Protective Insurance Corporation (formerly Baldwin & Lyons, Inc.) is a property-casualty insurer specializing in marketing and underwriting property, liability and workers compensation coverage for trucking and public transportation fleets, as well as coverage for trucking industry independent contractors. Additionally, we offer workers' compensation coverage for a variety of operations outside the transportation industry. We operate as one reportable property and casualty insurance segment, offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.
The term “Protective,” as used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), refers to Protective Insurance Corporation, the parent company. The terms the “Company,” “we,” “us” and our,” as used throughout this M&DA, refer to Protective and all of its subsidiaries unless the context clearly indicates otherwise. The term “Insurance Subsidiaries,” as used throughout this MD&A, refers to Protective Insurance Company, Protective Specialty Insurance Company, Sagamore Insurance Company and B&L Insurance, Ltd.
Effective January 1, 2017, we determined that our business constituted one reportable property and casualty insurance segment. During 2016, we had two reportable segments - property and casualty insurance and reinsurance. We moved to a single reportable segment based on how our operating results are regularly reviewed by our chief operating decision maker when making decisions about how resources are to be allocated and assessing performance.
Effective August 1, 2018, we changed our name to Protective Insurance Corporation to better align our holding company's and Insurance Subsidiaries' identities and to reflect our position within the insurance industry.
The primary sources of our liquidity are (1) funds generated from insurance operations, including net investment income, (2) proceeds from the sale of investments, and (3) proceeds from maturing investments.
On August 31, 2017, our Board of Directors authorized the reinstatement of our share repurchase program for up to 2,464,209 shares of our Class A or Class B Common Stock. On August 7, 2018, our Board of Directors reaffirmed our share repurchase program, but also provided that the aggregate dollar amount of shares of our common stock that may be repurchased under the share repurchase program through August 8, 2019 may not exceed $25.0 million. The repurchases may be made in the open market or through privately negotiated transactions, from time-to-time, and in accordance with applicable laws, rules and regulations. On September 24, 2018, we entered into a stock repurchase plan for the purpose of repurchasing up to $12.0 million of shares of our common stock, at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (the "Rule 10b5-1 Plan"). The Rule 10b5-1 Plan was established pursuant to, and as part of, our share repurchase program and permits shares to be repurchased in accordance with pre-determined criteria when repurchases would otherwise be prohibited, such as during self-imposed blackout periods, or under insider trading laws. The Rule 10b5-1 plan expired on November 8, 2018. The share repurchase program may be amended, suspended or discontinued at any time and does not commit us to repurchase any shares of our common stock. We have funded, and intend to continue to fund, the share repurchase program from cash on hand. The actual number and value of the shares to be purchased will depend on the performance of our stock price, market volume and other market conditions. During the year ended December 31, 2018, we paid $4.6 million to repurchase 7,770 shares of Class A and 191,898 shares of Class B Common Stock under the share repurchase program.
For several years, our investment philosophy has emphasized the purchase of short-term bonds with high quality and liquidity. Our fixed income investment portfolio continues to emphasize shorter-duration instruments. If there was a hypothetical increase in interest rates of 100 basis points, the price of our bonds at December 31, 2018 would be expected to fall by approximately 2.8%. The credit quality of our fixed income securities remains high with a weighted average rating of AA-, including cash. The average contractual life of our fixed income and short-term investment portfolio increased to 5.5 years at December 31, 2018 compared to 4.9 years at December 31, 2017. The average duration of our fixed income portfolio remains much shorter than both the contractual maturity average and the duration of our liabilities. We also remain an active participant in the equity securities market, allocating capital in excess of amounts considered necessary to fund our current operations. The long-term horizon for our equity investments allows us to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by our domestic property/casualty Insurance Subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners (the "NAIC"), which are designed to provide protection for both policyholders and shareholders.
Net cash provided by investing activities was $23.7 million for 2018 compared to net cash used in investing activities of $74.3 million in 2017. The $98.0 million change was primarily related to higher proceeds from sales of fixed income and equity securities and lower purchases of equity securities and fixed income investments. These increases were partially offset by lower proceeds from maturities of our fixed income securities and lower distributions from limited partnerships during 2018, in addition to the purchase of $10.0 million of company-owned life insurance in the first quarter of 2018. Net cash used in investing activities was $74.3 million for 2017 compared to $27.4 million in 2016. The increase of $46.9 million in cash used in investing activities was primarily related to higher purchases of equity securities and fixed income investments and lower proceeds from sales of equity and fixed income securities. These increases were partially offset by higher distributions from limited partnership investments and higher proceeds from maturities of fixed income securities in 2017.
