We lease office space in Bermuda, where our principal executive office is located and our casualty reinsurance segment is based. We also lease offices in (1) Chapel Hill, North Carolina, where our U.S. holding company, James River Group is based, (2) Raleigh, North Carolina, Santa Margarita, California, Princeton, New Jersey, and Saratoga Springs, New York where we conduct business in our Specialty Admitted Insurance segment and (3) Richmond, Virginia, Scottsdale, Arizona and Atlanta, Georgia for the conduct of business in our Excess and Surplus Lines segment. We believe that our facilities are adequate for our current needs and that suitable additional or substitute space will be available as needed.
Tangible equity is shareholders’ equity less goodwill and intangible assets. Tangible equity should not be viewed as a substitute for shareholders’ equity calculated in accordance with GAAP. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Reconciliation of Non-GAAP Measures” for a reconciliation of tangible equity to shareholders’ equity in accordance with GAAP.
For the year ended December 31, 2018, approximately 67.6% of our group-wide gross written premiums originated from the U.S. E&S lines market including business assumed by our Casualty Reinsurance segment. We also have a specialty admitted insurance business in the United States. We intend to concentrate substantially all of our underwriting in casualty insurance and reinsurance, and for the year ended December 31, 2018, we derived 98.5% of our group-wide gross written premiums from casualty insurance and reinsurance. We focus on writing business in specialty markets where our underwriters have particular expertise and where we have long-standing distribution relationships; maintaining a strong balance sheet with appropriate reserves; monitoring reinsurance recoverables carefully; managing our investment portfolio actively without taking undue risk; using technology to monitor trends in our business; responding rapidly to market opportunities and challenges; and actively managing our capital.
The Excess and Surplus Lines segment offers E&S commercial lines liability and property insurance in every U.S. state and the District of Columbia through James River Insurance and its wholly-owned subsidiary, James River Casualty. James River Insurance and James River Casualty are both non-admitted carriers. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them flexibility to change the coverage terms offered and the rate charged without the time constraints and financial costs associated with the rate and form filing process. In 2018, the average account in this segment (excluding commercial auto policies) generated annual gross written premiums of approximately $20,000. The Excess and Surplus Lines segment distributes primarily through wholesale insurance brokers. Members of our management team have participated in this market for over three decades and have long-standing relationships with the wholesale agents who place E&S lines accounts. The Excess and Surplus Lines segment produced 56.3% of our gross written premiums and 74.9% of our net written premiums for the year ended December 31, 2018.
of assumed business with ancillary property exposure. 83.7% of premiums written by our Casualty Reinsurance segment during 2018 were general liability accounts assumed from E&S carriers. The Casualty Reinsurance segment distributes through reinsurance brokers. The Casualty Reinsurance segment produced 11.6% of our gross written premiums and 17.8% of our net written premiums for the year ended December 31, 2018.
The Casualty Reinsurance segment writes business through two entities, JRG Re and Carolina Re. Through December 31, 2017, we had intercompany reinsurance agreements under which we ceded 70% of the net written premiums of our U.S. subsidiaries (after taking into account third-party reinsurance) to JRG Re. Effective January 1, 2018, we generally discontinued ceding 70% of our U.S.-written premiums to JRG Re and instead ceded 70% of our U.S.-written premiums to Carolina Re. This business is ceded under proportional, or quota-share, reinsurance treaties that provide for an arm’s length ceding commission. We exclude the effects of intercompany reinsurance agreements from the presentation of our segment results, consistent with the way we manage the Company. At December 31, 2018, 54.9% of our cash and invested assets were held at JRG Re, which benefits from a favorable operating environment, including an absence of corporate income or investment taxes.
On December 22, 2017, the United States enacted Public Law No. 115-97, informally titled the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act significantly changed the U.S. Internal Revenue Code of 1986, as amended (the “Code”), including by reducing the U.S. corporate income tax rate from 35% to 21% and imposing a base erosion and anti-abuse tax (“BEAT”). In response to the Tax Act, we made changes to our structure in 2018 to minimize the impact of BEAT that included the formation of Carolina Re, a Bermuda-domiciled, wholly-owned subsidiary of James River Group, Inc. Carolina Re is a Class 3A reinsurer and made an irrevocable election to be taxed as a U.S. domestic corporation under Section 953(d) of the Code effective January 1, 2018. Carolina Re is also the cedent on a stop loss reinsurance treaty with JRG Re.
case reserves based on the estimated ultimate losses on each claim. For proportional contracts, we typically receive aggregated claims information and record case reserves based on that information.
