retention, with one reinstatement. Included in this coverage is a Florida Hurricane Catastrophic Fund (“FHCF”) cover of $52.2 million in excess of $16.3 million with no reinstatement. The casualty program provides $45.0 million in coverage in excess of a $5.0 million retention. We pay a premium as consideration for ceding the risk.
We have reinsurance with ACP Re and Maiden Insurance that requires the reinsurers to provide collateral to mitigate any risk of default. As of December 31, 2016, ACP Re and Maiden Insurance had provided collateral in the amounts of $0.8 million and $13.3 million, respectively. As of December 31, 2015, ACP Re and Maiden Insurance had provided collateral in the amounts of $18.7 million and $30.8 million, respectively.
As of July 1, 2016, a reinsurance property catastrophe excess of loss program went into effect protecting the Reciprocal Exchanges against accumulations of losses resulting from a catastrophic event. The program provides a total of $355.0 million in coverage in excess of a $20.0 million retention, with one reinstatement.
On May 23, 2014, we sold $250.0 million aggregate principal amount of our 6.75% Notes due 2024 (the “6.75% Notes”) to certain purchasers in a private placement. The net proceeds we received from the issuance was approximately $245.0 million, after deducting the issuance expenses.
On October 8, 2015, we sold an additional $100.0 million aggregate principal amount of our 6.75% Notes to certain purchasers in a private placement. The additional 6.75% Notes bear interest at a rate equal to 6.75% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2015. The additional 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us. The net proceeds we received from the issuance was approximately $98.9 million, after deducting the estimated issuance expenses payable by us. The additional 6.75% Notes were issued under the same indenture as the original 6.75% Notes. Interest expense on the 6.75% Notes, including the additional issuance, for the years ended December 31, 2016 and 2015 was $23.6 million and $18.4 million, respectively.
On January 25, 2016, we entered into a $225.0 million credit agreement (the “Credit Agreement”), among JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association as Syndication Agent, and Associated Bank, National Association and First Niagara Bank, N.A., as Co-Documentation Agents, and the various lending institutions party thereto. The credit facility is a revolving credit facility with a letter of credit sublimit of $112.5 million and an expansion feature not to exceed $50.0 million. Proceeds of borrowings under the Credit Agreement may be used for working capital, acquisitions and general corporate purposes. The Credit Agreement has a maturity date of January 25, 2020.
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 March 27, 2015, we completed a public offering of 6,000,000 of our depositary shares, each representing a 1/40th interest in a share of our 7.50% Non-Cumulative Preferred Stock, Series B, $0.01 par value per share (the “Series B Preferred Stock”), with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). Each depositary share entitles the holder to a proportional fractional interest in all rights and preferences of the Series B Preferred Stock represented thereby (including any dividend, liquidation, redemption and voting rights). Dividends on the Series B Preferred Stock represented by the depositary shares will be payable on the liquidation preference amount, on a non-cumulative basis, when, as and if declared by our Board of Directors, at a rate of 7.50% per annum, quarterly in arrears, on January 15, April 15, July 15, and October 15 of each year, beginning on July 15, 2015, from and including the date of original issuance. The Series B Preferred Stock represented by the depositary shares is not redeemable prior to April 15, 2020. After that date, we may redeem at our option, in whole or in part, the Series B Preferred Stock represented by the depositary shares at a redemption price of $1,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends for prior dividend periods and accrued but unpaid dividends (whether or not declared) for the then current dividend period. A total of 6,000,000 depositary shares (equivalent to 150,000 shares of Series B Preferred Stock) were issued. Net proceeds from this offering were $145.3 million. We incurred $5.0 million in underwriting discount and commissions and expenses, which were recognized as a reduction to additional paid-in capital.
On September 20, 2016, the terms of the Restatement Agreement became effective altering the original terms of the ACP Re Credit Agreement principally by changing the borrower from ACP Re to ACP Re Holdings, LLC, lengthening the maturity date, reducing the interest rate and improving the credit profile. Such modification of terms was deemed to be a troubled debt restructuring under GAAP. Based on the maintenance covenant within the Restatement Agreement, we possess a collateral interest of at least 115% of the $125.0 million outstanding balance. At December 31, 2016, management determined no write down or reserve in the carrying value of the loan was required as a result of the new terms of the Restatement Agreement. We evaluate the loan for impairment on a quarterly basis, including the adequacy of our reserve position based on collateral levels maintained. (See Note 18, “Related Party Transactions” in the notes to our consolidated financial statements).
As of December 31, 2016, we had a 50% ownership interest in the LSC Entities which in turn owned 254 life settlement contracts with a carrying value of $356.9 million. In order to derive the economic benefit of the face value of these policies, the LSCs are required to make these premium payments.