In 2017, the Company recognized a $750,000 gain on the sale of the renewal rights of a portion of the low value dwelling book of business to another insurer. In 2016, the value of intangible assets recorded for insurance licenses were written off when two affiliated insurance subsidiaries were merged. In 2015, the Company recognized a gain as a result of the deconsolidation of an affiliate.
Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions, and other underwriting and administrative expenses. We organize our operations in three insurance businesses: commercial insurance lines, personal lines, and agency business. Together, the commercial and personal lines refer to “underwriting” operations that take insurance risk, and the agency business refers to non-risk insurance business.
Our recorded loss and loss adjustment expenses ("LAE") reserves represent management’s best estimate of unpaid loss and LAE at each balance sheet date, based on information, facts and circumstances known at such time. Our loss and LAE reserves reflect our estimates at the balance sheet date of:
Case reserves, which are unpaid loss and LAE amounts that have been reported; and
Expected claim reporting and payout patterns based on our own loss experience and supplemented with insurance industry data where applicable.
Loss ratio method-This method uses loss and LAE ratios for prior accident years, adjusted for current trends, to determine an appropriate expected loss and LAE ratio for a given accident year;
We allocate the applicable portion of our estimated loss and LAE reserves to amounts recoverable from reinsurers under reinsurance contracts and report those amounts separately from our loss and LAE reserves as an asset on our balance sheet.
Actuarial projections of what we, at a given time, expect to be the cost of the ultimate settlement and administration of claims reflecting facts and circumstances then known;
Analysis of other factors, such as variables in claims handling procedures, economic factors, and judicial and legislative trends and actions.
The following table shows the ratio of IBNR reserves to total reserves net of reinsurance recoverables as of December 31, 2019 (dollars in thousands):
The following table displays ultimate net loss and LAE and net loss and LAE reserves by accident year for the year ended December 31, 2019. We applied the sensitivity factors to each accident year amount and have calculated the amount of potential net loss and LAE reserve change and the impact on 2019 reported pre-tax income and on net income and shareholders’ equity at December 31, 2019. We believe it is not appropriate to sum the illustrated amounts as it is not reasonably likely that each accident year’s reserve estimate assumptions will vary simultaneously in the same direction to the full extent of the sensitivity factor. We also believe that such changes to our reserve balance would not have a material impact on our operating results, financial position, or liquidity. The net income and shareholders' equity amounts include an income tax rate assumption of 21%. The dollar amounts in the table are in thousands.
We carry debt securities classified as available-for-sale at fair value, and unrealized gains and losses on such securities, net of any deferred taxes, are reported as a separate component of accumulated other comprehensive income. Our equity securities that do not result in consolidation and are not accounted for under the equity method are measured at fair value and any changes in fair value are recognized in net income. We carry other equity investments that do not have a readily determinable fair value at cost, less impairment and adjusted for observable price changes under the measurement alternative provided under GAAP. We review these investments for impairment during each reporting period. We do not have any securities classified as trading or held-to-maturity.
Fair values are measured in accordance with ASC 820, Fair Value Measurements. The guidance establishes a framework for measuring fair value and a three-level hierarchy based upon the quality of inputs used to measure fair value. The three levels of the fair value hierarchy are: (1) Level 1: inputs are based on quoted prices (unadjusted) in active markets for identical assets or liabilities, (2) Level 2: inputs are other than quoted prices that are observable for the asset or liabilities, either directly or indirectly, for substantially the full term of the asset or liability and (3) Level 3: unobservable inputs that are supported by little or no market activity. The unobservable inputs represent the Company’s best assumption of how market participants would price the assets or liabilities. The Company also has investment company limited partnership investments, which are measured at net asset value (NAV). The fair value of these investments is based on the capital account balances reported by the investment funds subject to their management review and adjustment. The capital account balances reflect the fair value of the investment funds.
As of December 31, 2019, we have federal and state income tax net operating loss (“NOL”) carryforwards of $60.0 million and $17.7 million, respectively. Of the NOL carryforwards, $50.0 million will expire in tax years 2020 through 2039 and $10.0 million will never expire. Of the federal NOL amount, $14.1 million are subject to limitations under Section 382 of the Internal Revenue Code. These net NOL carryforwards are limited in the amount that can be utilized in any one year and may expire before they are realized. At this time we do not expect that any of the remaining NOL carryforwards will expire before utilized.
The carrying value of our gross deferred tax asset for the NOL carryforwards is equal to the total NOL carryforward amount times the applicable federal and state tax rates, and was $13.5 million and $10.7 million as of December 31, 2019 and 2018, respectively. Total gross deferred tax assets were $17.2 million and $15.4 million as of December 31, 2019 and 2018. A valuation allowance of $13.6 million and $12.6 million has been recorded against the gross deferred tax assets as of December 31, 2019 and 2018, respectively, as the Company has recognized a three-year cumulative loss as of December 31, 2019 which is significant negative evidence to support the lack of recoverability of those deferred tax assets in accordance with ASC 740, Income Taxes. If the $13.6 million valuation allowance as of December 31, 2019 were reversed in the future, it would increase book value by $1.41. The net deferred tax liabilities were zero and $115,000 as of December 31, 2019 and 2018.