We previously maintained a revolving line of credit with a $40.0 million limit that had an expiration date of September 23, 2018. Interest on this line of credit was referenced to the London Interbank Offered Rate ("LIBOR") and could be fixed for periods of up to one year at our option. Outstanding drawings on this line of credit were $20.0 million at December 31, 2017. On August 9, 2018, we entered into a credit agreement providing a revolving credit facility with a $40.0 million limit, with the option for up to an additional $35.0 million in incremental loans at the discretion of the lenders. This credit agreement, which has an expiration date of August 9, 2022, replaced our line of credit that was to expire on September 23, 2018. Interest on this credit facility is referenced to LIBOR and can be fixed for periods of up to one year at our option. Outstanding drawings on this revolving credit facility were $20.0 million as of December 31, 2018. At December 31, 2018, the effective interest rate was 3.61%, and we had $20.0 million remaining under the revolving credit facility. The current outstanding borrowings were used to repay the previous line of credit. Our revolving credit facility has two financial covenants, each of which were met as of December 31, 2018, requiring us to have a minimum U.S. Generally Accepted Accounting Principles ("GAAP") net worth and a maximum consolidated leverage ratio of 0.35 to 1.00.
Annualized net premiums written by our Insurance Subsidiaries for 2018 equaled approximately 112.3% of the combined statutory surplus of these Insurance Subsidiaries, a level consistent with higher premiums written. Premium writings of 100% and in some cases up to 200% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of our Insurance Subsidiaries substantially exceeded minimum risk-based capital requirements set by the NAIC as of December 31, 2018. Accordingly, we have the ability to significantly increase our business without seeking additional capital to meet regulatory guidelines.
Consolidated shareholders' equity is composed largely of GAAP shareholders' equity of our Insurance Subsidiaries. As such, there are statutory restrictions on the transfer of substantial portions of this equity to Protective. At December 31, 2018, $64.1 million may be transferred by dividend or loan to Protective without approval by, or prior notification to, regulatory authorities. An additional $213.1 million of shareholders' equity of our Insurance Subsidiaries could be advanced or loaned to Protective with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical. We believe these restrictions pose no material liquidity concerns for us. We also believe the financial strength and stability of our Insurance Subsidiaries would permit access by Protective to short-term and long-term sources of credit when needed. Protective had cash and marketable securities valued at $15.2 million at December 31, 2018.
Federal income tax benefit was $9.8 million for 2018 compared to income tax benefit of $8.2 million in 2017. The effective tax rate for 2018 was 22.3% compared to (81.0%) in 2017. The effective federal income tax rate in 2018 differed only slightly from the normal statutory rate primarily as a result of tax-exempt investment income. In the fourth quarter of 2017, we recorded a benefit of $9.6 million related to the remeasurement of deferred tax assets and liabilities pursuant to the U.S. Tax Act, which impacted our effective federal income tax rate for 2017.
Gross premiums written for 2017 increased $101.7 million (25.2%), while net premiums earned increased $52.1 million (18.9%), as compared to 2016. The increase in net premiums written and earned was primarily due to an increase of $60.8 million in net premiums earned related to commercial automobile products and $3.7 million in higher net premiums earned related to workers' compensation products, which were consistent with our growth strategy. These increases were partially offset by $8.1 million of lower premiums generated by reinsurance products, reflective of our decision to completely withdraw from the property catastrophe reinsurance and professional liability reinsurance markets, and a decrease of $3.9 million in premiums earned from personal automobile products. The difference in the percentage change for premiums written compared to earned is reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.
Net investment income for 2017 increased 24.9% to $18.1 million compared to $14.5 million for 2016, primarily due to higher interest rates leading to higher reinvestment yields for fixed income securities, increased dividends from equity securities and an increase in average funds invested resulting from positive cash flow. After-tax investment income of $12.7 million increased 23.0% during 2017 compared to the prior year reflecting the above factors, as well as the mix between taxable and tax-exempt investment income.
