Our executive offices and insurance operations are located in Richmond, Virginia, which occupy approximately 42,000 square feet of office space for annual rent of approximately $0.5 million. The lease for this space expires in 2020.
We do not own any real property. We believe that our facilities are adequate for our current needs.
Tangible stockholders’ equity is a non-GAAP financial measure. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Financial Condition" for a reconciliation of stockholders’ equity to tangible stockholders’ equity.
The ratio, expressed as a percentage, of total indebtedness for borrowed money, including capitalized lease obligations, to the sum of total indebtedness for borrowed money, including capitalized lease obligations, and stockholders’ equity.
The loss ratio is the ratio, expressed as a percentage, of losses and loss adjustment expenses to net earned premiums, net of the effects of reinsurance.
The adjusted loss ratio, adjusted expense ratio and adjusted combined ratio are non-GAAP financial measures. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Our Results of Operations - The MLQS."
Founded in 2009, we are an established and growing specialty insurance company. We focus exclusively on the E&S market in the U.S., where we can use our underwriting expertise to write coverages for hard-to-place small business risks and personal lines risks. We market and sell these insurance products in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands primarily through a network of independent insurance brokers. We have an experienced and cohesive management team, that has an average of over 25 years of relevant experience. Many of our employees and members of our management team have also worked together for decades at other E&S insurance companies.
We have one reportable segment, our Excess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2017, the percentage breakdown of our gross written premiums was 93.4% casualty and 6.6% property. Our commercial lines offerings include construction, small business, excess casualty, energy, general casualty, professional liability, life sciences, product liability, allied health, health care, commercial property, management liability, environmental, inland marine, public entity and commercial insurance. We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 3.9% of our gross written premiums in 2017.
Prior to our IPO in 2016, a significant amount of our business had been reinsured through our MLQS with third-party reinsurers. This agreement allowed us to cede a portion of the risk related to certain lines of business that we underwrite in exchange for a portion of our direct written premiums on that business, less a ceding commission. The MLQS was subject to annual renewal; however, we retained the right to adjust the amount of business we ceded on a quarterly basis in accordance with the terms of the MLQS. We monitored the ceding percentage under the MLQS and adjusted this percentage based on our projected direct written premiums and future business conditions in our industry. Generally, we increased the ceding percentage when gross written premiums were growing more strongly relative to the growth rate of Kinsale Insurance’s capital position, and decreased the ceding percentage when Kinsale Insurance’s capital position was growing more strongly relative to the growth rate of gross written premiums. In periods of high premium rates and shortages of underwriting
Effective January 1, 2016, we further reduced the ceding percentage from 40% to 15% while maintaining the provisional ceding commission rate at 41%, and we commuted the MLQS covering the 2014 calendar year. We reduced the ceding percentage due to Kinsale Insurance’s capital position growing more strongly as a result of the profitability of the business relative to the growth rate of gross written premiums. As a result of the successful completion of our IPO in August 2016, we terminated and commuted the MLQS contract on October 1, 2016, which covered the period January 1, 2016 through September 30, 2016, and the MLQS was not renewed for the 2017 calendar year. Effective January 1, 2017, the remaining MLQS was commuted covering the 2015 calendar year, and there are no remaining MLQS contracts outstanding.
Our results of operations may be difficult to compare from year to year as we made periodic adjustments to the amount of business we ceded under the terms of the MLQS, may have changed the negotiated terms of the MLQS upon renewal, and may have increased or decreased the ceding commission under the MLQS based on the loss experience of the business ceded. In light of the impact of the MLQS on our results of operations, we internally evaluated our financial performance both including and excluding the effects of the MLQS.
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs that are directly related to the successful acquisition of those policies are deferred. The amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the policy life. Other underwriting expenses represent the general and administrative expenses of our insurance business including employment costs, telecommunication and technology costs, the costs of our lease, and legal and auditing fees. We reduced the ceding percentage under the MLQS from 40% to 15% effective January 1, 2016, and subsequently terminated and commuted the MLQS effective October 1, 2016.
Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% generally indicates an underwriting profit. A combined ratio over 100% generally indicates an underwriting loss.