The Company’s net reserve for losses and loss adjustment expenses at December 31, 2018 was $1,194.1 million. Of this amount, 61.5% relates to IBNR. The Company’s net reserve for losses and loss adjustment expenses by segment are summarized as follows:
Our Reserve Committee consists of our Chief Actuary, President and Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer. Additionally, the presidents and chief actuaries of each of our three operating segments assist in the evaluations of their respective segments. The Reserve Committee meets quarterly to review the actuarial recommendations made by each chief actuary and uses its best judgment to determine the best estimate to be recorded for the reserve for losses and loss adjustment expenses on our balance sheet. The Reserve Committee believes that using judgment to supplement the actuarial recommendations is necessary to arrive at a best estimate given the nature of the business that we write and the limited operating experience of the Casualty Reinsurance segment, the fronting and program business in the Specialty Admitted Insurance segment and the commercial auto underwriting division in the Excess and Surplus Lines segment.
ultimate net reserve outcomes. The estimates of these percentiles are a result of a reserve variability analysis using a simulation approach.
Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate claims settlement values. In recording our best estimate of our reserve for losses and loss adjustment expenses, our Reserve Committee typically selects an amount above the actuarial recommendation due to the inherent variation associated with our reserve estimates and the likelihood that there are unforeseen or under-valued liabilities in the actuarial recommendations. We believe that the insurance that we write is subject to above-average variation in reserve estimates. The Excess and Surplus Lines market is subject to high policyholder turnover and changes in underlying mix of exposures. This turnover and change in underlying mix of exposures can cause actuarial estimates based on prior experience to be less reliable than estimates for more stable, admitted books of business. As a casualty insurer, losses on our policies often take a number of years to develop, making it difficult to estimate the ultimate losses associated with this business. Judicial and regulatory bodies have frequently interpreted insurance contracts in a manner that expands coverage beyond that which was contemplated at the time that the policy was issued. In addition, many of our policies are issued on an occurrence basis, and insureds suffering a loss frequently seek coverage beyond the policies’ original intent. The difficulty in pinpointing actual ultimate losses and loss adjustment expenses (“LAE”) is illustrated by the fact that at December 31, 2018, 61.6% of our net reserve for losses and loss adjustment expenses in the Excess and Surplus Lines segment is for claims that have not been reported.
IBNR reserve estimates are inherently less precise than case reserve estimates. A 5% change in net IBNR reserves at December 31, 2018 would equate to a $36.7 million change in the reserve for losses and loss adjustment expenses at such date, a $32.6 million change in after-tax net income, a 4.6% change in shareholders’ equity and a 6.6% change in tangible equity, in each case at or for the year ended December 31, 2018.
We carry fixed maturity 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. Equity securities (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net income. Fixed maturity securities purchased for short-term resale are classified as “trading” and are carried at fair value with unrealized gains and losses included in earnings as a component of investment income. We do not have any securities classified as “held-to-maturity.”
We evaluate our available-for-sale fixed maturity securities regularly to determine whether there have been declines in value that are other-than-temporary. Our outside investment managers assist us in this evaluation. When we determine that a security has experienced an other-than-temporary impairment, the impairment loss is recognized as a realized investment loss.
We consider a number of factors in assessing whether an impairment is other-than-temporary, including (1) the amount and percentage that current fair value is below amortized cost, (2) the length of time that the fair value has been below amortized cost and (3) recent corporate developments or other factors that may impact an issuer’s near term prospects. In addition, we consider the credit quality ratings for the securities, with a special emphasis on securities downgraded to below investment grade. We also consider our intent to sell available-for-sale fixed maturity securities in an unrealized loss position, and if it is “more likely than not” that we will be required to sell these securities before a recovery in fair value to their amortized cost basis. As a starting point for our evaluation, we compare the fair value of each available-for-sale security to its amortized cost to identify any securities with a fair value less than amortized cost.
Management concluded that none of the fixed maturity securities with an unrealized loss at December 31, 2018, 2017, and 2016 experienced an other-than-temporary impairment. Management does not intend to sell available-for-sale securities in an unrealized loss position, and it is not “more likely than not” that the Company will be required to sell these securities before a recovery in their value to their amortized cost basis occurs.
Effective January 1, 2018, with the adoption of ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, equity securities (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net investment income. Prior to the adoption of ASU 2016-01, changes in the fair value of equity securities were recognized net of taxes as a component of accumulated other comprehensive income.
Management concluded that none of the loans in the Company's bank loan portfolio were impaired as of December 31, 2018. At December 31, 2017, the aggregate allowance for credit losses was $3.2 million on five impaired loans with a total carrying value of $5.1 million and unpaid principal of $8.4 million. Impairments in the bank loan portfolio at December 31, 2017 largely reflected the impact of declining energy prices on the market values of loans to oil and gas companies in the energy sector at that time.