Net realized and unrealized gains on investments totaled $19.7 million in 2017 compared to $23.2 million during 2016. Direct trading gains during 2017 were $8.2 million lower compared to the prior year. Other-than-temporary impairment of $0.4 million, netted with gains of $1.6 million on previously impaired available-for-sale securities that were sold in 2017, are included in the net gains stated above. Investments in limited partnerships produced gains of $12.5 million in 2017, compared to gains of $2.5 million during 2016. Limited partnership investments utilized by us are primarily engaged in long-short equities, private equity, country-focused funds and real estate development as an alternative to direct equity investments. The aggregate of our share of gains and losses in these entities represented a 16.3% appreciation in value for 2017, compared to a 3.3% increase in value for 2016.
Income tax benefit was $8.2 million for 2017 compared to income tax expense of $14.1 million in 2016. We recorded a benefit of $9.6 million related to the remeasurement of deferred tax assets and liabilities in the fourth quarter of 2017 pursuant to the U.S. Tax Act. Our effective federal tax rate for 2017 was (81.0%) as compared to 32.8% in 2016. The effective tax rate for 2017 was affected primarily by the impact of the U.S. Tax Act discussed above.
Approximately 59% of the Company's assets are composed of investments at December 31, 2018. Approximately 92% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 8% of investments are composed primarily of minority interests in several limited partnerships. These limited partnerships are engaged in long-short equities, private equity, country-focused funds and real estate development as an alternative to direct equity investments. These partnerships do not have readily-determinable market values themselves. Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the limited partnerships. While a substantial portion of the underlying assets are publicly-traded securities, those which are not publicly-traded have been valued by the respective limited partnerships using their experience and judgment.
Under Financial Accounting Standards Board ("FASB") guidance, if a fixed income security is in an unrealized loss position and the Company has the intent to sell the security, or it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to net realized gains (losses) on investments in the consolidated statements of operations. For impaired fixed income securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in net realized gains (losses) on investments in the consolidated statements of operations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity within accumulated other comprehensive income (loss).
It is important to note that all available-for-sale securities included in the Company's consolidated financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments, as described above, does not change these valuations but, rather, determines when a decline in value will be recognized in the consolidated statements of operations (other-than-temporary decline), as opposed to a charge to shareholders' equity (temporary decline). This evaluation process is subject to risks and uncertainties because it is not always clear what has caused a decline in value of an individual security or because some declines may be associated with general market conditions or economic factors, which relate to an industry in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process as described above. However, to the extent that certain declines in value are reported as unrealized at December 31, 2018, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2018, the total gross unrealized loss included in the Company's fixed income portfolio was approximately $10.8 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2018, there would have been no impact on total shareholders' equity or book value since the decline in value of these securities was previously recognized as a reduction to shareholders' equity.
Amounts recoverable under the terms of reinsurance contracts comprised approximately 26% of total Company assets as of December 31, 2018. In order to be able to provide the high limits required by the Company's insureds, the Company shares a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts. Some reinsurance contracts provide that a loss will be shared among the Company and its reinsurers on a predetermined pro-rata basis ("quota-share"), while other contracts provide that the Company will keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount ("excess of loss"). Some risks are covered by a combination of quota-share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by certain of the Company's insurance policies for commercial automobile liability, workers' compensation and professional liability risks provide more variability in the estimation process than lines of business with lower coverage limits.
As with any receivable, credit risk exists in the recoverability of reinsurance. This may be even more pronounced than in normal receivable situations since recoverable amounts are not generally due until the loss is settled which, in some cases, may be many years after the contract was written. If a reinsurer is unable, in the future, to meet its financial commitments under the terms of the contracts, the Company would be responsible to satisfy the reinsurer's portion of the loss. The financial condition of each of the Company's reinsurers is vetted upon the execution of a given treaty, and only reinsurers with superior credit ratings are utilized. However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period. Reviews of the current financial strength of each reinsurer are made frequently and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company's additional liability. Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit loss rather than a deficiency associated with the loss reserving process.
