Management’s discussion and analysis of financial condition and results of operations (“MD&A”) provides supplemental information, which sets forth management’s views of the major factors that have affected our financial condition and results of operations that should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. The MD&A is divided into subsections entitled “Business Overview,” “Critical Accounting Policies,” “Results of Operations,” “Fair Value of Investments,” “Liquidity and Capital Resources” and “Losses and Loss Adjustment Expenses.”
Our insurance segment had revenues of $4,047,310 for the year ended December 31, 2016 and $3,095,798 for the year ended December 31, 2015. Operating and management expenses were $4,039,285 for the year ended December 31, 2016 and $3,571,540 for the year ended December 31, 2015. This resulted in segment income of $8,025 and a segment loss of $475,742 for the years ended December 31, 2016 and 2015, respectively.
Our results of operations for the years ended December 31, 2016 and December 31, 2015 are discussed below.
Expenses,” the amount that we have reserved is based on actuarial estimates which were prepared as of December 31, 2016. Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a “low,” “central” and “high” estimate of the loss and loss adjustment expenses. As of December 31, 2016, the range of actuarially determined liability for loss and loss adjustment expense reserves was as follows: the low estimate was $7.1 million, the high estimate was 9.7 million, and the central estimate was $8.3 million. We selected reserves of $8,941,991 as of December 31, 2016, which is marginally greater than the central estimate of our independent actuary. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management’s policy has been to reserve marginally greater than the actuarial central estimate.
We recorded net income of $1,471,323 in 2016 compared to a net loss of $1,396,484 in 2015. The increase in net income was mainly attributable to the increase in commission income from $3,093,980 in 2015 to $4,044,726 in 2016 as a result of a higher volume of premiums written under the Agency Agreement and to the increase in realized gains on investments net of impairment from $195,796 for the year ended December 31, 2015 to $2,555,767 for the year ended December 31, 2016 as a result of increased sales of equity securities in an unrealized gain position during 2016 compared to 2015. This was partially offset by the increase in operating and management expenses from $4,765,725 in 2015 to $5,211,450 in 2016, as discussed in further detail below.
Our net premiums earned were $7,124,066 for the year ended December 31, 2016 compared to $5,423,599 for the year ended December 31, 2015, an increase of $1,700,467 or 31.4%. The net premiums earned during 2016 and 2015 were attributable to net premium cessions from C&F under the Reinsurance Agreement. The increase in net premiums earned under the Reinsurance Agreement resulted from increased cessions from C&F in 2016, arising from a higher volume of underwriting activity under the Agency Agreement. The continued marketing of the program by APSL resulted in increased penetration in targeted markets.
We recorded net investment income of $277,537 for the year ended December 31, 2016 compared to $256,270 for the year ended December 31, 2015, an increase of $21,267 or 8.3%. The increase in net investment income was due to (i) the increase in dividend income, which was attributable to higher yielding equity securities held in the Company’s investment portfolio during 2016 compared 2015 and (ii) the increase in interest income, which is attributable to the increase in the investment portfolio due to the purchase of fixed income securities during 2016. Annualized investment yield, calculated as total interest and dividends divided by the net average amount of total investments and cash and cash equivalents, was 1.0% in 2016 and 2015.
Unrealized gain on investments was $4,337,510 at December 31, 2015 compared to $3,799,408 at December 31, 2016. We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at fair value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The decrease in unrealized gain on investments was due primarily to the sales of equity securities in an unrealized gain position during 2016. Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the fair value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
The composition of the investment portfolio at December 31, 2016 and 2015 is as follows:
We will continue to monitor our reserve for losses and loss expenses for any new claims information and adjust our reserve for losses and loss adjustment expenses accordingly.
The following tables show the fair value of the Company’s investments in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures” as of December 31, 2016 and 2015.
The Company had no planned sales of its fixed maturity investments classified as available-for-sale that were in an unrealized loss position at December 31, 2016. In assessing whether it is more likely than not that the Company will be required to sell a fixed maturity investment before its anticipated recovery, the Company considers various factors including its future cash flow requirements, legal and regulatory requirements, the level of its cash, cash equivalents, short term investments and fixed maturity investments available for sale in an unrealized gain position, and other relevant factors. For the year ended December 31, 2016, the Company did not recognize any other-than-temporary impairments due to sales.
If we conclude a security is other-than-temporarily impaired, we write down the amortized cost of the security to fair value, with a charge to net realized investment gains (losses) in the Consolidated Statement of Operations. Gross unrealized losses on the investment portfolio as of December 31, 2016 and December 31, 2015, relating to 16 and 11 fixed maturity securities, amounted to $89,937 and $18,853, respectively, and 11 and 15 equity securities, amounted to $128,395 and $87,838, respectively. The Company has the intent and ability to hold these securities either to maturity or until the fair value recovers above the adjusted cost. The unrealized losses on these available for sale fixed maturity securities were not as a result of credit, collateral or structural issues. As a result of the decline in fair value below cost, the Company recorded a total other-than-temporary impairment charge of $219,417 and $783,005 on nine and nine equity securities during the years ended December 31, 2016 and 2015, respectively.
In May 2016, the manager of our hedge fund portfolio chose to liquidate the fund and return its capital to the investors. The liquidation of the fund and the return of capital to its investors is expected to take place over a 15 month period.
As stated above, in May 2016, the manager of our hedge fund portfolio chose to liquidate the fund and return its capital to the investors. The liquidation of the fund and the return of capital to its investors is expected to take place over a 15-month period.
Though current market conditions appear to have improved, there is still the potential for further instability. This could present additional risks and uncertainties for our business and make it more difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions and estimates that may have significant period-to-period changes that could have a material adverse effect on our results of operations or financial condition.
Total cash, investments and other invested assets increased from $27,056,148 at December 31, 2015 to $31,673,066 at December 31, 2016, an increase of $4,616,918 or 17.1%. The net increase resulted primarily from positive cash inflows in relation to net investment income and net premiums received under the Reinsurance Agreement in the amount of $3,439,465. These increases were partially offset by net cash outflows to fund our operations and dividends of $305,759 paid during the year.
The assumed reinsurance balances receivable represents the current assumed premiums receivable less commissions payable to the fronting carriers. As of December 31, 2016, the balance was $1,285,126 compared to $1,031,992 as of December 31, 2015. The increase resulted from a higher level of premiums assumed under the Reinsurance Agreement during 2016.
Deferred policy acquisition costs, which represent the deferral of ceding commission expense related to premiums not yet earned, increased from $1,066,789 at December 31, 2015 to $1,384,915 at December 31, 2016. The increase in deferred policy acquisition costs in 2016 was due to the increase in both net premiums written and unearned premiums assumed under the Reinsurance Agreement compared to the prior year. The ceding commission rate under the Reinsurance Agreement is 37%.
Total dividends paid were $305,759 and $316,207 in 2016 and 2015, respectively, net of the recorded write backs. Continuation of dividend payments is subject to the Board of Directors’ continuing evaluation of our level of surplus compared to our capacity to accept more business. One of our objectives is to retain sufficient surplus to enable the successful implementation of our business plan.
becomes known, the liability is adjusted as appropriate, and reflected in current financial reports. The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and LAE. Future average severity is projected based on historical trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. These anticipated trends are monitored based on actual developments and are modified as necessary.
An actuarial review and projection was performed for us by our independent actuary as of December 31, 2016. We review the actuarial estimates throughout the year for the possible impact on our financial position. Loss reserves relate only to accountants’ and attorneys’ professional liability from CAMICO and Crum & Forster (“C&F”) programs, and were calculated under the methodologies described below. During 2016, losses emerged at levels consistent with expectations in total for both CAMICO and C&F business.
CAMICO was a new program for the Company in 2005. The program provided professional liability coverage to accountants. To calculate the policy year ultimate losses and allocated loss adjustment expenses for CAMICO the actuary applied paid and incurred loss development, paid and incurred Bornhuetter-Ferguson, and paid and incurred Cape Cod methods to the actual CAMICO experience as of December 31, 2016. In the calculations, the actuary used CAMICO and industry benchmark paid and incurred loss and allocated loss adjustment expense development information. The a priori loss and allocated loss adjustment expense ratios used in the Bornhuetter-Ferguson method calculations were selected based on the Company’s unpaid claim liability review of CAMICO experience as of December 31, 2015. Low and high scenario ultimate loss and allocated loss adjustment expense estimates were selected by the actuary based on sensitivity testing of results of the CAMICO actuarial analysis to reasonable alternative assumptions.
We have audited the accompanying consolidated balance sheets of AmerInst Insurance Group, Ltd. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
On September 25, 2009, AmerInst Professional Services, Limited, an indirect wholly-owned subsidiary (“APSL”), entered into an agency agreement (the “Agency Agreement”) with The North River Insurance Company, United States Fire Insurance Company, Crum & Forster Indemnity Company, Crum and Forster Insurance Company, and Crum & Forster Specialty Insurance Company (collectively, “C&F”) pursuant to which C&F appointed APSL as its exclusive agent for the purposes of soliciting, underwriting, quoting, binding, issuing, cancelling, non-renewing and endorsing accountants’ professional liability and lawyers’ professional liability insurance coverage in all 50 states of the United States and the District of Columbia. The initial term of the Agency Agreement was for four years with automatic one-year renewals thereafter. The Agency Agreement automatically renewed on September 25, 2016.
Premiums assumed are earned on a pro rata basis over the terms of the underlying policies to which they relate. Premiums assumed relating to the unexpired portion of policies in force at the balance sheet date are recorded as unearned premiums.
AmerInst classifies all of its investments as available-for-sale. Accordingly, AmerInst reports these securities at their estimated fair values with unrealized holding gains and losses being reported as other comprehensive income (loss). Realized gains and losses on sales of investments are accounted for by specifically identifying the cost and are reflected in the income statement in the period of sale.
Declines in the fair value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which
improvements to disclosure requirements for insurance companies that issue short-duration contracts. The ASU requires enhanced disclosures, on an annual basis, related to the reserve for losses and loss expenses which include (1) net incurred and paid claims development information by accident year, (2) a reconciliation of incurred and paid claims development information to the aggregate carrying amount of the reserve for losses and LAE, (3) for each accident year presented of incurred claims development, information about claim frequency (unless impracticable), and the amounts of IBNR liabilities, including expected development on reported claims, included in the reserve for losses and LAE, (4) a description of, and any significant changes to the methods for determining both IBNR and expected development on reported claims, and (5) for each accident year presented of incurred claims development, quantitative information about claims frequency, as well as a description of methodologies used for determining claim frequency information. The ASU is effective for annual periods beginning after December 15, 2015. While the adoption of this guidance impacted our disclosures, it did not have an impact on our consolidated financial statements.
Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
In August 2014, the FASB issued Accounting Standards Update 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). There was no guidance under U.S. GAAP regarding management’s responsibility to assess whether there is substantial doubt about an entity’s ability to continue as a going concern. Under ASU 2014-15, the Company assesses its ability to continue as a going concern each interim and annual reporting period and provide certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern, including management’s plan to alleviate the substantial doubt. ASU 2014-15 was effective for the year ended December 31, 2016. The adoption of ASU 2014-15 did not have on a material impact on the Company’s consolidated financial statements.
sheet or notes to the financial statements. ASU 2016-01 is effective for annual periods beginning after January 1, 2018, including interim periods. Early application is permitted. The Company is has assessed that the adoption of ASU 2016-01 will have no impact on future financial statements and disclosures.
In November 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-18, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU goes into effect for periods beginning after December 15, 2017.
Pursuant to its reinsurance agreements, AMIC Ltd. is required to provide its ceding companies with collateral to secure its obligations to them. At December 31, 2016 and 2015, AMIC Ltd. provided CAMICO with a letter of credit issued by Comerica Bank with supporting investments with a carrying value of $103,623 and $310,407, respectively. Also, at December 31, 2016 and 2015, AMIC Ltd. has provided C&F with a Section 114 Trust, held by Comerica Bank, with restricted cash and cash equivalents and investments with a carrying value of $11,330,173 and $8,266,507, respectively.
As of December 31, 2016, there were twenty-seven securities in an unrealized loss position with an estimated fair value of $7,811,779. Of these securities, six had been in an unrealized loss position for 12 months or greater. As of December 31, 2016, none of these securities were considered to be other than temporarily impaired. The Company has the intent to hold these securities and it is not more likely than not that the Company will be required to sell these securities before their fair values recover above the adjusted cost. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
As of December 31, 2015, none of these securities were considered to be other than temporarily impaired. The Company has the intent to hold these securities and it is not more likely than not that the Company will be required to sell these securities before their fair values recover above the adjusted cost. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The following tables show the fair value of the Company’s investments in accordance with ASC 820, “Fair Value Measurements and Disclosures” as of December 31, 2016 and 2015.
Though current market conditions appear to have improved, there is still the potential for further instability which could present additional risks and uncertainties for our business and make it more difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions and estimates that may have significant period-to-period changes that could have a material adverse effect on our results of operations or financial condition.
per depositor, per insured institution. FDIC insurance is backed by the full faith and credit of the United States government. The stated interest rate of an FDIC insured CD varies greatly among commercial banks and savings associations, depending on the term of the CD and the institution’s need for funding. The liquidity of “marketable” CDs is marginal, even though they are assigned an FDIC number, a CUSIP number and are held in book-entry form through the Depository Trust Company. Depending on market liquidity and conditions, the bid price for an FDIC insured CD would reflect the supply of and the demand for deposits of the particular bank or savings association, as well as prevailing interest rates, the remaining term of the deposit, specific features of the CD, and compensation of the broker arranging the sale of the CD. These time deposits mature in less than one year and are classified as other invested assets on the Company’s consolidated balance sheet.
The Company’s investments in the CD are categorized in their entirety in Level 2 of the fair value hierarchy, in accordance with ASC 820.
Property and equipment, primarily associated with APSL, at December 31, 2016 and 2015 at cost, less accumulated depreciation and amortization, totaled $226,988 and $130,740, respectively as follows:
As a result of the change in estimates of insured events in prior years, the provision for losses and loss adjustment expenses increased by $499,546 in 2016 and decreased by $109,533 in 2015. The 2016 unfavorable development was primarily due to higher than expected large loss emergence in accident year 2015, partially offset by favorable settlements on claims in accident years 2012 through 2014. The 2015 favorable development was due to better than expected loss emergence in accident year 2013.
With the exception of APSL, AmerInst and its other direct and indirect subsidiaries have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. Citadel Management Bermuda Limited (formerly Cedar Management Limited) provides AmerInst and AMIC Ltd. certain management, administrative and operations services under the direction of AmerInst’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party upon not more than 90 days nor less than 60 days prior written notice. Mr. Stuart Grayston, our President, was formerly a director and officer of Cedar Management Limited, and Mr. Thomas R. McMahon, our Treasurer and Chief Financial Officer, is a shareholder, officer, director and employee of Citadel Management Bermuda Limited. The Company paid Citadel Management Bermuda Limited $327,500 in fees during 2016 and 2015, respectively.
Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $525,517 in 2016 and $488,581 in 2015. Included as a part of this
compensation are annual retainers paid to directors in the form of common shares of the Company in the amount of $70,000 for the years ended December 31, 2016 and 2015, respectively. Such amounts are included as part of purchase of shares by subsidiary, net, in the consolidated statements of changes in shareholders’ equity and cash flows.
AMIC Ltd.’s ability to pay dividends to AmerInst is subject to the provisions of the Bermuda insurance and companies laws and the requirement to provide the ceding companies with collateral. Under the Companies Act,
AmerInst’s ability to pay common shareholders’ dividends and its operating expenses is dependent on cash dividends from AMIC Ltd. and its other subsidiaries. The payment of such dividends by AMIC Ltd. to AmerInst is limited under Bermuda law by the Bermuda Insurance Act 1978 and Related Regulations, as amended, which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2016 and 2015 these requirements have been met as follows:
APSL has employment agreements with four key members of senior management, including one of our named executive officers, Kyle Nieman, the President of APSL, which grant them phantom shares of the Company. Under these agreements, these employees were initially granted an aggregate of 75,018 phantom shares of the Company on the date of their employment, subject to certain vesting requirements. The phantom shares are eligible for phantom dividends payable at the same rate as regular dividends on the Company’s common shares. The phantom dividends may be used only to purchase additional phantom shares with the purchase price of such phantom shares being the net book value of the Company’s actual common shares as of the end of the previous quarter. During the year ended December 31, 2016, 1,569 phantom shares were granted arising from the dividends declared on the Company’s common shares. 84,725 phantom shares were outstanding at December 31, 2016.
The liability relating to these phantom shares is recalculated quarterly based on the net book value of the Company’s common shares at the end of each quarter. As a result of the overall decrease in the net book value of the Company’s common shares since the grant dates, no liability has been recorded by the Company relating to these phantom shares at December 31, 2016.