(1) Unrealized gains and losses on equity securities were included in consolidated revenue and net earnings in 2019 and 2018 and flowed through comprehensive earnings in prior years.
The combined ratio, which is derived from components of underwriting income, is a common industry performance measure of profitability for underwriting operations and is calculated in two components. First, the loss ratio is losses and settlement expenses divided by net premiums earned. The second component, the expense ratio, reflects the sum of policy acquisition costs and insurance operating expenses divided by net premiums earned. All items included in these components of the combined ratio are presented in our GAAP consolidated financial statements. The sum of the loss and expense ratios is the combined ratio. The difference between the combined ratio and 100 reflects the per-dollar rate of underwriting income or loss. For example, a combined ratio of 90 implies that for every $100 of premium we earn, we record $10 of underwriting income.
Loss and loss adjustment expense (LAE) reserves represent our best estimate of ultimate payments for losses and related settlement expenses from claims that have been reported but not paid and those losses that have occurred but have not yet been reported to the Company. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to the Company, review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability and many other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.
Due to inherent uncertainty underlying loss reserve estimates, including, but not limited to, the future settlement environment, final resolution of the estimated liability may be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a significantly different amount than currently reserved - favorable or unfavorable.
The amount by which currently estimated losses differ from those estimated for a period at a prior valuation date is known as development. Development is unfavorable when the losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for reserve increases on unresolved claims. Development is favorable when losses ultimately settle for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the results of operations in the period the estimates are changed.
Our IBNR reserving process involves three steps: (1) an initial IBNR generation process that is prospective in nature, (2) a loss and LAE reserve estimation process that occurs retrospectively and (3) a subsequent discussion and reconciliation between our prospective and retrospective IBNR estimates, which includes changes in our provisions for IBNR where deemed appropriate. These three processes are discussed in more detail in the following sections.
Our best estimate of ultimate loss and LAE reserves are proposed by our lead reserving actuary and approved by our Loss Reserve Committee (LRC). The LRC is made up of various members of the management team including the lead reserving actuary, chief executive officer, chief operating officer, chief financial officer, chief legal officer and other selected executives. We do not use discounting (recognition of the time value of money) in reporting our estimated reserves for losses and settlement expenses. Based on current assumptions used in calculating reserves, we believe that our reserve levels at December 31, 2019, make a reasonable provision to meet our future obligations.
For certain property products, we use an alternative method of determining an appropriate provision for initial IBNR. Since this segment is characterized by a shorter period of time between claim occurrence and claim settlement, the IBNR reserves are determined by IBNR percentages applied to premium earned. The percentages are determined based on expected loss ratios and loss development assumptions. The loss development assumptions are typically based on historical reporting patterns but could consider alternative sources of information. The IBNR percentages are reviewed and updated periodically. No deductions for paid or case reserves are made. This alternative method of determining initial IBNR allows incurred losses and ALAE to react more rapidly to the actual emergence and is more appropriate for our property products where final claim resolution occurs over a shorter period of time.
● A new business or one experiencing significant growth and/or high turnover,
● Unique reinsurance features including those with aggregate stop-loss, reinstatement clauses, commutation provisions or clash protection,
● Assumed reinsurance businesses where there is an extended reporting lag and/or a heavier utilization of ceding company data and claims and product expertise,
Estimates of the expected value of the unpaid loss and LAE are derived using standard actuarial methodologies on a quarterly basis. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance.
Loss reserve estimates are subject to a high degree of variability due to the inherent uncertainty of ultimate settlement values. Periodic adjustments to these estimates will likely occur as the actual loss emergence reveals itself over time. Our loss reserving processes reflect accepted actuarial practices and our methodologies result in a reasonable provision for reserves as of December 31, 2019.
We determined the fair value of certain financial instruments based on their underlying characteristics and relevant transactions in the marketplace. We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
We regularly evaluate our fixed income securities using both quantitative and qualitative criteria to determine impairment losses for other-than-temporary declines in the fair value of the investments. The following are some of the key factors we consider for determining if a security is other-than-temporarily impaired:
● The probability of significant adverse changes to the cash flows,
● Changes in technology that may impair the earnings potential of the investment,
● The discontinuance of a segment of business that may affect future earnings potential,
● Specific concerns related to the issuer’s industry or geographic area of operation,
● A downgrade in credit quality by a major rating agency.
For mortgage-backed securities and asset-backed securities that have significant unrealized loss positions and major rating agency downgrades, credit impairment is assessed using a cash flow model that estimates likely payments using security-specific collateral and transaction structure. All of our mortgage-backed and asset-backed securities remain AAA-rated by one of the major rating agencies and the fair value is not significantly less than amortized cost.
Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid losses and settlement expenses are reported separately as assets, rather than being netted with the related liabilities, since reinsurance does not relieve the Company of its liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and settlement expenses impact the estimates for the ceded portion of such liabilities. We continually monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements, Securities and Exchange Commission (SEC) filings for reinsurers that are publicly traded, AM Best and S&P rating developments and insurance industry developments that may impact the financial condition of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverability tests, including one based on average default by S&P rating. Based upon our review and testing, our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.
We defer incremental direct costs that relate to the successful acquisition of new or renewal insurance contracts, including commissions and premium taxes. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance contract, or when efforts to obtain or renew the insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense in proportion to
Consolidated revenue totaled $1.0 billion in 2019, compared to $0.8 billion in 2018. Increased levels of earned premium and net investment income, as well as unrealized gains on equity securities, led to increased consolidated revenue in 2019. Net premiums earned increased 6 percent, as growth from products within our casualty and property segments more than offset the impact of our exit from certain underperforming products and the reduction in our participation on a quota share reinsurance agreement with Prime Holdings Insurance Services, Inc. (Prime). Net investment income increased by 11 percent in 2019, primarily due to a larger asset base relative to the prior year. We recorded net realized gains on our investment portfolio in both 2019 and 2018, due to portfolio rebalancing. Additionally, net unrealized gains on equity securities were recorded in 2019, as the overall equity market experienced positive returns. In contrast, equity markets experienced negative returns in 2018, resulting in net unrealized losses on equity securities.
