Investment income is an important element of our net income. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in other lines of business that pay claims more quickly. From December 31, 2011 to December 31, 2016, our investment portfolio, including cash and cash equivalents, increased from $851.5 million to $1.1 billion and produced net investment income of $28.1 million in 2016, $27.9 million in 2015 and $27.2 million in 2014.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2017 includes 19 reinsurers that provide coverage to us in excess of a certain specified loss amount, or retention level. Our 2017 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $70.0 million, subject to applicable limitations, deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million for any single claimant, subject to applicable deductibles, retentions and aggregate limits. Losses in the layer between $2.0 million and $10.0 million are ceded to a multi-year reinsurance treaty with an aggregate annual deductible of approximately $5.6 million and an aggregate limit of coverage of approximately $29.6 million for 2017. As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.
The workers’ compensation insurance industry is cyclical in nature and influenced by many factors, including price competition, medical cost increases, natural and man-made disasters, changes in interest rates, changes in state laws and regulations, and general economic conditions. A hard market in our industry is characterized by decreased competition that results in higher premium rates, more restrictive policy coverage terms, and lower commissions paid to agencies. In contrast, a soft market is characterized by increased competition that results in lower premium rates, expanded policy coverage terms, and higher commissions paid to agencies. Our strategy is to focus on maintaining underwriting profitability throughout the cycle.
In establishing our reserves, we review the results of analyses using actuarial methods that utilize historical loss data from our more than 31 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates.
Net Premiums Written. Net premiums written for 2016 were $362.7 million, compared to $375.3 million for 2015, a decrease of 3.3%. The decrease was primarily attributable to the decrease in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 2.7% for 2016 compared to 2.9% for 2015.
Net Premiums Earned. Net premiums earned for 2016 were $368.7 million, compared to $375.9 million for 2015, a decrease of $1.9%.
Net Realized Gains (Losses) on Investments. Net realized losses on investments in 2016 totaled $0.5 million, compared to losses of $2.5 million in 2015. In 2016, net realized losses of $0.9 million resulted from the sale of fixed maturity securities classified as available-for-sale. These losses were partially offset by realized gains of $0.3 million on called fixed maturity securities. In 2015, net realized losses of $2.7 million resulted from an other-than-temporary impairment of four fixed maturity securities. These losses were partially offset by realized gains of $0.2 million on called fixed maturity securities and other sales of securities.
Gross Premiums Written. Gross premiums written for 2015 were $386.5 million, compared to $393.8 million for 2014, a decrease of 1.9%. The decrease was attributable to a $4.6 million decrease in premiums resulting from payroll audits and related premium adjustments, a $2.5 million decrease in annual premiums on voluntary policies written during the period, a $0.4 million decrease in direct assigned risk premiums, offset by a $0.3 million increase in premiums from mandatory pooling arrangements. Related premium adjustments in 2015 include a $2.4 million increase in “earned but unbilled”, or EBUB, premium.
Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $214.6 million for 2015, compared to $244.9 million for 2014, a decrease of $30.3 million, or 12.4%. The current accident year losses and LAE incurred were $262.4 million, or 69.8% of net premiums earned, compared to $268.6 million, or 71.5% of net premiums earned for 2014. We recorded favorable prior accident year development of $47.8 million in 2015, compared to $23.7 million in 2014. This is discussed in more detail below in “Prior Year Development.” Our net loss ratio was 57.1% for 2015 and 65.2% for 2014.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2015 were $84.1 million, compared to $85.0 million for 2014, a decrease of 1.0%. This decrease was primarily due to a $1.5 million decrease in insurance related assessments, a $0.4 million decrease in commission expense, a $0.3 million decrease in bad debt expense offset by a $0.3 million increase in experience-rated commissions. Our underwriting expense ratio decreased to 22.4% in 2015 from 22.6% in 2014.
The Company recorded favorable prior accident year loss and loss adjustment expense development of $51.3 million in calendar year 2016, $47.8 million in calendar year 2015 and $23.7 million in calendar year 2014. The table below sets forth the favorable development for accident years 2011 through 2015 and, collectively, all accident years prior to 2011.
At December 31, 2016, our incurred amounts for certain accident years, particularly 2013 and 2014, developed more favorably than management previously expected. Multiple factors can cause loss development both unfavorable and favorable. The favorable loss development we experienced across accident years was largely due to favorable case reserve development from closed claims and claims where the worker had reached maximum medical improvement. We believe the favorable loss development in 2013 and 2014 resulted primarily from an intensive claims management focus with the Company actively seeking to settle claims, leading to favorable development.