Gross written premiums were $223.2 million for the year ended December 31, 2017 compared to $188.5 million for the year ended December 31, 2016, an increase of $34.7 million, or 18.4%. Premium growth in 2017 was due to an increase in the number of policies written, offset in part by a decrease in the average premium per policy. The average premium on a policy written by us was $8,200 in 2017 compared to $8,800 in 2016. The changes in gross written premiums were most notable in the following lines of business:
Energy, which represented approximately 10.3% of our gross written premiums in 2017, increased by $6.7 million, or 41.7%, for the year ended December 31, 2017 over the prior year;
The following table summarizes the components of the expense ratio for the years ended December 31, 2017 and 2016:
year. Excluding the effects of the MLQS, the adjusted expense ratio was 26.8% for the year ended December 31, 2016. The decrease in the expense ratio for the year ended December 31, 2017 compared to the adjusted expense ratio for the year ended December 31, 2016 was attributable to lower variable compensation costs primarily due to higher catastrophe losses, as well as higher net earned premiums without a proportional increase in the amount of other underwriting expenses resulting from management's focus on controlling costs. Direct commissions paid as a percent of gross written premiums was 14.8% for each of the years ended December 31, 2017 and 2016.
Our net investment income increased by 41.2% to $10.6 million for the year ended December 31, 2017 from $7.5 million for the year ended December 31, 2016, primarily due to the increase in our investment portfolio from proceeds received from the IPO in the latter half of 2016 and additional premiums collected in 2017.
The weighted average duration of our fixed income portfolio, including cash equivalents, was 3.9 years at December 31, 2017 and 3.7 years at December 31, 2016. Our investment portfolio had a gross return of 2.4% as of December 31, 2017, compared to 2.2% as of December 31, 2016.
For the year ended December 31, 2017, other expenses were comprised primarily of costs related to the Company's secondary common stock offering, which occurred during the second quarter of 2017. For the year ended December 31, 2016, other expenses were comprised primarily of interest expense related to a note payable that was repaid in the fourth quarter of 2016 and costs from the Company's initial and secondary common stock offerings, which occurred during the latter half of 2016.
Our net income was $26.2 million for the year ended December 31, 2016 compared to $22.3 million for the year ended December 31, 2015, an increase of $3.9 million, or 17.5%. Our underwriting income increased by $5.0 million, or 17.2%, to $34.3 million for the year ended December 31, 2016 compared to $29.3 million for the year ended December 31, 2015. The increase in our underwriting income reflected an increase in number of policies written and higher favorable prior year loss development during 2016 compared to 2015.
Gross written premiums were $188.5 million for the year ended December 31, 2016 compared to $177.0 million for the year ended December 31, 2015, an increase of $11.5 million, or 6.5%. Premium growth in 2016 was due to an increase in the number of policies written, offset in part by a decrease in the average premium per policy. The average premium on a policy written by us was $8,800 in 2016 compared to $10,400 in 2015. The changes in gross written premiums were most notable in the following lines of business:
Our loss ratio was 53.0% for the year ended December 31, 2016 compared to 56.8% for the year ended December 31, 2015. Our adjusted loss ratio was 50.0% for the year ended December 31, 2016 compared to 51.5% for the year ended December 31, 2015. The decrease in the loss ratio for 2016 was primarily due to higher favorable development across most of the statutory lines of business for the 2015 and 2014 accident years.
The following table summarizes the effect of the factors indicated above on the expense ratio for the years ended December 31, 2016 and 2015:
The increase in the expense ratio in 2016 was due primarily to the change in the ceding percentage under the MLQS for the year ended December 31, 2016 compared to December 31, 2015. Other underwriting expenses were $22.4 million for the year ended December 31, 2016 compared to $19.6 million for the year ended December 31, 2015, an increase of $2.8 million, or 14.0%. This increase was primarily due to higher employee compensation and public company costs for 2016 compared to 2015. Direct commissions paid as a percent of gross written premiums was 14.8% for each of the years ended December 31, 2016 and 2015.
Excluding the effects of the MLQS, the adjusted expense ratio was 26.8% for the year ended December 31, 2016 compared to 26.0% for the year ended December 31, 2015.
The following table summarizes the components of net investment income and net investment gains for the years ended December 31, 2016 and 2015:
We perform quarterly reviews of all securities within our investment portfolio to determine whether any other-than-temporary impairment has occurred. In connection with that review, we recognized an impairment loss of $0.3 million on our foreign market ETF for the year ended December 31, 2016. The impairment was based on our assessment of the security's prospect of recovery in the near term. Management concluded that none of the fixed maturity securities with an unrealized loss at December 31, 2016 experienced an other-than-temporary impairment.