For the Company's commercial automobile risks, which are covered by regularly changing reinsurance agreements and which contain wide-ranging self-insured retentions ("SIR"), traditional actuarial methods are supplemented by other methods, as described below, in consideration of the Company's exposures to loss. In situations where the Company's reinsurance structure, the insured's SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous enough with historical loss data to allow for reliable projection of future developed losses. Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from the Company's proprietary databases to arrive at the reserve for IBNR losses for the calendar/accident period under review. As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a monthly and quarterly basis and adjusts reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses. This process continues until all losses are settled for each period subject to this method.
Expected loss ratios for the current book of business, particularly the Company's commercial automobile products, where the number of accounts insured, selected SIRs, policy limits and reinsurance structures may vary widely from period to period.
To the extent possible, the Company attempts to recover the impact of inflation on loss costs and operating expenses by increasing the premiums it charges. Within the commercial automobile business, a majority of the Company's accounts are charged as a percentage of an insured's gross revenue, mileage or payroll. As these charging bases increase with inflation, premium revenues are immediately increased. The remaining premium rates charged are adjustable only at periodic intervals and often require state regulatory approval. Such periodic increases in premium rates may lag far behind cost increases.
The Company's loss and loss expense reserves do not have contractual maturity dates, and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, the above table presents an estimate of when the Company might expect its direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid. Timing of the collection of the related reinsurance recoverable, estimated to be $392.4 million at December 31, 2018, or 45% of the amounts presented in the above table, would approximate that of the above projected direct reserve payout but could lag behind such payments by several months in some instances.
The investment commitment in the above table relates to a maximum unfunded capital obligation for a limited partnership investment at December 31, 2018. The actual call dates for such funding could vary from that presented.
Borrowings made under the Company's line of credit can be called by the lender, under certain circumstances, with short notice. The Company entered into a new line of credit on August 9, 2018 with an expiration date of August 9, 2022.
We have audited the accompanying consolidated balance sheets of Protective Insurance Corporation and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedules listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
(All dollars amounts presented in these notes are in thousands, except share and per share data)
Effective January 1, 2017, the Company determined that its business constituted one reportable property and casualty insurance segment. During 2016 and prior years, the Company had two reportable segments - property and casualty insurance and reinsurance. The Company moved to a single reportable segment based on how its operating results are regularly reviewed by the Company's chief operating decision maker when making decisions about how resources are allocated and assessing performance.
consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Inter-company transactions and accounts have been eliminated in consolidation.
Investments: Carrying amounts for fixed income securities represent fair value and are based on quoted market prices, where available, or broker/dealer quotes for specific securities where quoted market prices are not available. Equity securities are carried at quoted market prices (fair value). Commercial mortgage loans are carried primarily at amortized cost along with a valuation allowance for losses when necessary. These investments represent interests in commercial mortgage loans originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. There was no valuation allowance on the Company's commercial mortgage loans as of December 31, 2018.
Short-term and other investments are carried at cost, which approximates their fair values.
Effective January 1, 2018, equity securities are recorded at fair value, with unrealized net gains or losses reflected as a component of net unrealized gains (losses) on equity securities and limited partnership investments within the consolidated statements of operations. Realized gains and losses on disposals of equity securities are recorded on the trade date and included in net realized gains (losses) on investments, excluding impairment losses. Prior to adoption of the new accounting guidance, unrealized gains and losses related to equity securities were reflected directly in shareholders’ equity unless a decline in value was determined to be other-than-temporary, in which case the loss was charged to income.
In accordance with the Financial Accounting Standards Board's ("FASB") other-than-temporary impairment guidance, if a fixed income security is in an unrealized loss position and the Company has the intent to sell the fixed income security, or it is more likely than not that the Company will have to sell the fixed income security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to other-than-temporary impairment losses on investments in the consolidated statements of operations. For impaired fixed income securities that the Company does not intend to sell or in cases where it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in other-than-temporary impairment losses on investments in the consolidated statements of operations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity.
and equipment are carried at cost, less accumulated depreciation. Depreciation is computed principally by the straight-line method.