Reinsurance premium estimates are reviewed by management periodically. Any adjustment to these estimates is recorded in the period in which it becomes known. The impact of any premium adjustments on net income is offset by corresponding changes to related policy acquisition costs and losses and loss adjustment expenses. For the years ended December 31, 2018, 2017, and 2016, these adjustments were immaterial.
investee) to be measured at fair value with changes in fair value recognized in net income. Upon adoption on January 1, 2018, the Company made a $4.7 million cumulative-effect adjustment to increase retained earnings and reduce accumulated other comprehensive income. The adoption of ASU 2016-01 did not materially impact the Company's financial position, cash flows, or total comprehensive income. The Company's results of operations were impacted as changes in fair value of equity instruments are now presented in net income rather than other comprehensive (loss) income. For the year ended December 31, 2018, the respective impact on net income was a reduction of $4.7 million ($0.16 reduction in basic and diluted earnings per share).
Effective January 1, 2018, the Company adopted ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This update was issued as a result of the enactment of the Tax Act on December 22, 2017. The ASU allows for the option to reclassify the stranded tax effects resulting from the implementation of the Tax Act out of accumulated other comprehensive income and into retained earnings. As the adoption of ASU 2016-01 in 2018 resulted in the reclassification of the entire unrealized balance on equity securities from accumulated other comprehensive income into retained earnings, only the stranded tax effects on the unrealized balances of fixed income securities were impacted by the adoption of ASU 2018-02. The reclassification resulted in a $711,000 decrease to the Company's retained earnings with a corresponding increase to accumulated other comprehensive income in the first quarter of 2018.
The results for the years ended December 31, 2018 and 2017 included certain non-operating items that are significant to the Company. These items (on a pre-tax basis) include:
Interest expense of $1.6 million and $1.3 million for the years ended December 31, 2018 and 2017, respectively, relating to finance expenses in connection with a minority interest in a real estate partnership pursuant to which we are deemed an owner for accounting purposes. The debt is nonrecourse to us and was not arranged by us.
acquisition activities, professional service fees related to the filing of registration statements for the offering of securities, severance costs associated with terminated employees, and interest expense and other income and expenses on a leased building that we are deemed to own for accounting purposes. We use adjusted net operating income as an internal performance measure in the management of our operations because we believe it gives our management and other users of our financial information useful insight into our results of operations and our underlying business performance. Adjusted net operating income should not be viewed as a substitute for net income calculated in accordance with GAAP, and our definition of adjusted net operating income may not be comparable to that of other companies.
Our income before taxes and net income for the years ended December 31, 2018 and 2017 reconcile to our adjusted net operating income as follows:
The combined ratio is a measure of underwriting performance and represents the relationship of incurred losses, loss adjustment expenses and other operating expenses to net earned premiums. Our combined ratio for the year ended December 31, 2018 was 96.6%. A combined ratio of less than 100% indicates an underwriting profit, while a combined ratio greater than 100% reflects an underwriting loss. In 2018, the combined ratio included $17.7 million, or 2.2 percentage points, of net adverse reserve development on prior accident years, including $15.0 million of net adverse reserve development from the Excess and Surplus Lines segment (including $4.9 million, or 0.9 percentage points, of favorable reserve development on the 2017 catastrophe losses from Hurricanes Harvey, Irma, and Maria), $5.6 million of net favorable reserve development from the Specialty Admitted Insurance segment, and $8.2 million of net adverse reserve development from the Casualty Reinsurance segment.
Our combined ratio for the year ended December 31, 2017 was 99.2%. It included $21.5 million, or 2.9 percentage points, of net adverse reserve development on prior accident years, including $20.0 million of net adverse reserve development from the Excess and Surplus Lines segment, $2.7 million of net favorable development from the Specialty Admitted Insurance segment, and $4.2 million of net adverse reserve development from the Casualty Reinsurance segment. The combined ratio for the year ended December 31, 2017 also includes $6.9 million, or 0.9 percentage points, of catastrophe losses from Hurricanes Harvey, Irma, and Maria.
