The following tables set forth our selected historical consolidated financial and operating information for the periods ended and as of the dates indicated. The income statement data for the years ended December 31, 2019, 2018 and 2017 and the balance sheet data as of December 31, 2019 and 2018 are derived from our audited financial statements included elsewhere in this annual report. These historical results are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information together with the other information contained in this annual report, including “
The discussion of our financial condition and results of operations for the year ended December 31, 2017 included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2018 is incorporated by reference into this MD&A.
Investment income is also an important part of our business. Because we often do not settle claims until several months or longer after we receive the original policy premiums, we are able to invest cash from premiums for significant periods of time. We invest our capital and surplus in accordance with state and regulatory guidelines. Our net investment income was $141.2 million, $119.0 million and $102.0 million for the years ended December 31, 2019, 2018 and 2017, respectively. We held 3.3% and 5.2% in cash, cash equivalents and restricted cash of our total invested assets as of December 31, 2019 and 2018, respectively.
Our most significant balance sheet liability is our unpaid loss and loss adjustment expense (“LAE”) reserves. As of December 31, 2019 and 2018, our reserves, net of reinsurance recoverable on unpaid losses, were $1.8 billion and $1.7 billion, respectively. We record reserves for estimated losses under insurance policies that we write and for LAE related to the investigation and settlement of policy claims. Our reserves for loss and LAE represent the estimated cost of all reported and unreported loss and LAE incurred and unpaid at any given point in time based on known facts and circumstances. Reserves are based on estimates of the most likely ultimate cost of individual claims. These estimates are inherently uncertain. Judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of future claims, length of time to achieve ultimate settlement of claims, inflation of medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our
Use of estimates and assumptions. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our principal estimates include unpaid losses and LAE reserves; deferred acquisition costs; reinsurance recoverable, including the provision for uncollectible amounts; recording of impairment losses for other-than-temporary declines in fair value; determining the fair value of investments; determining the fair value of stock-based awards for stock compensation; the valuation of intangibles and the determination of goodwill and goodwill impairment; and income taxes. In developing the estimates and assumptions, management uses all available evidence. Because of uncertainties associated with estimating the amounts, timing and likelihood of possible outcomes, actual results could differ from estimates.
Premiums and other receivables. We recognize earned premium on a pro rata basis over the terms of the policies, generally periods of six or twelve months. Unearned premium represents the portion of premiums written applicable to the unexpired terms of the policies. Net premiums receivable represent premium written and not yet collected, net of an allowance for uncollectible premium. We regularly evaluate premium and other receivables and adjust for uncollectible amounts as appropriate. Receivables specifically identified as uncollectible are charged to expense in the period the determination is made.
Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. We immediately write down investments that we consider to be impaired based on the foregoing criteria collectively.
in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statements of income.
Change in unearned premium. Change in unearned premium is the change in the balance of the portion of premium that we have written but have yet to earn during the relevant period because the policy is unexpired.
All fee income is recognized as follows. An installment fee is recognized at the time each policy installment bill is due. A late payment fee is recognized when the customer’s payment is not received after the listed due date and any applicable grace period. A policy cancellation fee is recognized at the time the customer’s policy is canceled. A policy reinstatement fee is recognized when the customer’s policy is reinstated. An insufficient fund fee is recognized when the customer’s payment is returned by the financial institution. The amounts charged are primarily intended to compensate us for the administrative costs associated with processing and administering policies that generate insurance
Net gains and losses on investments. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment loss. We report net unrealized gains (losses) on debt securities classified as available for sale within accumulated other comprehensive income (loss) in our balance sheet. We report all gains (losses) on equity securities within net gains (losses) on investments in our statement of income. Net gains and losses on investments include foreign exchange gains and losses which are generated by the remeasurement of financial statement balances that are denominated or stated in another currency into the functional currency.
Other income. Other income represents the bargain purchase gain or the gain on sale of a business.
Loss and loss adjustment expense. Loss and LAE represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle, and we revise our estimates as we receive additional information about the condition of claimants and the costs of their medical treatment. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor in our profitability.
Net operating expense. These expenses consist of the sum of general and administrative expenses and acquisition costs and other underwriting expenses less ceding commission income, service and fee income and other general and administrative expenses (arbitration award / litigation settlement expense).
Net combined ratio before amortization and impairment (non-GAAP). The net combined ratio before amortization and impairment (non-GAAP) is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss ratio and net operating expense ratio before amortization and impairment (non-GAAP). Management believes that this measure of underwriting profitability provides a more useful comparison to the combined ratio of other insurance companies involved in fewer acquisitions. Our definition of net operating expense ratio before amortization and impairment is as follows:
In 2017, we entered into an Auto Quota Share Agreement (the “Auto Quota Share Agreement”) covering our auto line of business. Effective January 1, 2019, we ceded 7.0% of net liability. On July 1, 2019, we renewed our Auto Quota Share Agreement for a two-year term. Effective July 1, 2019, we ceded 10.0% of net liability with the ability to increase the cession to up to 30.0% and decrease the cession down to 5.0% under certain conditions. We receive a 31.2% provisional ceding commission on premiums ceded to the reinsurer during the term of the Auto Quota Share Agreement, subject to a sliding scale adjustment to a maximum of 32.8% if the loss ratio for the reinsured business is 64.7% or less and a minimum of 30.0% if the loss ratio is 67.5% or higher. Effective January 1, 2020, we cede 5.0% of net liability under new and renewal auto policies written.