For the year ended December 31, 2019, we continued to expand our commercial lines in areas where we have had the most success, reduced exposure in the more challenging areas, and repositioned our personal lines of business. Our commercial lines gross written premiums decreased by $3.3 million, or 3.4%, to $94.4 million in 2019, compared to $97.7 million in 2018. Personal lines gross written premiums increased by $788,000, or 11.8% to $7.5 million in 2019, compared to $6.7 million in 2018.
The Company reported a net loss of $7.8 million, or $0.88 per share, in 2019, compared to a net loss of $9.2 million, or $1.08 per share, in 2018.
The 2019 results were mainly driven by $10.6 million of adverse development. The largest difference between net loss and adjusted operating loss is related to the ADC (described below) in which the $5.7 million deferred gain as of December 31, 2018 was fully utilized in 2019.
The 2017 results were mainly driven by adverse development on prior-year reserves, the cost of the ADC, and losses from Hurricanes Irma and Harvey.
Earned premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. Almost all commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. Almost all personal automobile policies are six month term policies under which premiums are earned evenly over a six-month period. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over time.
Net losses and LAE decreased by $2.7 million, or 4.4%, for the year ended December 31, 2019, as compared to the same period in 2018. The calendar year loss ratios were 66.8% and 66.4% for the years ended December 31, 2019 and 2018, respectively.
The $9.0 million of adverse development in 2018 consisted of $6.2 million from commercial lines and $2.8 million from personal lines and mostly related to the 2016 and 2015 accident years.
Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses. In prior periods the wholesale agency operations and Corporate expenses were included in expense ratio calculation. We have changed the calculation to remove wholesale agency operations and Corporate expenses to provide a better measure of the underwriting operations’ efficiency. The 2018 ratios have been recast to reflect the new presentation. Refer to Note 17 ~ Segment Information for further details.
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased by 1.0%, from 29.2% in 2018, to 28.2% in 2019.
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the years ended December 31, 2019 and 2018 (dollars in thousands):
Net investment income increased by $695,000, or 20.8%, to $4.0 million for the year ended December 31, 2019, as compared to $3.3 million for the year ended December 31, 2018. This increase was mainly due to an increase in average invested assets during 2019. Average invested assets as of December 31, 2019 were $154.9 million, compared to $148.9 million as of December 31, 2018, an increase of $6.0 million, or 4.0%. As of December 31, 2019, the average invested asset balance was comprised of 81.1% debt securities, 5.8% equity securities and 13.1% short-term investments, compared to the December 31, 2018 mix of 86.3% debt securities, 6.9% equity securities and 6.8% short term investments.
The portfolio’s average quality was AA at December 31, 2019 and 2018. The portfolio produced a tax-equivalent book yield of 2.6% and 2.8% for the years ended December 31, 2019 and 2018, respectively. The duration-to-worst average of the debt securities portfolio was 3.0 years and 3.1 years at December 31, 2019 and 2018, respectively.
Interest expense was $2.9 million and $2.6 million for the years ended December 31, 2019 and 2018, respectively. We issued $22.0 million of public senior unsecured notes (the "Notes") in the third quarter of 2018. We issued an additional $3.3 million of the Notes in the fourth quarter of 2018. Proceeds from the notes were used to pay down $19.5 million of the $30.0 million of subordinated notes that were issued in the third quarter of 2017. Interest expense includes the amortization of debt issuance costs relating to the new Notes which is $260,000 per annum over the 5-year life of the Notes. The interest expense relating to the amortization of debt issuance costs for the existing $10.5 million of the subordinated notes is $50,000 per annum over the 20-year life of the subordinated notes.
In 2018, the Company recognized a measurement period adjustment of $42,735 related to loss reserve discounting, which reduced deferred tax expense. The Company also recognized a measurement period adjustment of $42,735 related to the loss reserve discounting transitional adjustment, which increased deferred tax expense. The measurement period adjustments were based upon obtaining additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts under the Act. The measurement period adjustments had no effect on the effective tax rate for the year ended December 31, 2018. The accounting for the income tax effects of the Act pursuant to SAB 118 has been completed as of the end of the December 22, 2018, measurement period and for the year ended December 31, 2018.
The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and operating expenses to net earned premiums and other income from underwriting operations. The 2018 and 2017 ratios have been recast to reflect the new presentation. Refer to Note 17 ~ Segment Information for further details.
Earned premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. All commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. Almost all personal automobile policies are six-month term policies under which premiums are earned evenly over a six-month period. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over time.