Goodwill and Other Intangible Assets: Goodwill is not amortized. Rather, it is tested for impairment in accordance with FASB guidance, at the reporting-unit level. Goodwill is tested annually (during the fourth quarter) or more often if events or circumstances, such as adverse changes in the business climate, indicate there may be impairment. As a result of the impairment analysis conducted by the Company in the fourth quarter of 2018, the Company concluded the entire goodwill balance was impaired, resulting in an impairment loss of $3,152. See Note M for further discussion. This impairment charge is included within other operating expenses in the consolidated statements of operations. Intangible assets determined to have finite lives, such as customer relationships and employment agreements, are amortized over their estimated useful lives in a manner that best reflects the economic benefits of the intangible asset. In addition, impairment testing is performed on these amortizing intangible assets if impairment indicators are noted.
contracts covering catastrophic events are, to the extent reasonably determinable, recorded concurrently with the related loss.
of restricted stock vest over the vesting period from the date of grant and certain shares of restricted stock are accelerated for retirement-eligible recipients in accordance with the non-substantive, post-grant date vesting clause of Accounting Standards Codification ("ASC") Topic 715, Compensation-Retirement Benefits. Restricted stock is valued based on the closing price of the Company's Class B Common Stock on the day the award is granted. Non-vested shares of restricted stock will be forfeited should an executive's employment terminate for any reason other than death, disability, or retirement as defined by the Compensation Committee (the "Compensation Committee") of the Board of Directors (the "Board") of the Company.
In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606), or ASU 2014-09, as amended by subsequently issued ASUs, to clarify the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, the Company's commission and fee income, other than that directly associated with insurance contracts, is subject to this updated guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to the first quarter of 2018. The Company adopted the new guidance as of January 1, 2018. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. The Company had no material contract assets, contract liabilities, or deferred contract costs recorded on its consolidated balance sheet at December 31, 2018.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 changed the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income. Previously, the Company's equity securities were classified as available-for-sale and changes in fair value were recognized in accumulated other comprehensive income (loss) as a component of shareholders' equity. The Company adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective approach and recorded a cumulative-effect adjustment to reclassify unrealized gains on equity securities of $71,012 ($46,157, net of tax) from other comprehensive income (loss) to retained earnings within the consolidated balance sheet as of December 31, 2018. Going forward, unrealized gains or losses on equity securities will be recognized in the consolidated statements of operations within net unrealized gains (losses) on equity securities and limited partnership investments.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, or ASU 2016-15. This update addresses the presentation and classification on the statement of cash flows for eight specific items, with the objective of reducing existing diversity in practice in how certain cash receipts and cash payments are presented and classified. The Company adopted ASU 2016-15 as of January 1, 2018. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.
The following is a summary of available-for-sale securities at December 31:
Effective January 1, 2018, the Company adopted ASU 2016-01 and equity securities are no longer classified as available-for-sale. Prior periods have not been restated to conform to the current presentation. See Note A - Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements for further discussion.
The fair value and the cost or amortized cost of fixed income investments at December 31, 2018, organized by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.
Gain and loss activity for fixed income and equity security investments, as shown in the previous table, includes adjustments for other-than-temporary impairment for the years ended December 31 summarized as follows:
There is no primary market and only a limited secondary market for the Company's investments in limited partnerships and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and generally must seek approval from the applicable general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. The Company has a commitment to contribute up to an additional $1,317 to a limited partnership as of December 31, 2018.
The Company's limited partnerships include one investment which primarily invests in public and private equity markets in India. This limited partnership investment's value as of December 31, 2018 and 2017 was $26,344 and $29,817, respectively. At December 31, 2018, the Company's estimated ownership interest in this limited partnership investment was approximately 6%. The Company's share of income (losses), from both realized and unrealized appreciation (losses) from this limited partnership investment was ($3,473), $7,665 and ($1,117) in 2018, 2017 and 2016, respectively. The summarized financial information of this limited partnership investment as of and for the years ended December 31 is as follows:
The Company's limited partnerships include an additional investment which primarily invests in public equity and fixed income markets. This limited partnership investment's value as of December 31, 2018 and 2017 was $14,975 and $19,380, respectively. At December 31, 2018, the Company's estimated ownership interest in this limited partnership investment was approximately 5%. The Company's share of income (losses) from both realized and unrealized appreciation (losses) from this limited partnership investment was ($4,404), $1,452 and $2,662 in 2018, 2017 and 2016, respectively. The summarized financial information of this limited partnership investment as of and for the years ended December 31 is as follows:
The fair value of regulatory deposits with various insurance departments in the United States and Canada totaled $87,981 and $86,335 at December 31, 2018 and 2017, respectively.
Short-term investments at December 31, 2018 included $1,000 in certificates of deposit issued by a Bermuda bank.
The Company's fixed income securities are over 90% invested in investment grade fixed income investments. The Company has no fixed income investments that were originally issued with guarantees by a third-party insurance company nor does the Company have any direct exposure to any guarantor at December 31, 2018.
Approximately $54,233 of fixed income investments (6.2% of the Company's consolidated investment portfolio, which includes money market instruments classified as cash equivalents) consists of non-rated bonds and bonds rated as less than investment grade at year-end. These investments include a diversified portfolio of over 40 issuers and have a $5,202 aggregate net unrealized loss position at December 31, 2018.
The $16,786 prior accident year deficiency that developed during 2018 primarily related to unfavorable loss development in commercial automobile coverages. This unfavorable loss development was the result of increased claim severity due to a more challenging litigation environment, as well as an unexpected increase in the time to settle claims leading to an unfavorable change in claim settlement patterns. This 2018 deficiency compares to a deficiency of $19,215 for 2017, also related to unfavorable loss development from commercial automobile coverages, particularly from severe transportation loss events that occurred primarily during the first six months of 2017 and higher than expected loss development for discontinued lines of business.
The following is information about incurred and paid claims development as of December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts.
The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expenses in the consolidated balance sheet at December 31 is as follows.
The following is supplementary information about average historical claims duration as of December 31, 2018:
The Insurance Subsidiaries cede portions of their gross premiums written to certain other insurers under excess of loss and quota share treaties and by facultative placements. Some reinsurance contracts provide that a loss be shared among the Company and its reinsurers on a predetermined pro-rata basis ("quota-share"), while other contracts provide that the Company keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount ("excess of loss"). Reinsurance treaties with other companies permit the recovery of a portion of related direct losses. Management determines the amount of net exposure it is willing to accept generally on a product-line basis. Certain historical treaties covering commercial automobile risks include annual deductibles which must be exceeded before the Company can recover under the terms of the treaty. The Company retains a higher percentage of the direct premium in consideration of these deductible provisions. The Company remains liable to the extent the reinsuring companies are unable to meet their obligations under reinsurance contracts.
The Company also serves as an assuming reinsurer on treaties with direct writing insurance companies and, prior to June 30, 2015, under retrocessions from other reinsurers for catastrophic property coverages. Accordingly, for periods prior to that date, the occurrence of catastrophic events could have had a significant impact on the Company's operations. In addition, the Insurance Subsidiaries participate in certain mandatory residual market pools, which require insurance companies to provide coverages on assigned risks. The assigned risk pools allocate participation to all insurers based upon each insurer's portion of premium writings on a state or national level. Historically, the operation of these assigned risk pools has resulted in net losses being allocated to the Company, although such losses have not been material in relation to the Company's operations.
Net losses and loss expenses incurred for 2018, 2017 and 2016 have been reduced by ceded reinsurance recoveries of approximately $148,173, $128,086 and $108,656, respectively. Ceded reinsurance premiums and loss recoveries for the purchase of catastrophe reinsurance coverage on the Company's net direct business were not material.
On December 22, 2017, the U.S. Tax Act was signed into law, which lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. As a result, the Company recorded a tax benefit of $9,572 related to the remeasurement of its deferred tax assets and liabilities at December 31, 2017. As of December 31, 2017, the Internal Revenue Service ("IRS") had not yet published all of the detailed regulations resulting from the enactment of the U.S. Tax Act; therefore, while the Company had not completed its accounting for the tax effects, it made a reasonable estimate of the tax effects on its existing deferred tax balances at December 31, 2017. The Company finalized its accounting for the tax effects of the U.S. Tax Act during 2018. No material adjustments to income tax expense (benefit) were recorded during 2018.