We forecast claim payments based on our historical trends. We seek to manage the funding of claim payments by actively managing available cash and forecasting cash flows on a short- and long-term basis. Cash payments, net of reinsurance, for claims were $187.7 million in 2016, $189.7 million in 2015 and $182.5 million in 2014. We fund claim payments out of cash flow from operations, principally premiums, net of amounts ceded to our reinsurers, and net investment income. Our investment portfolio increased from $851.5 million at December 31, 2011 to $1.1 billion at December 31, 2016.
As discussed above under “Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2017 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
In December 2016, the Company commuted reinsurance agreements with Hannover Reinsurance Limited (Ireland) (“Hannover”) and Tokio Millennium Re Limited (“Tokio”) covering portions of accident years 2011 through 2013. The Company received cash of $0.2 million and an additional $25.4 million payment effectuated solely through offset against the balance of the funds withheld account under the reinsurance agreements in exchange for releasing Hannover and Tokio from their reinsurance obligations under the commuted agreements. Both Hannover and Tokio remain obligated to the subsidiaries of the Company under other reinsurance agreements. As a result of the commutation, the effect on the Company’s net income in the year ended December 31, 2016 was immaterial.
Major components of cash provided by operating activities in 2014 were net premiums collected of $373.1 million and investment income collected of $42.1 million, offset in-part by claim payments of $183.7 million, $71.7 million of operating expenditures, federal taxes paid of $19.9 million and dividends to policyholders paid of $1.1 million.
Net cash used in financing activities was $74.3 million in 2016, as compared to net cash used in financing activities of $64.5 million in 2015 and net cash used in financing activities of $31.6 million in 2014. Major components of cash used in financing activities in 2016 included cash used for dividends paid to shareholders of $76.1 million, offset by $1.0 million of tax benefit from share-based compensation and $0.8 million of proceeds from the exercise of stock options. Major components of cash used in financing activities in 2015 included $1.8 million of proceeds from the exercise of stock options and $2.2 million of tax benefit from share-based compensation, offset by cash used for dividends paid to shareholders of $68.6 million. Major components of cash provided in financing activities in 2014 included $2.7 million of proceeds from the exercise of stock options and $2.8 million of tax benefit from share-based compensation, offset by cash used for dividends paid to shareholders of $37.1 million.
The Company has a line of credit agreement with Frost Bank for borrowings up to a maximum of $20.0 million. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate or LIBOR and are unsecured. Under the agreement, the Company pays a fee of 0.25% on the unused portion of the loan in arrears quarterly, for a fee of $50,000 annually. At December 31, 2016, there were no outstanding borrowings. Unless renewed, the agreement will expire in December 2019.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including AIIC, SOCI and AIICTX. AMERISAFE’s primary assets are the capital stock of these insurance subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. Based upon the prescribed calculation, the insurance subsidiaries could pay to AMERISAFE dividends of up to $78.9 million in 2017 without seeking regulatory approval. See “Business-Regulation-Dividend Limitations” in Item 1 of this report.
In 2016, 2015 and 2014, the Company paid regular quarterly cash dividends of $0.18, $0.15 and $0.12 per share, respectively. In addition, the Company paid extraordinary cash dividends of $3.25 in 2016, $3.00 in 2015 and $0.50 and $1.00 per share in 2014.
For our securities classified as available-for-sale, the securities are “marked to market” as of the end of each calendar quarter. As of that date, unrealized gains and losses are recorded against Accumulated Other Comprehensive Income (Loss), except when such securities are deemed to be other-than-temporarily impaired. For our securities classified as held-to-maturity, unrealized gains and losses are not recorded in the financial statements until realized or until a decline in fair value, below amortized cost, is deemed to be other-than-temporary.
The following table summarizes the fair value of, and the amount of, unrealized losses on our investment securities, segregated by the time period each security has been in a continuous unrealized loss position as of December 31, 2016 and 2015:
The pre-tax investment yield on our investment portfolio was 2.5% per annum during the twelve months ended December 31, 2016, compared to 2.5% per annum during the same period in 2015.
The table below provides information with respect to our contractual obligations as of December 31, 2016.
The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2016 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense process, see “Business-Loss Reserves” in Item 1 of this report. Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the amounts shown in the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors- Risks Related to Our Business-Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Item 1A of this report for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
We are subject to various annual assessments imposed by certain of the states in which we write insurance policies. These assessments are generally based upon the amount of premiums written or losses paid during the applicable year. Assessments based on premiums are generally paid within one year after the calendar year in which the policies are written, while assessments based on losses are generally paid within one year after calendar year in which the loss is paid. When we establish a reserve for loss and loss adjustment expenses for a reported claim, we accrue our obligation to pay any applicable assessments. If settlement of the claim is to be paid out over more than one year, our obligation to pay any related loss-based assessments extends for the same period of time. Because our reserves for loss and loss adjustment expenses are based on estimates, our accruals for loss-based insurance assessments are also based on estimates. Actual payments of loss and loss adjustment expenses may differ, perhaps materially, from our reserves. Accordingly, our actual loss-based insurance assessments may vary, perhaps materially, from our accruals.
Audited Financial Statements as of December 31, 2016 and 2015 and for the three years in the period ended December 31, 2016:
The Company provides workers’ compensation insurance for small to mid-sized employers engaged in hazardous industries, principally construction, trucking, manufacturing, agriculture, and oil and gas. Assets and revenues of AIIC represent at least 95% of comparable consolidated amounts of the Company for each of 2016, 2015 and 2014.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The new guidance requires that all tax effects related to share-based payments be made through the income statement at the time of settlement as opposed to recognizing excess tax benefits in additional paid-in capital. It also requires the cash flows resulting from share-based payments to be included as an operating activity. In addition to the changes, the
In May 2014, the FASB Issued ASU 2014-09 (Topic 606): Revenue from Contracts with Customers. The guidance revises the criteria for revenue recognition and requires that the revenue recognized reflect the transfer of promised goods or services to customers in an amount that represents the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for us in the first quarter of 2018. Revenue from insurance contracts is excluded from the scope of the new guidance and as a result, adoption of this guidance is not expected to have a material impact on our financial condition and results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses. The new guidance replaces the methodology of credit loss impairment, which currently, delays the recognition of credit losses until a probable loss has been incurred. The new guidance requires credit losses for securities measured at amortized cost, to be determined using current expected credit losses estimates. These estimates are to be derived from historical, current and reasonable supporting forecasts, including prepayments and estimates, and will be recorded through a valuation allowance account that will run through the income statement. The same method will be used for available-for-sale securities, but the valuation allowance will be limited to the amount by which the fair value is below amortized cost. The standard is effective for us in the first quarter of 2020. The Company will continue to monitor the impact as the implementation date approaches.
The direct costs of successfully acquiring and renewing business are capitalized to the extent recoverable and are amortized over the effective period of the related insurance policies in proportion to premium revenue earned. These capitalized costs consist mainly of sales commissions, premium taxes and other underwriting costs. The Company evaluates deferred policy acquisition costs for recoverability by comparing the unearned premiums to the estimated total expected claim costs and related expenses, offset by anticipated investment income. The Company would reduce the deferred costs if the unearned premiums were less than expected claims and expenses after considering investment income, and report any adjustments in amortization of deferred policy acquisition costs. There were no adjustments necessary in 2016, 2015 or 2014.
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2015 are summarized as follows:
A summary of the amortized cost and fair value of investments in fixed maturity securities, classified as available-for-sale at December 31, 2016, by contractual maturity, is as follows:
At December 31, 2016, there were $21.2 million of held-to-maturity investments, $0.4 million of available-for-sale investments and $0.1 million of cash on deposit with regulatory agencies of states in which the Company does business.
A summary of the Company’s realized gains and losses on sales, calls or redemptions of investments for 2016, 2015 and 2014 is as follows:
In 2016, there were no impairment losses recognized for other-than-temporary declines in the fair value of our investments.
Included in premiums receivable at December 31, 2016, 2015 and 2014 is the Company’s estimate for EBUB premium of $7.7 million, $7.6 million and $5.2 million, respectively.
Furniture and equipment included property held under capital leases of $0.2 million at December 31, 2016. Accumulated depreciation includes $80,000 that is related to these properties at December 31, 2016. Furniture and equipment included property held under capital leases of $0.1 million at December 31, 2015. Accumulated depreciation includes $97,000 that is related to these properties at December 31, 2015. Furniture and equipment included property held under capital leases of $0.1 million at December 31, 2014. Accumulated depreciation includes $49,000 that is related to these properties at December 31, 2014. The capital lease obligations related to these properties are included in accounts payable and other liabilities.
Tax years 2013 through 2016 are subject to examination by the federal and state taxing authorities. In 2016, the Company was notified by the Illinois Department of Revenue that the examination of tax years 2011 and 2012 had been completed with no findings.