Commercial lines gross written premiums increased $5.6 million, or 6.1%, to $97.7 million for the year ended December 31, 2018, as compared to $92.1 million for the year ended December 31, 2017. This increase was seen across many commercial product lines as a result of our continued strategic expansion efforts.
Personal lines gross written premiums decreased $15.5 million, or 69.9%, to $6.7 million for the year ended December 31, 2018, as compared to $22.2 million for the same period in 2017. This was largely driven by a reduction in wind-exposed homeowners business in both Hawaii and Florida.
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings or policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the year December 31, 2018 and December 31, 2017 remained flat at $1.6 million.
We have changed the calculation to remove wholesale agency operations and Corporate expenses to provide a better measure of the underwriting operations’ efficiency. The loss ratio calculation excludes other income from wholesale agency and Corporate. The 2018 and 2017 ratios have been recast to reflect the new presentation. Refer to Note 17 ~ Segment Information for further details.
Net losses and LAE decreased by $11.4 million, or 15.4%, for the year ended December 31, 2018, as compared to the same period in 2017. The calendar year loss ratios were 66.4% and 79.9% for the years ended December 31, 2018 and 2017, respectively.
Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses. In prior periods the wholesale agency operations and Corporate expenses were included in expense ratio calculation. We have changed the calculation to remove wholesale agency operations and Corporate expenses to provide a better measure of the underwriting operations’ efficiency. The 2018 and 2017 ratios have been recast to reflect the new presentation. Refer to Note 17 ~ Segment Information for further details.
Our expense ratio increased by 1.1%, to 45.9 for the year ended December 31, 2018, as compared to the same period in 2017. The increase in the expense ratio was due to lower net earned premium in 2018 in our personal lines of business, as much of the wind-exposed homeowners business rolled off.
On December 22, 2017, the U.S. federal government enacted H.R. 1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Act”). The Act provided for significant changes to corporate taxation including the decrease of the corporate tax rate from 34% to 21%. In 2017, the Company completed an analysis of the impact of the Act and followed the additional guidance provided by the Security and Exchange Commission’s Staff Accounting Bulletin No. 118 (“SAB 118”). There were no material provisional balances as of December 31, 2017.
In 2018, the Company recognized a measurement period adjustment of $42,735 related to loss reserve discounting, which reduced deferred tax expense. The Company also recognized a measurement period adjustment of $42,735 related to the loss reserve discounting transitional adjustment, which increased deferred tax expense. The measurement period adjustments were based upon obtaining additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts under the Act. The measurement period adjustments had no effect on the effective tax rate for the year ended December 31, 2018. The accounting for the income tax effects of the Act pursuant to SAB 118 has been completed as of the end of the December 22, 2018, measurement period and for the year ending December 31, 2018.
At December 31, 2019, we had $38.9 million in cash, cash equivalents, and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturity and sale of invested assets and other income. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt.
We contributed $3.9 million to our Insurance Company Subsidiaries in 2019. No contributions to our Insurance Company Subsidiaries were made in 2018. We contributed $20.9 million to our Insurance Company Subsidiaries in 2017. We believe that the current statutory surplus levels and the funds available at the holding company level will provide the necessary statutory capital to support our premium volume growth over the next two years.
We are aware that our outstanding debt securities are currently trading at a substantial discount to their face amount. In order to reduce future cash interest payments, as well as future amounts due at maturity or upon redemption, we may, from time to time, purchase such debt for cash, in exchange for common stock, or for a combination of cash and common stock, in open market or privately negotiated transactions. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in such transactions, individually or in the aggregate, may be material.
Investing Activities. Cash used in investing activities for the year ended December 31, 2019, was $25.0 million as compared to cash provided by investing activities of $12.2 million for the year ended December 31, 2018. The increase in funds used in investing activities was due to an increase in funds available to be invested in our investment portfolio in the insurance subsidiaries.
Cash provided by investing activities for the year ended December 31, 2018, was $12.2 million as compared to $26.0 million used in investing activities for the same period in 2017. The increase in funds provided by investing activities was due to a decrease in funds available to be invested in our investment portfolios in the insurance subsidiaries as cash collections decreased and paid losses increased from operating activities.
The carrying value of the Notes and Subordinated Notes are offset by $2.3 million of debt issuance costs that will be amortized through interest expense over the life of the loans. Refer to Note 7 ~ Debt of the Notes to the Consolidated Financial Statements, for additional information regarding our outstanding debt.
The estimated unpaid loss and loss adjustment expense payments were made using estimates based on historical payment patterns. However, future payments may be different than historical payment patterns.
Insurance operations are subject to various leverage tests (e.g., premium-to-statutory surplus ratios), which are evaluated by regulators and rating agencies. As of December 31, 2019, on a trailing twelve-month statutory combined basis, the gross written and net written premium leverage ratios were 1.7 to 1.0 and 1.5 to 1.0, respectively.