The following tables set forth selected consolidated historical financial information of Conifer Holdings, Inc. and Subsidiaries as of the dates and for the periods indicated. The selected financial data for the years ended December 31, 2015, 2014, 2013 and 2012 were derived from our audited consolidated financial statements and related notes thereto.
All common stock shares and per share amounts for all periods presented have been adjusted retroactively to reflect the 10.2-to-1 stock split, effected in the form of a stock dividend, which was effectuated immediately prior to the effectiveness of the initial public offering in August 2015.
In March 2015, the Company reclassified the then carrying amount of its preferred stock of $6,180 from temporary equity to permanent equity as the redemption of the preferred stock became within the Company’s control as a result of the amendments to the preferred stock designations.
The following Management’s Discussion and Analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K file with the U. S. Securities and Exchange Commission (“SEC”).
The forward-looking statements contained in this report are based on management’s good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks and uncertainties, many of which are beyond our control, which could cause our actual results to differ materially from those in the forward-looking statements, including those described above in Item 1A Risk Factors and subsequent reports filed with or furnished to the SEC. Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified herein. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable laws or regulations.
Through our commercial insurance lines, we offer coverage for both commercial property and commercial liability. Within these two main lines we offer coverage for property, commercial multi-peril as part of commercial property and general liability and liquor liability as a part of our commercial liability. We also offer coverage for commercial automobiles and workers’ compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis.
Through our personal insurance lines, we offer nonstandard homeowners insurance and dwelling fire insurance products to individuals in four states. Our Midwest homeowners insurance line is comprised of dwelling insurance tailored for owners of lower valued homes, which we have historically offered in Illinois and Indiana. We are now expanding into other regions of the U.S., including Louisiana and Texas (where we have an office in Waco), and have renamed our Midwest homeowners line to “low-value dwelling.” Our specialty homeowners products include wind-exposed homeowners coverage, including hurricane and wind coverage to underserved homeowners in Florida, Hawaii, and Texas. We have renamed our specialty homeowners line to “wind-exposed homeowners.” There has been no change in our approach to managing or evaluating these lines.
Our recorded loss and loss adjustment expenses ("LAE") reserves represent management’s best estimate of unpaid loss and LAE at each balance sheet date, based on information, facts and circumstances known at such time. Our loss and LAE reserves reflect our estimates at the balance sheet date of the following items:
• Case reserves, which are unpaid loss and LAE amounts we expect to pay for losses that have been reported; and
• Incurred but not reported ("IBNR") reserves, which are (1) unpaid loss and LAE amounts we expect to pay for losses that have been incurred but not yet reported; and (2) the expected development of losses and LAE on open reported cases.
Case reserves for reported losses and LAE are initially set by our claims personnel. When a claim is reported to us, our claims department completes a case-basis valuation and establishes a case reserve for the estimated amount of the ultimate payment as soon as practicable and after it has sufficient information to form a judgment about the probable ultimate losses and LAE associated with that claim, with a goal of setting the case reserve at the ultimate expected loss and LAE amount. Our claims department updates their case-basis valuations upon receipt of additional information. The case reserve is based primarily upon an evaluation of the following factors:
LAE on a quarterly basis. Our Reserve Review Committee (which includes our Chief Executive Officer, President, Chief Financial Officer, other members of executive management, and key actuarial, underwriting and claims personnel) meets each quarter to review our actuaries’ estimated ultimate expected loss and LAE.
We use several generally accepted actuarial methods to develop estimated ultimate loss and LAE estimates by line of business and accident year. This process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is a reasonable basis for predicting future outcomes. These methods utilize various inputs, including but not limited to:
• Loss development methods-Loss development methods assume that the losses and LAE yet to emerge for an accident year are proportional to the paid or reported loss and LAE amounts observed to-date. The paid loss development method uses losses and LAE paid to date, while the reported loss development method uses losses and LAE reported to date;
Our actuaries estimate an IBNR reserve for our unallocated LAE not specifically identified to a particular claim, namely our internal claims department salaries and associated general overhead and administrative expenses associated with the adjustment and processing of claims. These estimates, which are referred to as unallocated loss adjustment expenses ("ULAE") reserves, are based on internal cost studies and analyses reflecting the relationship of ULAE paid to actual paid and incurred losses. We select factors that are applied to case reserves and IBNR reserve estimates in order to estimate the amount of ULAE reserves applicable to estimated loss reserves at the balance sheet date.