The average annual percentage payout of incurred claims by age, net of reinsurance, for workers’ compensation and general liability as of December 31, 2016 is summarized below. Since workers’ compensation has long payout periods, the table below shows less than 100% in the years disclosed.
The following table provides a reconciliation of the beginning and ending reserve balances, net of related amounts recoverable from reinsurers, for 2016, 2015 and 2014:
Pursuant to regulatory requirements, AIIC cannot pay dividends to the Company in excess of the greater of 10% of statutory surplus, or statutory net income, excluding realized investment gains, for the preceding 12-month period, without the prior approval of the Nebraska Director of Insurance. However, for purposes of this dividend calculation, net income from the previous two calendar years may be carried forward to the extent that it has not already been paid out as dividends. AIIC paid $67.0 million in dividends to the Company in 2016, $50.0 million in 2015 and $25.0 million in 2014. Based upon the dividend limitation described above, AIIC could pay to the Company dividends of up to $68.7 million in 2017 without seeking regulatory approval.
The Company is authorized to issue 10,000,000 shares of preferred stock, par value $0.01 per share. At December 31, 2016, there were no shares of preferred stock outstanding.
The following table summarizes information about the stock options outstanding under the 2005 Incentive Plan at December 31, 2014, 2015 and 2016:
The following table summarizes information about the restricted stock outstanding under the 2005 Incentive Plan at December 31, 2016:
A maximum of 500,000 shares of common stock may be issued or transferred upon the exercise of option rights or appreciation rights, as restricted shares and released from substantial risk of forfeiture, in payment of restricted stock units, in payment of performance shares or performance units that have been earned, as awards of shares of common stock, as other awards granted under the 2012 Incentive Plan, or in payment of dividend equivalents paid with respect to awards made under the plan subject to adjustment in the event of a merger, stock dividend, stock split or similar event, which may be original issue shares or treasury shares or a combination of the two.
In 2016, 27,077 shares of restricted stock were granted under the 2012 Incentive Plan, which will vest through 2021. In 2015, 50,461 shares of restricted stock were granted under the 2012 Incentive Plan, which will vest through 2020. At December 31, 2016, there were 355,777 shares of common stock available for future awards under the 2012 Incentive Plan.
The following table summarizes information about the restricted stock outstanding under the 2012 Incentive Plan at December 31, 2016:
The Company’s 401(k) benefit plan is available to all employees. The Company matches up to 2% of employee compensation for participating employees, subject to certain limitations. Employees are fully vested in employer contributions to this plan after five years. Company contributions to this plan were $0.4 million in 2016, 2015 and 2014.
The Company leases equipment and office space under noncancelable operating leases. At December 31, 2016, future minimum lease payments are as follows (in thousands):
Net premiums earned during 2016, 2015 and 2014 for the top ten states in 2016 and all others are shown below:
Cash and Cash Equivalents-The carrying amounts reported in the accompanying consolidated balance sheets for these financial instruments approximate their fair values.
Other Investments- Other investments consist of a limited partnership interest that is accounted for under the equity method valued using the net asset value provided by the general partner of the limited partnership, which approximates the fair value of the interest. The limited partnership’s objective is to generate absolute returns by investing long and short in publicly-traded global securities. Redemptions are allowed monthly following a 60-day notice with no lock up periods. The Company has no unfunded commitments to the limited partnership.
At December 31, 2016, the Company held two securities measured at fair value on a nonrecurring basis due to a recognized impairment of $0.3 million. The securities are valued using Level 2 inputs and had a value of $0.3 million at December 31, 2016. The securities were valued at fair value at the time of impairment and are currently being carried at the adjusted amortized cost. The fair value of the securities was $0.5 million at December 31, 2016.
The Company’s Board of Directors initiated a share repurchase program in February 2010. In October 2016, the Board reauthorized this program with a limit of $25.0 million with no expiration date. There were no shares repurchased under this program in 2016. Since the beginning of this plan, the Company has repurchased a total of 1,258,250 shares for $22.4 million, or an average price of $17.78, including commissions.
In 2013, the Company’s Board of Directors initiated a regular quarterly dividend. During 2016, the Company’s Board of Directors declared a quarterly dividend of $0.18 per share compared to $0.15 per share in 2015, $0.12 per share in 2014 and $0.08 per share in 2013. The Company declared extraordinary dividends totaling $3.25 per share in 2016, $3.00 per share in 2015 and $1.50 per share in 2014. There were no extraordinary dividends declared in 2013.