Service and fee income. Service and fee income increased by $80.4 million, or 14.3%, from $561.6 million for the year ended December 31, 2018 to $642.0 million for the year ended December 31, 2019, primarily driven by our group administration fees and third party technology services fees.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $92.1 million, or 12.5%, from $735.3 million for the year ended December 31, 2018 to $827.4 million for the year ended December 31, 2019, due to an increase of $54.5 million in the P&C segment and an increase of $37.6 million in the A&H segment, primarily due to premium growth.
The consolidated net operating expense ratio increased from 23.5% for the year ended December 31, 2018 to 23.7% for the year ended December 31, 2019. Excluding the Reciprocal Exchanges, the net operating expense ratio was 23.4% and 23.0% for the years ended December 31, 2019 and 2018, respectively. The Reciprocal Exchanges’ net operating expense ratio was 29.4% and 33.9% for the years ended December 31, 2019 and 2018, respectively.
Net gain (loss) on investments. Net gain (loss) on investments increased by $43.0 million, from a $29.5 million loss for the year ended December 31, 2018 to a $13.5 million gain for the year ended December 31, 2019. The increase was mainly attributable to sales at gain from repositioning our debt securities portfolio.
Interest expense. Interest expense for the years ended December 31, 2019 and 2018 was $51.5 million and $51.4 million, respectively.
Net premium written. Net premium written increased by $362.8 million, or 11.3%, from $3,201.2 million for the year ended December 31, 2018 to $3,564.0 million for the year ended December 31, 2019, primarily as a result of decreased ceded premium to the Quota Shares ($232.0 million) upon commencement of the reduced Auto Quota Share Agreement cession in 2019, the acquisition of Farmers Union Insurance ($71.8 million) and decreased ceded premium by the Reciprocal Exchanges ($50.9 million).
Service and fee income. Service and fee income increased by $16.9 million, from $375.6 million for the year ended December 31, 2018 to $392.5 million for the year ended December 31, 2019.
Acquisition costs and other underwriting expenses. Acquisition costs and other underwriting expenses increased by $54.5 million, from $550.5 million for the year ended December 31, 2018 to $605.0 million for the year ended December 31, 2019. The increase was primarily due to premium growth.
Gross premium written. Gross premium written increased by $70.5 million, or 10.1%, from $698.1 million for the year ended December 31, 2018 to $768.6 million for the year ended December 31, 2019, primarily as a result of growth in our small group self-funded and individual products ($81.4 million), partially offset by the fourth quarter sale of our international business.
Net premium written. Net premium written increased by $34.1 million, or 5.4%, from $626.5 million for the year ended December 31, 2018 to $660.6 million for the year ended December 31, 2019, primarily as a result of growth in our small group self-funded and individual products ($66.0 million), partially offset by the fourth quarter sale of our international business.
Service and fee income. Service and fee income increased by $63.5 million, or 34.1%, from $186.0 million for the year ended December 31, 2018 to $249.5 million for the year ended December 31, 2019, primarily driven by our group administration fees and third party technology services fees.
Net operating expense (non-GAAP); net operating expense ratio (non-GAAP). Net operating expense increased by $22.6 million, or 11.7%, from $193.6 million for the year ended December 31, 2018 to $216.1 million for the year ended December 31, 2019. Our A&H net operating expense ratio increased from 31.4% for the year ended December 31, 2018 to 32.6% for the year ended December 31, 2019.
The average yield on our investment portfolio was 3.1% for both years ended December 31, 2019 and 2018, and the average duration of the portfolio was 4.2 years as of December 31, 2019 and 2018.
For more information related to our investments, see Note 3, “Investments” in the notes to our consolidated financial statements.
respectively. Historically, we have funded claim payments from cash flow from operations (principally premiums), net of amounts ceded to our third-party reinsurers. We presently expect to maintain sufficient cash flow from operations to meet our anticipated claim obligations and operating and capital expenditure needs. Our cash and cash equivalents (including restricted cash) and total investments increased from $4.0 billion at December 31, 2017 to $4.5 billion at December 31, 2018, and increased to $5.0 billion at December 31, 2019. We do not anticipate selling securities in our investment portfolio to pay claims or to fund operating expenses. Should circumstances arise that would require us to do so, we may incur losses on such sales, which would adversely affect our results of operations and financial condition and could reduce investment income in future periods.
We file a consolidated Federal income tax return and participate in a Federal income tax allocation agreement. Under the tax allocation agreement, each subsidiary computes and pays to the Company its respective share of the federal income tax liability primarily based on separate return calculations. The Reciprocal Exchanges are not a party to the tax allocation agreement and file separate tax returns.