Our other expenses increased by $0.6 million to $2.6 million for the year ended December 31, 2016 compared to $2.0 million for the year ended December 31, 2015 and the increase was due to costs related to our IPO and secondary offering.
Our cash flows for the years ended December 31, 2017, 2016 and 2015 were:
We have posted positive operating cash flow in each of the last three years. The fluctuation of cash provided by operating activities in 2017, 2016 and 2015 was due primarily to the timing of premium received, claim payments and reinsurance balances. Cash flows from operations in each of the past three years were used to fund investing activities and to pay dividends in 2017 and 2016.
Net cash used in investing activities decreased by $45.7 million in 2017 from 2016. Net cash used in investing activities during for the year ended December 31, 2017 reflected lower purchases of fixed maturity securities. During 2017, we were selective in our purchases of fixed income securities given current bond valuations, and held a significant portion of excess funds in cash equivalents. This was offset in part by higher purchases of equity securities during 2017, including $19.9 million of preferred stock. Net cash used by investing activities increased by $8.1 million in 2016 from 2015 primarily due to higher net purchases of fixed maturity investments of $6.0 million and equity securities of $2.1 million.
4, 2020. Our wholly-owned subsidiaries, Kinsale Management and Aspera, were guarantors of the term loan. The assets of Kinsale Management and the stock of Kinsale Insurance were pledged as collateral to PrivateBank.
For the year ended December 31, 2017, property insurance represented 6.6% of our gross written premiums. When we do write property insurance, we buy reinsurance to significantly mitigate our risk. We use computer models to analyze the risk of severe losses from weather-related events and earthquakes. We measure exposure to these catastrophe losses in terms of PML, which is an estimate of what level of loss we would expect to experience in a windstorm or earthquake event occurring once in every 100 or 250 years. We manage this PML by purchasing catastrophe reinsurance coverage. Effective June 1, 2017, we purchased catastrophe reinsurance coverage of $45 million per event in excess of our $5 million per event retention.
The following table illustrates our contractual obligations and commercial commitments by due date as of December 31, 2017:
Reserves for losses and loss adjustment expenses represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. As discussed previously, the estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis. The assumptions used in estimating the payments due by period are based on industry and peer-group claims payment experience. Due to the uncertainty inherent in the process of estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed above. Amounts disclosed above are gross of anticipated amounts recoverable from reinsurers. Reinsurance balances recoverable on reserves for losses and loss adjustment expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. Reinsurance balances recoverable on reserves for paid and unpaid losses and loss adjustment expenses totaled $49.6 million at December 31, 2017 and $70.3 million at December 31, 2016. Effective January 1, 2017, the Company commuted the 2015 MLQS, which reduced reinsurance recoverables on unpaid losses by approximately $27.9 million.
Tangible stockholders’ equity is a non-GAAP financial measure. We define tangible stockholders’ equity as stockholders’ equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders’ equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders’ equity
On May 17, 2017, the Company completed a second follow-on offering of 4,557,774 shares of common stock at a price of $33.00 per share, which included 594,492 shares sold to the underwriters pursuant to their over-allotment option. All of the shares in the offering were offered by the selling stockholders. The Company did not receive any proceeds from the offering.
On July 27, 2016, the Kinsale Capital Group, Inc. 2016 Omnibus Incentive Plan (the "2016 Incentive Plan"), became effective. The 2016 Incentive Plan provides for grants of stock options, stock appreciation rights, restricted stock, other stock-based awards and other cash-based awards to directors, officers and other employees, as well as independent contractors or consultants providing consulting or advisory services to the Company. The number of shares of common stock available for issuance under the 2016 Incentive Plan may not exceed 2,073,832. On July 27, 2016, the Board of Directors approved, and we granted, 1,036,916 stock options with an exercise price equal to the IPO price of $16.00 per share. The stock options have a maximum contractual term of 10 years, and will vest in 4 equal annual installments following the date of the grant.
On January 1, 2018, the Board of Directors granted 6,666 shares of restricted stock under the 2016 Incentive Plan to the Company’s directors. The restricted stock had a fair value on the date of grant of $45.00 per share and will vest over a 1 year period.