The U.S. Tax Act provides for a change in the methodology employed to calculate reserves for tax purposes. Beginning January 1, 2018, a higher interest rate assumption and longer payout patterns are used to discount these reserves. In addition, companies are no longer able to elect to use their own experience to discount reserves, but instead are required to use the industry-based tables published by the IRS annually. During 2017, the Company estimated the provisional tax impacts related to the change in methodology as $1,696. During 2018, the IRS published the discount factor tables and the Company calculated the tax impact of the methodology change and recorded an updated amount for deferred tax assets and an offsetting deferred tax liability of $2,262 at December 31, 2018. The deferred tax liability was amortized into income in the amount of $323 during 2018 in accordance with the 8-year inclusion described in the U.S. Tax Act.
The provision for deferred federal income taxes as of December 31 consists of the following:
Details of changes in net unrealized gains (losses) on investments for the years ended December 31 are as follows:
(1) Effective January 1, 2018, the Company adopted ASU 2016-01 and unrealized gains (losses) related to equity securities are no longer reflected in accumulated other comprehensive income (loss). Prior periods have not been restated to conform to the current presentation.
The Company maintains a defined contribution 401(k) Employee Savings and Profit Sharing Plan (the "Plan") which covers nearly all employees. The Company's contributions are based on a set percentage and the contributions to the Plan for 2018, 2017 and 2016 were $3,486, $2,797 and $2,449, respectively.
In accordance with the terms of the 1981 Stock Purchase Plan (the "1981 Plan"), the Company is obligated to repurchase shares issued under the 1981 Plan, at a price equal to 90% of the book value of the shares at the end of the quarter immediately preceding the date of repurchase from one outside director. A limited number of shares have ever been repurchased under the 1981 Plan. At December 31, 2018, there were 46,875 shares of Class A Common Stock and 187,500 shares of Class B Common Stock outstanding which remain eligible for repurchase by the Company.
The Company issues shares of restricted Class B Common Stock to the Company's outside directors, which serve as the annual retainer compensation for the outside directors. The shares are distributed to the outside directors on the vesting date, which, with the exception of pro-rated annual retainers granted to outside directors, is one year following the date of grant. The table below provides details of the restricted stock issuances to directors for 2018, 2017 and 2016:
In May 2017, the Company's Compensation Committee granted equity-based awards pursuant to the Company's Long-Term Incentive Plan (the "Long-Term Incentive Plan"), which was approved by the Company's shareholders at the 2017 Annual Meeting of Shareholders. Certain participants under the Long-Term Incentive Plan were granted performance-based equity awards (the "2017 LTIP Awards"), with the number of shares of Class B Common Stock earned pursuant to such award determined by applying a performance matrix consisting of a measurement of the combined results of the Company's 2017 growth in net premiums earned and the Company's 2017 combined ratio. The combined ratio is calculated as a ratio of (A) losses and loss expenses incurred, plus other operating expenses, less commission and other income to (B) net premiums earned. No 2017 LTIP Awards were earned based on the Company's performance in 2017, and therefore no shares were issued pursuant to the 2017 LTIP Awards. In addition to the 2017 LTIP Awards, in May 2017 the Company's Compensation Committee also granted Value Creation Incentive Plan awards (the "2017 VCIP Awards") to certain participants under the Long-Term Incentive Plan. The 2017 VCIP Awards are performance-based equity awards that will be earned based on the Company's cumulative operating income over a three-year performance period from January 1, 2017 through December 31, 2019 relative to a cumulative operating income goal for the period set by the Compensation Committee in March 2017. For the purpose of the 2017 VCIP Awards, cumulative operating income is equal to income before taxes excluding net realized gains (losses) on investments. Any 2017 VCIP Awards that are earned will be paid in unrestricted shares of the Company's Class B Common Stock at the end of the three-year performance period, but no later than March 15, 2020. No shares are eligible to be issued under the 2017 VCIP Awards as of December 31, 2018.