All of the Company’s U.S.-domiciled insurance subsidiaries are party to an intercompany pooling agreement that distributes the net underwriting results among the group companies based on their approximate pro-rata level of statutory capital and surplus to the total Company statutory capital and surplus. Additionally, each of the Company’s U.S.-domiciled insurance subsidiaries is a party to a quota share reinsurance agreement that in prior periods ceded 70% of their premiums and losses to JRG Re, and starting January 1, 2018, ceded 70% of their premiums and losses to Carolina Re, an entity domiciled in Bermuda that made an irrevocable election to be taxed as a U.S. domestic corporation under Section 953(d) of the Code effective January 1, 2018. JRG Re also provides stop loss reinsurance to Carolina Re. We report all segment information in this ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ prior to the effects of intercompany reinsurance, consistent with the manner in which we evaluate the operating performance of our reportable segments.
The premium growth in our fronting business was driven by growth in the gross written premium from our largest agency relationship, which produced $201.7 million of gross written premium for the year ended December 31, 2018, up from $183.0 million for the year ended December 31, 2017, as well as new fronting arrangements entered into during the year.
Underwriting results include gross fee income of $13.9 million and $17.0 million for the years ended December 31, 2018 and 2017, respectively.
The expense ratio for this segment was slightly higher at 13.5% for 2018 compared to 13.4% in 2017. Gross fee income contributed to a reduction in the expense ratio of 2.5 and 3.7 percentage points for the years ended December 31, 2018 and 2017, respectively.
Our commercial auto business has a lower expense ratio and higher loss ratio than our other business in the segment. Commercial auto made up 56.7% of the segment’s net earned premiums for 2018 compared to 53.3% for 2017.
As a result of the items discussed above, the underwriting profit of the Excess and Surplus Lines segment increased 44.3%, from $29.7 million for the year ended December 31, 2017 to $42.8 million for the year ended December 31, 2018.
As a result of the items discussed above, the Casualty Reinsurance segment had an underwriting profit of $5.1 million for the year ended December 31, 2018 compared to an underwriting loss of $1.8 million for the year ended December 31, 2017.
Other operating expenses for the Corporate and Other segment include personnel costs associated with the Bermuda and U.S. holding companies, professional fees, and various other corporate expenses that are included in our calculation of our expense ratio and our combined ratio. Other operating expenses of the Corporate and Other segment represent the expenses of both the Bermuda and U.S. holding companies that were not reimbursed by our subsidiaries, including costs associated with our internal quota share, rating agencies and strategic initiatives. These costs vary from period-to-period based on the status of these initiatives.
For the years ended December 31, 2018 and 2017, the total operating expenses of the Corporate and Other segment were $26.9 million and $25.3 million, representing a 6.2% increase over the prior year. The increases were driven by compensation costs, including stock compensation expenses, associated with increases in headcount and costs associated with the formation and operations of Carolina Re, a new Class 3A reinsurer that has made an irrevocable election to be taxed as a U.S. domestic
At December 31, 2017, the Company held a participation in a loan issued by a company that produces and supplies power to Puerto Rico through a power purchase agreement with Puerto Rico Electric Power Authority (“PREPA”), a public corporation and governmental agency of the Commonwealth of Puerto Rico. Management concluded that the loan was impaired at December 31, 2017 and established an allowance for credit losses on the loan of $759,000 to reduce the loan's carrying value to zero at December 31, 2017. The unpaid principal on the loan was $807,000 at December 31, 2017. In the first quarter of 2018, the full outstanding principal on the loan was repaid and the Company recognized a realized gain of $807,000 on the repayment.
Management concluded that none of the loans in the Company's bank loan portfolio were impaired as of December 31, 2018. At December 31, 2017, the aggregate allowance for credit losses was $3.2 million on five impaired loans with a total carrying value of $5.1 million and unpaid principal of $8.4 million. Impairments in the bank loan portfolio at December 31, 2017 largely reflect the impact of declining energy prices on the market values of loans to oil and gas companies in the energy sector.
The following table sets forth the composition of the Company’s portfolio of fixed maturity securities by rating as of December 31, 2018:
At December 31, 2018, the Company had no investments in securitizations of alternative-A mortgages or sub-prime mortgages.
Interest expense was $11.6 million and $9.0 million for the years ended December 31, 2018 and 2017, respectively. See “-Liquidity and Capital Resources-Sources and Uses of Funds” for information regarding our senior debt facilities and trust preferred securities.
The Company recorded $597,000 of amortization of intangibles for each of the years ended December 31, 2018 and 2017, respectively.