Gross premiums written increased by 8 percent in 2019 to a record $1.1 billion. Excluding exited lines, such as the medical professional liability product and the reduction in our quota share reinsurance agreement with Prime, written premium increased by 15 percent. Positive rate movement across most of the casualty and property portfolio and market disruption provided for growth opportunities in established lines. Newer product initiatives within our casualty segment have also continued to gain scale.
The 2019 fiscal year benefited from a reduced level of catastrophe activity compared to 2018. In 2019, we incurred $9.5 million of losses from storms, which added 1.1 points to the combined ratio. Catastrophe losses totaled $40.5 million in 2018, adding 5.1 points to the combined ratio, with Hurricane Michael responsible for $23.0 million, Hurricane Florence responsible for $7.5 million and other storms and volcanic activity in Hawaii composing the balance. Apart from the impact of catastrophes, results for both years reflected a combination of positive underwriting results for the current accident year and favorable loss reserve development on prior accident years. Favorable development in prior accident years’ reserves was $75.3 million in 2019 and $50.0 million in 2018. Further discussion of reserve development can be found in note 6 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data.
In total, underwriting income was $67.6 million on a 91.9 combined ratio in 2019, compared to $41.6 million on a 94.7 combined ratio in 2018. We achieved our 24th consecutive year of underwriting profit in 2019, with all three segments contributing to the positive performance. Our ability to continue to produce underwriting income, and to do so at margins which have consistently outperformed the broader industry, is a testament to our underwriters’ discipline throughout the insurance cycle and our continued commitment to underwriting for a profit. We believe our underwriting discipline can
The following tables and narrative provide a more detailed look at individual segment performance over the last two years.
As previously announced, we reduced our quota share reinsurance agreement with Prime from 25 percent to 6 percent at the beginning of 2019 to better manage our exposure to their growth relative to our overall product portfolio. In addition, we exited from our medical professional liability lines due to unfavorable market conditions and poor underwriting performance. These actions account for the decline in other casualty and offset continued growth in our general binding authority (GBA) and mortgage reinsurance lines.
Gross premiums written from our property segment totaled $241.4 million in 2019, up 19 percent from 2018. Market disruption created new business opportunities for our marine product and, along with rate increases, led to a 27 percent increase in premiums. Our commercial property business grew 14 percent in 2019, as an improving market has allowed our underwriters to find more opportunities with acceptable rate levels. Rates on wind-prone exposures increased for the second
Underwriting income from the property segment was $18.1 million on an 88.9 combined ratio in 2019, compared to $0.9 million on a 99.4 combined ratio in 2018. Catastrophe losses for the property segment consisted of $8.8 million of storm losses in 2019, compared to total catastrophe losses of $38.3 million in 2018, which included $28.9 million from Hurricanes Michael and Florence and $6.1 million from volcanic activity in Hawaii. Partially offsetting the impact of catastrophes, favorable development in prior years’ reserves benefited underwriting results in each of the past two years. Results for 2019 included $4.5 million of net favorable development on prior years’ reserves. Marine experienced $2.4 million of the favorable development, primarily on accident years 2017 and 2018. Specialty personal and commercial property also contributed to the
The fixed income portfolio increased by $222.6 million during the year as the majority of operating cash flows were allocated to the fixed income portfolio and a decline in interest rates was experienced during the year, increasing the fair value of fixed income securities. The tax-adjusted total return on a mark-to-market basis was 8.3 percent. Our equity portfolio increased by $120.1 million to $460.6 million in 2019 as a result of the strong equity market returns during the year. The total return for the year on the equity portfolio was 28.7 percent.
We regularly evaluate the quality of our investment portfolio. When we determine that a fixed income security has suffered an other-than-temporary decline in value, the investment’s value is adjusted by reclassifying the decline from unrealized to realized losses. This has no impact on shareholders’ equity. We did not recognize any impairment losses in 2019. During 2018, we recognized $0.2 million in impairment losses on fixed income securities we no longer had the intent to hold until recovery.
We maintain a diversified investment portfolio with a prudent mix of fixed income and risk assets. We continually monitor economic conditions, our capital position and the insurance market to determine our tactical allocation. As of December 31, 2019, the portfolio had a fair value of $2.6 billion, an increase of $366.1 million from the end of 2018.
As of December 31, 2019, our investment portfolio had the following asset allocation breakdown:
Fixed income represented 77 percent of our total 2019 portfolio, down 3 percent from 2018. As of December 31, 2019, the fair value of our fixed income portfolio consisted of 49 percent AAA-rated securities, 17 percent AA-rated securities, 19 percent A-rated securities, 9 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities. This compares to 48 percent AAA-rated securities, 16 percent AA-rated securities, 20 percent A-rated securities, 10 percent BBB-rated securities and 6 percent non-investment grade or non-rated securities in 2018.
Consistent underwriting income allows a portion of our investment portfolio to be invested in equity securities and other risk asset classes. Our equity portfolio had a fair value of $460.6 million at December 31, 2019. Equities comprised 18 percent of our total 2019 portfolio, up 2 percent over 2018. Securities within the equity portfolio are well diversified and are primarily invested in large-cap issues with a preference for dividend income. Our strategy has a value tilt and security selection takes precedence over market timing. Likewise, low turnover throughout our long investment horizon minimizes transaction costs and taxes.
As of December 31, 2019, our fixed income portfolio had the following rating distributions:
The following table summarizes the distribution of our mortgage-backed securities (MBS) portfolio by investment type, as of December 31,:
We believe agency MBS investments add diversification, liquidity, credit quality and additional yield to our portfolio. Our objective for the agency MBS portfolio is to provide reasonable cash flow stability where we are compensated for the call risk associated with residential refinancing. The agency MBS portfolio includes mortgage-backed pass-through securities and collateralized mortgage obligations (CMO), which include planned amortization classes (PACs) and sequential pay structures. Our agency MBS portfolio does not include interest-only securities or principal-only securities. As of December 31, 2019, all of the securities in our agency MBS portfolio were rated AAA and issued by Government Sponsored Enterprises (GSEs) such as the Governmental National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC).