Our cash and invested assets consist of fixed maturity securities, cash and cash equivalents, equity securities and short-term investments. At December 31, 2017, $81.7 million represented the cash and cash equivalents portion of our total cash and invested assets of $561.1 million. The majority of the portfolio, or $425.2 million, was comprised of fixed maturity securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. Also included in our investments were $54.1 million of equity securities classified as available-for-sale. Our fixed maturity securities, including cash equivalents, had a weighted average duration of 3.9 years and an average rating of "AA" at December 31, 2017. Our investment portfolio had a gross return of 2.4% as of December 31, 2017, compared to 2.2% as of December 31, 2016.
We do not have any material off-balance sheet arrangements as of December 31, 2017.
The reserves for unpaid losses and loss adjustment expenses are the largest and most complex estimate in our consolidated balance sheet. The reserves for unpaid losses and loss adjustment expenses represent our estimated ultimate cost of all unreported and reported but unpaid insured claims and the cost to adjust these losses that have occurred as of or before the balance sheet date. As a relatively new company, our historical loss experience is limited. We estimate the reserves using individual case-basis valuations of reported claims and statistical analyses. Those estimates are based on our historical information, industry information and our estimates of future trends in variable factors such as loss severity, loss frequency and other factors such as inflation. We regularly review our estimates and adjust them as necessary as
Our Reserve Committee consists of our Chief Actuary, Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. The Reserve Committee meets quarterly to review the actuarial recommendations made by the Chief Actuary. In establishing the actuarial recommendation for the reserves for losses and loss adjustment expenses, our actuary estimates an initial expected ultimate loss ratio for our statutory lines of business by accident year. Input from our
underwriting and claims departments, including premium pricing assumptions and historical experience, is considered by our actuary in estimating the initial expected loss ratios. Our reserving methodology uses a loss reserving model that calculates a point estimate for our ultimate losses. Although we believe that our assumptions and methodology are reasonable, our ultimate payments may vary, potentially materially, from the estimates we have made.
Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3). The use of valuation methodologies may require a significant amount of judgment. During periods of financial market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable. We review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities.
Fair values of our investment portfolio are estimated using unadjusted prices obtained by our investment manager from nationally recognized third-party pricing services, where available. For securities where we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from our investment manager. We perform several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements at December 31, 2017, including (1) obtaining and reviewing the internal control report from our investment manager that obtain fair values from third party pricing services, (2) discussing with our investment manager their process for reviewing and validating pricing obtained from outside pricing services and (3) reviewing the security pricing received from our investment manager and monitoring changes in unrealized gains and losses at the individual security level.
We record deferred income taxes as assets or liabilities on our balance sheet to reflect the net tax effect of the temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and their respective tax bases. Deferred tax assets and liabilities are measured by applying enacted tax rates in effect for the years in which such differences are expected to reverse. Our deferred tax assets result from temporary differences primarily attributable to loss reserves and unearned premium reserves. Our deferred tax liabilities result primarily from unrealized gains in the investment portfolio and deferred acquisition costs. We review the need for a valuation allowance related to our deferred tax assets each quarter. We reduce our deferred tax assets by a valuation allowance when we determine that it is more likely than not that some portion or all of the deferred tax assets will not be realized. The assessment of whether or not a valuation allowance is needed requires us to use significant judgment. See Note 6 of the notes to the consolidated financial statements for further discussion regarding our deferred tax assets and liabilities.
issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. The TCJA did not specify the application of certain elements of the legislation and the U.S. Treasury has yet to issue interpretive guidance to specify the loss payment patterns and the corporate bond yield curve under the new law for 2018. The Company has recognized the provisional tax impacts of $3.5 million related to the transition adjustment for loss discounting which has been included in its components of deferred tax assets and liabilities as part of its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the TCJA. The accounting is expected to be complete when the U.S. Treasury issues further guidance.