• Actuarial projections of what we, at a given time, expect to be the cost of the ultimate settlement and administration of claims reflecting facts and circumstances then known;
The following table displays ultimate net loss and LAE and net loss and LAE reserves by accident year for the year ended December 31, 2015. We applied the sensitivity factors to each accident year amount and have calculated the amount of potential net loss and LAE reserve change and the impact on 2015 reported pretax income and on net income and shareholders’ equity at December 31, 2015. We believe it is not appropriate to sum the illustrated amounts as it is not reasonably likely that each accident year’s reserve estimate assumptions will vary simultaneously in the same direction to the full extent of the sensitivity factor. We also believe that such changes to our reserve balance would not have a material impact on our operating results, financial position, or liquidity. The dollar amounts in the table are in thousands.
Fair values are measured in accordance with ASC 820, Fair Value Measurements. The guidance establishes a framework for measuring fair value and a three-level hierarchy based upon the quality of inputs used to measure fair value. The three levels of the fair value hierarchy are: (1) Level 1: inputs are based on quoted prices (unadjusted) in active markets for identical assets or liabilities, (2) Level 2: inputs are other than quoted prices that are observable for the asset or liabilities, either directly or indirectly, for substantially the full term of the asset or liability and (3) Level 3: unobservable inputs that are supported by little or no market activity. The unobservable inputs represent the Company’s best assumption of how market participants would price the assets or liabilities.
The fair values of fixed maturity securities and equity securities have been determined using fair value prices provided by our investment managers, who utilize internationally recognized independent pricing services. The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities).
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in the United States and numerous state jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.
As of December 31, 2015, we have federal and state income tax net operating loss (“NOL”) carryforwards of $17.4 million and $7.8 million, respectively, which will expire at various dates from 2019 through 2035. Of the federal NOL amount, $15.2 million are subject to limitations under Section 382 of the Internal Revenue Code. These net NOL carryforwards are limited in the amount that can be utilized in any one year and may expire before they are realized. At this time we do not expect that any of the remaining NOL carryforwards will expire before utilized.
The carrying value of our gross deferred tax asset for the NOL carryforwards is equal to the total NOL carryforward amount times the current tax rate of 34%, and was $6.1 million and $7.1 million as of December 31, 2015 and 2014, respectively. Total gross deferred tax assets were $9.8 million and $9.8 million as of December 31, 2015 and 2014. A valuation allowance of $5.2 million and $6.9 million has been recorded against the gross deferred tax assets as of December 31, 2015 and 2014, respectively, as the Company has recognized a three year cumulative loss as of December 31, 2015 which is significant negative evidence to support the lack of recoverability of those deferred tax assets in accordance with ASC 740, Income Taxes.
Operating income and operating income per share are non-GAAP measures that represent net income allocable to common shareholders excluding net realized investment and other gains, net of tax. The most directly comparable financial GAAP measures to operating income and operating income per share are net income and net income per share, respectively. Operating income and operating income per share are intended as supplemental information and are not meant to replace net income or net income per share. Operating income and operating income per share should be read in conjunction with the GAAP financial results. Our definition of operating income may be different from that used by other companies. The following is a reconciliation of net income to operating income (dollars in thousands), as well as net income per share to operating income per share:
We use operating income and operating income per share, in conjunction with other financial measures, to assess our performance and to evaluate the results of our business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized investment gains and losses as a result of our market risk sensitive instruments, which primarily relate to fixed income securities that are available for sale and not held for trading purposes. Realized investment gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying loss or profitability of our business. We believe that it is useful for investors to evaluate operating income and operating income per share, along with net income and net income per share, when reviewing and evaluating our performance.
The improved results were largely attributable to an 11.8 percentage point reduction in the loss ratio in 2015, compared to 2014 as the mix of business continues to align with our longer term goals. Our expense ratio remained flat as we expanded our underwriting operations with the addition of three experienced underwriting teams in 2015. These additions adversely effected the expense ratio as the new underwriting teams have yet to fully establish an earned premium base. The run-off personal automobile line of business also adversely impacted the expense ratio as it incurred underwriting and administrative expenses with minimal earned premium in 2015.
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings or policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the year December 31, 2015 decreased $142,000, or 7.8%, to $1.7 million as compared to $1.8 million for the year ended December 31, 2014.
The tables below detail our losses and LAE and loss ratios for the years ended December 31, 2015 and 2014 (dollars in thousands).
Overall reserve development on prior accident years for the year ended December 31, 2015 was unfavorable by $1.5 million, or 2.1 percentage points of the loss ratio. For the year ended December 31, 2015, there was $1.2 million and $835,000 of unfavorable reserve development in the personal automobile and commercial automobile lines, respectively. This unfavorable development was partially offset by $320,000, $189,000, and $101,000 of favorable reserve development in the workers' compensation line, the low-value dwelling lines and the other liability line, respectively.
Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other income was 21.6% and 20.4% for the years ended December 31, 2015 and 2014, respectively. The 1.2 percentage point increase was due to the expansion of our underwriting operations, more specifically, the addition of our security guard team in late 2014 that began contributing premium at the beginning of 2015; the low-value dwelling team, located in the southwest United States, which was formed in early 2015 and began writing business in May 2015; and the hospitality team that joined the Company in the fourth quarter of 2015 and did not start binding policies until January 2016. For the year, expenses also increased as we added corporate staff to support the new underwriting teams and manage responsibilities associated with our recent status as a public company. The increase in the operating expenses as a percentage of net earned premiums and other income was also due to underwriting and
Net investment income increased by $727,000, or 61.9%, to $1.9 million for the year ended December 31, 2015, as compared to $1.2 million for the year ended December 31, 2014. This increase was the result of growth of the investment portfolio and a change in the mix of investments. Average invested assets as of December 31, 2015 were $111.5 million as compared to $81.2 million at December 31, 2014, an increase of $30.3 million, or 37.3%. As of December 31, 2015, the average invested asset balance was comprised of 85.8% fixed maturities, 3.8% equity securities and 10.4% short-term investments, compared to the December 31, 2014 mix of 79.2% fixed maturities, 4.8% equity securities and 16.0% short term investments.
Interest expense was $769,000 and $584,000 for the years ended December 31, 2015 and 2014, respectively. Interest expense increased primarily due to the additional outstanding borrowings under the Revolver and 2014 Term Note. The outstanding borrowings under the Revolver were repaid from the proceeds received from the Company’s IPO, in August 2015.
For the year ended December 31, 2015, the Company had $0 of federal income tax expense due to a valuation allowance that offset any use of prior period net operating loss carryforwards and $48,000 of state income tax expense. The income tax benefit of $281,000 for the year ended December 31, 2014 relates to the impact of changes to net unrealized gains during the
year. This tax effect was included in the change in other comprehensive income and the corresponding change to the valuation allowance was reflected in the consolidated statement of operations as a deferred tax benefit.
The gross written premiums in our personal lines increased by $12.0 million or, 71.7%, to $28.8 million for the year ended December 31, 2014, as compared to $16.8 million for the same period in 2013. This increase was primarily due to a $5.5 million assumption of premium for the Florida homeowners business from Citizens, the acquisition of ACIC, and a $2.8 million increase in our existing Texas homeowners business.
In December 2014, we began writing Florida homeowners business by assuming $5.5 million of premium from Citizens as part of its depopulation program. Citizens provides homeowners insurance to Florida residences that cannot find coverage in the voluntary market. Insurance companies, such as ours, can enter into a policy assumption agreement with Citizens to reduce the number of policies Citizens has acquired. We are able to select from the existing Citizens book of business based on various underwriting criteria that we find acceptable. Upon assuming this premium we become the primary insurer to the policyholders as if we were the original insurer. We are only responsible for claims occurring on or after the assumption date.
Net written premiums increased $28.7 million, or 76.1%, to $66.3 million for the year ended December 31, 2014, compared to $37.6 million for the same period in 2013. Net written premium grew less than gross written premium as a result
The Company’s losses and LAE increased from $15.8 million for the year ended December 31, 2013 to $40.7 million for the year ended December 31, 2014. This $24.9 million increase is largely a consequence of our increased level of business activity in 2014 as compared to 2013, as reflected by the growth in our net earned premiums of 108.2% from 2013 to 2014. Holding all other factors constant and assuming losses proportionate to the net earned premium growth experienced, an increase of $17.1 million in losses would have been expected for the year ended December 31, 2014. Included in the increased losses from this growth was twelve months of ACIC activity in 2014, compared to only one month of activity from ACIC in 2013, as it was acquired on November 30, 2013. The effect of twelve months of ACIC contributed $7.9 million to the increase in losses in 2014.
The increase in losses and LAE resulted in an increase in our calendar year loss ratio from 55.6% for the year ended December 31, 2013 to 68.6% for the year ended December 31, 2014. The ACIC personal automobile business contributed four percentage points to the increased loss ratio in 2014. This business is now in run-off. The greater-than-normal weather-related losses also contributed to the increased calendar loss ratio. The non-standard personal automobile and low-value dwelling lines together contributed 14.4 percentage points to the consolidated calendar year loss ratio for 2014.