The Company completed its impairment tests and fair value analysis for goodwill and other intangible assets during the fourth quarter of 2018 and 2017. Falls Lake General was merged into Falls Lake National in the fourth quarter of 2018. In
Our effective tax rate fluctuates from period to period based on the relative mix of income reported by country and the respective tax rates imposed by each tax jurisdiction. In 2017, the Company experienced a higher proportion of U.S.-sourced income, resulting in a higher effective tax rate for that year. For U.S.-sourced income, our U.S. federal income tax expense differs from the amounts computed by applying the federal statutory income tax rate (21% in 2018 and 35% in 2017) to income before taxes due primarily to interest income on tax-advantaged state and municipal securities, dividends received income, and excess tax benefits on share based compensation. For the years ended December 31, 2018 and 2017, our effective tax rate was 9.9% and 21.0%, respectively. Income taxes for 2017 included $1.1 million of U.S. withholding taxes on an intercompany dividend paid from the U.S. holding company to our U.K. intermediate holding company. Income taxes for 2017 also include a $3.5 million tax benefit as the U.S. net deferred tax liability was remeasured at 21%, down from 35% in prior periods, due to the enactment of the Tax Act.
Underwriting profit includes fee income of $28.3 million and $14.2 million for the years ended December 31, 2017 and 2016, respectively.
We had an underwriting profit of $5.8 million for the year ended December 31, 2017. This compares to an underwriting profit of $29.5 million for the prior year. On a consolidated basis, the Company recognized $21.5 million of net unfavorable reserve development for the year ended December 31, 2017 and $23.7 million of net favorable reserve development for the year ended December 31, 2016.
$2.0 million of net realized investment losses and $7.6 million of net realized investment gains for the years ended December 31, 2017 and 2016, respectively. Net realized investment losses in 2017 were primarily from $4.0 million of impairment losses on one equity security and an increase in the allowance for credit losses on impaired bank loans, offset by realized gains of $1.3 million from the sale of bank loan participations, $328,000 from the sale of fixed maturity securities and $369,000 from the sale of equity securities. Net realized investment gains in 2016 include net realized gains from equity securities of $4.8 million and net realized gains from fixed maturity securities of $1.8 million.
$539,000 and $1.6 million of other expenses for the years ended December 31, 2017 and 2016, respectively. Other expenses for 2017 include $535,000 of legal and other professional services related to secondary share offerings in 2017. Other expenses for 2016 include $1.5 million of employee severance costs.
Interest expense for the years ended December 31, 2017 and 2016 include $1.3 million and $1.4 million, respectively, relating to finance expenses in connection with a minority interest in a real estate partnership pursuant to which we are deemed an owner for accounting purposes. The debt is nonrecourse to us and was not arranged by us. See Note 1 to the Notes to the Audited Consolidated Financial Statements for additional information with respect to our minority interest.
Manufacturers and Contractors division (representing 16.2% of this segment’s 2017 business) which increased $2.4 million (or 2.9%) over the prior year.
Loss Ratio. The loss ratio of 80.2% for the year ended December 31, 2017 includes $20.0 million, or 4.3 percentage points, of adverse development in our loss estimates for prior accident years. The adverse reserve development in this segment was almost entirely from one large commercial auto account in the 2016 accident year. The loss ratio for the year ended December 31, 2017 also includes $5.2 million of losses from Hurricanes Harvey, Irma, and Maria primarily related to property losses in Florida. The catastrophe losses represent 1.1 percentage points of loss ratio additions for the year. The loss ratio of 62.6% for the year ended December 31, 2016 includes $24.1 million, or 8.0 percentage points, of net favorable development in our loss estimates for prior accident years.
Expense Ratio. The expense ratio decreased from 21.7% in 2016 to 13.4% in 2017. The decrease in the expense ratio is attributable to the 53.8% increase in net earned premiums as well as a decrease in the total amount of operating expenses. Additionally, fee income increased as a percentage of net earned premiums and contributed to a reduction in the expense ratio of 3.7 and 3.3 percentage points for the years ended December 31, 2017 and 2016, respectively.
The reduced expense ratio and higher loss ratio in this segment reflects an increase in the commercial auto premium as a percentage of the segment’s total premium. Our commercial auto business has a lower expense ratio and higher loss ratio than our other business in the segment. Commercial auto made up 46.8% of the segment’s gross written premium for 2017 compared to 29.7% for 2016.
Underwriting profit includes fee income of $11.3 million and $4.2 million for the years ended December 31, 2017 and 2016, respectively.
Combined Ratio. The combined ratio of the Specialty Admitted Insurance segment for the year ended December 31, 2017 was 95.4%, comprised of a loss ratio of 65.9% and an expense ratio of 29.5%. This compares to the combined ratio in the prior year of 94.5%, comprised of a loss ratio of 59.1% and an expense ratio of 35.4%.