Reinsurance recoverables recorded on insurance losses ceded under reinsurance contracts are subject to judgments and uncertainties similar to those involved in estimating gross loss reserves. In addition to these uncertainties, our reinsurance recoverables may prove uncollectible if the reinsurers are unable or unwilling to perform under the reinsurance contracts. In establishing our reinsurance allowance for amounts deemed uncollectible, we evaluate the financial condition of our reinsurers and monitor concentration of credit risk arising from our exposure to individual reinsurers. To determine if an allowance is necessary, we consider, among other factors, published financial information, reports from rating agencies, payment history, collateral held and our legal right to offset balances recoverable against balances we may owe. Our reinsurance allowance for doubtful accounts is subject to uncertainty and volatility due to the time lag involved in collecting amounts recoverable from reinsurers. Over the period of time that losses occur, reinsurers are billed and amounts are ultimately collected, economic conditions, as well as the operational and financial performance of particular reinsurers may change and these changes may affect the reinsurers’ willingness and ability to meet their contractual obligations to us. It is difficult to fully evaluate the impact of major catastrophic events on the financial stability of reinsurers, as well as the access to capital that reinsurers may have when such events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear the collection risk if any reinsurer fails to meet its obligations under the reinsurance contracts. We target reinsurers with A.M. Best financial strength ratings of "A" (Excellent) or better. Based on our evaluation of the factors discussed above, we believe all of our recoverables are collectible and, therefore, no allowance for uncollectible reinsurance was provided for at December 31, 2017.
On March 30, 2017, the FASB issued ASU 2017-08, "Premium Amortization on Purchased Callable Debt Securities," which shortens the amortization period of the premium for certain callable debt securities, from the contractual maturity date to the earliest call date. This ASU is effective in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including in an interim period. Upon adoption, the update will be applied on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period presented. We are currently evaluating the impact of the adoption on our consolidated financial statements.
Management does not expect that its internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. The design of any system of internal control over financial reporting also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
We have audited the accompanying consolidated balance sheets of Kinsale Capital Group, Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedules II and V (collectively, the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Short-term investments are carried at cost, which approximates fair value. Short-term investments have maturities greater than three months but less than one year at the date of purchase. There were no short-term investments at December 31, 2017 or December 31, 2016.
The following was considered in the estimation of fair value for each class of financial instruments for which it was practicable to estimate that value. The Company’s investment manager uses independent pricing vendors to estimate the fair value of fixed maturity securities and the Company’s management reviews these prices for reasonableness. U.S. Treasury Securities that have quoted prices in active markets are included in the amounts disclosed as Level 1. For
In January 2016, the FASB issued ASU 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities," which requires equity investments to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years. Upon adoption, a cumulative-effect adjustment to the balance sheet will be made as of the beginning of the fiscal year of adoption. For the year ended December 31, 2017, accumulated other comprehensive income included $6.5 million of net unrealized gains on equity securities, net of taxes. Adoption of this ASU is not expected to have a material impact on the Company's financial position or cash flows, but may have a material impact on the Company's results of operations in the future as changes in the fair value of equity instruments will be presented in net income rather than other comprehensive income.
and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact of the adoption on its consolidated financial statements.
There are no other prospective accounting standards which, upon their effective date, would have a material impact on the Company's consolidated financial statements.
At December 31, 2017, the Company held 195 fixed maturity securities with a total estimated fair value of $203.4 million and gross unrealized losses of $2.2 million. Of those securities, 126 were in a continuous unrealized loss position for greater than one year. Unrealized losses were caused by interest rate changes or other market factors and were not credit specific issues. At December 31, 2017, 91.1% of the Company’s fixed maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities. At December 31, 2017, the Company held 13 securities in its equity portfolio with a total estimated fair value of $10.8 million and gross unrealized losses of $0.2 million. None of these securities were in a continuous unrealized loss position for greater than one year. Based on its review, the Company concluded that there were no other-than-temporary impairments from fixed maturity or equity securities with unrealized losses for the year ended December 31, 2017.
At December 31, 2016, the Company held 231 fixed maturity securities with a total estimated fair value of $239.7 million and gross unrealized losses of $5.2 million. Of these securities, 24 were in a continuous unrealized loss position for greater than one year. Unrealized losses were caused by interest rate changes or other market factors and were not credit specific issues. At December 31, 2016, 92.6% of the Company’s fixed maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities. Based on its review, the Company concluded that none of the fixed maturity securities with an unrealized loss at December 31, 2016 experienced an other-than-temporary impairment.
The Company had invested assets with a carrying value of $7.1 million and $7.0 million on deposit with state regulatory authorities at December 31, 2017 and 2016, respectively.
Fair value was estimated for each class of financial instrument for which it was practical to estimate fair value. Fair value is defined as the price in the principal market that would be received for an asset to facilitate an orderly transaction between market participants on the measurement date. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Fair value hierarchy disclosures are based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value.
There were no transfers into or out of Level 1 and Level 2 during the years ended December 31, 2017 or 2016. There were no assets or liabilities measured at fair value on a nonrecurring basis as of December 31, 2017 or 2016.
with a transition rule that spreads adjustments related to pre-effective-date losses and loss adjustment expenses over the next eight years beginning in 2018.
U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. The TCJA did not specify the application of certain elements of the legislation and the U.S. Treasury has yet to issue interpretive guidance to specify the loss payment patterns and the corporate bond yield curve under the new law for 2018. The Company has recognized the provisional tax impacts of $3.5 million related to the transition adjustment for loss discounting which has been included in its components of deferred tax assets and liabilities as part of its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the TCJA. The accounting is expected to be complete when the U.S. Treasury issues further guidance.
The Company’s effective income tax rate on income before income taxes differs from the prevailing federal income tax rate and is summarized as follows:
At December 31, 2017 and 2016, the Company had state net operating loss carryforwards ("NOLS") of $13.6 million and $12.2 million, respectively. The state NOLs are available to offset future taxable income or reduce taxes payable and begin expiring in 2029.
Management evaluates the need for a valuation allowance related to its deferred tax assets. At December 31, 2017 and 2016, the Company recorded a tax valuation allowance equal to the state NOLs and the deferred tax assets, net of existing deferred tax liabilities that were expected to reverse in future periods, related to certain state jurisdictions. No other valuation allowances were established against the Company’s deferred tax assets at December 31, 2017 and 2016, as the Company believes that it is more likely than not that the remaining deferred tax assets will be realized given the carry back availability, reversal of existing temporary differences and future taxable income.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for 2017 and 2016 was as follows:
During the year ended December 31, 2017, our net incurred losses for accident years 2016 and prior developed favorably by $11.3 million. This favorable development included $9.4 million for the 2016 accident year, $4.2 million for the 2015 accident year and $1.8 million for accident year 2014. This favorable development was primarily due to reported losses emerging at a lower level than expected, across most lines of business. The favorable development was offset in part by adverse development of $2.1 million for the 2013 accident year, $1.3 million for the 2012 accident year and $0.7 million for the 2011 accident year. The unfavorable development was primarily attributable to claims on the other liability occurrence line of business.
which would distort development patterns related to those transactions. See Note 8 for further details regarding the commutation of the MLQS. Cumulative number of reported claims is reported on a per claim basis.
Reconciliation of Incurred and Paid Claims Development to the Liability for Unpaid Claims and Claim Adjustment Expenses
The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expenses in the consolidated statement of financial position is as follows:
Under the terms of the MLQS covering the period January 1, 2015 to December 31, 2015 (the "2015 MLQS"), the Company received a provisional ceding commission equal to 41% of ceded written premiums and paid a reinsurance margin equal to 4.00% of ceded written premium. The 2015 MLQS contract included a sliding scale commission
provision that can adjust the ceding commissions within a range of 25% to 41% based on the loss experience of the business ceded. The 2015 MLQS ceding percentage was 50% until October 1, 2015, at which time the Company decreased the percentage to 40%. The change in the ceding percentage reduced ceded written premiums by $6.8 million at October 1, 2015, with a corresponding reduction to ceded unearned premiums.
The terms of the MLQS covering the period January 1, 2016 to December 31, 2016 (the "2016 MLQS") were largely consistent with the 2015 MLQS. However, effective January 1, 2016, the Company further reduced the ceding percentage from 40% to 15%. The change in the ceding percentage reduced ceded written premiums by $17.0 million at January 1, 2016, with a corresponding reduction to ceded unearned premiums.
The Company maintained a funds-held account for the reinsurers who were a party to the MLQS contracts, which was credited with interest at a rate equal to the 10 year U.S. Treasury rate plus a spread (150 basis points), subject to a 4% minimum. The funds-held account represented the excess of the ceded written premium and interest credited over ceded paid losses and LAE, the Company’s ceding commission and the reinsurers’ margin. Assets supporting the funds-held liability were not segregated or restricted. The funds-held account, shown as a liability on the accompanying consolidated balance sheets, was $36.5 million at December 31, 2016.