In 2014 and 2013, commercial lines reported favorable development mostly from our commercial liability products. The 2013 redundancy included $4.8 million of favorable development from the 2008-2012 accident years, and the 2014 redundancy included $0.6 million of favorable development relating to the 2008-2012 accident years. The favorable reserve development was primarily due to better-than-expected settlement valuations within the commercial liability lines.
The percentage of policy acquisition costs to net earned premiums and other income was 24.8% and 26.9% for 2014 and 2013, respectively. The reduction in the ratio was mostly due to the personal automobile product line. The Illinois automobile business went into run-off in early 2014 as we no longer write policies for this line. The premium volume from the Illinois business was replaced with the Florida automobile business acquired in late 2013. The Florida automobile business had a significantly lower commission rate than the Illinois automobile business.
Net investment income increased by $175,000 for the year ended December 31, 2014 as compared to 2013, primarily from the growth of the investment portfolio. Average invested assets for 2014 was $81.2 million compared to $53.9 million for 2013, an increase of $27.3 million, or 50.6%. The increase in the portfolio was primarily due to the Company raising additional capital of $28.5 million from common stock and $6.1 million from preferred stock issuances. The Company also increased borrowings on senior debt by $14.5 million.
Interest expense was $584,000 and $541,000 for the years ended December 31, 2014 and 2013, respectively. In September 2014, the Company entered into an amendment to its credit agreement to provide for the 2014 Term Note and increased the commitment under the Revolver from $10.0 million to $17.5 million. Interest expense increased due to the additional term loan and increased borrowings under the Revolver of approximately $8 million in the fourth quarter of 2014. The proceeds from the
additional borrowings were contributed to our Insurance Company Subsidiaries to allow for further growth and fund current operations.
We conduct our business operations primarily through our Insurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the holding company. Secondarily, the holding company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the holding company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the holding company under certain circumstances. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10% of statutory surplus at the end of the preceding year. There were $3.1 million, $500,000 and $1.0 million of dividends paid from our Insurance Company Subsidiaries to the holding company during the years ended December 31, 2015, 2014 and 2013, respectively.
Operating Activities. Cash used in operating activities for the year ended December 31, 2015, was $3.1 million as compared to cash provided by operating activities of $6.3 million for the year ended December 31, 2014. $7.3 million of the change in cash from operating activities in 2015 from 2014 was primarily attributable to the change in the ceded unearned premium related to the quota share arrangement which was adopted December 31, 2014 and dissolved on August 1, 2015.
Net cash provided by investing activities for the year ended December 31, 2013 was $3.7 million and was partially attributable to receiving $8.8 million from acquisitions, net of cash paid. The increase in cash received was partially offset by net investments into fixed maturity securities of $5.5 million
During the year ended December 31, 2014, the $48.6 million of cash provided by financing activities was primarily attributable to $28.5 million of cash raised through the issuance of common stock, $6.1 million from the issuance of preferred stock and $14.5 million of additional net senior debt borrowings.
Net cash provided by financing activities for the year ended December 31, 2013 was $1.2 million which was primarily attributable to additional net senior debt borrowings.
We are party to a $30.0 million senior credit facility with Comerica Bank which currently consists of the 2014 Term Note of $7.5 million, the Term Note of $5.0 million and the Revolver with an available $17.5 million which expires on August 1, 2016. Management intends to renew the Revolver prior to the expiration date. Our total outstanding senior debt at December 31, 2015, was $12.8 million. Our minimum principal and interest payments on our senior debt for future years is $8.6 million for 2016-2017 and $4.9 million for 2018-2019.
The following table is a summary of our contractual obligations and commitments as of December 31, 2015 (dollars in thousands):
(1) The estimated unpaid loss and loss adjustment expense payments were made using estimates based on historical payment patterns, however, future payments may be different than historical payment patterns.
Insurance operations are subject to various leverage tests (e.g., premium-to-statutory surplus ratios), which are evaluated by regulators and rating agencies. As of December 31, 2015, on a trailing twelve-month statutory combined basis, the gross and net premium leverage ratios were 1.4 to 1.0 and 1.1 to 1.0, respectively.
collectively, are useful tools for identifying companies that may be experiencing financial difficulty, they are only a guide for regulators and should not be considered an absolute indicator of a Company's financial condition. While inquiries from regulators are not uncommon, our Insurance Company Subsidiaries have not experienced any regulatory actions due to their IRIS ratio results or otherwise.
Refer to list of Financial Statement Schedules (including the Report of Independent Registered Public Accounting Firm referenced therein) set forth in Item 15 of this Annual Report on Form 10-K and Note 19 ~ Quarterly Financial Data (Unaudited)of the Notes to the Consolidated Financial Statements.