Loss Ratio. The loss ratio for the year ended December 31, 2017 of 65.9% included $2.7 million, or 4.0 percentage points of net favorable development on prior accident years. The loss ratio for the year ended December 31, 2016 of 59.1% included $3.8 million, or 7.3 percentage points of net favorable development on prior accident years. The favorable development in both 2017 and 2016 reflects the fact that actual loss emergence of the workers’ compensation book for prior accident years has been better than expected.
Underwriting Profit. As a result of the items discussed above, the underwriting profit improved from $2.9 million for the year ended December 31, 2016 to $3.2 million for the year ended December 31, 2017.
Combined Ratio. The combined ratio of the Casualty Reinsurance segment for the year ended December 31, 2017 was 100.8%, comprised of a loss ratio of 66.3% and an expense ratio of 34.5%. This compares to the combined ratio in the prior year of 100.1%, comprised of a loss ratio of 65.3% and an expense ratio of 34.8%.
For the years ended December 31, 2017 and 2016, the total operating expenses of the Corporate and Other segment were $25.3 million and $20.4 million, respectively. The increase in these expenses was primarily related to increases in stock compensation expense resulting from the options and restricted stock units granted in February 2017, increases in public company expenses and other professional service fees.
investment grade. At December 31, 2017 and 2016, the fair market value of these securities was $236.5 million and $203.1 million, respectively.
At December 31, 2015, the Company held participations in two loans issued by companies that produce and supply power to Puerto Rico through power purchase agreements with PREPA, a public corporation and governmental agency of the Commonwealth of Puerto Rico. PREPA’s credit strength and ability to make timely payments was impacted by the economic conditions in Puerto Rico, thus raising doubt about the companies’ ability to meet the debt obligations held by the Company. In June 2016, one of the loans was repaid in full at its scheduled maturity. Management concluded that the remaining loan was impaired at December 31, 2016. The loan had a carrying value of $1.7 million, unpaid principal of $2.0 million, and an allowance for credit losses of $177,000 at December 31, 2016. In July 2017, PREPA filed a petition for relief in U.S. District Court under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act. Also in 2017, the devastation caused by Hurricane Maria on the island of Puerto Rico raised additional doubt about PREPA's ability to make payments to the issuer. The maturity of the remaining loan, originally scheduled for November 2017, was deferred until March 2018. Management established an allowance for credit losses of $759,000 to reduce the loan's carrying value to zero at both September 30, 2017 and December 31, 2017. The unpaid principal on the loan was $807,000 at December 31, 2017.
Management also concluded that one non-energy sector loan was impaired at December 31, 2017. At December 31, 2017, the impaired loan had a carrying value of $561,000, unpaid principal of $706,000, and an allowance for credit losses of $145,000. At December 31, 2016, three non-energy sector loans were impaired with a total carrying value of $3.2 million, unpaid principal of $3.5 million, and an allowance for credit losses of $221,000.
At December 31, 2017, our available-for-sale investment portfolio of fixed maturity and equity securities had net unrealized gains of $14.6 million representing 1.4% of the cost or amortized cost of the portfolio. Additionally, at December 31, 2017, 99.4% of our fixed maturity security portfolio was rated “BBB-” or better (“investment grade”) by Standard & Poor’s or had an equivalent rating from another nationally recognized statistical rating organization. Fixed maturity securities with ratings below investment grade by Standard & Poor’s or another nationally recognized statistical rating organization at December 31, 2017 had an aggregate fair value of $6.5 million and an aggregate net unrealized gain of $305,000. The average duration of our investment portfolio was 3.5 years at December 31, 2017.
Other expenses for the years ended December 31, 2017 and 2016 were $539,000 and $1.6 million, respectively. In 2017, these expenses include $535,000 of legal and other professional services related to secondary share offerings in 2017. In 2016, these expenses include $1.5 million of employee severance costs.
Interest expense was $8.9 million and $8.4 million for the years ended December 31, 2017 and 2016, respectively. See “-Liquidity and Capital Resources-Sources and Uses of Funds” for information regarding our senior bank debt facility and trust preferred securities.
Financial results for 2017 reflect provisional amounts related to the December 2017 enactment of the Tax Act. These provisional estimates are based on the Company’s initial analysis and current interpretation of the legislation. Given the complexity of the Tax Act, anticipated guidance from the U.S. Department of the Treasury, and the potential for additional guidance from the Securities and Exchange Commission (SEC) or the Financial Accounting Standards Board, these estimates may be adjusted during 2018.
