Net earnings and diluted earnings per share for the year ended December 31, 2015, were $51.5 million and $4.51, respectively, compared with $57.2 million and $4.95, respectively, for 2014. The decrease in diluted earnings per share for the year ended December 31, 2015, was primarily due to a decrease in underwriting income as the result of an increase in the accident year combined ratio from 96.4% at December 31, 2014, to 97.8% at December 31, 2015.
Refer to Results of Operations - Underwriting - Profitability for a more detailed discussion of our underwriting results.
Pre-tax net investment income for the year ended December 31, 2015, was $36.8 million compared with $35.6 million for 2014.
(Refer to Note 1- Significant Reporting and Accounting Policies of the Notes to Consolidated Financial Statements)
Incurred but not reported (IBNR) reserves are established for the quarter and year-end based on a quarterly reserve analysis by our actuarial staff. Various standard actuarial tests are applied to subsets of the business at a state, product and coverage basis. Included in the analyses are the following:
Factors that can significantly affect actual frequency include, among others, changes in weather, driving patterns or trends and class of driver. Changes in claims settlement and reserving practices can affect estimates of average frequency and severity. Auto repair and medical cost inflation, jury awards and changes in policy limit profiles can affect loss severity. Estimation of LAE reserves is subject to variation from factors such as the use of outside adjusters, frequency of lawsuits, claims staffing and experience levels.
We believe that our relatively low average policy limit and concentration on the nonstandard auto driver classification generally help stabilize fluctuations in frequency and severity. For example, approximately 88% of our policies include only the state-mandated minimum policy limits for bodily injury, which somewhat mitigates the challenge of estimating average severity. These low limits tend to reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout.
As noted above, the highest degree of uncertainty is associated with reserves in the first 12 to 18 months. The following table displays the accident year combined ratios developed through December 31, 2015, for the four most recent accident years along with the potential combined ratios based on the low and high outcomes of the loss and LAE tests utilized:
the extent to which fair value is less than cost basis;
For fixed maturity securities that are other-than-temporarily impaired, we assess our intent to sell and the likelihood that we will be required to sell the security before recovery of our amortized cost. If a fixed maturity security is considered other-than-temporarily impaired but we do not intend to and will not more than likely be required to sell the security before our recovery to amortized cost, the amount of the impairment is separated into a credit loss component and the amount due to all other factors. The excess of the amortized cost over the present value of the expected cash flows determines the credit loss component of an impairment charge on a fixed maturity security. The present value is determined using the best estimate of cash flows discounted at (i) the effective interest rate implicit at the date of acquisition for non-structured securities; or (ii) the book yield for structured securities. The techniques and assumptions for determining the best estimate of cash flows vary depending on the type of security. We recognize the credit loss component of an impairment charge in net earnings and the non-credit component in accumulated other comprehensive income. If we intend to sell or will, more likely than not, be required to sell a security, the entire amount of the impairment is treated as a credit loss.
We continually evaluate potential liabilities and reserves for litigation using the criteria established by the Loss Contingency topic of the FASB Accounting Standards Codification. Under this guidance, we may only record reserves for loss if the likelihood of occurrence is probable and the amount is reasonably estimable. We consider each legal action and record reserves for losses in accordance with this guidance. We believe the current assumptions and other considerations used to estimate potential liability for litigation are appropriate. Certain claims and legal actions have been brought against us for which, under the rules described above, no loss has been accrued. While it is not possible to know with certainty the ultimate outcome of these claims or lawsuits, we do not expect them to have a material effect on our financial condition or liquidity. Refer to Note 13 - Legal and Regulatory Proceedings of the Notes to Consolidated Financial Statements for a discussion of our material legal proceedings.
Funds to meet expenditures at the holding company come primarily from dividends and tax payments from the insurance subsidiaries as well as cash and investments held by the holding company. The ordinary dividend capacity and total payment activity, including extraordinary dividends, of our insurance companies for the two most recent years, as well as the dividend capacity for the upcoming year, are shown in the following table ($ in thousands):
At December 31, 2015, we had $275 million principal outstanding of 5.0% senior notes due September 2022 (the "5.0% Senior Notes"). The 5.0% Senior Notes accrue interest at 5.0%, payable semiannually each March and September. Refer to Note 4 - Long-Term Debt of the Notes to Consolidated Financial Statements for more information on our long-term debt.
In August 2014 we renewed our agreement for a $50 million three-year revolving credit facility (the “Credit Agreement”) that requires us to meet certain financial and other covenants. We are currently in compliance with all covenants under the Credit Agreement. At December 31, 2015, there were no borrowings outstanding under the Credit Agreement.
In February 2016 we increased our quarterly dividend to $0.52 per share from $0.43 per share. At this current amount, our 2016 annualized dividend payments will be approximately $23.2 million.
We base the payout pattern for reserves for losses and LAE upon historical payment patterns and they do not represent actual contractual obligations. The timing and amounts ultimately paid will vary from these estimates, as discussed above under Critical Accounting Policies and in Note 1 - Significant Reporting and Accounting Policies of the Notes to Consolidated Financial Statements.
Approximately 91.7% of our fixed maturity portfolio at December 31, 2015, was rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. The average credit rating of our fixed maturity portfolio was AA- at December 31, 2015. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate stable and predictable investment returns.
Because we carry all of these securities at fair value in the Consolidated Balance Sheets, there is virtually no effect on liquidity or financial condition upon the sale and ultimate realization of unrealized gains and losses. The average duration of our fixed maturity portfolio was 3.2 years at December 31, 2015.
Fair values of instruments are based on (i) quoted prices in active markets for identical assets (Level 1); (ii) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs are observable in active markets (Level 2); or (iii) valuations derived from valuation techniques in which one or more significant inputs are unobservable in the marketplace (Level 3).
The $4.5 million balance in receivable for securities sold at December 31, 2014, represents fixed income securities sold in the normal course of business that had not settled prior to the end of the year.
The $7.3 million and $17.2 million balances in payable for securities purchased at December 31, 2015, and December 31, 2014, respectively, represent fixed income securities and treasury stock purchased in the normal course of business that had not settled prior to the end of their respective years.
Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. Our exposures to market risk relate principally to our investment portfolio, which is exposed primarily to interest rate risk and credit risk and, to a lesser extent, equity price risk.
government securities, is $9.1 million or 0.7% of the fixed income investment portfolio. The top five investments in fixed income securities, excluding those issued by the U.S. government, make up 2.6% of the fixed income portfolio. All of the fixed maturities owned at December 31, 2015, were producing their stated rate of investment income.
We categorize securities by rating based upon available ratings issued by Moody's, Standard & Poor's or Fitch. If all three ratings are available but not equivalent, we exclude the lowest rating and the lower of the remaining ratings is used. If ratings are only available from two agencies, the lowest is used. This methodology is consistent with that used by the major bond indices. State and municipal bond ratings presented are underlying ratings without regard to any insurance.
The following table presents the credit rating and fair value of our fixed maturity portfolio by major security type at December 31, 2015, ($ in thousands):
We implemented rate revisions in various states with an overall rate increase of 9.8% during 2015. Gross written premium grew despite the decline in policies in force primarily due to an increase in average premiums per policy.
The growth in the Focus States was partially offset by declining gross written premium in the Other States as we discontinued writing new business in Georgia, Nevada, and Pennsylvania effective January 1, 2015.
During 2014 personal auto insurance gross written premium in our Focus States grew 3.8% compared with 2013. The increase in gross written premium was primarily due to growth in California and Florida, which grew a combined 3.8% during 2014 as a result of higher average premium in both states, renewal business growth in California and new business growth in Florida.
Gross written premium in our Classic Collector product grew 8.6% during 2014. This growth was primarily due to growth in renewal business.
While we report financial results in accordance with GAAP for shareholder and other users’ purposes, we report it on a statutory basis for insurance regulatory purposes. We evaluate underwriting profitability based on a combined ratio calculated using statutory accounting principles. The statutory combined ratio represents the sum of the following ratios: (i) losses and LAE incurred as a percentage of net earned premium; and (ii) underwriting expenses incurred, net of fees, as a percentage of net written premium. Certain expenses are treated differently under statutory and GAAP accounting principles. Under GAAP, commissions, premium taxes and other variable costs incurred in connection with successfully writing new and renewal business are capitalized as deferred policy acquisition costs and amortized on a pro rata basis over the period in which the related premium is earned. On a statutory basis, these items are expensed as incurred. Additionally, bad debt charge-offs on agent balances and premium receivables are included only in the GAAP combined ratios.
The GAAP combined ratio for the twelve months ended December 31, 2015, increased by 0.5 point compared with 2014. Excluding the effect of development from both periods, the GAAP combined ratio increased by 1.3 points for the twelve months ended December 31, 2015, compared with 2014.
The statutory combined ratio for the twelve months ended December 31, 2014, decreased by 2.4 points from the same period of 2013. The twelve months ended December 31, 2014, included $17.4 million of favorable development on prior year loss and LAE reserves compared with $2.9 million of unfavorable development on prior year loss and LAE reserves in 2013. Excluding the effect of development from both periods, the statutory combined ratio decreased by 0.9 points for the twelve months ended December 31, 2014, compared with 2013.
The GAAP combined ratio for the twelve months ended December 31, 2014, decreased by 2.9 points compared with 2013. Excluding the effect of development from both periods, the GAAP combined ratio decreased by 1.3 points for the twelve months ended December 31, 2014, compared with 2013.
The 1.2 points decline in the Focus States combined ratio for the twelve months ended December 31, 2014, was primarily due to improvement in the California calendar year loss ratio as a result of favorable development from prior accident year loss and LAE reserves as well as an increase in average earned premium.
Installment and other fees charged to policyholders were relatively unchanged in 2015 and declined 3.2% during 2014 primarily due to a reduction in late fees charged.
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. In 2014, net investment income and annualized returns declined when compared with the prior year primarily due to a decline in book yields as operating cash flows have been invested at lower new money rates.
Consolidated Statements of Earnings: Years ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income: Years ended December 31, 2015, 2014 and 2013
Consolidated Statements of Changes in Shareholders’ Equity: Years ended December 31, 2015, 2014 and 2013