Positive Physicians Holdings, Inc. (“Company”) is a newly created Pennsylvania domiciled holding company formed to be the stock holding company for Positive Physicians Insurance Company (“Positive Insurance Company”) following the conversions of PPIX, PCA, and PIPE from reciprocal insurance exchanges to stock insurance companies. The Company had minimal assets and liabilities and had not engaged in any operations as of December 31, 2018.
PPIX was an unincorporated exchange organized on April 20, 2004 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange. PPIX provided medical professional liability insurance consisting of claims-made, tail occurrence, claims made plus, and occurrence policies to its subscribers (policyholders). On October 9, 2018, Positive Physicians Captive Insurance Company, a sponsored captive insurance company, was incorporated in the State of New Jersey and became a wholly-owned subsidiary of PPIX. PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018. PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”). Keystone is owned by an insured of Positive Insurance Company.
PPIX marketed its medical professional liability insurance policies direct to physicians and through independent producers to doctors and allied healthcare professionals who practice in Pennsylvania, Delaware, Maryland, New Jersey, and Ohio.
For the year ended December 31, 2018, PPIX had direct premiums written of $15.6 million, net premiums earned of $13.1 million, and net loss of $(63,000). At December 31, 2018, PPIX had total assets of $63.6 million and a surplus of $16.8 million. For the year ended December 31, 2017, PPIX had direct premiums written of $15.3 million, net premiums earned of $12.3 million, and net loss of $(21,000). At December 31, 2017, PPIX had total assets of $67.2 million and a surplus of $17.5 million.
PPIX was managed by Specialty Insurance Services, LLC (“SIS”), a Pennsylvania limited liability company, pursuant to the terms of an Attorney-In-Fact Agreement between the exchange and SIS. Pursuant to the terms of the Attorney-in-Fact Agreement, as amended, SIS provided underwriting and administrative services to PPIX based on a percentage not to exceed 25.0% of gross written premiums, less return premiums. SIS, as the attorney-in-fact, had the power to direct the activities of PPIX that most significantly impact PPIX’s economic performance. Diversus acquired 100% of the ownership interests of SIS on January 1, 2017.
PCA marketed its medical professional liability insurance policies through independent producers primarily to doctors and allied healthcare providers who practice in Pennsylvania. In November 2015, PCA was granted a license to write insurance in Michigan and began writing policies in Michigan in the fourth quarter of 2015.
For the year ended December 31, 2018, PCA had direct premiums written of $6.3 million, net premiums earned of $7.1 million, and a net loss of $(4.5) million. At December 31, 2018, PCA had total assets of $36.0 million and a surplus of $9.0 million. For the year ended December 31, 2017, PCA had direct premiums written of $7.7 million, net premiums earned of $7.5 million, and net income of $0.3 million. At December 31, 2017, PCA had total assets of $39.6 million and a surplus of $13.9 million. The net loss for PCA in 2018 is attributed to more losses and loss adjustment expenses than originally recorded as well as a decrease in direct premiums written of $1.4 million due a decrease in extended reporting policies written and non-renewal of policies and limited new business growth. The loss in PCA’s direct premiums written of $4.2 million in 2017 is attributed to loss of a major client, a decrease in extended reporting policies written and non-renewals of policies, and limited new business growth.
PTP was a Pennsylvania corporation formed to operate as the attorney-in-fact for PCA pursuant to the terms of an agreement between PTP and PCA. Pursuant to the terms of the agreement, PTP provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PCA and paid certain expenses on behalf of PCA in exchange for 25% of the gross written premium. PTP, as the attorney-in-fact of PCA, had the power to direct the activities of PCA that most significantly impact PCA’s economic performance by acting as the attorney-in-fact of PCA. Diversus acquired 100% of the ownership interests of PTP on June 4, 2014.
PIPE marketed its medical professional liability insurance policies through independent producers to doctors and allied healthcare professionals who practice primarily in Pennsylvania.
Losses and loss adjustment expenses represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims, including legal fees.
Expenses incurred to underwrite risks are referred to as policy acquisition expenses and underwriting and administrative expenses. Policy acquisition costs consist of commission expenses, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business. These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies. Underwriting and administrative expenses consist of salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately, and payments to bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data.
The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related footnotes. Each exchange evaluated these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that it believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.
When a claim is reported to Diversus Management, its claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. The amount of the loss reserve for the reported claim is based primarily upon a claim-by-claim evaluation of coverage, liability, and injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. Each claim is contested or settled individually based upon its merits, and some claims may take years to resolve, especially if legal action is involved. Case reserves are reviewed on a regular basis and are updated as new information becomes available.
We utilize an independent actuary to assist with the estimation of our losses and loss adjustment expense reserves in the third and fourth quarter of each calendar year. This actuary prepares estimates of the ultimate liability for unpaid losses and loss adjustment expenses based on established actuarial methods described below. Diversus Management reviews these estimates and supplements the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy. Diversus Management may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the financial statements.
Actual versus Expected Model - The Actual versus Expected Model utilizes the actuarial point ultimate loss and defense containment cost (“DCC”) estimates as of the prior reserve review which were adjusted based on the difference between actual and expected loss development during that prior reserve review and the current evaluation to arrive at an updated actuarial point ultimate loss and DCC estimate. The method is dependent on the loss development factors used to determine the expected losses.
Frequency/Severity Method - The Frequency/Severity Method estimates ultimate losses by estimating a frequency and a severity component. For each year, the actuary estimates ultimate claims costs and an ultimate average severity. The actuary then multiplies these two estimates together. The method is useful when the claim count development pattern is more stable than the loss development pattern.
Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for losses and loss adjustment expense reserves may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. We reflect adjustments to loss reserves in the results of operations in the period the estimates are changed.
Trends and risks in claim costs, such as risk that medical cost inflation could increase.
Specifically, the following factors could impact the frequency and severity of claims, and therefore, the ultimate amount of losses and loss adjustment expenses paid:
The estimation process for determining the liability for unpaid losses and loss adjustment expenses inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts less than originally estimated or a reduction in the estimate for unpaid losses and loss adjustment expense (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts greater than originally estimated or an increase in the estimate for unpaid losses and loss adjustment expense (unfavorable development).
At December 31, 2018 and December 31, 2017, PPIX’s total liability for losses and loss adjustment expenses was $34.6 million and $38.0 million, respectively. During the years ended December 31, 2018 and 2018, PPIX had favorable developments of $2.9 million and $2.6 million, respectively. The favorable development of $2.6 million during the year ended December 31, 2017 was primarily related to settlement of known claims below the amount for which they have been previously reserved, as well as additional revisions to the exchange’s estimate of its ultimate losses for the 2012 through 2015 accident years. The favorable development of $2.9 million during the year ended December 31, 2018 was primarily related to reductions of the ultimate losses for the 2010, 2011, and 2015 policy years which were offset by strengthening the ultimate loss reserves for the 2016 and 2017 policy years.
As discussed earlier, the estimation of PPIX’s reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given policy year. The ranges presented above represent the expected variability around the actuarially determined central estimate.
The following table provides case and IBNR reserves for losses and loss adjustment expenses of PCA as of December 31, 2018 and December 31, 2017.
The table below summarizes the impact on PCA’s equity from changes in estimates of unpaid losses and loss adjustment expenses as of December 31, 2018 (dollars in thousands) (unaudited):
The following table provides case and IBNR reserves for losses and loss adjustment expenses of PIPE as of December 31, 2018 and December 31, 2017.
As discussed earlier, the estimation of PIPE’s reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given policy year. The ranges presented above represent the expected variability around the actuarially determined central estimate.
If the liability for losses and loss adjustment expenses were recorded at the high end of the actuarially-determined range, the liability for losses and loss adjustment expenses would increase by $1.4 million. This increase in reserves would have the effect of increasing net loss and decrease equity as of December 31, 2018 by $1.1 million. If the liability for losses and loss adjustment expenses were recorded at the low end of the actuarially-determined range, the liability for losses and loss adjustment expenses at December 31, 2017 would be reduced by $0.5 million with corresponding increases in net income and equity of $0.4 million.
If the liability for losses and loss adjustment expenses reserves were to adversely develop to the high end of the range, approximately $1.4 million of anticipated future payments for the losses and loss adjustment expenses would be required to be paid, thereby affecting cash flows in future periods as the payments for losses are made.
The fixed maturity investments are classified as available-for-sale and equity securities of PPIX, PCA, and PIPE are carried at estimated fair value as determined by management based upon quoted market prices or a recognized pricing service at the reporting date for those or similar investments. Limited partnership investments are measured at fair value using net asset values of the partnerships as a practical expedient. Changes in unrealized investment gains or losses on fixed maturity available-for-sale investments, net of applicable income taxes, are reflected directly in equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income (loss). Beginning with January 1, 2018, changes in unrealized investment gains or losses on equity investments are reflected in net investment income. For 2017, changes in unrealized investment gains or losses on previously classified available-for-sale securities, net of applicable income taxes, are reflected directly in equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income (loss). Investment income is recognized when earned, and capital gains and losses are recognized when investments are sold, or other-than-temporarily impaired.
We use fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Fixed maturity available-for-sale securities and equity securities are recorded at fair value on a recurring basis. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy under ASC Topic 820 are as follows:
Quoted prices for similar assets in active markets, quoted prices for identical or similar assets in nonactive markets (few transactions, limited information, noncurrent prices, high variability over time, etc., inputs other than quoted prices that are observable for the asset (interest rates, yield curves, volatilities, default rates, etc., and inputs that are derived principally from or corroborated by other observable market data.
We obtain one price for each security primarily from a third-party pricing service (“pricing service”), which generally uses quoted prices or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. Because we are responsible for the determination of fair value, we perform analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value.
The fair value and unrealized losses for PPIX’s securities that were temporarily impaired as of December 31, 2018 and December 31, 2017 are as follows:
PPIX evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. PPIX found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed. Our fixed maturity portfolio is managed by our investment committee in concert with an outside investment manager for investment grade bond investments. By agreement, the investment manager cannot sell any security without the consent of our investment committee if such sale will result in a net realized loss.
The fair value and unrealized losses for PCA’s securities that were temporarily impaired as of December 31, 2018 and December 31, 2017 are as follows:
Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions.
PCA evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. PCA found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed.
The table below presents the level within the fair value hierarchy generally utilized by PIPE to estimate the fair value of assets disclosed on a recurring basis at December 31, 2018 (in thousands) (audited):
The table below presents the level within the fair value hierarchy generally utilized by PIPE to estimate the fair value of assets disclosed on a recurring basis at December 31, 2017 (in thousands) (audited):
Our management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. Our management reviews all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in common sectors, durations, and credit ratings. This review will also include all fixed maturity securities rated lower than “A” by Moody’s or S&P. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service. In its review, management did not identify any such discrepancies for the years ended December 31, 2018 and 2017; accordingly, no adjustments were made to the estimates provided by the pricing service for the years ended December 31, 2018 and 2017. The classification within the fair value hierarchy of ASC 820, Fair Value Measurement, is then confirmed based on the final conclusions from the pricing review.
At December 31, 2018 and December 31, 2017, PCA’s deferred acquisition costs and the related unearned premium reserves were as follows (dollars in thousands):
At December 31, 2018 and December 31, 2017, PIPE’s deferred acquisition costs and the related unearned premium reserves were as follows (dollars in thousands):
We cede reinsurance risk to other insurance companies. This arrangement allows us to reduce the net loss potential arising from large risks. Reinsurance contracts do not relieve us of our obligation to our policyholders. Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract.
At December 31, 2018 and December 31, 2017, PPIX had no material unrecognized tax benefits or accrued interest and penalties. Federal tax years 2015 through 2017 are open for examination.
PCA had gross deferred tax assets of $1.4 million and $0.5 million at December 31, 2018 and December 31, 2017, respectively. At December 31, 2018 and 2017, PCA had unused net operating loss carryforwards of $3.9 million and $0, respectively. A valuation allowance is required to be established for any portion of the deferred tax asset for which PCA believed it is more likely than not that it will not be realized. PCA believed it is more likely than not that all of the deferred tax assets will be realized. Accordingly, no valuation allowance had been established at December 31, 2018 and December 31, 2017.
Our premium levels and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the MPLI industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle and makes it difficult to attract and retain properly priced MPLI business. The markets we operate in, and the national MPLI markets, are currently experiencing a soft market cycle. Therefore, it is generally unlikely that insurers will be able to increase their rates or profit margins. A soft market typically has a negative effect on premium growth, which can include absolute reductions in premiums written.
As discussed above, we evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to using GAAP based performance measurements, we also utilize certain financial performance measures that are used widely in the property and casualty insurance industry and that we believe are valuable in managing our business and for comparison to our peers. These financial performance measures are underwriting income, losses and loss adjustment expenses ratio, expense ratio, combined ratio, and net written premiums to statutory surplus ratio.
During the years ended December 31, 2018 and 2017, PPIX had favorable developments of $2.9 million and $2.6 million, respectively. The favorable development of $2.6 million during the year ended December 31, 2017 was primarily related to settlement of known claims below the amount for which they have been previously reserved, as well as additional revisions to PPIX’s estimate of its ultimate losses for the 2012 through 2015 accident years. The favorable development of $2.9 million during the year ended December 31, 2018 was primarily related to reductions of the ultimate losses for the 2010, 2011, and 2015 policy years which were offset by strengthening the ultimate loss reserves for the 2016 and 2017 policy years.
The provision for income taxes for the years ended December 31, 2018 and 2017 resulted in income tax benefits of $(101,000) and $(260,000), respectively. PPIX’s effective tax rate for the years ended December 31, 2018 and 2017 was 21% and 34%, respectively.
For the year ended December 31, 2018, PPIX had a net loss of $(63,000) as compared to a net loss of ($21,000) for the year ended December 31, 2017.
As a result of the conversion on March 27, 2019, PPIX merged with and into PPIX Conversion Corp., and PPIX no longer exists as a separate company. Upon completion of the conversions of PPIX, PCA and PIPE on March 27, 2019, the combination of PPIX Conversion Corp., PIPE Conversion Corp., and PCA Conversion Corp., and the offering, the pro forma shareholders’ equity of Positive Insurance Company was approximately $69.7 million. This increased capitalization should permit Positive Insurance Company to (i) increase direct premium volume to the extent competitive conditions permit, (ii) increase net premium volume by decreasing reliance on reinsurance, and (iii) enhance investment income by increasing Positive Insurance Company’s investment portfolio.
The following table summarizes, as of December 31, 2018, PPIX’s future payments under contractual obligations and estimated claims and claims related payments for continuing operations.
For the year ended December 31, 2018, cash flows from operations were $(2.1) million as compared to $3.7 million for the year ended December 31, 2017. The decrease in cash flows from operating activities was primarily attributable to the timing of paid losses. For the year ended December 31, 2018, cash flows from investing activities were $1.5 million as compared to $(6.1) million for the year ended December 31, 2017. The smaller decrease in cash flows from investing activities is primarily attributable to the time necessary to reinvest maturing securities. For the year ended December 31, 2018, cash flows from financing activities were $0.4 million as compared $(0.6) million for the year ended December 31, 2017. The increase in cash flows from financing activities for 2018 is attributable to execution of a $500,000 surplus note between PPIX and PIPE.
PPIX had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital reserves.
The table below shows the interest rate sensitivity of PCA’s fixed maturity investments measured in terms of fair value (which is equal to the carrying value for all of its investment securities that are subject to interest rate changes) at December 31, 2018 (unaudited):
Equity price risk is the risk that the exchange will incur economic losses on its equity securities due to adverse changes in equity prices.
Net investment income for the year ended December 31, 2018 was $0.3 million as compared to $0.6 million for the year ended December 31, 2017. The average monthly net investment income decreased from $48,000 for the year ended December 31, 2017 to $27,000 for the year ended December 31, 2018. For the year ended December 31, 2018, PCA adopted an accounting standard which requires that unrealized gains or losses for equity securities previously classified as available-for-sale securities for 2017 be recorded against earnings of the exchange. The effect of adopting the accounting standard was to reduce net investment income by $0.4 million or a reduction of the average monthly net investment income amount for 2018 by $35,000. With the exclusion of adopting the new accounting standard, the average monthly net investment income would have been $62,000 and the return on average cash and invested assets would have been 2.38% for the year ended December 31, 2018.
PCA had net realized gains of $10,000 for the year ended December 31, 2018 as compared to net realized gains of approximately $13,000 for the year ended December 31, 2017.
As discussed above, we evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to using GAAP based performance measurements, we also utilize certain financial performance measures that are used widely in the property and casualty insurance industry. These financial performance measures are underwriting income (loss), losses and loss adjustment expenses ratio, expense ratio, combined ratio, and net written premiums to statutory surplus ratio.
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs, were $3.4 million for the year ended December 31, 2018 as compared to $3.5 million for the year ended December 31, 2017. PCA had $153,000 and $125,000 in initial public offering and conversion costs that were expensed in 2018 and 2017, respectively, and are included in underwriting and administrative expenses. Administrative costs are directly tied to the amount of premiums written by PCA in a given period, because the fees payable to PTP were equal to 25% of the premiums written by PCA.
PCA had a pre-tax loss of $(6.0) million for the year ended December 31, 2018 as compared to pre-tax income of $0.5 million for the year ended December 31, 2017. The decrease in income before income taxes between the years ended December 31, 2017 and 2018 is primary related due to a reduction in net premiums earned of $0.4 million and an increase in loss and loss adjustment expenses of $6.0 million.
At December 31, 2018, PCA had total assets of $36.0 million as compared to $39.6 million at December 31, 2017. Total assets decreased by $3.6 million from December 31, 2017 and December 31, 2018. Total cash and invested assets decreased by $4.2 million from December 31, 2017 to December 31, 2018, due to the timing of receipt of reinsurance receivables, lower premiums in 2018 as compared to 2017, an increase of loss
At December 31, 2018, PCA had total equity of $9.0 million as compared to $13.9 million at December 31, 2017. The change in equity during the year ended December 31, 2018 is related to comprehensive loss of $(4.9) million. The change in equity during the year ended December 31, 2017 is related to comprehensive income of $0.6 million.
PCA generated sufficient funds from its operations and maintained a high degree of liquidity in its investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of funds were premium collections, investment earnings, and maturing investments.
PCA maintained investment and reinsurance programs that were intended to provide sufficient funds to meet its obligations without forced sales of investments. PCA maintained a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.
The following table summarizes, as of December 31, 2018 (unaudited), PCA’s future payments and estimated claims and claims related payments for continuing operations.
The following table sets forth PIPE’s average cash and invested assets and investment income for the years ended December 31, 2018 and 2017 (dollars in thousands) (unaudited):
PIPE’s fixed maturity investments are available-for-sale because it would, from time to time, make sales of securities that are not impaired, consistent with its investment goals and policies. At December 31, 2018, PIPE had gross unrealized losses on fixed maturity securities of approximately $453,000 as compared to gross unrealized losses on fixed maturity securities of $188,000 at December 31, 2017. Most of these unrealized losses were attributable to fluctuations in interest rates. PIPE evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. PIPE believed that the foregoing declines in fair value in its existing portfolio are most likely attributable to fluctuations in interest rates, and there is no evidence the entire amortized cost basis will not be recovered.
Underwriting income (loss) measures the pretax profitability of a company’s insurance business. It is derived by subtracting losses and loss adjustment expenses, amortization of deferred policy acquisition costs, and underwriting and administrative expenses from earned premiums. Each of these captions is presented in our statements of operations but not subtotaled. The sections below provide more insight into the variances in the categories of losses and loss adjustment expenses and amortization of deferred policy acquisition costs and underwriting and administrative expense, which impact underwriting profitability.
Amortization of Deferred Policy Acquisition Costs and Underwriting and Administrative Expenses
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs, were $2.0 million for the year ended December 31, 2018 as compared to $1.9 million for the year ended December 31, 2017. PIPE had $151,000 and $99,000 in initial public offering and conversion costs in 2017 and 2016, respectively, which are included in underwriting and administrative expenses. Administrative costs are directly tied to the amount of premiums written by PIPE in a given period, because the fees payable to PIPE Management were equal to 25% of the premiums written by PIPE.
Each Pennsylvania domiciled property and casualty insurer pays PIGA an annual assessment based on its premiums written in Pennsylvania. PIPE incurred assessment expense of $3,000 and 27,000 for the years ended December 31, 2018 and 2017, respectively.
PIPE generated sufficient funds from its operations and maintained a high degree of liquidity in its investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of funds were premium collections, investment earnings and maturing investments.
PIPE maintained investment and reinsurance programs that were intended to provide sufficient funds to meet its obligations without forced sales of investments. PIPE maintained a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.
The timing of the amounts of the gross losses and loss adjustment expense payments is an estimate based on historical experience and the expectations of future payment patterns. However, the timing of these payments may vary from the amounts stated above.
For the year ended December 31, 2018, cash flows from operations was ($1.3) million as compared to $(1.1) million for the year ended December 31, 2017. The larger negative cash flows from operating activities was primarily attributable to the timing of paid losses and less premium written in 2018 as compared to 2017. For the year ended December 31, 2018, cash flows from investing activities were $0.2 million as compared to $(5.1) million for the year ended December 31, 2017. The positive cash flows from investing activities is primarily attributable to the time necessary to reinvest maturing securities and the execution of the surplus note receivable between PIPE and PPIX during the year ended December 31, 2018. For the years ended December 31, 2018 and 2017, there were no cash flows from financing activities.
We have audited the accompanying balance sheet of Positive Physicians Holdings, Inc (the “Company”) as of December 31, 2018, the related statements of income, and cash flows, for the period from May 1, 2018 (date of inception) to December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the period from May 1, 2018 (date of inception) to December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America.
PPIX, PCA, and PIPE were reciprocal insurance exchanges. As such, they had no shareholders, but did have subscribers or members. The subscribers of PPIX, PCA, and PIPE were their policyholders. Unlike shareholders, the subscribers had no voting rights with respect to the governance of their respective exchange. All of the decision making authority relating to the operations and governance of a reciprocal insurance exchange resided in the attorney-in-fact, which under the organizational documents of PPIX, PCA, and PIPE, could only be terminated with the mutual agreement of the attorney-in-fact and the respective exchange. The subscribers only had such voting rights as were required by Pennsylvania law, including the right to vote to approve the conversion from reciprocal insurance exchange to stock form. In addition, unlike shares held by shareholders, the memberships in PPIX, PCA, and PIPE were not transferable and did not exist separate from the related insurance policy issued by the exchange. Therefore, these membership rights were extinguished when a policyholder canceled or did not renew its policy or the policy is otherwise terminated.
On June 1, 2018, PIPMC adopted a plan of conversion by which PIPE would convert from a reciprocal insurance exchange to a stock insurance company by merging with and into PIPE Conversion Corp. Following the conversion, PIPE Conversion Corp. became a wholly owned subsidiary of the Company. The affirmative vote of at least two-thirds of the votes cast by subscribers of PIPE as of June 1, 2018, is necessary to approve the plan of conversion at a special meeting of the subscribers which was held on March 25, 2019.
Under the subscription offering phase, the eligible subscribers of PPIX, PCA, and PIPE as of June 1, 2018 have the right to purchase shares of common stock in the offering subject to the limitation that no eligible subscriber can, together with its affiliates, purchase more than 5,000 shares in the offering and to the allocation of shares in the event of an oversubscription, as defined.
Under the community offering phase, shares of common stock will be offered to certain stockholders of Diversus and to ICG and Enstar Holdings (US) LLC (“Enstar”), the majority stockholder of Diversus. Unlike the subscription offering, except for ICG and Enstar, purchasers in the community offering do not have any right to purchase shares in the offering, and their orders are subordinate to the rights of the purchasers in the subscription offering.
The standby purchaser’s right to purchase shares in the offering is subject to the rights of eligible subscribers to purchase in the subscription offering phase. If purchasers in the subscription offering phase subscribe to purchase all of the 4,830,000 shares offered hereby, ICG, Enstar, and Diversus stockholders will be unable to purchase shares in the offering. Additionally, if purchasers in the subscription offering subscribe to purchase 2,415,000 shares or more, ICG will not be able to purchase a majority of the number of shares in the offering. Accordingly, ICG’s ownership percentage of the Company’s common stock after the completion of the offering will range from 0% to 60%.
ICG has agreed to loan up to $750,000 to the Company to fund expenses the Company would incur in connection with the conversion and the offerings. The Company has issued an exchangeable note to ICG in connection with such credit facility. The outstanding principal balance of the exchangeable note will automatically convert into shares of the Company’s common stock at a price of $10 per share upon completion of the offerings. The shares issued upon the conversion of the exchangeable note will count towards the minimum number of shares that must be sold in the offerings. Enstar has agreed with ICG that Enstar will fund 30% of the advances made under the exchangeable note. At December 31, 2018, there was no outstanding balance of the exchangeable note.
During the year ended December 31, 2018, PPIX, PCA, and PIPE paid for certain conversion and securities offering costs on behalf of the Company. The amount due to the exchanges at December 31, 2018 was $261,207.
The Company has agreed to provide a $6,000,000 credit facility to Diversus to provide working capital. Diversus may borrow up to $500,000 at any time and may borrow additional amounts at any time after the completion of the conversions and the offering. Outstanding borrowings under the credit facility will bear interest at 8%, will be unsecured, and will be subordinate to the existing senior debt and other commercial loan obligations of Diversus. The loan is to be convertible into common stock shares of Diversus at a price of $1 per share at the option of Diversus. At December 31, 2018, there was no outstanding balance of the credit facility.
Upon completion of the conversions of PPIX, PCA, and PIPE and the securities offering, the Company and Diversus entered into an option agreement on March 27, 2019 whereby either party has the option to cause Diversus to merge with and become a wholly-owned subsidiary of the Company. Under the terms of the agreement, the option may be exercised by either the Company or Diversus at any time (1) during the period beginning two years after completion of the conversions of the exchanges and ending 54 months after the completion of the conversions, or (2) if earlier than two years after the completion of the conversions, then such date that ICG no longer has the right to appoint a majority of the board of directors of the Company. In connection with any merger, the common stock shareholders of Diversus will receive either cash, common stock shares of the Company, or some combination thereof for their shares of Diversus’s common stock. In regard to the preferred stock shares of Diversus, they will either be paid out in cash or converted into common stock shares of Diversus as if such preferred stock shares were converted into Diversus’s common stock shares immediately prior to the effective date of the merger.
The order of the Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by the Company to ICG or Enstar without the prior approval of the Department, for a period of three years following the effective date of the conversions.
FOR THE PERIOD FROM MAY 1, 2018 (DATE OF INCEPTION) TO DECEMBER 31, 2018