Investment income is an important element of our net income. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in other lines of business that pay claims more quickly. From December 31, 2013 to December 31, 2018, our investment portfolio, including cash and cash equivalents, increased from $1.0 billion to $1.2 billion and produced net investment income of $30.5 million in 2018, $29.3 million in 2017 and $28.1 million in 2016.
For example, for the five-year period ended December 31, 2018 we had recorded 78 severe claims, or an average of 16 severe claims per year for accident years 2014 through 2018. The number of severe claims reported in any one accident year in this five-year period ranged from a low of 12 in 2014 to a high of 21 in 2016. The average reported case severity for these claims ranged from $2.2 million for the 2015 accident year to $2.9 million for the 2014 accident year. For the five accident years, the case incurred for these severe claims accounted for an average of 10.6 percentage points of our overall loss and loss adjustment expense, or LAE, ratio, measured at December 31, 2018.
Our gross reserves for loss and loss adjustment expenses at December 31, 2018, 2017 and 2016 were $798.4 million, $771.8 million and $742.8 million, respectively. As a percentage of gross reserves at year end, IBNR represented 20.1% in 2018, 16.8% in 2017 and 22.2% in 2016.
Premiums are earned on a daily pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2018 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2018 and the other half in 2019. On a monthly basis, we also recognize net premiums earned from mandatory pooling arrangements.
Premiums Receivable. Premiums receivable represents premium-related balances due from our policyholders based on annual premiums for policies written, including surcharges and deposits and adjustments for premium audits, endorsements, cancellations, cash transactions and charge offs. The balance is shown net of the allowance for doubtful accounts and includes an estimate for EBUB. The EBUB estimate is subject to significant variability and can either increase or decrease premiums receivable and earned premiums based upon several factors, including changes in premium growth, industry mix and economic conditions. EBUB assumptions include historical development factors, current economic outlook and current trends in particular sectors of our business.
The current accident year loss ratio is calculated by dividing loss and loss adjustment expenses incurred for the current accident year by the current year’s net premiums earned.
The net combined ratio is the sum of the net loss ratio, the net underwriting expense ratio and the net dividend ratio.
Gross Premiums Written. Gross premiums written for 2018 were $351.7 million, compared to $350.3 million for 2017, an increase of 0.4%. The increase was attributable to a $6.8 million increase in premiums resulting from payroll audits and related premium adjustments which was offset by a $5.2 million decrease in annual premiums on voluntary policies written during the period. Related premium adjustments in 2018 include a $1.2 million increase in “earned but unbilled”, or EBUB, premium.
Net Premiums Earned. Net premiums earned for 2018 were $350.3 million, compared to $346.2 million for 2017, an increase of 1.2%. The increase was attributable to the increase in net premiums written during the period.
Net Investment Income. Net investment income in 2018 was $30.5 million, an increase of 4.0% from the $29.3 million reported in 2017. The pre-tax investment yield on our investment portfolio was 2.6% per annum for 2018 versus 2.5% per annum for 2017. The tax-equivalent yield on our investment portfolio was 3.2% per annum for 2018, compared to 2.9% per annum for 2017. The tax-equivalent yield is calculated using the effective interest rate and the appropriate marginal tax rate as of January 1, 2019. Average invested assets, including cash and cash equivalents, increased 0.5%, from an average of $1,188.7 million for 2017 to an average of $1,195.1 million for 2018.
Loss and Loss Adjustment Expenses Incurred. Loss and LAE incurred totaled $204.9 million for 2018, compared to $209.3 million for 2017, a decrease of $4.4 million, or 2.1%. The current accident year losses and LAE incurred were $250.5 million, or 71.5% of net premiums earned, compared to $244.1 million, or 70.5% of net premiums earned for 2017. We recorded favorable prior accident year development of $45.6 million in 2018, compared to $34.8 million in 2017. This is discussed in more detail below in “Prior Year Development.” Our net loss ratio was 58.5% for 2018 and 60.5% for 2017.
Net Premiums Written. Net premiums written for 2017 were $341.4 million, compared to $362.7 million for 2016, a decrease of 5.9%. The decrease was primarily attributable to the decrease in gross premiums written. As a percentage of gross premiums earned, ceded premiums were 2.5% for 2017 compared to 2.7% for 2016.
Net Investment Income. Net investment income in 2017 was $29.3 million, an increase of 4.2% from the $28.1 million reported in 2016. The pre-tax investment yield on our investment portfolio was 2.5% per annum for 2017 and 2016. The tax-equivalent yield on our investment portfolio was 2.9% per annum for 2017, compared to 3.2% per annum for 2016. The tax-equivalent yield is calculated using the effective interest rate and the appropriate marginal tax rate. Average invested assets, including cash and cash equivalents, increased 2.0%, from an average of $1,165.4 million for 2016 to an average of $1,188.7 million for 2017.
Income tax expense. Income tax expense for 2017 was $36.0 million, compared to $35.0 million for 2016. The effective tax rate also increased to 43.8% for 2017, compared to 31.0% for 2016. This increase is due to the impact of tax reform legislation requiring a revaluation of our net deferred tax assets. Excluding the impact of tax reform, our effective rate for 2017 was 28.4% compared to 31.0% for 2016. This decrease is due to a higher proportion of tax-exempt investment income to underwriting income relative to 2016.
The Company recorded favorable prior accident year loss and loss adjustment expense development of $45.6 million in calendar year 2018, $34.8 million in calendar year 2017 and $51.3 million in calendar year 2016. The table below sets forth the favorable development for accident years 2013 through 2017 and, collectively, all accident years prior to 2013.
In 2016, major components of net cash used in investing activities included investment purchases of $354.6 million and net purchases of furniture, fixtures and equipment of $1.6 million, offset by proceeds from sales and maturities of investment of investments of $305.8 million.
Major components of cash used in financing activities in 2017 included cash used for dividends paid to shareholders of $82.6 million. Major components of cash used in financing activities in 2016 included cash used for dividends paid to shareholders of $76.1 million, offset by $1.0 million of tax benefit from share-based compensation and $0.8 million of proceeds from the exercise of stock options.
The Board of Directors initially authorized the Company’s share repurchase program in February 2010. In October 2016, the Board reauthorized this program with no expiration date. As of December 31, 2018, we had repurchased a total of 1,258,250 shares of our outstanding common stock for $22.4 million. The Company had $25.0 million available for future purchases at December 31, 2018 under this program. There were no share repurchases in 2018, 2017 or 2016. The purchases may continue to be effected from time to time depending upon market conditions and subject to applicable regulatory considerations. It is anticipated that future purchases will be funded from available capital.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including AIIC, SOCI and AIICTX. AMERISAFE’s primary assets are the capital stock of these insurance subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. Based upon the prescribed calculation, the insurance subsidiaries could pay to AMERISAFE dividends of up to $71.0 million in 2019 without seeking regulatory approval. See “Business-Regulation-Dividend Limitations” in Item 1 of this report.
In 2018, 2017, 2016, 2015 and 2014, the Company paid regular quarterly cash dividends of $0.22, $0.20, $0.18, $0.15 and $0.12 per share, respectively. In addition, the Company paid extraordinary cash dividends of $3.50 in 2018, $3.50 in 2017, $3.25 in 2016, $3.00 in 2015 and $0.50 and $1.00 per share in 2014.
During 2018 and 2017, the Company had no impairment losses recognized for other-than-temporary declines in the fair value of our investments.
Rental expense was $0.2 million in 2018, $0.1 million in 2017 and $0.2 million in 2016, respectively.
The table below provides information with respect to our contractual obligations as of December 31, 2018.
The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2018 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense process, see “Business-Loss Reserves” in Item 1 of this report. Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the amounts shown in the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors- Risks Related to Our Business-Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Item 1A of this report for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
Audited Financial Statements as of December 31, 2018 and 2017 and for the three years in the period ended December 31, 2018:
Schedules I, III, IV and V are not applicable and have been omitted
To the Shareholders and the Board of Directors of AMERISAFE, Inc. and subsidiaries
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, 2018, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 28, 2019 expressed an unqualified opinion thereon.
In January 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance requires fair value measurement for equity investments (not including those that result in consolidation of the investee or use the equity method of accounting) and the recognition of changes in fair value to be presented as a component of net income. The guidance also revises the disclosure requirements related to fair value changes of liabilities presented in comprehensive income, eliminates disclosure related to the methods and assumptions underlying fair value for financial instruments measured at amortized cost, and simplifies impairment assessments for equity investments without readily determinable fair values. The adoption of this new guidance in the first quarter of 2018 resulted in an immaterial decrease in net income of $390 thousand or a $0.02 decrease to our diluted earnings per common share. At December 31, 2017, equity investments were classified as available-for-sale on the Company’s balance sheet. However, upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity investments.
In May 2014, the FASB issued ASU 2014-09 (Topic 606): Revenue from Contracts with Customers. The guidance revises the criteria for revenue recognition and requires that the revenue recognized reflect the transfer of promised goods or services to customers in an amount that represents the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard was effective for us in the first quarter of 2018. The adoption of the new guidance had no impact on the Company's reporting and disclosure of net premiums earned, net investment income or net realized gains and losses, as these items are not within the scope of this new guidance. The remaining revenue sources are immaterial.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Under current guidance for lessees, leases are only included on the balance sheet if certain criteria, classifying the contract as a capital lease, are met. The new guidance requires a lessee to recognize a lease liability and a right of use asset for all leases extending beyond twelve months. The new guidance is effective for us in the first quarter of 2019. We will elect the new transition method under the transition guidance within the new standard which means prior comparative periods will not be adjusted. We will also elect the package of practical expedients, which among other things, allows us to carryforward the historical lease classification. We will make an accounting policy election not to recognize lease assets and lease liabilities for short-term operating leases. Adoption of the guidance is not expected to have a material effect on the Company’s consolidated financial statements as the Company does not have any significant leases.
The Company has the ability and positive intent to hold certain investments until maturity. Therefore, fixed maturity securities classified as held-to-maturity are recorded at amortized cost. Fixed maturity securities classified as available-for-sale are recorded at fair value. Temporary changes in the fair value of these securities are reported in shareholders’ equity as a component of other comprehensive income, net of deferred income taxes. Changes in the fair value of equity securities are recorded in net income.
The Company regularly reviews the fair value of its investments. Impairment of an investment security results in a reduction of the carrying value of the security and the realization of a loss when the fair value of the security declines below the cost or amortized cost, as applicable, for the security and the impairment is deemed to be other-than-temporary. The Company regularly reviews its investment portfolio to evaluate the existence of other-than-temporary declines in the fair value of investments. The Company considers various factors in determining if a decline in the fair value of an individual security is other-than-temporary, including but not limited to a reduction or interruption in scheduled cash flows, the financial condition of the issuer, how long and by how much the fair value has been below amortized cost, losses due to credit concerns, downgrades and the Company’s intent to sell or ability to hold the security.
The direct costs of successfully acquiring and renewing business are capitalized to the extent recoverable and are amortized over the effective period of the related insurance policies in proportion to premium revenue earned. These capitalized costs consist mainly of sales commissions, premium taxes and other underwriting costs. The Company evaluates deferred policy acquisition costs for recoverability by comparing the unearned premiums to the estimated total expected claim costs and related expenses, offset by anticipated investment income. The Company would reduce the deferred costs if the unearned premiums were less than expected claims and expenses after considering investment income, and report any adjustments in amortization of deferred policy acquisition costs. There were no adjustments necessary in 2018, 2017 or 2016.
All advertising expenditures incurred by the Company are charged to expense in the period to which they relate and are included in underwriting and certain other operating costs in the consolidated statements of income. Total advertising expenses incurred were $0.5 million in 2018 and 2017, and $0.7 million in 2016.
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as held-to-maturity at December 31, 2018 are summarized as follows:
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as available-for-sale at December 31, 2018 are summarized as follows:
At December 31, 2018, the Company held 398 individual fixed maturity securities that were in an unrealized loss position, of which 323 were in a continuous unrealized loss position for longer than 12 months.
an evaluation as to whether there are any credit losses on debt securities.
In 2018, 2017 and 2016, there were no impairment losses recognized for other-than-temporary declines in the fair value of our investments.
The Company received reinsurance recoveries of $1.3 million in 2018, $1.6 million in 2017 and $0.5 million in 2016.
The average annual percentage payout of incurred claims by age, net of reinsurance, for workers’ compensation and general liability as of December 31, 2018 is summarized below. Since workers’ compensation has long payout periods, the table below shows less than 100% in the years disclosed. This is required supplementary information, which is unaudited.
The following table provides a reconciliation of the beginning and ending reserve balances, net of related amounts recoverable from reinsurers, for 2018, 2017 and 2016:
The following table summarizes information about the common and restricted stock activity under the 2012 Incentive Plan:
The Company recognized compensation expense of $726,000, $884,000 and $849,000 in 2018, 2017 and 2016, respectively, related to share-based grants. The Company recognized compensation expense of $976,000, $724,000 and $334,000 in 2018 2017 and 2016, respectively, related to long-term incentive awards under the 2012 Incentive Plan. The long-term incentive award is a liability award.
The AMERISAFE Non-Employee Director Restricted Stock Plan (the “Restricted Stock Plan”) is administered by the Compensation Committee of the Board and provides for the automatic grant of restricted stock awards to non-employee directors of the Company. Awards to non-employee directors are generally subject to terms including non-transferability, immediate vesting upon death or total disability of a director, forfeiture of unvested shares upon termination of service by a director and acceleration of vesting upon a change of control of the Company. The maximum number of shares of common stock that may be issued pursuant to restricted stock awards under the Restricted Stock Plan is 150,000 shares, subject to the authority of the Board to adjust this amount in the event of a merger, consolidation, reorganization, stock split, combination of shares, recapitalization or similar transaction affecting the common stock. At December 31, 2018, there were 57,907 shares of common stock available for future awards under the Restricted Stock Plan.
The following table summarizes information about the restricted stock activity under the Non-Employee Director Restricted Stock Plan:
The Company recognized compensation expense of $351,000 in 2018, $355,000 in 2017 and $361,000 in 2016 related to the Non-Employee Director Restricted Stock Plan. There were no tax benefits realized for tax deductions from vesting of restricted stock in 2018 and 2017. Total tax benefits realized for tax deductions from vesting of restricted stock in 2016 was $52,000.
Net premiums earned during 2018, 2017 and 2016 for the top ten states in 2018 and all others are shown below:
Investments-The Company’s fixed maturity securities are priced by an independent pricing service. The prices provided by the independent pricing service are estimated based on observable market data in active markets utilizing pricing models and processes, which may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, sector groupings, matrix pricing and reference data. The Company reviews the prices provided by pricing services for reasonableness and compares them to prices provided by the Company’s custodian which uses different pricing services.
The Company carries available-for-sale securities at fair value in our consolidated financial statements and determines fair value measurements and disclosure in accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures.
The Company determines the fair values of its financial instruments based on the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard defines fair value, describes three levels of inputs that may be used to measure fair value, and expands disclosures about fair value measurements.
ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset, also known as current replacement cost. Valuation techniques used to measure fair value are to be consistently applied.
The fair values of the Company’s investments are based upon prices provided by an independent pricing service. The Company has reviewed these prices for reasonableness and has not adjusted any prices received from the independent provider. Securities reported at fair value utilizing Level 1 inputs represent assets whose fair value is determined based upon observable unadjusted quoted market prices for identical assets in active markets. Level 2 securities represent assets whose fair value is determined using observable market information such as previous day trade prices, quotes from less active markets or quoted prices of securities with similar characteristics. There were no transfers between Level 1 and Level 2 during the year ended December 31, 2018.
There was an immaterial transfer between Level 1 and Level 3 in 2017 due to the reclassification of a common stock security with unobservable fair value inputs.
At December 31, 2018, the Company held one security measured at fair value on a nonrecurring basis due to a recognized impairment of $100,000. The security is valued using Level 2 inputs and had a value of $11,000 at December 31, 2018. The security was valued at fair value at the time of impairment and is currently being carried at the adjusted amortized cost. The fair value of the security is $31,000 at December 31, 2018.
The Company’s Board of Directors initiated a share repurchase program in February 2010. In October 2016, the Board reauthorized this program with a limit of $25.0 million with no expiration date. There were no shares repurchased under this program in 2018. Since the beginning of this plan, the Company has repurchased a total of 1,258,250 shares for $22.4 million, or an average price of $17.78, including commissions.
In 2013, the Company’s Board of Directors initiated a regular quarterly dividend. During 2018, the Company’s Board of Directors declared a quarterly dividend of $0.22 per share compared to $0.20 per share in 2017, $0.18 per share in 2016, $0.15 per share in 2015, $0.12 per share in 2014 and $0.08 per share in 2013. The Company declared extraordinary dividends totaling $3.50 per share in 2018 and 2017, $3.25 per share in 2016, $3.00 per share in 2015 and $1.50 per share in 2014. The Company did not pay any extraordinary cash dividends in 2013.
The Board intends to continue to consider the payment of a regular cash dividend each calendar quarter. On an annualized basis, the cash dividend is expected to be $1.00 per share.