Net cash provided by financing activities decreased by $162.8 million, primarily due to cash received from issuance of common and preferred stock in 2018 compared to 2019.
As of December 31, 2019 we did not have any off-balance sheet arrangements that have or are likely to have a material effect on our financial condition, results of operations, liquidity or capital resources.
We utilize various excess of loss, quota share, state-based industry pools or facilities, and catastrophe reinsurance programs to limit our exposure. Reinsurance agreements transfer portions of the underlying risk of the business we write. Reinsurance does not discharge or diminish our obligation to pay claims covered by the insurance policies we issue; however, it does permit us to recover certain incurred losses from our reinsurers and our reinsurance recoveries reduce the maximum loss that we may incur as a result of a covered loss event. We believe it is important to ensure that our reinsurance partners are financially strong and they generally carry at least an A.M. Best rating of “A-” (Excellent) or the recoverables are fully collateralized. The total amount, cost and limits relating to the reinsurance coverage we purchase may vary from year to year based upon a variety of factors, including the availability of quality reinsurance at an acceptable price and the level of risk that we choose to retain for our own account.
We assume and cede insurance risks under various reinsurance agreements, on both a pro rata basis and an excess of loss basis. We purchase reinsurance to mitigate the volatility of direct and assumed business, which may be caused by the aggregate value or the concentration of written exposures in a particular geographic area or business segment and may arise from catastrophes or other large loss events.
We have $350.0 million aggregate principal amount outstanding of our 6.75% Notes due 2024 (the “6.75% Notes”). The 6.75% Notes bear interest at a rate equal to 6.75% per year, payable semiannually in arrears on May 15 and November 15 of each year. The 6.75% Notes are our general unsecured obligations and rank equally in right of payment with our other existing and future senior unsecured indebtedness and senior in right of payment to any of our indebtedness that is contractually subordinated to the 6.75% Notes. The 6.75% Notes mature on May 15, 2024, unless earlier redeemed or purchased by us. Interest expense on the 6.75% Notes for the years ended December 31, 2019, 2018 and 2017 was $23.6 million, $23.6 million and $23.7 million, respectively.
We have $100.0 million aggregate principal amount outstanding of our 7.625% subordinated notes due 2055 (the “7.625% Notes”). The 7.625% Notes bear interest at a rate equal to 7.625% per year, payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The 7.625% Notes are our subordinated unsecured obligations and are structurally subordinated to all existing and future indebtedness, liabilities and other obligations of our subsidiaries. The 7.625% Notes mature on September 15, 2055, unless earlier redeemed or purchased by us. Interest expense on the 7.625% Notes for the years ended December 31, 2019, 2018 and 2017 was $7.6 million, $7.6 million and $7.5 million, respectively.
We have junior subordinated debentures (the “Subordinated Debentures”) relating to the issuance of trust preferred securities. The Subordinated Debentures require interest-only payments to be made on a quarterly basis, with principal due at maturity. The Subordinated Debentures’ principal amounts of $41.2 million and $30.9 million mature in 2035 and 2037, respectively, and bear interest at an annual rate equal to LIBOR plus 3.40% and LIBOR plus 4.25%, respectively. The Subordinated Debentures are redeemable by us at a redemption price equal to 100% of their principal amount. Interest expense on the Subordinated Debentures for the years ended December 31, 2019, 2018 and 2017, was $4.5 million, $4.3 million and $3.8 million, respectively.
On February 25, 2019 we refinanced our existing credit agreement and entered into a new credit agreement (the “2019 Credit Agreement”), with JPMorgan Chase Bank, N.A., as Administrative Agent, KeyBank National Association and Fifth Third Bank, as Co-Syndication Agents, and the various lending institutions party thereto. The 2019 Credit Agreement is currently a $340.0 million base revolving credit facility with a letter of credit sublimit of $150.0 million and an expansion feature of up to $50.0 million. Borrowings under the 2019 Credit Agreement bear interest at either the Alternate Base Rate (“ABR”) or the LIBO rate. ABR borrowings under the 2019 Credit Agreement will bear interest at the greatest of (a) the prime rate in effect on such day, (b) the federal funds effective rate on such day plus 0.5 percent or (c) the adjusted LIBO rate for a one-month interest period on such day plus 1 percent. Eurodollar borrowings under the 2019 Credit Agreement will bear interest at the adjusted LIBO rate plus the Eurodollar spread for the interest period in effect. Fees payable by us under the 2019 Credit Agreement include a letter of credit participation fee, a letter of credit fronting fee with respect to each letter of credit (0.125%) and a commitment fee on the available commitments of the lenders (a range of 0.175% to 0.25% based on our consolidated leverage ratio, which rate was 0.225% as of December 31, 2019). The 2019 Credit Agreement has a maturity date of February 25, 2023. As of December 31, 2019, there was $140.0 million outstanding under the 2019 Credit Agreement.
For information about our preferred stock, refer to Note 15, “Stockholders’ Equity” in the notes to our consolidated financial statements.
The following table sets forth certain of our contractual obligations as of December 31, 2019: