Our Company’s primary source of revenue is generated from writing insurance in Connecticut, Florida, Georgia, Hawaii, Louisiana, Massachusetts, New Jersey, New York, North Carolina, Rhode Island, South Carolina and Texas. Our target market in such areas consists of states where the perceived threat of natural catastrophe has caused large national insurance carriers to reduce their concentration of policies. We believe an opportunity exists for UPC Insurance to write profitable business in such areas.
We have historically grown our business through strong organic growth complemented by strategic acquisitions, including our acquisition of AmCo in April 2017, IIC in April 2016, and Family Security Holdings, LLC (FSH) in February 2015. As a result of these acquisitions, along with organic growth of premium in states in which we currently write premium, we have grown our policies in-force by 17.1% from 451,155 policies in-force at December 31, 2016 to 528,193 policies in-force at December 31, 2017.
The following discussion highlights significant factors influencing the consolidated financial position and results of operations of UPC Insurance. In evaluating our results of operations, we use premiums written and earned, policies in-force and new and renewal policies by geographic concentration. We also consider the impact of catastrophe losses and prior year development on our loss ratios, expense ratios and combined ratios. In monitoring our investments, we use credit quality, investment income, cash flows, realized gains and losses, unrealized gains and losses, asset diversification and portfolio duration. To evaluate our financial condition, we consider our: liquidity, financial strength, ratings, book value per share and return on equity.
(2) Expense ratio, net is calculated as the sum of all operating expenses less interest expense relative to net premiums earned.
(5) Included in both the expense ratio and the combined ratio are $38,104,000, $11,108,000, and $1,675,000 for the years ended December 31, 2017, 2016, and 2015, respectively, of merger professional fees and amortization expense predominately associated with the AmCo, IIC, and FSH acquisitions. Excluding these additional expenses, the Company would have reported underlying combined ratios of 78.9%, 85.1%, and 85.7% for the year ended December 31, 2017, 2016, and 2015 respectively.
Combined ratio excluding the effects of current year catastrophe losses, prior year reserve development and ceding commission income earned (underlying combined ratio) is a non-GAAP ratio, which is computed by subtracting the effect of current year catastrophe losses, prior year development, and ceding commission income earned related to our quota share reinsurance agreement from the combined ratio. We believe that this ratio is useful to investors and it is used by management to reveal the trends in our business that may be obscured by current year catastrophe losses, losses from lines in run-off, prior year development, and ceding commission income earned. Current year catastrophe losses cause our loss trends to vary significantly between periods as a result of their incidence of occurrence and magnitude, and can have a significant impact on the combined ratio. Prior year development is caused by unexpected loss development on historical reserves. Ceding commission income compensates the Company for expenses it incurs in generating the premium ceded under our quota share reinsurance agreement. We believe it is useful for investors to evaluate these components separately and in the aggregate when reviewing our performance. The most direct comparable GAAP measure is the combined ratio. The underlying combined ratio should not be considered as a substitute for the combined ratio and does not reflect the overall profitability of the Company’s business.
(2) Assumed premium written for 2017 includes commercial property business assumed from an unaffiliated insurer and the Texas Windstorm Insurance Association (TWIA) and 2016 premium assumed includes homeowners’ business from Citizens Property Insurance Corporation (Citizens) and TWIA.
Expenses for the year ended December 31, 2017 increased $173,449,000, or 36.1%, to $653,663,000 for the year ended December 31, 2017 from $480,214,000 for the same period in 2016, primarily due to increased losses, policy acquisition costs, operating costs and general and administrative expenses. The calculation of our combined and underlying loss ratios is shown below.
Policy acquisition costs increased by $57,786,000, or 49.1%, to $175,444,000 for the year ended December 31, 2017 from $117,658,000 for the year ended December 31, 2016. The primary driver of the increase in costs was the result of the managing general agent fees paid to AmRisc in relation to AmCo commercial premium which was a cost increase anticipated with the acquisition of AmCo. The remaining change was the result of policy acquisition costs varying directly with changes in gross premiums earned and were generally consistent with our growth in premium production and higher average market commission rates outside of Florida.
General and administrative expenses increased by $38,806,000, or 90.3%, to $81,762,000 for the year ended December 31, 2017 from $42,956,000 for the year ended December 31, 2016, primarily due to amortization costs related to the merger with AmCo.
(2) Assumed premiums written includes $1,610,000 of homeowners’ premium assumed from Maidstone Insurance Company in conjunction with the IIC acquisition in 2016, as well as premiums assumed from Citizens in 2015 and 2016 as well as TWIA in 2016.
ANALYSIS OF FINANCIAL CONDITION - DECEMBER 31, 2017 COMPARED TO DECEMBER 31, 2016
With respect to our investments, we primarily attempt to preserve capital, maximize after-tax investment income, maintain liquidity and minimize risk. To accomplish our goals, we purchase debt securities in sectors that we believe represent the most attractive relative value, and we maintain a moderate equity exposure. We must comply with applicable state insurance regulations that prescribe the type, quality and concentrations of investments our insurance affiliates can make; therefore, our current investment policy limits investment in non-investment grade fixed maturities and limits total investment amounts in preferred stock, common stock and mortgage notes receivable. We do not invest in derivative securities.
Our cash and investment portfolios totaled $1,130,806,000 at December 31, 2017 compared to $679,335,000 at December 31, 2016. The increase is a result of the addition of the ACIC portfolio in April 2017 and net proceeds from the issuance of our $150,000,000 6.250% senior notes in December 2017.
We classify all of our investments as available-for-sale. Our investments at December 31, 2017 and 2016 consisted mainly of U.S. government and agency securities, states, municipalities and political subdivisions and securities of investment-grade corporate issuers. Our equity holdings consisted mainly of securities issued by companies in the energy, consumer products, financial, technology and industrial sectors. Most of the corporate bonds we hold reflected a similar diversification. At December 31, 2017, approximately 86.5% of our fixed maturities were U.S. Treasuries, or corporate bonds rated “A” or better, and 13.5% were corporate bonds rated “BBB” or “BB”.
At December 31, 2017, there were 214 fixed maturity securities in an unrealized loss position for a period of 12 months or longer reflecting unrealized losses of $2,394,000 and no equity securities in an unrealized loss position for a period of 12 months or longer. We currently have no plans to sell these 214 securities, and we expect to fully recover our cost basis. We
Effective December 31, 2017, we replaced our 15% quota share agreement that expired on November 30, 2017 and our 5% quota share agreement that was set to renew on December 1, 2017 with a new quota share reinsurance agreement with a term of 12 months and a cession rate of 20% for all subject business. Effective January 1, 2018, we renewed the Aggregate Excess of Loss Treaty to provide coverage against accumulated losses from specified catastrophe events, for a term of 12 months.
See Note 9 in our Notes to Consolidated Financial Statements for additional information regarding our reinsurance program.
Unpaid losses and LAE totaled $482,232,000 and $140,855,000 as of December 31, 2017 and December 31, 2016, respectively. The balance has increased year over year as a result of losses incurred from Hurricanes Harvey and Irma during the second half of 2017, as well as from the merger with AmCo in the first half of 2017.
During the years ended December 31, 2017 and 2016 we contributed $30,000,000 and $41,000,000 of capital to our insurance subsidiaries, respectively. We may make future contributions of capital to our insurance subsidiaries as circumstances require.
On May 26, 2016, we issued a $5,200,000, 15-year term note payable to Branch Banking & Trust (BB&T) with the intent to use the funds to renovate, furnish and equip our corporate headquarters. The note bears interest at 1.65% in excess of the one-month LIBOR. The interest rate resets monthly and was 3.00% at December 31, 2017. Please refer to Note 11 in the Notes to Consolidated Financial Statements for a discussion of the additional terms associated with this note.
$150M Senior Notes Payable - Our senior notes provide that the Company and its subsidiaries shall not incur any indebtedness unless no default exists and the Company’s leverage ratio as of the last day of any annual or quarterly period (the "Balance Sheet Date") immediately preceding the date on which such additional indebtedness is incurred would have been no
Florida State Board of Administration (SBA) Note Payable (SBA Note) - Our SBA Note requires that UPC maintain either a 2:1 ratio of net written premium to surplus, or net writing ratio, or a 6:1 ratio of gross written premium to surplus, or gross writing ratio, to avoid additional interest penalties. The SBA Note agreement defines surplus for the purpose of calculating the required ratios as the $20,000,000 of capital contributed to UPC under the agreement plus the outstanding balance of the note. Should UPC fail to exceed either a net writing ratio of 1.5:1 or a gross writing ratio of 4.5:1, UPC’s interest rate will increase by 450 basis points above the 10-year Constant Maturity Treasury rate (as defined in the SBA Note agreement) which was 2.33% at the end of 2017. Any other writing ratio deficiencies result in an interest rate penalty of 25 basis points above the stated rate of the note, which was 2.31% at the end of 2017. Our SBA Note further provides that the SBA may, among other things, declare its loan immediately due and payable for all defaults existing under the SBA Note; however, any payment is subject to approval by the insurance regulatory authority. At December 31, 2017, we were in compliance with the covenants as specified in the SBA Note.
The principal cash inflows from our operating activities come from premium collections, reinsurance recoveries, and investment income. The principal cash outflows from our operating activities are the result of claims and related costs, reinsurance premiums, policy acquisition costs, and salaries and employee benefits. A primary liquidity concern with respect to these cash flows is the risk of large magnitude catastrophe events.
During the year ended December 31, 2017 and December 31, 2016, some changes in operating assets and liabilities were significantly impacted by catastrophe losses associated with Hurricanes Harvey and Irma in 2017 and Hurricane Matthew in 2016. Unpaid losses and LAE increased significantly during the period and, as a result, we expect a considerable increase in cash outflows related to the payment of catastrophe claims in the near future. However, reinsurance recoverable on paid and unpaid losses also increased significantly during the period. We expect that a considerable increase in cash inflows related to reinsurance recoveries in the near future will largely offset the cash outflows from the payment of losses.
The principal cash inflows from our investing activities come from repayments of principal, proceeds from maturities and sales of investments. We closely monitor and manage these risks through our comprehensive investment risk management process. The principal cash outflows relate to purchases of investments and cost of property, equipment and capitalized software acquired. Additional cash outflows relate to purchases of subsidiaries. The primary liquidity concerns with respect to these cash flows are the risk of default by debtors and market disruption.
The principal cash inflows from our financing activities come from issuances of debt and other securities. The principal cash outflows come from repayments of debt and payments of dividends. The primary liquidity concern with respect to these cash flows is market disruption in the cost and availability of credit. We believe our current capital resources, together with cash provided from our operations, are sufficient to meet currently anticipated working capital requirements.
Reserves for unpaid losses and LAE represent the most significant accounting estimate inherent in the preparation of our financial statements. These reserves represent management’s best estimate of the amount we will ultimately pay for losses and we base the amount upon the application of various actuarial reserve estimation techniques as well as considering other material facts and circumstances known at the balance sheet date.
As discussed in Note 3 in our Notes to Consolidated Financial Statements, we value our investments at fair value using quoted prices from active markets, to the extent available. For securities for which quoted prices in active markets are unavailable, we use observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. We have investments in limited partnerships that require us to use unobservable inputs.
For investments classified as available for sale, the difference between fair value and cost or amortized cost for fixed income securities and cost for equity securities is reported as a component of accumulated other comprehensive income on our Consolidated Balance Sheet and is not reflected in our net income of any period until reclassified to net income upon the consummation of a transaction with an unrelated third party or when a write-down is recorded due to an other-than-temporary decline in fair value. We have a portfolio monitoring process to identify and evaluate each fixed income and equity security whose carrying value may be other-than-temporarily impaired.
For each fixed income security in an unrealized loss position, we assess whether management with the appropriate authority, has made the decision to sell or whether it is more likely than not we will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, the security’s decline in fair value is considered other-than-temporary and is recorded in earnings.
recovery value if we determine that the security is dependent on the liquidation of collateral for ultimate settlement. If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an other-than-temporary impairment for the difference between the estimated recovery value and amortized cost is recorded in earnings. The portion of the unrealized loss related to factors other than credit remains classified in accumulated other comprehensive income. If we determine that the fixed income security does not have sufficient cash flow or other information to estimate a recovery value for the security, we may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.
Once assumptions and estimates are made, any number of changes in facts and circumstances could cause us to subsequently determine that a fixed income or equity security is other-than-temporarily impaired, including: (1) general economic conditions that are worse than previously forecasted or that have a greater adverse effect on a particular issuer or industry sector than originally estimated; (2) changes in the facts and circumstances related to a particular issue or issuer’s ability to meet all of its contractual obligations; and (3) changes in facts and circumstances that result in changes to management’s intent to sell or result in our assessment that it is more likely than not we will be required to sell before recovery of the amortized cost basis of a fixed income security or cause a change in our ability or intent to hold an equity security until it recovers in value. Changes in assumptions, facts and circumstances could result in additional charges to earnings in future periods to the extent that losses are realized. The charge to earnings, while potentially significant to net income, would not have a significant effect on stockholders’ equity, since our securities are designated as available for sale and carried at fair value and as a result, any related unrealized loss, net of taxes would already be reflected as a component of accumulated other comprehensive income in stockholders’ equity.
As discussed in Note 2(p) in our Notes to Consolidated Financial Statements, the qualitative assessment is an assessment of historical information and relevant events and circumstances to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. We may elect not to perform the qualitative assessment and perform a two-step quantitative impairment test.
The following table summarizes our expected payments for contractual obligations at December 31, 2017:
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Our report dated March 28, 2018, expressed an opinion that the Company had not maintained effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
United Insurance Holdings Corp. is a property and casualty insurance holding company that sources, writes, and services residential and commercial property and casualty insurance policies using a network of agents and four wholly-owned insurance subsidiaries. Our primary insurance subsidiary is United Property & Casualty Insurance Company (UPC), which was formed in Florida in 1999 and has operated continuously since that time. Our other three insurance subsidiaries are Family Security Insurance Company (FSIC), acquired via merger on February 3, 2015, Interboro Insurance Company (IIC), acquired via merger on April 29, 2016, and American Coastal Insurance Company (ACIC), acquired via merger on April 3, 2017. See Note 4 in our Notes to Consolidated Financial Statements for additional information regarding these acquisitions.
Our other subsidiaries include United Insurance Management L.C. (UIM), the managing general agent that manages substantially all aspects of UPC’s business; Skyway Claims Services, LLC (our claims adjusting subsidiary) that provides services to our insurance subsidiaries; AmCo Holding Company (AmCo) and Family Security Holdings (FSH) (holding company subsidiaries) that consolidate their respective insurance companies; BlueLine Cayman Holdings (a reinsurance subsidiary) that reinsurers a portfolio of E&S policies; UPC Re (a reinsurance subsidiary) that provides a portion of the reinsurance protection purchased by our insurance subsidiaries; and Skyway Reinsurance Services (a reinsurance brokerage subsidiary) that provides reinsurance brokerage services for our insurance companies.
Our primary product is homeowners’ insurance, which we currently offer in Connecticut, Florida, Georgia, Hawaii, Louisiana, Massachusetts, New Jersey, New York, North Carolina, Rhode Island, South Carolina, and Texas, under authorization from the insurance regulatory authorities in each state. We are also licensed to write property and casualty insurance in Alabama, Delaware, Maryland, Mississippi, New Hampshire, and Virginia; however, we have not commenced writing in these states.
We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP). While preparing our consolidated financial statements, we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, as well as reported amounts of revenues and expenses during the reporting period. Accordingly, actual results could differ from those estimates. Reported amounts that require us to make extensive use of estimates include our reserves for unpaid losses and loss adjustment expenses, investments and goodwill. Except for the captions on our Consolidated Balance Sheets and Consolidated Statements of Comprehensive Income, we generally use the term loss(es) to collectively refer to both loss and loss adjustment expenses.
Our cash and cash equivalents include demand deposits with financial institutions and short-term, highly liquid instruments with original maturities of three months or less when purchased.
A large portion of our investment portfolio consists of fixed maturities, which may be adversely affected by changes in interest rates as a result of governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would decrease the net unrealized holding gains of our investment portfolio, offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would increase the net unrealized holding gains of our investment portfolio, offset by lower rates of return on funds reinvested.
See Note 3 in our Notes to Consolidated Financial Statements for a discussion regarding the fair value measurement of our investments at December 31, 2017.
We capitalize certain direct development costs associated with internal-use software. We expect to amortize the capitalized software costs related to our data warehouse and policy administration system over its expected seven-year useful life.
See Note 7 in our Notes to Consolidated Financial Statements for a discussion of our property, equipment and capitalized software that were held during 2017 and 2016.
We estimate our reserves for unpaid losses using individual case-basis estimates for reported claims and actuarial estimates for incurred but not reported (IBNR) claims, and we continually review and adjust our estimated losses as necessary based on our historical experience and as we obtain new information. If our unpaid loss reserves prove to be deficient or redundant, we increase or decrease the liability in the period in which we identify the difference, thereby impacting net income. Though our estimate of the ultimate cost of settling all reported and unreported claims may change at any point in the future, a reasonable
On our Consolidated Balance Sheets, we report our reserves for unpaid losses gross of the amounts related to unpaid losses recoverable from reinsurers. On our Consolidated Statements of Comprehensive Income, we report losses net of amounts ceded to reinsurers. We do not discount our loss reserves for financial statement purposes.
We also earn ceding commission on our quota share reinsurance contract, which is presented as other income with any excess unearned ceding commission recognized as unearned revenue in other liabilities. Ceding commission income is amortized over the contract period consistent with our deferred policy acquisition costs.
We estimate uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. We recorded no bad debt expense related to reinsurance during the years ended December 31, 2017, 2016 or 2015.
We record any income tax penalties and income-tax-related interest as income tax expense in the period incurred. We did not incur any material tax penalties or income-tax-related interest during the years ended December 31, 2017, 2016 or 2015.
a concentration of credit risk with regard to our cash, because we choose to deposit all our cash at six financial institutions.
With regard to our cash balances held at financial institutions, we had $314,147,000 and $159,288,000 in excess of Federal Deposit Insurance Corporation (FDIC) insurance limits at December 31, 2017 and 2016, respectively. The $154,859,000 increase in excess of FDIC insurance limits was the result of holding more cash and at the end of 2017 than we did in 2016.
Goodwill is the excess of cost over the estimated fair value of net assets acquired. We attribute all goodwill associated with our acquisitions to one reporting unit.
The valuation methodologies utilized are subject to key judgments and assumptions that are sensitive to change. Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments. These estimates and the judgments and assumptions upon which the estimates are based will, in all likelihood, differ in some respects from actual future results. Declines in the estimated fair value of our reporting unit could result in goodwill impairments in future periods which could materially adversely affect our results of operations or financial position.
For the 2017 annual goodwill impairment test, we utilized the qualitative assessment and determined it was not more likely than not that the fair value of the reporting units tested using the qualitative assessment was less than their carrying amount and, therefore no further testing was needed for the reporting units. We determined that the fair values of the reporting units were in excess of the carrying value and, therefore goodwill was not impaired.
Non-amortizing intangible assets generally represent the cost of insurance licenses acquired. Non-amortizing intangible assets are tested for impairment in the fourth quarter of each fiscal year by comparing the fair value of the licenses acquired to their carrying values. We established fair value for purposes of impairment testing using the income approach. If the carrying value of a license acquired exceeds its fair value, an impairment loss is recognized equal to that excess. For 2017, we determined that the fair values of the intangible assets were not impaired.
In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, Topic 220 (ASU 2018-02), which amends ASC Topic 220 and ASC Topic 740 by addressing the stranded amounts of AOCI which may result from the enactment of the 2017 Tax Act. Though AOCI is presented on a net-of-tax basis, ASC Topic 740 requires that the effects of new tax laws on items in AOCI be recognized without a corresponding adjustment to AOCI and instead recorded to income tax expense. ASU 2018-02 permits stranded amounts of AOCI specifically resulting from the 2017 Tax Act to be removed from AOCI and reclassified to retained earnings, if elected. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018, including interim periods therein, and early adoption is permitted. We adopted the guidance as of year end and elected to recognize a $1,549,000 reclassification from retained earnings to AOCI in the consolidated financial statements for the year ended December 31, 2017, related to a revaluation of deferred income tax assets and liabilities for items in AOCI at the 2017 Tax Act federal tax rate which changed from 35% to 21%.
In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718)-Scope of Modification Accounting (ASU 2017-09). This update provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods, with early adoption permitted for certain requirements. We did not early adopt and are assessing the impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.
When we sell investments, we calculate the gain or loss realized on the sale by comparing the sales price (fair value) to the cost or adjusted/amortized cost of the security sold. We determine the cost or adjusted/amortized cost of the security sold using the specific-identification method. The following tables detail our realized gains (losses) by major investment category for the years ended December 31, 2017, 2016 and 2015:
If we have not made the decision to sell the fixed income security and it is not more likely than not that we will be required to sell the fixed income security before recovery of its amortized cost basis, we evaluate whether we expect the security to receive cash flows sufficient to recover the entire cost or amortized cost basis of the security. We calculate the estimated recovery value by discounting the best estimate of future cash flows at the security’s original or current effective rate, as appropriate, and compare this to the cost or amortized cost of the security. If we do not expect to receive cash flows sufficient to recover the entire cost or amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss related to other factors recognized in other comprehensive income.
During the years ended December 31, 2017, 2016 and 2015, we recorded no other-than-temporary impairment charges.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Assets and liabilities recorded on the Consolidated Balance Sheets at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:
The carrying amounts for the following financial instrument categories approximate their fair values at December 31, 2017 and 2016 because of their short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance recoverable, reinsurance payable, other assets, and other liabilities. The carrying amount of the notes payable to the Florida State Board of Administration, the Branch Banking & Trust Corporation (BB&T), and our $150,000,000 senior notes payable approximate fair value as the interest rates are variable.
Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; this is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the fair value of our financial instruments measured on a non-recurring basis by level at December 31, 2017:
The table below presents the rollforward of our Level 3 investments held at fair value during the year ended December 31, 2017:
At the end of each quarter, we determine whether we need to transfer the fair values of any securities between levels of the fair value hierarchy and, if so, we report the transfer as of the end of the quarter. During 2017, we transferred one investment from a Level 3 to a Level 2 investment, due to changes in the availability of market observable inputs. We used unobservable inputs to derive our estimated fair value for Level 3 investments and the unobservable inputs are significant to the overall fair value measurement.
At December 31, 2017, we held commercial portfolio loans of $20,000,000. We believe that making sound loans is a necessary and desirable means of employing funds available for investment. Recognizing our obligation to our stockholders, management is expected to seek to develop and make sound, profitable loans that resources permit and that opportunity affords. These are short-term collateralized loans (less than one year), which we expect to be repaid primarily from cash flows of the borrowers.
We have not calculated an allowance for a loan loss at December 31, 2017. The allowance would represent an estimate of the amount of probable losses believed to be inherent in our portfolio. Due to the short-term nature of the loans, the projects being substantially complete and the fact that all loans are current with respect to their scheduled payments, we determined that an allowance for loan losses was not necessary, and therefore the related disclosures on the allowance for loan losses and past due loans have been omitted. We expect our loans to be repaid in full upon completion of the projects in March 2018.
We account for business acquisitions in accordance with the acquisition method of accounting, which requires, among other things, that most assets acquired, liabilities assumed, and earn-out consideration be recognized at their fair values as of the acquisition date. Measurement period adjustments to provisional purchase price allocations are recognized in the period in which they are determined as if the accounting had been competed on the acquisition date.
On April 3, 2017, the Company completed its acquisition of AmCo. The transaction was completed through a series of mergers that ultimately resulted in the Company issuing 20,956,355 shares of its common stock as merger consideration to the equity holders of RDX Holding, LLC, the former parent company of AmCo. As a result of the mergers, AmCo merged with and into a wholly-owned subsidiary of the Company. The acquisition of AmCo supported the Company's growth strategy and further strengthened the Company's overall position in the commercial property and casualty insurance market. Goodwill recorded in the transaction, which reflected the synergies expected from the acquisition and enhanced reinsurance opportunities, is not tax deductible.
The operations of AmCo are included in our Consolidated Statements of Comprehensive Income effective April 3, 2017. We have one year from the acquisition date to finalize the allocation of the purchase price of AmCo and its subsidiaries. The final purchase price allocation was as follows:
Basic earnings per share (EPS) is based on the weighted average number of shares of common stock outstanding for the period, excluding any dilutive common stock equivalents. Diluted EPS reflects the potential dilution resulting from vesting of restricted stock awards. The following table shows the computation of basic and diluted EPS for the years ended December 31, 2017, 2016 and 2015:
See Note 20 for additional information on the stock grants related to dilutive securities.
Depreciation and amortization expense under property and equipment was $5,806,000, $2,424,000 and $1,803,000, respectively, for the years ended December 31, 2017, 2016 and 2015. During the year ended December 31, 2017, we incurred non-cash capitalized software impairment charges as a result of our decision to discontinue one of our software development projects.
The changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2016 are as follows:
We completed our most recent goodwill impairment testing during the fourth quarter of 2017 and determined that there was no impairment in the value of our assets as of December 31, 2017.
Effective June 1, 2017, UPC Insurance, through our wholly-owned insurance subsidiaries UPC, ACIC, FSIC and IIC, entered into reinsurance agreements with several private reinsurers and with the Florida State Board of Administration (SBA), which administers the Florida Hurricane Catastrophe Fund (FHCF). These agreements provide coverage for catastrophe losses from named or numbered windstorms and earthquakes in all states UPC Insurance operates except for the FHCF agreement, which only provides coverage in Florida against storms that the National Hurricane Center designates as hurricanes.
Sufficient coverage for a 1-in-100-year event followed by a 1-in-50-year event in the same season;
Group retention of $55,000,000 for a first event and $30,000,000 for a second and subsequent events including a $5,000,000 retention related to our captive reinsurer BlueLine Cayman Holding, which represents approximately 11% of group equity for a first event, lower than in any prior year for UPC Insurance;
Realized cost synergies by placing a combined program with AmCo that surpassed our previously stated goal of $20,000,000 annually;
UPC Insurance renewed our quota share reinsurance agreement (the “quota share agreement”) and our aggregate excess of loss reinsurance agreement (the “aggregate excess of loss agreement”) with private reinsurers. These agreements provide coverage for in-force, new and renewal business. The quota share agreement provides coverage only for UPC, while the aggregate excess of loss agreement provides coverage for UPC, ACIC, IIC, and FSIC. These new reinsurance programs are designed to work in conjunction with our catastrophe excess of loss reinsurance program to provide the Company broad risk transfer protection and to lessen financial volatility.
for all losses in excess of 4.75% of the covered companies’ gross earned premium in the aggregate not to exceed $20,000,000 over the term of the treaty. Recoveries under this treaty will be calculated quarterly based on the cumulative gross earned premium.
(1) Incurred loss and LAE is equal to losses and LAE paid plus the change in case and incurred but not reported reserves. Shown net of losses ceded to reinsurers. Incurred loss and LAE and number of events includes the current year development on storms during the year in which it occurred.
We write flood insurance under an agreement with the National Flood Insurance Program. We cede 100% of the premiums written and the related risk of loss to the federal government. We earn commissions for the issuance of flood policies based upon a fixed percentage of net written premiums and the processing of flood claims based upon a fixed percentage of incurred losses, and we can earn additional commissions by meeting certain growth targets for the number of in-force policies. We recognized commission revenue from our flood program of $1,255,000, $1,056,000, and $959,000 for the years ended December 31, 2017, 2016, and 2015, respectively.
thresholds; therefore, we received reinsurance recoveries for losses that we incurred on these storms and expect to receive additional recoveries during 2018.
We determine our ultimate losses by using multiple actuarial methods to determine an actuarial estimate within a relevant range of indications that we calculate using generally accepted actuarial techniques. Our selection of the actuarial estimate is influenced by the analysis of our historical loss and claim experience. For each accident year, we estimate the ultimate incurred losses for both reported and unreported claims. In establishing this estimate, we review the results of various actuarial methods discussed below.
The various methods we use have strengths and weaknesses that depend upon the circumstances of the segment and the age of the claims experience we analyze. The nature of our book of business allows us to place substantial, but not exclusive, reliance on the loss development methods, and the selected LDFs, represent the most critical aspect of our loss reserving process. We use the same set of LDFs in the methods during our loss reserving process that we also use to calculate the premium necessary to pay expected ultimate losses.
As reflected by our losses incurred related to prior years, the favorable development experienced in 2017 was primarily the result of losses related to the 2016 and 2015 accident years coming in better than expected and the favorable development in 2015 was primarily the result of losses related to the 2014 and 2013 accident years coming in better than expected. During 2016, we had a reserve deficiency. Since we place substantial reliance on loss-development-based actuarial models when determining our estimate of ultimate losses, the deficiencies resulted from additional development on prior accident years which caused our ultimate losses to increase.
The table below presents all long-term debt outstanding as of December 31, 2017 and December 31, 2016:
On December 13, 2017, we issued $150,000,000 of senior notes that will mature in 10 years and bear interest at a rate equal to 6.25% per annum payable semi-annually on each June 15 and December 15, commencing June 15, 2018. The notes are senior unsecured obligations of the Company. We may redeem the notes at our option, at any time and from time to time in whole or in part, at a redemption price equal to the greater of (i) 100% of the principal amount of the notes to be redeemed and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon from the date of redemption to September 15, 2027. Thereafter, we may redeem the notes at par.
On December 5, 2016, we issued $30,000,000 of senior notes to private investors pursuant to an Indenture dated as of December 5, 2016, by and between the Company and the trustee. The notes bore interest at a floating rate equal to the three-month LIBOR plus 5.75% per annum, with interest payable quarterly in arrears. The notes were redeemed at par value on December 13, 2017 without a pre-payment penalty.
On September 22, 2006, we issued a $20,000,000, 20-year note payable to the Florida State Board of Administration (SBA note). For the first three years of the SBA note we were required to pay interest only. On October 1, 2009, we began to repay the principal in addition to interest. The SBA note bears an annual interest rate equivalent to the 10-year U.S. Treasury Bond rate. The rate will be adjusted quarterly for the term of the SBA note based on the 10-year Constant Maturity Treasury rate.
We are involved in claims-related legal actions arising in the ordinary course of business. We accrue amounts resulting from claims-related legal actions in unpaid losses and LAE during the period that we determine an unfavorable outcome becomes probable and we can estimate the amounts. Management makes revisions to our estimates based on its analysis of subsequent information that we receive regarding various factors, including: (i) per claim information; (ii) company and
industry historical loss experience; (iii) judicial decisions and legal developments in the awarding of damages, and (iv) trends in general economic conditions, including the effects of inflation.
At December 31, 2017, we were not involved in any material non-claims-related legal actions.
The actual income tax expense differs from the expected income tax expense computed by applying the combined applicable effective federal and state tax rates to income before the provision for income taxes as follows:
financial statements and provides a one-year measurement period from the enactment date to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the following:
the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.
The statute of limitations related to our consolidated Federal income tax returns and our Florida income tax returns expired for all tax years up to and including 2013; therefore, only the 2014 through 2017 tax years remain subject to examination by taxing authorities. No taxing authorities are currently examining any of our federal or state income tax returns.
UPC Insurance’s reinsurance subsidiary, which is based in the Cayman Islands, made an irrevocable election under section 953(d) of the U.S. Internal Revenue Code of 1986, as amended, to be treated as a domestic insurance company for U.S. Federal income tax purposes. As a result of this election, our reinsurance subsidiary is subject to United States income tax on its worldwide income as if it were a U.S. corporation.
The NAIC has Risk-Based Capital (RBC) guidelines for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Most states, including Florida, Hawaii and New York, have enacted statutory requirements adopting the NAIC RBC guidelines, and insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. State insurance regulatory authorities could require an insurer to cease operations in the event the insurer fails to maintain the required statutory capital.
Governmental agencies or certain quasi-governmental entities can levy assessments upon us in the states in which we write policies. See Note 2(k) for a description of how we recover assessments imposed upon us. We expense an assessment when the particular governmental agency or quasi-governmental entity levies it upon us; therefore, expected recoveries are not assets and we will record the amounts as income when collected from policyholders.
Governmental agencies or certain quasi-governmental entities can also levy assessments upon policyholders, and we collect the amount of the assessments from policyholders as surcharges for the benefit of the assessing agency. We currently collect assessments levied upon policyholders on behalf of Citizens Property Insurance Corporation (Citizens) in the amount of 1.0%, and on behalf of FHCF in the amount of 1.3%. We multiply the premium written on each policy, except our flood policies, by these assessment percentages to determine the additional amount that we will collect from the policyholder and remit to the assessing agencies.
NAIC law limits an insurer’s investment in equity instruments and also restricts investments in medium to low quality debt instruments. We were in compliance with all investment restrictions at December 31, 2017 and 2016.
The table below reconciles our consolidated GAAP net income to the statutory net income of our insurance subsidiaries:
The table below reconciles our consolidated GAAP stockholders’ equity to the surplus as regards policyholders of our insurance subsidiaries:
In accordance with the managing general agent underwriting contract with AmRisc, we recorded $220,150,000 of gross written premiums for the year ended December 31, 2017, resulting in fees and commission (including a profit commission) of $60,016,000 due to AmRisc. Receivables are stated net of the fees and commission due under the contract.
In addition to the direct premiums written, we recorded $3,564,000 in ceded premiums to AmRisc as a reinsurance intermediary for the year ended December 31, 2017. We also incurred $25,000 during that period for rent under a sublease agreement with AmRisc.
We provide a 401(k) plan for substantially all of our employees. We match 100% of the first 5% of employees’ contributions to the plan. For the years ended December 31, 2017, 2016, and 2015, our contributions to the plan on behalf of the participating employees were $604,000, $444,000, and $365,000, respectively.
On April 3, 2017, we completed the acquisition of AmCo by issuing 20,956,355 shares of our common stock as consideration for the final purchase price. See Note 4 for additional information on this acquisition.
On February 3, 2015, we completed the acquisition of FSH and its subsidiaries by issuing 503,857 shares of our common stock as consideration for the initial purchase price. In March 2016 we paid contingent consideration of 32,943 shares of common stock as part of the FSH acquisition.
See Note 20 for information regarding the activity of our common stock and share-based compensation.
We granted 167,622 shares of restricted common stock awards during the twelve months ended December 31, 2017, which had a weighted-average grant date fair value of $15.62 per share. We granted 115,405 shares of restricted stock during the twelve months ended December 31, 2016, which had a weighted-average grant date fair value of $16.90 per share.
We had approximately $343,000 of unrecognized director stock-based compensation expense at December 31, 2017 related to non-vested director stock-based compensation granted, which we expect to recognize ratably until the 2018 Annual Meeting of Stockholders. We recognized $996,000, $1,070,000 and $1,166,000 of director stock-based compensation expense during the twelve months ended December 31, 2017, 2016 and 2015, respectively.
(1) The sum of the quarterly reported amounts may not equal the full year, as each is computed independently.
On February 21, 2018, our Board of Directors declared a $0.06 per share quarterly cash dividend payable on March 14, 2018 to stockholders of record on March 7, 2018.