At December 31, 2018, our Bermuda holding company had $240,000 of cash and cash equivalent assets. At December 31, 2018, our U.S. holding company had $53.7 million of cash and invested assets, comprised of cash and cash equivalents of $7.3 million, other invested assets of $46.1 million, and short-term investments of $325,000, which are not subject to regulatory restrictions. Additionally, our U.K. intermediate holding company had no invested assets and cash of less than $10,000 at December 31, 2018.
A $102.5 million secured revolving facility utilized by JRG Re to issue letters of credit for the benefit of third-party reinsureds. This portion of our credit facility is secured by our investment securities. At December 31, 2018, the Company had $75.5 million of letters of credit issued under the secured facility.
A $112.5 million unsecured revolving facility to meet the working capital needs of the Company. All unpaid principal on the revolver is due at maturity. Interest accrues quarterly and is payable in arrears at 3-month LIBOR plus a margin which is currently 1.5% and is subject to change according to terms in the credit agreement. At December 31, 2018 and 2017, the Company had a drawn balance of $73.3 million outstanding on the unsecured revolver.
On August 2, 2017, the Company, and its wholly-owned subsidiary, JRG Re, together as borrowers, entered into a credit agreement (the "2017 Facility") that provides the Company with a revolving line of credit of up to $100 million, which may be used for loans and letters of credit made or issued, at the borrowers' option, on a secured or unsecured basis. Obligations under the 2017 Facility carry a variable rate of interest subject to terms in the credit agreement and will mature 30 days after notice of termination from the lender. The 2017 Facility contains certain financial and other covenants which we are in compliance with at December 31, 2018. The loans and letters of credit made or issued under the revolving line of credit of the 2017 Facility may be used to finance the borrowers' general corporate purposes. At December 31, 2018, unsecured loans of $30.0 million and secured letters of credit totaling $7.6 million were outstanding on the 2017 Facility.
In May 2004, we issued $15.0 million of senior debt due April 29, 2034. The senior debt is not redeemable by the holder or subject to sinking fund requirements. Interest accrues quarterly and is payable in arrears at a floating rate per annum equal to the 3-month LIBOR plus 3.85%. This senior debt is redeemable at par prior to its stated maturity at our option in whole or in part. The terms of the senior debt contain certain covenants, with which we are in compliance at December 31, 2018, and which, among other things, restrict our ability to assume senior indebtedness secured by our U.S. holding company's common stock or its subsidiaries' capital stock or to issue shares of its subsidiaries' capital stock.
The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities outstanding at December 31, 2018 (including the Company’s repurchase of a portion of these trust preferred securities):
The junior subordinated debt contains certain covenants with which we are in compliance as of December 31, 2018.
At December 31, 2018 and December 31, 2017, the ratio of total debt outstanding, including both senior debt and junior subordinated debt, to total capitalization (defined as total debt plus total shareholders’ equity) was 23.9% and 22.6%, respectively. Having debt as part of our capital structure allows us to generate a higher return on equity and greater book value per share results than we could by using equity capital alone.
The property catastrophe reinsurance treaty has a limit of $40.0 million with one reinstatement.
The following is a summary of our Specialty Admitted Insurance segment’s ceded reinsurance in place as of December 31, 2018:
Excluding one program which has quota share coverage for 90% of the first $1.0 million per occurrence and excess of loss coverage for $49.0 million in excess of $1.0 million.
In our Casualty Reinsurance segment, we also have limited property catastrophe exposure. In the aggregate, we believe our pre-tax group-wide PML from a 1 in 1,000 year property catastrophe event would not exceed $10.0 million, inclusive of reinstatement premiums payable.
We also have a clash and contingency reinsurance treaty to cover both the Excess and Surplus Lines and Specialty Admitted Insurance segments in the event of a claims incident involving more than one of our insureds. The treaty covers $10.0 million in excess of a $2.0 million retention for loss occurrences within the treaty term. This coverage has two reinstatements in the event we exhaust any of the coverage. As of December 31, 2018, our average net retained limit per risk is $2.5 million.
The Company’s insurance segments remain liable to policyholders if its reinsurers are unable to meet their contractual obligations under applicable reinsurance agreements. We establish allowances for amounts considered uncollectible. At December 31, 2018, there was no allowance for such uncollectible reinsurance recoverables. To minimize exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk. The Company generally seeks to purchase reinsurance from reinsurers with A.M. Best financial strength ratings of “A-” (Excellent) or better. The Company’s reinsurance contracts generally require reinsurers that are not authorized as reinsurers under U.S. state insurance regulations or that experience rating downgrades from rating agencies below specified levels to fund their share of the Company’s ceded outstanding losses and loss adjustment expense reserves, typically through the use of irrevocable and unconditional letters of credit. In fronting arrangements, which the Company conducts through its Specialty Admitted Insurance segment, we are subject to credit risk with regard to insurance companies who act as reinsurers for us in such arrangements. We customarily require a collateral trust arrangement to secure the obligations of the insurance entity for whom we are fronting.