In March 2018, the Company's Compensation Committee granted equity-based awards pursuant to the Long-Term Incentive Plan. Certain participants under the Long-Term Incentive Plan were granted equity awards (the "2018 LTIP Awards"), with the number of shares of Class B Common Stock earned pursuant to such award determined by applying a performance matrix consisting of a measurement of the combined results of the Company's 2018 growth in gross premiums earned and the Company's 2018 combined ratio, as defined above. No 2018 LTIP Awards were earned based on the Company's performance in 2018, and therefore no shares were issued pursuant to the 2018 LTIP Awards. In addition to the 2018 LTIP Awards, in March 2018 the Company's Compensation Committee also granted Value Creation Incentive Plan awards (the "2018 VCIP Awards") to certain participants under the Long-Term Incentive Plan. The 2018 VCIP Awards are performance-based equity awards that will be earned based on the Company's cumulative operating income, as defined above, over a three-year performance period from January 1, 2018 through December 31, 2020 relative to a cumulative operating income goal for the period set by the Compensation Committee in March 2018. Any 2018 VCIP Awards that are earned will be paid in unrestricted shares of the Company's Class B Common Stock at the end of the three-year performance period, but no later than March 15, 2021. No shares are eligible to be issued under the 2018 VCIP Awards as of December 31, 2018.
On November 13, 2018, the Company entered into an employment agreement (the "Agreement") with its Interim Chief Executive Officer, John D. Nichols, Jr. Pursuant to the terms of the Agreement, on November 13, 2018, Mr. Nichols was granted 85,000 restricted shares of the Company's Class B Common Stock (the "Stock Grant"), of which 42,500 shares will vest as of October 17, 2019; 21,250 shares will vest as of October 17, 2020, and 21,250 shares will vest as of October 17, 2021. The Company recorded $140 in expense in the fourth quarter of 2018 related to the Stock Grant.
The following table summarizes segment revenues for the years ended December 31:
During the fourth quarter of 2018, the Company conducted its annual impairment review. Based on the results of that review, the Company concluded that its entire goodwill balance was impaired, resulting in an impairment loss of $3,152. The Company utilized a market approach, which considered revenue and earnings multiples of its own and comparable company information. In the analysis, the Company considered the significant decline in its stock price and the decline in overall financial performance during 2018, particularly in more recent periods, as well as the downgrade to its A.M. Best rating in late 2018.
Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The carrying amounts reported in the consolidated balance sheets for cash, accounts receivables, reinsurance recoverable, accounts payable and accrued expenses, income taxes payable, short-term borrowings and unearned premiums approximate fair value because of the short-term nature of these items. The following tables summarize fair value measurements by level for assets measured at fair value on a recurring basis:
Transfers between levels, if any, are recorded as of the beginning of the reporting period. There were no significant transfers of assets between Level 1 and Level 2 during 2018.
A summary of the carrying value and fair value by level of financial instruments not recorded at fair value on the Company's consolidated balance sheets at December 31, 2018 and 2017 is as follows:
On August 9, 2018, the Company entered into a credit agreement providing a revolving credit facility with a $40,000 limit, with the option for up to an additional $35,000 in incremental loans at the discretion of the lenders. This credit agreement, which has an expiration date of August 9, 2022, replaced the Company's revolving line of credit that was to expire on September 23, 2018. Interest on this credit facility is referenced to the London Interbank Offered Rate and can be fixed for periods of up to one year at the Company's option. Outstanding drawings on this revolving credit facility were $20,000 as of December 31, 2018. At December 31, 2018, the effective interest rate was 3.61%, and the Company had $20,000 remaining under the revolving credit facility. The current outstanding borrowings were used to repay the previous line of credit. The Company's revolving credit facility has two financial covenants, each of which were met as of December 31, 2018, requiring the Company to have a minimum U.S. generally accepted accounting principles net worth and a maximum consolidated leverage ratio of 0.35 to 1.00.
The Company utilizes the services of an investment firm of which one director of the Company is a partial owner. These investment firms manage equity securities and fixed income portfolios with an aggregate market value of approximately $17,065 at December 31, 2018. Total commissions and net fees earned by the investment firms and affiliates on these portfolios were $103, $97 and $207 for the years ended December 31, 2018, 2017 and 2016.
In January 2019, the Company withdrew $10,000 from the New Vernon India Fund limited partnership, which reduced the Company's investment in this limited partnership. The Company also withdew $5,684 from the New Vernon Global Opportunity Fund limited partnership, which liquidated the Company's investment in this limited partnership.
On February 26, 2019, the Board of Directors of Protective Insurance Corporation declared a quarterly dividend of $0.10 per share on the Company's Class A and Class B Common Stock. The dividend per share will be payable March 26, 2019 to shareholders of record on March 12, 2019.