When making investments in MBS/ABS/CMBS, we evaluate the quality of the underlying collateral, the structure of the transaction, which dictates how any losses in the underlying collateral will be distributed, and prepayment risks. We had $1.0 million in unrealized losses in these asset classes as of December 31, 2019.
Eighty-six percent of our municipal fixed income securities were rated AA or better, while 99 percent were rated A or better. The municipal portfolio includes 74 percent tax-exempt and 26 percent taxable securities.
As of December 31, 2019, our corporate debt portfolio totaled $692.1 million (35 percent) of the fixed income portfolio compared to $668.7 million (38 percent) as of December 31, 2018. The corporate allocation includes floating rate bank loans and bonds that are below investment grade in credit quality and offer incremental yield over our core fixed income portfolio. Non-investment grade bonds totaled $115.4 million at the end of 2019. The corporate debt portfolio has an overall quality rating of BBB+ diversified among 552 issues.
We incurred $7.6 million of interest expense on outstanding debt during 2019 and $7.4 million in 2018. At December 31, 2019 and 2018, our long-term debt consisted of $150.0 million in senior notes maturing September 15, 2023, and paying interest semi-annually at the rate of 4.875 percent.
Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the recently revised corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the receipt of dividends, such as a sale. We received a $13.2 million dividend from Maui Jim in 2019 and recognized a $1.8 million tax benefit from applying the lower tax rate applicable to affiliated dividends (7.4 percent in 2019), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. Standing alone, the dividend resulted in a 0.8 percent reduction to the 2019 effective tax rate. In the fourth quarter of 2017, Maui Jim gave notification that a $9.9 million dividend would be paid in January 2018. Even though no dividend was received in 2017, we were aware that the lower tax rate applicable to affiliated dividends would be applied when the dividend was paid in 2018 and we therefore recorded a $1.4 million tax benefit in 2017. As no additional dividends were declared from unconsolidated investees in 2018, there was no impact to the 2018 effective tax rate.
Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP in 2019 and 2018 resulted in tax benefits of $1.1 million and $1.2 million, respectively. These tax benefits reduced the effective tax rate for 2019 and 2018 by 0.5 percent and 1.8 percent, respectively.
Gross reserves (liability) and the reinsurance balances recoverable (asset) are generally subject to the same influences that affect net reserves, though changes to our reinsurance agreements can cause reinsurance balances recoverable to behave differently. Total gross loss and LAE reserves increased to $1.6 billion at December 31, 2019, from $1.5 billion at December 31, 2018, while ceded loss and LAE reserves increased to $384.5 million from $365.0 million over the same period.
We have three primary types of cash flows: (1) operating cash flows, which consist mainly of cash generated by our underwriting operations and income earned on our investment portfolio, (2) investing cash flows related to the purchase, sale and maturity of investments and (3) financing cash flows that impact our capital structure, such as changes in debt and shares outstanding. The following table summarizes these three cash flows over the last two years:
We have posted positive operating cash flow in the last two years. Variations in operating cash flow between periods are largely driven by the volume and timing of premium receipt, claim payments, reinsurance and taxes. In addition, fluctuations in insurance operating expenses impact operating cash flow. During 2019, the majority of cash flow uses were related to financing and investing activities and associated with the payments of dividends and net purchases of investments, respectively.
Loss and settlement expense reserves represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by periods are based on our historical claims payment experience. Due to the uncertainty inherent in the process of estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed
The next largest contractual obligation relates to long-term debt outstanding. On October 2, 2013, we completed a public debt offering of $150.0 million in senior notes maturing September 15, 2023, (a 10-year maturity) and paying interest semi-annually at the rate of 4.875 percent. The notes were issued at a discount resulting in proceeds, net of discount and commission, of $148.6 million. We are not party to any off-balance sheet arrangements. See note 4 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data for more information on our long-term debt. Additionally, see note 2 to the consolidated financial statements within Item 8, Financial Statements and Supplementary Data for information on our obligations for other invested assets.
Our capital structure is comprised of equity and debt obligations. As of December 31, 2019, our capital structure consisted of $149.3 million in 10-year maturity senior notes (long-term debt) and $995.4 million of shareholders’ equity. Debt outstanding comprised 13 percent of total capital as of December 31, 2019.
In 2019, we achieved several notable milestones in a year when much of the industry was refining its risk appetite. Despite exiting several underperforming products, top line premium exceeded $1 billion for the first time in our company’s history. Premium growth was broad based over the course of the last twelve months and the majority of our products saw opportunities in the market. Additionally, we surpassed $1 billion in statutory surplus as underwriting profit contributed to the bottom line for the 24th consecutive year. We expect a continued strong economy to provide further growth opportunities in 2020.
Our casualty portfolio experienced premium headwinds in 2019, due to the reduction in our assumed reinsurance treaty with Prime and several product exits. Although we recognized adverse loss development from some of these runoff products in 2019, we believe our bottom line will benefit over the long term. A majority of our mature products grew during the year and newer products have started to gain scale. Our diverse portfolio will continue to evolve over time.
Selecting diversified exposures is an important component of our property segment and our recent investment in marketing and technology will support growth in our Hawaii homeowners business. While our underwriting results will continue to be influenced by the level of catastrophe activity in U.S., we have seen first-hand that taking care of customers in the wake of an event bolsters the intangibles that define strong relationships. Deep understanding of catastrophe risks has long been a part of our DNA and we expect this to be beneficial in the current environment.
Our surety top line will continue to be challenged. Over the last couple of years, we exited select programs in our miscellaneous book that no longer meet our risk appetite. In the larger commercial account driven business, we have also exited select accounts where the credit quality of our principal had deteriorated. This represents a continuous process of underwriting our accounts to determine if we should continue extending credit. Although new business is difficult to win in this competitive market, our successes stem from nurturing strong relationships with current accounts. Opportunities are brighter in the small contractor’s space as the construction market continues to expand.
Capital markets posted one of the strongest years in recent memory in 2019. The Federal Reserve’s accommodative support led to positive returns in nearly every asset class. With a more positive backdrop, Wall Street has changed its tune and is now forecasting modest growth with low recession risk. That sentiment will hopefully sustain the economic recovery, where the United States just completed an entire calendar decade without a recession. Although we believe fundamentals will remain sound over the next twelve months, the abundance of commentary stating there is no recession in sight offers some reason for skepticism.
Wages continue to climb higher, adding to consumer confidence and household wealth. These trends have yet to manifest themselves into higher inflation, which remains below the Fed’s target. We do not expect the Fed to change policy much in the coming year, unless circumstances require defensive actions. Our allocation among asset classes will likely remain fairly steady, with a preference for high quality bonds and slight overweight to duration.
On May 4, 2018, RLI Corp. changed its state of incorporation from the State of Illinois to the State of Delaware (the Reincorporation). The Reincorporation was effected by merging RLI Corp., an Illinois corporation (RLI Illinois), into RLI Corp., a Delaware corporation (RLI Delaware). The separate corporate existence of RLI Illinois ceased and RLI Delaware continues in existence as the surviving corporation and possesses all rights, privileges, powers and franchises of RLI Illinois. The Reincorporation did not result in any change in the name, business, management, fiscal year, location of the principal executive offices, assets or liabilities of the Company. Each outstanding share of RLI Illinois common stock, which had a par value of $1.00 per share, was automatically converted into one outstanding share of RLI Delaware common stock, with a par value of $0.01 per share. In order to reflect the new par value of common stock on the balance sheet, a $66.4 million reclassification from common stock to paid-in-capital was made.
ASU 2016-02 was issued to improve the financial reporting of leasing transactions. Under previous guidance for lessees, leases were only included on the balance sheet if certain criteria, classifying the agreement as a capital lease, were met. This update requires the recognition of a right-of-use asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. For operating leases, the asset and liability are expensed over the lease term on a straight-line basis, with all cash flows included in the operating section of the statement of cash flows. For finance leases, interest on the lease liability is recognized separately from the amortization of the right-of-use asset in the statement of earnings and the repayment of the principal portion of the lease liability is classified as a financing activity while the interest component is included in the operating section of the statement of cash flows.
We adopted ASU 2016-02, ASU 2018-10 Codification Improvements to Topic 842: Leases and ASU 2018-11 Leases (Topic 842): Targeted Improvements on January 1, 2019. We applied the standards using the alternative transition method provided by ASU 2018-11 under which leases were recognized at the date of adoption and a cumulative-effect adjustment to the opening balance of retained earnings would have been recognized in the period of adoption. As the standard did not have an impact on our net earnings, no adjustment to the opening balance of retained earnings was required. As of December 31, 2019, $22.3 million of right-of-use assets and $24.5 million of lease liabilities were included in the other assets and other liabilities line items of the consolidated balance sheet, respectively, as a result of the adoption of these updates. We implemented controls for the adoption of the standard and the ongoing monitoring of the right-of-use asset and lease liability, but they did not materially affect our internal control over financial reporting.
Under previous guidance, the amortization period for callable debt securities held at a premium was generally the contractual life of the instrument. However, if an entity had a large number of similar loans, it could consider estimates of future principal prepayments. For those who chose not to incorporate an estimate of future prepayments, ASU 2017-08 shortens the amortization period for premium on debt securities to the earliest call date, rather than the maturity date, to align the amortization method with how the securities are quoted, priced and traded. After the earliest call date, if the call option is not exercised, the entity shall reset the effective yield using the payment terms of the debt security. Any excess of the amortized cost basis over the amount payable will be amortized to the next call date or to maturity if there are no other call dates. The method of accounting for a discount does not change and will continue to be amortized over the life of the bond.
ASU 2016-13 was issued to provide more decision-useful information about the expected credit losses on financial instruments. Current GAAP delays the recognition of credit losses until it is probable a loss has been incurred. The update will require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net earnings. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale securities is similar under current GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through an irreversible write-down.
reasonable). Finally, for investments measured at net asset value, the requirements have been modified so that the timing of liquidation and the date when restrictions from redemption might lapse are only disclosed if the investee has communicated the timing to the entity or announced the timing publicly.
Interest on fixed maturities and short-term investments is credited to earnings on an accrual basis. Premiums and discounts are amortized or accreted over the lives of the related fixed maturities. Dividends on equity securities are credited to earnings on the ex-dividend date. Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the settlement date.
We continuously monitor the financial condition of our reinsurers. As part of our monitoring efforts, we review their annual financial statements, quarterly disclosures and Securities and Exchange Commission (SEC) filings for reinsurers that are publicly traded. We also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit risk associated with our reinsurance balances recoverable by monitoring the AM Best and Standard & Poor’s (S&P) ratings of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverable tests, including one based on average default by S&P rating. Based upon our review and testing, our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover.
We maintain a 40 percent interest in the equity and earnings of Maui Jim, Inc. (Maui Jim), a manufacturer of high-quality sunglasses, which is accounted for under the equity method. We also maintain a similar minority representation on their board of directors. Maui Jim’s chief executive officer owns a controlling majority of the outstanding shares of Maui Jim. We carry this investment at the holding company level as it is not core to our insurance operations. Our investment in Maui Jim was $79.6 million at December 31, 2019 and $79.5 million at December 31, 2018. In 2019, we recorded $13.6 million in investee earnings for Maui Jim, compared to $12.5 million in 2018 and $14.4 million in 2017. Maui Jim recorded net income of $35.6 million in 2019, $30.3 million in 2018 and $34.4 million in 2017. Additional summarized financial information for Maui Jim for 2019 and 2018 is outlined in the following table:
As of December 31, 2019, we had a 23 percent interest in the equity and earnings of Prime Holdings Insurance Services, Inc. (Prime), which is accounted for under the equity method. Prime writes business through two Illinois domiciled insurance carriers, Prime Insurance Company, an excess and surplus lines company, and Prime Property and Casualty Insurance Inc., an admitted insurance company. Our investment in Prime was $24.2 million at December 31, 2019 and $15.4 million at December
31, 2018. In 2019, we recorded $7.4 million in investee earnings for Prime, compared to $3.6 million in 2018 and $2.8 million in 2017. Additionally, we maintain a quota share reinsurance treaty with Prime, which contributed $13.1 million of gross premiums written and $28.7 million of net premiums earned during 2019, compared to $41.1 million of gross premiums written and $34.2 million of net premiums earned during 2018 and $29.6 million of gross premiums written and $21.0 million of net premiums earned during 2017. The decrease in gross written premium is reflective of our decreased quota share participation with Prime.
Goodwill and intangibles totaled $54.1 million and $54.5 million at December 31, 2019 and 2018, respectively, as detailed in the following table:
During the first quarter of 2018 and the second quarter of 2017, adverse loss experience triggered the need to test the medical professional liability reporting unit. The testing resulted in a $4.4 million non-cash impairment charge on goodwill and intangible assets in 2018 and a $3.4 million non-cash impairment charge on goodwill and intangible assets in 2017. In each instance, the fair value for the medical professional liability reporting unit’s agency relationships, carried as a definite-lived intangible asset, was determined by using a discounted cash flow valuation. In 2018, the carrying value exceeded the fair value, resulting in a $0.8 million non-cash impairment charge. In 2017, the resulting non-cash impairment charge on definite-lived intangibles was $1.8 million. The fair value for the medical professional liability reporting unit’s goodwill was determined by using a weighted average of a market approach and discounted cash flow valuation. The carrying value exceeded the fair value in each year, resulting in a $3.6 million non-cash impairment charge in 2018 and a $1.6 million non-cash impairment charge during 2017. Subsequent to the 2018 impairment, the medical professional liability reporting unit had no remaining goodwill or intangible assets. All impairment charges were recorded as net realized losses in the respective period’s consolidated statement of earnings.
Basic earnings per share (EPS) is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stock or common stock equivalents were exercised or converted into common stock. When inclusion of these items increases the earnings per share or reduces the loss per share, the effect on earnings is anti-dilutive. Under these circumstances, the diluted net earnings or net loss per share is computed excluding these items. The following represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the consolidated financial statements:
ASU 2018-02 addressed issues arising from the enactment of the Tax Cuts and Jobs Act of 2017. Deferred tax items are required to be revalued based on new tax laws with changes included in earnings. Since other comprehensive earnings was not affected by the revaluation of deferred tax items, the accumulated other comprehensive earnings balance was reflective of the historic tax rate instead of the newly enacted rate, which created a stranded tax effect. ASU 2018-02 allowed for the reclassification of our $3.7 million stranded tax effect out of accumulated other comprehensive earnings into retained earnings.
The sale or other-than-temporary impairment of an available-for-sale security results in amounts being reclassified from accumulated other comprehensive earnings to current period net earnings. The effects of reclassifications out of accumulated other comprehensive earnings by the respective line items of net earnings are presented in the following table. As previously mentioned, 2019 and 2018 reflect activity on available-for-sale fixed income securities, while 2017 also includes activity from the equity portfolio.
● Pricing Level 3 is applied to valuations that are derived from techniques in which one or more of the significant inputs are unobservable.
Common Stock: As of December 31, 2019, all of our common stock holdings were traded on an exchange. Exchange traded equities have readily observable price levels and are classified as Level 1 (fair value based on quoted market prices). Pricing for the equity security not traded on an exchange in 2018 was provided by a third-party pricing source and was classified as Level 2.
We expense the estimated fair value of employee stock options and similar awards. We measure compensation cost for awards of equity instruments to employees based on the grant-date fair value of those awards and recognize compensation expense over the service period that the awards are expected to vest. The tax effects related to share-based payments are made through net earnings. See note 8 for further discussion and related disclosures regarding stock options.
Our insurance coverages include exposure to catastrophic events. We monitor all catastrophe exposures by quantifying our exposed policy limits in each region and by using computer-assisted modeling techniques. Additionally, we limit our risk to such catastrophes through restraining the total policy limits written in each region and by purchasing reinsurance. Our major catastrophe exposure is to losses caused by earthquakes, primarily on the West Coast. In 2019, we had reinsurance protection of $400 million in excess of $25 million first-dollar retention for earthquakes in California and $425 million in excess of a $25 million first-dollar retention for earthquakes outside of California. These amounts are subject to certain co-participations by the Company on losses in excess of the $25 million retentions. Our second largest catastrophe exposure is to losses caused by wind storms to commercial properties throughout the Gulf and East Coasts, as well as to homes we insure in Hawaii. In 2019, these coverages were supported by $275 million in excess of a $25 million first-dollar retention in traditional catastrophe reinsurance protection, subject to certain co-participations by the Company in the excess layers. In addition, we have incidental exposure to international catastrophic events.
Our insurance subsidiaries are highly regulated by the state in which they are incorporated and by the states in which they do business. Such regulations, among other things, limit the amount of dividends, impose restrictions on the amount and types of investments and regulate rates insurers may charge for various coverages. We are also subject to insolvency and guaranty fund assessments for various programs designed to ensure policyholder indemnification. We generally accrue an assessment during the period in which it becomes probable that a liability has been incurred from an insolvency and the amount of the related assessment can be reasonably estimated.
The National Association of Insurance Commissioners (NAIC) has developed Property/Casualty Risk-Based Capital (RBC) standards that relate an insurer’s reported statutory surplus to the risks inherent in its overall operations. The RBC formula uses the statutory annual statement to calculate the minimum indicated capital level to support investment and underwriting risk. The NAIC model law calls for various levels of regulatory action based on the magnitude of an indicated RBC capital deficiency, if any. We regularly monitor our subsidiaries’ internal capital requirements and the NAIC’s RBC developments. As of December 31, 2019, we determined that our capital levels are well in excess of the minimum capital requirements for all RBC action levels and that our capital levels are sufficient to support the level of risk inherent in our operations. See note 9 for further discussion of statutory information and related insurance regulatory restrictions.
As of December 31, 2019, we had $1.8 million of fixed income securities whose fair value was measured using significant unobservable inputs (Level 3). We did not own any Level 3 securities during 2018. Additionally, there were no securities transferred in or out of Levels 1, 2 or 3 during 2019 or 2018.
Expected maturities may differ from contractual maturities due to call provisions on some existing securities. At December 31, 2019, the net unrealized gains of available-for-sale fixed income securities totaled $67.8 million pretax. At December 31, 2018, the net unrealized losses of available-for-sale fixed maturities securities totaled $16.0 million pretax.
Our equity portfolio consists of common stocks and exchange traded funds (ETF). Gross unrealized losses in the equity portfolio decreased $8.1 million to $2.0 million in 2019 as equity markets improved during the year.
to sell the security before the recovery of our amortized cost basis. Significant changes in these factors could result in a charge to net earnings for impairment losses. Impairment losses result in a reduction of the underlying investment’s cost basis.
The fixed income portfolio contained 154 securities in an unrealized loss position as of December 31, 2019. Of these 154 securities, 65 have been in an unrealized loss position for 12 consecutive months or longer and represent $0.9 million in unrealized losses. All fixed income securities continue to pay the expected coupon payments under the contractual terms of the securities. Credit-related impairments on fixed income securities that we do not plan to sell, and for which we are not more
Our investments in private funds totaled $46.0 million at December 31, 2019, compared to $30.3 million at December 31, 2018, and we had $15.5 million of associated unfunded commitments at December 31, 2019. Our interest in these investments is generally restricted from being transferred or otherwise redeemed without prior consent by the respective entities. An initial public offering would allow for the transfer of interest in some situations, while the timed dissolution of the partnership would trigger redemption in others.
As of December 31, 2019, $15.5 million of investments were pledged as collateral with the FHLBC to ensure timely access to the secured lending facility that ownership of the FHLBC stock provides. As of and during year ended December 31, 2019, there were no outstanding borrowings with the FHLBC.
We paid $7.3 million of interest on our senior notes in each of the last three years. The average rate on debt was 4.91 percent in 2019, 2018 and 2017.
We maintain a revolving line of credit with JP Morgan Chase Bank N.A., which permits the Company to borrow up to an aggregate principal amount of $50.0 million. Under certain conditions, the line may be increased up to an aggregate principal amount of $75.0 million. This facility has a two-year term that expires on May 24, 2020. As of and during the years ended December 31, 2019, 2018 and 2017, no amounts were outstanding on these facilities.
Ceded unearned premiums and reinsurance balances recoverable on unpaid losses and settlement expenses are reported separately as an asset, rather than being netted with the related liability, since reinsurance does not relieve the Company of our liability to policyholders. Such balances are subject to the credit risk associated with the individual reinsurer. We continually monitor the financial condition of our reinsurers and actively follow up on any past due or disputed amounts. As part of our monitoring efforts, we review their annual financial statements and SEC filings for those reinsurers that are publicly traded. We also review insurance industry developments that may impact the financial condition of our reinsurers. We analyze the credit
risk associated with our reinsurance balances recoverable by monitoring the AM Best and S&P ratings of our reinsurers. In addition, we subject our reinsurance recoverables to detailed recoverability tests, including a segment-based analysis using the average default rating percentage by S&P rating, which assists the Company in assessing the sufficiency of the existing allowance. Additionally, we perform an in-depth reinsurer financial condition analysis prior to the renewal of our reinsurance placements.
Our policy is to charge to earnings, in the form of an allowance, an estimate of unrecoverable amounts from reinsurers. This allowance is reviewed on an ongoing basis to ensure that the amount makes a reasonable provision for reinsurance balances that we may be unable to recover. Once regulatory action (such as receivership, finding of insolvency, order of conservation or order of liquidation) is taken against a reinsurer, the paid and unpaid recoverable for the reinsurer are specifically identified and written off through the use of our allowance for estimated unrecoverable amounts from reinsurers. When we write-off such a balance, it is done in full. We then re-evaluate the remaining allowance and determine whether the balance is sufficient as detailed above and if needed, an additional allowance is recognized and income charged. The amounts of allowances for uncollectible amounts on paid and unpaid recoverables were $15.7 million and $9.4 million, respectively, at December 31, 2019. At December 31, 2018, the amounts were $16.1 million and $9.8 million, respectively. We have no receivables with a due date that extends beyond one year that are not included in our allowance for uncollectible amounts.
The following table is a reconciliation of our unpaid losses and settlement expenses (LAE) for the years 2019, 2018 and 2017:
develop in a similar manner are grouped together. This has resulted in the presentation of loss information for our property and surety segments at the segment level, while information for our casualty segment has been separated in four groupings: primary occurrence, excess occurrence, claims made and transportation. Primary occurrence includes select lines within the professional services product along with general liability, small commercial and other casualty products. Excess occurrence encompasses commercial excess and personal umbrella, while claims made includes select lines within the professional services product, executive products and other casualty. Reported claim counts represent claim events on a specified policy rather than individual claimants and includes claims that did not or are not expected to result in an incurred loss. The information about incurred and paid claims development for the years ended December 31, 2010 to 2018 is presented as unaudited required supplementary information.
Actuaries perform a ground-up reserve study of the expected value of the unpaid loss and LAE derived using multiple standard actuarial methodologies on a quarterly basis. Each method produces an estimate of ultimate loss by accident year. We review all of these various estimates and assign weights to each based on the characteristics of the product being reviewed. These estimates are then compared to the carried loss reserves to determine the appropriateness of the current reserve balance. In addition, an emergence analysis is completed quarterly to determine if further adjustments are necessary.
The following table summarizes our prior accident years’ loss reserve development by segment for 2019, 2018 and 2017:
2019. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2019. The casualty segment contributed $62.5 million in favorable development, inclusive of unallocated loss and adjustment expenses (ULAE), which is excluded from the incurred loss and loss adjustment expense tables above. Accident years 2017 and 2018 contributed the majority of the favorable development, with earlier years developing favorably in aggregate to a lesser extent. Risk selection by our underwriters continued to provide better results than estimated in our reserving process. Within the primary occurrence grouping, the general liability product contributed $11.8 million to our favorable development. Small commercial products were favorable by $6.3 million. Within the excess occurrence grouping, commercial excess was favorable by $6.8 million and our personal umbrella product developed favorably by $7.8 million. Within the claims made grouping, professional services coverages developed favorably by $10.2 million, which was offset by adverse development of $7.3 million on executive products and $2.3 million on medical professional liability coverages. Transportation experienced favorable development of $16.6 million, primarily on accident years 2016 through 2018.
Marine contributed $2.4 million of the $4.5 million total favorable property development, inclusive of ULAE. Accident years 2017 and 2018 contributed to the marine products’ favorable development. Homeowners contributed $1.1 million of favorable development with other commercial property insurance and assumed reinsurance products contributing the balance.
The surety segment experienced $5.9 million of favorable development, inclusive of ULAE. The majority of the favorable development came from the 2017 accident year, which served to offset the unfavorable development from accident years 2011 and 2016. Commercial surety contributed favorable development of $6.3 million. Miscellaneous surety experienced adverse development totaling $0.8 million.
2017. We experienced favorable emergence relative to prior years’ reserve estimates in all of our segments during 2017. The casualty segment contributed $17.5 million in favorable development, inclusive of ULAE. Accident years 2014, 2015 and
The surety segment experienced favorable development of $9.3 million, inclusive of ULAE. The majority of the favorable development was from accident year 2016. Commercial and contract surety products were the main contributors with favorable development of $5.0 million and $4.4 million, respectively. Miscellaneous surety had unfavorable development of $0.1 million.
The following table represents paid and unpaid environmental, asbestos and mass tort claims data (including incurred but not reported losses) as of December 31, 2019, 2018 and 2017:
Our effective tax rates were 17.7 percent, 5.0 percent and -24.2 percent for 2019, 2018 and 2017, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate was higher in 2019 primarily due to higher levels of pretax earnings, which caused the tax-favored adjustments to be smaller on a percentage basis in 2019 compared to 2018. The effective rate was significantly lower in 2017 as a result of the impact of tax reform.
Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP in 2019, 2018 and 2017 resulted in tax benefits of $1.1 million, $1.2 million and $2.9 million, respectively. These tax benefits reduced the effective tax rate for 2019, 2018 and 2017 by 0.5 percent, 1.8 percent and 3.4 percent, respectively.
Although we are not currently under audit by the IRS, tax years 2016 through 2019 remain open and are subject to examination.
During 2019, the ESOP purchased 60,768 shares of RLI Corp. stock on the open market at an average price of $69.99 ($4.3 million) relating to the contribution for plan year 2018. Shares held by the ESOP as of December 31, 2019, totaled
2,758,290 and are treated as outstanding in computing our earnings per share. During 2018, the ESOP purchased 98,717 shares of RLI Corp. stock on the open market at an average price of $62.80 ($6.2 million) relating to the contribution for plan year 2017. During 2017, the ESOP purchased 124,186 shares of RLI Corp. stock on the open market at an average price of $58.02 ($7.2 million) relating to the contribution for plan year 2016. The above-mentioned ESOP purchases relate only to our annual contributions to the plan and do not include amounts or shares resulting from the reinvestment of dividends.
We maintain rabbi trusts for deferred compensation plans for directors, key employees and executive officers through which our shares are purchased. The employer stock in the plan is classified and accounted for as equity, in a manner consistent with the accounting for treasury stock.
Our RLI Corp. Long-Term Incentive Plan (2010 LTIP) was in place from 2010 to 2015. The 2010 LTIP provided for equity-based compensation, including stock options, up to a maximum of 4,000,000 shares of common stock (subject to adjustment for changes in our capitalization and other events). Between 2010 and 2015, we granted 2,878,000 stock options under the 2010 LTIP. The 2010 LTIP was replaced in 2015.
In 2015, our shareholders approved the 2015 RLI Corp. Long-Term Incentive Plan (2015 LTIP), which provides for equity-based compensation and replaced the 2010 LTIP. In conjunction with the adoption of the 2015 LTIP, effective May 7, 2015, options were no longer granted under the 2010 LTIP. Awards under the 2015 LTIP may be in the form of restricted stock, restricted stock units, stock options (non-qualified only), stock appreciation rights, performance units as well as other stock-based awards. Eligibility under the 2015 LTIP is limited to employees and directors of the Company or any affiliate. The granting of awards under the 2015 LTIP is solely at the discretion of the board of directors. The maximum number of shares of common stock available for distribution under the 2015 LTIP is 4,000,000 shares (subject to adjustment for changes in our capitalization and other events). Since the plan’s approval in 2015, we have granted 2,282,460 awards under the 2015 LTIP, including 378,830 in 2019.
The following tables summarize option activity in 2019, 2018 and 2017:
The majority of our stock options are granted annually at our regular board meeting in May. In addition, options are approved at the May meeting for quarterly grants to certain retirement eligible employees. Since stock option grants to retirement eligible employees are fully expensed when granted, the approach allows for a more even expense distribution throughout the year.
In 2018, 432,000 options were granted with an average exercise price of $64.91 and an average fair value of $10.58. Of these grants, 330,750 were granted at the board meeting in May with a calculated fair value of $10.31. We recognized $4.5 million of expense during 2018 related to options vesting. Since options granted under our plan are non-qualified, we recorded a deferred tax benefit of $0.9 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $5.6 million, which will be recognized over the remainder of the vesting period.
benefit of $1.5 million related to this compensation expense. Total unrecognized compensation expense relating to outstanding and unvested options was $5.7 million, which will be recognized over the remainder of the vesting period.
As of December 31, 2019, 45,350 RSUs have been granted to employees under the 2015 LTIP, including 15,275 during 2019, and 43,681 remain outstanding. We recognized $0.9 million, $0.6 million and $0.4 million of expense on these units during 2019, 2018 and 2017, respectively. Total unrecognized compensation expense relating to outstanding and unvested employee RSUs was $0.9 million, which will be recognized over the remainder of the vesting period.
In 2019 and 2018, each outside director received RSUs with a fair value of $50,000 on the date of grant as part of annual director compensation. Director RSUs vest one year from the date of grant. As of December 31, 2019, 15,085 RSUs were granted to directors under the 2015 LTIP, including 6,655 in 2019, and 6,162 director RSUs remain outstanding. We recognized $0.6 million and $0.3 million of compensation expense on these units during 2019 and 2018, respectively. Total unrecognized compensation expense relating to outstanding and unvested director RSUs was $0.2 million, which will be recognized over the remainder of the vesting period.
Year-end statutory surplus for 2019 presented in the table below includes $190.9 million of RLI Corp. stock (cost basis of $64.6 million) held by Mt. Hawley Insurance Company, compared to $132.8 million and $106.9 million in 2018 and 2017, respectively. The Securities Valuation Office provides specific guidance for valuing this investment, which is eliminated in our GAAP consolidated financial statements.
The following table includes selected information for our insurance subsidiaries for the year ended and as of December 31:
Ordinary dividends, which may be paid by our principal insurance subsidiary without prior regulatory approval, are subject to certain limitations based upon statutory income, surplus and earned surplus. The maximum ordinary dividend distribution from our principal insurance subsidiary in a rolling 12-month period is limited by Illinois law to the greater of 10 percent of RLI Ins. policyholder surplus, as of December 31 of the preceding year, or the net income of RLI Ins. for the 12-month period ending December 31 of the preceding year. Ordinary dividends are further restricted by the requirement that they be paid from earned surplus. In 2019, 2018 and 2017, our principal insurance subsidiary paid ordinary dividends totaling $59.0 million, $13.0 million and $107.0 million, respectively, to RLI Corp. Any dividend distribution in excess of the ordinary dividend limits is deemed extraordinary and requires prior approval from the IDOI. In 2018, our principal insurance subsidiary sought and received regulatory approval prior to the payment of extraordinary dividends totaling $110.0 million. No extraordinary dividends were paid in 2019 or 2017. As of December 31, 2019, $65.3 million of the net assets of our principal insurance subsidiary are not restricted and could be distributed to RLI Corp. as ordinary dividends. Because the limitations are based upon a rolling 12-month period, the amount and impact of these restrictions vary over time. In addition to restrictions from our principal subsidiary’s insurance regulator, we also consider internal models and how capital adequacy is defined by our rating agencies in determining amounts available for distribution.
We are party to numerous claims, losses and litigation matters that arise in the normal course of our business. Many of such claims, losses or litigation matters involve claims under policies that we underwrite as an insurer. We believe that the resolution of these claims and losses will not have a material adverse effect on our financial condition, results of operations or cash flows. We are also involved in various other legal proceedings and litigation unrelated to our insurance business that arise in the ordinary course of business operations. Management believes that any liabilities that may arise as a result of these legal matters is not reasonably likely to have a material adverse effect on our financial condition, results of operations or cash flows.
We adopted ASU 2016-02, Leases on January 1, 2019, which resulted in the recognition of operating leases on the balance sheet in 2019 and forward. See note 1.C. for more information on the adoption of the ASU. Right-of-use assets are included in the other assets line item and lease liabilities are included in the other liabilities line item of the consolidated balance sheet. We determine if a contract contains a lease at inception and recognize operating lease right-of-use assets and operating lease liabilities based on the present value of the future minimum lease payments at the commencement date. Collateralized advance rates from an existing borrowing facility are obtained at the commencement date of each lease and serve as our incremental borrowing rate to determine the present value of future payments. Lease agreements may include options to extend or terminate. The options are exercised at our discretion and are included in operating lease liabilities if it is reasonably certain the option will be exercised. Lease agreements have lease and non-lease components, which are accounted for as a single lease component. Lease expense is recognized on a straight-line basis over the lease term.
The Company’s operating lease obligations are for branch office facilities. Our leases have remaining terms of one to 15 years. Expenses associated with leases totaled $6.9 million in 2018 and $6.8 million in 2017. The components of lease expense and other lease information as of and during the year ended December 31, 2019 are as follows:
Future minimum lease payments under non-cancellable leases as of December 31, 2019 and 2018 were as follows:
The segments of our insurance operations include casualty, property and surety. The casualty portion of our business consists largely of commercial excess, personal umbrella, general liability, transportation and executive products coverages, as well as package business and other specialty coverages, such as professional liability and workers’ compensation for office-based professionals. We also assume a limited amount of hard-to-place risks through a quota share reinsurance agreement. We provided medical and healthcare professional liability coverage in the excess and surplus market, but exited these businesses on
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
We identified the assessment of the Company’s estimate of unpaid losses and settlement expenses as a critical audit matter. Specialized actuarial skills and knowledge were required to assess the methodologies and assumptions used to estimate unpaid losses and settlement expenses. The assumptions used by the Company to estimate unpaid losses and settlement expenses included expected loss ratios, loss development patterns, qualitative factors, and the weighting of actuarial methodologies. These assumptions included a range of potential inputs and changes to these assumptions could affect the estimate of unpaid losses and settlement expenses recorded by the Company.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s process to estimate unpaid losses and settlement expenses, including methodologies and assumptions used to derive the actuarial central estimate and the Company’s best estimate of unpaid losses and settlement expenses. We also involved an actuarial professional with specialized skills and knowledge, who assisted in:
● Comparing the Company’s actuarial methodologies and assumptions used to generally accepted actuarial standards;
● Evaluating certain assumptions used by the Company, including expected loss ratios, loss development patterns, internal and external qualitative factors, and weighting of actuarial methodologies, by comparing to the Company’s trends and data and industry trends and data;
● Performing independent actuarial analyses of unpaid losses and settlement expenses for certain lines of business;