At December 31, 2018, we had reinsurance recoverables on unpaid losses of $467.4 million and reinsurance recoverables on paid losses of $18.3 million, and all material recoverable amounts were from companies with A.M. Best ratings of “A-” or better or collateral had been posted by the reinsurer for our benefit.
The following table sets forth our most significant reinsurers by amount of reinsurance recoverables and the amount of reinsurance recoverables pertaining to each such reinsurer as well as its A.M. Best rating as of December 31, 2018:
Our sources of operating funds consist primarily of premiums written, investment income, reinsurance recoveries and proceeds from offerings of debt and equity securities and from sales and redemptions of investments. We use the operating cash flows primarily to pay operating expenses, losses and loss adjustment expenses, and income taxes. Cash flow from operations may differ substantially from net income. The potential for a large claim under an insurance or reinsurance contract means that substantial and unpredictable payments may need to be made within relatively short periods of time. We have generated positive cash flow from operations in each of the three years ended December 31, 2018, 2017, and 2016. The following table summarizes our cash flows:
Cash used in investing activities reflects our efforts to enhance the yield in our investment portfolio by investing available cash and cash equivalents into higher yielding fixed maturity securities and bank loan participations. Cash and cash equivalents comprised 9.3%, 10.1% and 7.6% of total cash and invested assets at December 31, 2018, 2017 and 2016, respectively.
The financial strength ratings assigned by A.M. Best have an impact on the ability of our regulated subsidiaries to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that our subsidiaries receive. The “A” (Excellent) ratings assigned to our insurance and reinsurance subsidiaries are consistent with our business plans and we believe allow our subsidiaries to actively pursue relationships with the agents and brokers identified in their marketing plans.
For the years ended December 31, 2018, 2017, and 2016, the Company recognized $6.2 million, $7.7 million and $5.5 million, respectively, of share based compensation expense. As of December 31, 2018, the Company had $8.4 million of unrecognized share based compensation expense expected to be charged to earnings over a weighted-average period of 1.8 years.
Financing obligations represent obligations for a build-to-suit lease relating to an investment by the Company for a minority interest in a real estate limited partnership pursuant to which we were deemed to be an owner for accounting purposes. Upon adoption of ASU 2016-02, Leases (Topic 842) on January 1, 2019, the Company will derecognize the $30.9 million financing obligation associated with the lease designated as build-to-suit under the previous guidance. The lease will be classified as an operating lease under the new standard. The Company will record a right-of-use asset and lease liability for the lease under the new standard.
We believe that the disclosure of underwriting profit by individual segment and of the Company as a whole is useful to investors, analysts, rating agencies and other users of our financial information in evaluating our performance because our objective is to consistently earn underwriting profits. We evaluate the performance of our segments and allocate resources based primarily on underwriting profit. Our definition of underwriting profit may not be comparable to that of other companies.
The following table reconciles the underwriting profit by individual segment and for the entire Company to consolidated income before U.S. federal income taxes for the years ended December 31, 2018, 2017 and 2016.
Underwriting profit includes gross fee income of $28.7 million, $28.3 million, and $14.2 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Key financial measures that we use to assess our longer term financial performance include the percentage growth in our tangible equity per share and our return on tangible equity. We believe tangible equity is a good measure to evaluate the strength of our balance sheet and to compare returns relative to this measure. Tangible equity before dividends increased 10.9% from $474.5 million at December 31, 2017 to $526.1 million at December 31, 2018, largely due to net income of $63.8 million and $22.2 million of unrealized losses, net of taxes, on available-for-sale fixed maturity securities. Tangible equity after dividends increased 3.2% from $474.5 million at December 31, 2017 to $489.9 million at December 31, 2018. Tangible equity per common share was $16.34 at December 31, 2018, net of $1.20 of dividends per share paid by the Company during 2018. The 2018 adjusted net operating income return on average tangible equity was 14.8%, which compares to 9.7% for the full year 2017.
We define tangible equity as the sum of shareholders’ equity less goodwill and intangible assets (net of amortization). Our definition of tangible equity may not be comparable to that of other companies, and it should not be viewed as a substitute for shareholders’ equity calculated in accordance with GAAP. The following table reconciles shareholders’ equity to tangible equity as of December 31, 2018, 2017 and 2016 and reconciles tangible equity to pre dividend tangible equity as of December 31, 2018: