We offer property and casualty insurance products to individuals through our wholly-owned subsidiary, Kingstone Insurance Company (“KICO”). KICO’s insureds are located primarily in downstate New York, consisting of New York City, Long Island and Westchester County, although we are actively writing business in New Jersey, Rhode Island, Connecticut and Massachusetts. We are licensed in the States of New York, New Jersey, Rhode Island, Massachusetts, Pennsylvania, Connecticut, Maine, and New Hampshire. For the year ended December 31, 2019, 85.0% of KICO’s direct written premiums came from the New York policies.
We derive substantially all of our revenue from KICO, which includes revenues from earned premiums, ceding commissions from quota share reinsurance, net investment income generated from its portfolio, and net realized gains and losses on investment securities. All of KICO’s insurance policies are written for a one-year term. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the one-year life of the policy). A significant period of time can elapse from the receipt of insurance premiums to the payment of insurance claims. During this time, KICO invests the premiums, earns investment income and generates net realized and unrealized investment gains and losses on investments. Our holding company earns investment income from its cash holdings and may also generate net realized and unrealized investment gains and losses on future investments.
Net premiums earned: Net premiums earned is the earned portion of our written premiums, less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement. Insurance premiums are earned on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies have a term of one year. Accordingly, for a one-year policy written on July 1, 2019, we would earn half of the premiums in 2019 and the other half in 2020.
Loss and loss adjustment expenses incurred: Loss and LAE incurred represent our largest expense item, and for any given reporting period include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations, statistical analyses and actuarial procedures. We seek to establish all reserves at the most likely ultimate liability based on our historical claims experience. It is typical for certain claims to take several years to settle and we revise our estimates as we receive additional information on such claims. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor affecting our profitability.
Other operating expenses: Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc., and operating expenses of Cosi. These expenses include executive employment costs, legal and auditing fees, and other costs directly associated with being a public company. Cosi operating expenses primarily include commissions paid to brokers, employment costs, and consulting costs.
In May 2019, due to the poor performance of this line we placed a moratorium on new commercial lines and new commercial umbrella submissions while we further reviewed this business. In July 2019, due to the continuing poor performance of these lines, we made the decision to no longer underwrite commercial lines or commercial umbrella risks. In force policies for these lines are being non-renewed at the end of their current annual terms. For the twelve months ended December 31, 2019, these policies represent approximately 10.7% of net premiums earned and as of December 31, 2019, 42.8% of loss and LAE reserves net of reinsurance recoverables. See discussion below under “Additional Financial Information”.
Net loss ratio: The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.
During 2019, we initiated an alternative distribution program through Cosi (“Alternative Distribution”). The goal of this program is to enhance our personal lines distribution channel to include nationally recognized name-brand carriers along with nationwide call center and digital insurance agencies. While still in early stages of development, the impact of this initiative can be measured by the amount of new premiums written compared to total premiums written, which includes renewals from our independent agency network. The table below shows premiums written by distribution channel for our homeowners and dwelling fire components of personal lines.
(1) Effective July 1, 2018, we decreased the quota share ceding rate in our personal lines quota share treaty from 20% to 10%. Effective July 1, 2019, our personal lines 10% quota share treaty expired on a run-off basis. Effective December 15, 2019, we entered into a 25% quota share treaty.
(2) The years ended December 31, 2019 and 2018 includes catastrophe losses, which are defined as losses from an event for which a catastrophe bulletin and related serial number has been issued by the Property Claims Services (PCS) unit of the Insurance Services Office (ISO). PCS catastrophe bulletins are issued for events that cause more than $25 million in total insured losses and affect a significant number of policyholders and insurers.
Direct written premiums during the year ended December 31, 2019 (“Year Ended 2019”) were $171,214,000 compared to $146,716,000 during the year ended December 31, 2018 (“Year Ended 2018”). The increase of $24,498,000, or 16.7%, was primarily due to an increase in policies in-force during Year Ended 2019 as compared to Year Ended 2018. We wrote more new policies as a result of continued demand for our products in the markets that we serve. Policies in-force increased by 14.1% as of December 31, 2019 compared to December 31, 2018.
In Year Ended 2018, we started writing homeowners policies in Massachusetts. In the Year Ended 2019, we started writing homeowners policies in Connecticut. We refer to our New York business as our “Core” business and the business outside of New York as our “Expansion” business. Direct written premiums from our Expansion business were $25,647,000 in Year Ended 2019 compared to $9,080,000 in Year Ended 2018.
Through June 30, 2019, our quota share reinsurance treaties were on a July 1 through June 30 fiscal year basis. Effective December 15, 2019, we entered into a quota share reinsurance treaty for our personal lines business covering the period from December 15, 2019 through December 31, 2020 (“2019/2020 Treaty”). In addition to the 2019/2020 Treaty, our personal lines quota share reinsurance treaties in effect for Year Ended 2019 and Year Ended 2018 were covered under a treaty covering a two-year period from July 1, 2017 through June 30, 2019 (“2017/2019 Treaty”). The following table describes the quota share reinsurance ceding rates in effect for each treaty year during Year Ended 2019 and Year Ended 2018 under the 2019/2020 Treaty and the 2017/2019 Treaty, respectively. This table should be referred to in conjunction with the discussions for net written premiums, net premiums earned, ceding commission revenue and net loss and loss adjustment expenses that follow.
The 2017/2019 Treaty expired on a run-off basis effective July 1, 2019 (the “2019 Run-off”).
See “Reinsurance” below for changes to our personal lines quota share treaty effective December 15, 2019, and July 1, 2019, 2018 and 2017.
Net written premiums increased $5,785,000, or 4.8%, to $125,579,000 in Year Ended 2019 from $119,794,000 in Year Ended 2018. Net written premiums include direct and assumed premiums, less the amount of written premiums ceded under our reinsurance treaties (quota share, excess of loss, and catastrophe). Our personal lines business was subject to the 2017/2019 Treaty under the 2018/2019 Treaty Year through June 30, 2019. Following June 30, 2019, any earned premium and associated claims for policies still inforce will continue to be ceded under the 10% quota share rate until such policies expire (run-off) over the next year. The 2019 Run-off period is from July 1, 2019 through June 30, 2020 and there is no return of unearned premiums under this arrangement. The 2018 Cut-off on July 1, 2018 resulted in a $4,553,000 return of unearned premiums from our reinsurers that were previously ceded under the expiring personal lines quota share treaty.
The table below shows the effect of the changes in quota share treaties on net written premiums for Year Ended 2019 and Year Ended 2018, respectively:
Without the effect of changes in quota share treaties, net written premiums increased by $26,658,000, or 23.1%, in Year Ended 2019 compared to Year Ended 2018.
Our ceded catastrophe premiums are paid based on the total direct written premiums subject to the catastrophe reinsurance treaty.
Net premiums earned increased $24,209,000, or 23.4%, to $127,624,000 in Year Ended 2019 from $103,415,000 in Year Ended 2018. The increase was due to the increase in written premiums discussed above and our retaining more earned premiums effective: (1) July 1, 2019 as a result of the expiration and non-renewal of the 2017/2019 Treaty, and (2) July 1, 2018, as a result of the reduction in the quota share reinsurance rates. The 2019/2020 Treaty in effect as of December 15, 2019 had very little impact on net premiums earned due to the short amount of time it was in effect during Year Ended 2019.
Ceding commission revenue was $4,651,000 in Year Ended 2019 compared to $5,333,000 in Year Ended 2018. The decrease of $682,000, or 12.8%, was due to a decrease in provisional ceding commissions earned, partially offset by an increase in contingent ceding commissions earned. The reduction in provisional ceding commissions occurred due to the reduction in quota share reinsurance rates through December 15, 2019 (see below for discussion of provisional ceding commissions earned and contingent ceding commissions earned).
We receive a provisional ceding commission based on ceded written premiums. The $1,300,000 decrease in provisional ceding commissions earned is primarily due to: (1) the decrease in the quota share ceding rate effective July 1, 2018 to 10%, from the 20% rate in effect from July 1, 2017 through June 30, 2018, and (2) the elimination of the 10% quota share effective July 1, 2019. There was a reduction in ceded premiums in Year Ended 2019 available from which to earn ceding commissions compared to Year Ended 2018 due to the changes in quota share ceding rates. The decrease in provisional ceding commissions was partially offset by an increase in personal lines direct written premiums subject to the quota share. The 2019/2020 Treaty in effect as of December 15, 2019 had very little impact on provisional ceding commissions earned due to the short amount of time it was in effect during Year Ended 2019.
Cash and invested assets were $231,700,000 as of December 31, 2019, compared to $195,567,000 as of December 31, 2018. The $36,133,000 increase in cash and invested assets resulted primarily from increased operating cash flows for the Year Ended 2019.
Other income was $1,828,000 in Year Ended 2019 compared to $1,334,000 in Year Ended 2018. The increase of $494,000, or 37.0%, was primarily due to an increase in installment and other fees earned in our insurance underwriting business.
The following graph summarizes the changes in the components of net loss ratio for the periods indicated, along with the comparable components excluding commercial lines business:
The net loss ratio was 70.7% for Year Ended 2019, a 14.3 point increase compared to Year Ended 2018. The loss ratio for Year Ended 2019 is elevated primarily due to prior year loss development of $11.1 million, which has an 8.7 point effect on the loss ratio. This compares to 1.1 points of prior year loss development in Year Ended 2018, or an increase of 7.6 points from the impact of prior year loss development. Unfavorable claim resolution trends led to a complete review of open liability case reserves by new claims leadership in Year Ended 2019. The review determined that case reserve strengthening was required and resulted in adjustments to ultimate loss projections, primarily for commercial liability claims. Of the $11.1 million of prior year loss development for the year, $8.1 million was from commercial liability claims. The case reserve adjustments underscored the volatility of our commercial lines business, and contributed to our decision to stop writing these risks. The prior year loss development significantly increased the ultimate loss ratio projections for the commercial lines business in accident years 2014 and forward leading to the conclusion that these lines are not returning the required level of profitability to be viable going forward. Excluding commercial lines, prior year development for Year Ended 2019 had a 2.7 point impact on our loss ratio, compared to a 1.0 point impact from prior year loss development for Year Ended 2018. Most of the prior year loss development outside of commercial liability claims was related to liability claims in our New York Dwelling Fire product.
The impact of catastrophes was 6.0 points in Year Ended 2019, unchanged from the impact from catastrophes in Year Ended 2018. Although the impact from catastrophes was the same in each year, both years had a catastrophe impact significantly above the Company’s long-term average. The average catastrophe impact for the five years ending in 2018 has been 3.8 points. There were nine PCS catastrophe events affecting Kingstone in Year Ended 2019, but 56% of net losses or 3.4 points of the impact relates to the first winter freeze event in Mid-January.
The underlying loss ratio excluding the impact of catastrophes and prior year loss development was 56.0% for Year Ended 2019, an increase of 6.8 points from the 49.2% underlying loss ratio recorded for Year Ended 2018. The underlying loss ratio increased compared to Year Ended 2018 due to continued increases in average claim severity for non-weather water damage property claims as well as increased large fire claim activity. In addition, the underlying loss ratio for Year Ended 2019 is affected by increased loss ratio expectations for commercial lines as a result of increases in prior year loss ratio estimates for that business as noted above. Excluding commercial lines, the underlying loss ratio excluding the impact of catastrophes and prior year development for Year Ended 2019 was 53.1%, an increase of 5.1 points from the 48.0% underlying loss ratio recorded for Year Ended 2018. See table below under “Additional Financial Information” summarizing net loss ratios by line of business.
Commission expense was $30,193,000 in Year Ended 2019 or 18.9% of direct earned premiums. Commission expense was $25,342,000 in Year Ended 2018 or 19.0% of direct earned premiums. The increase of $4,851,000 is due to the increase in direct written premiums in Year Ended 2019 as compared to Year Ended 2018.
Our largest single component of other underwriting expenses is salaries and employment costs, with costs of $10,358,000 in Year Ended 2019 compared to $9,280,000 in Year Ended 2018. The increase of $1,078,000, or 11.6%, was less than the 16.7% increase in total direct written premiums. The increase in employment costs was due to hiring of additional staff to service our current level of business and anticipated growth in volume, as well as annual increases in salaries.
Our net underwriting expense ratio in Year Ended 2019 was 38.1% compared to 38.4% in Year Ended 2018. The following table shows the individual components of our net underwriting expense ratio for the periods indicated:
Depreciation and amortization was $2,546,000 in Year Ended 2019 compared to $1,787,000 in Year Ended 2018. The increase of $759,000, or 42.5%, in depreciation and amortization was primarily due to depreciation of our new systems platform for handling business being written in Expansion states. The increase was also impacted by newly purchased assets used to upgrade our systems infrastructure and improvements to the Kingston, New York home office building from which we operate.
Income tax benefit in Year Ended 2019 was $1,816,000, which resulted in an effective tax rate of 23.3%. Income tax benefit in Year Ended 2018 was $86,000, which resulted in an effective tax rate of (2.9)%. Loss before taxes was $7,783,000 in Year Ended 2019 compared to income before taxes of $3,007,000 in Year Ended 2018.
Net loss was $5,967,000 in Year Ended 2019 compared to net income of $3,093,000 in Year Ended 2018. The decrease in net income of $9,060,000, or 292.9%, was due to the circumstances described above, which caused the increase in our net loss ratio, decrease in ceding commission revenue, increases in other underwriting expenses, and depreciation and amortization, partially offset by the increase in our net premiums earned, net investment income and net gains on investments.
See discussions above with regard to “Net Loss and LAE”, as to catastrophe losses in the years ended December 31, 2019 and 2018.
Our insurance underwriting business reported on a standalone basis for the years ended December 31, 2019 and 2018 follows:
The key measures for our insurance underwriting business for the years ended December 31, 2019 and 2018 are as follows:
For the year ended December 31, 2018, the effect of catastrophe loss on our net underwriting expense ratio includes the direct effect of reduced contingent ceding commission revenue by $459,068 and does not include the indirect effects of a $124,817 decrease in other underwriting expenses.
The following table presents a breakdown of the amortized cost, aggregate estimated fair value and unrealized gains and losses by investment type as of December 31, 2019 and 2018:
The following table presents a breakdown of the cost, estimated fair value, and gross gains and losses of investments in equity securities as of December 31, 2019 and 2018:
A summary of the amortized cost and estimated fair value of our investments in held-to-maturity securities by contractual maturity as of December 31, 2019 and 2018 is shown below:
The table below details the average yield by type of fixed-maturity security as of December 31, 2019 and 2018:
The table below lists the weighted average maturity and effective duration in years on our fixed-maturity securities as of December 31, 2019 and 2018:
The table below summarizes the gross unrealized losses of our fixed-maturity securities available-for-sale and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2019 and 2018:
For the year ended December 31, 2019, the primary source of cash flow for our holding company was the dividends received from KICO, subject to statutory restrictions. For the year ended December 31, 2019, KICO paid dividends of $7,000,000 to us.
Net cash used in investing activities was $14,974,000 in Year Ended 2019 compared to $43,401,000 in Year Ended 2018. The $28,427,000 decrease in net cash used in investing activities was the result of a $38,463,000 decrease in acquisitions of invested assets and a $8,827,000 decrease in sales or maturities of invested assets.
Net cash used in financing activities was $3,632,000 in Year Ended 2019 compared to $6,137,000 used in Year Ended 2018. The $2,505,000 decrease in net cash used in financing activities was attributable to higher withholding taxes paid on net exercises of stock options, a purchase of $540,000 in treasury stock in Year Ended 2018 as compared to none in Year Ended 2019 and a decrease in dividends paid to shareholders.
The following table provides summary information with respect to each reinsurer that accounted for more than 10% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2019:
Through June 30, 2019, our quota share reinsurance treaties were on a July 1 through June 30 fiscal year basis. Effective December 15, 2019, we entered into a quota share reinsurance treaty for our personal lines business covering the period from December 15, 2019 through December 31, 2020 (“2019/2020 Treaty”).
Our quota share reinsurance treaties in effect during Years Ended 2019 and 2018 for our personal lines business, which primarily consists of homeowners’ policies, were covered under the 2019/2020 Treaty and under a treaty covering a two-year period from July 1, 2017 through June 30, 2019 (“2017/2019 Treaty”). The treaty in effect during Year Ended 2019 was covered under the July 1, 2018 through June 30, 2019 treaty year (“2018/2019 Treaty Year”) and since December 15, 2019, the 2019/2020 Treaty. The treaty in effect during Year Ended 2018 was covered under the July 1, 2017 through June 30, 2018 treaty year (“2017/2018 Treaty Year”) and the 2018/2019 Treaty Year that began on July 1, 2018.
In August 2018, we terminated our contract with one of the reinsurers that was a party to the 2017/2019 Treaty. This termination was retroactive to July 1, 2018 and had the effect of reducing the quota share ceding rate to 10% under the 2018/2019 Treaty Year from 20% under the 2017/2018 Treaty Year.
Catastrophe coverage is limited on an annual basis to two times the per occurrence amounts. Duration of 168 consecutive hours for a catastrophe occurrence from windstorm, hail, tornado, hurricane and cyclone.
Effective July 1, 2019, reinstatement premium protection for $292,500,000 of catastrophe coverage in excess of $7,500,000.