At December 31, 2017, the net reinsurance receivable, defined as the sum of paid and unpaid reinsurance recoverables and ceded unearned premiums less reinsurance payables, from five reinsurers represented 92.4% of the total balance.
At January 1, 2016, the Company was authorized to issue 18,333,333 shares of Common Stock, $0.0001 par value per share ("Common Stock"), of which 15,000,000 shares were designated as Class A Common Voting Shares ("Class A Common Stock") and 3,333,333 were designated as Class B Common Non-Voting Shares ("Class B Common Stock"). On July 28, 2016, in connection with the IPO as discussed below, the Company amended and restated its certificate of incorporation to recapitalize the Company’s authorized capital stock to consist of 400,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share. There were no shares of preferred stock issued or outstanding at December 31, 2017 or December 31, 2016.
On July 27, 2016, the Kinsale Capital Group, Inc. 2016 Omnibus Incentive Plan (the "2016 Incentive Plan") became effective. The 2016 Incentive Plan provides for grants of stock options, stock appreciation rights, restricted stock, other stock-based awards and other cash-based awards to directors, officers and other employees, as well as independent contractors or consultants providing consulting or advisory services to the Company. The number of shares of common stock available for issuance under the 2016 Incentive Plan may not exceed 2,073,832. On July 27, 2016, the Board of Directors approved, and the Company granted, 1,036,916 stock options with an exercise price equal to the IPO price of $16.00 per share. The options have a maximum contractual term of 10 years and will vest in 4 equal annual installments following the date of the grant.
The following table summarizes nonvested share-based awards under the 2016 Incentive Plan as of December 31, 2017:
As of December 31, 2017, the Company had $1.7 million of unrecognized share-based compensation expense expected to be charged to earnings over a weighted-average period of 2.5 years. The total fair value of shares vested during the years ended December 31, 2017 and 2016 was $6.9 million and $0.9 million, respectively.
In 2015, pursuant to the 2010 Incentive Plan, the Compensation Committee awarded restricted stock grants of 33,500 to certain directors, executive officers, and employees, which had a total grant-date fair value of $40 in 2015. The fair value of the Company’s share-based awards that vested was $0.1 million in each of the years ended December 31, 2016 and 2015. The fair value of the Company’s restricted stock grants was determined based on a valuation of Class B Common Stock on the grant date using a binomial lattice option pricing model. The model the Company used to value the Class B Common Stock, like any option pricing model for a nonpublic security, required
the input of highly subjective assumptions including the underlying security price, strike price, risk-free rate of return, expected term and expected stock price volatility. The underlying security price was based on the Company’s book value of equity and the application of a multiple of tangible equity. The strike price was based on the liquidation preference of the Company’s Class A Common Stock at the grant date. The risk-free interest rate was based on the U.S. Treasury rate at the date of the grant. The expected term was based on an equal chance for a liquidity event at any time between 0 years and 0.50 years from the grant date. The expected stock volatility was based on stock price volatility using a set of comparable publicly traded companies.
The Board of Directors granted 6,666 shares of restricted stock on January 1, 2018 under the 2016 Incentive Plan to the Company’s non-employee directors. The restricted stock had a fair value on the date of grant of $45.00 per share and will vest over a 1 year period.
The Company has an operating lease for office space, which expires in 2020. In addition, the Company had a capital lease related to a software license that expired in 2017. Expenses associated with these leases totaled $0.3 million in 2017, $0.4 million in 2016, and $0.5 million in 2015.
The Company has established a defined contribution employee retirement plan ("Plan") in accordance with Section 401(k) of the Internal Revenue Code. Expenses related to the Plan were $1.0 million, $0.9 million and $0.8 million in 2017, 2016 and 2015, respectively.
The Company does business with three unaffiliated insurance brokers that generated $26.4 million, $24.4 million and $23.1 million of gross written premiums for the year ended December 31, 2017, representing 11.8%, 10.9% and 10.4% of gross written premiums, respectively. No other broker generated 10.0% or more of the gross written premiums for the year ended December 31, 2017.
Kinsale Insurance maintains its accounts in conformity with accounting practices prescribed or permitted by state regulatory authorities that vary in certain respects from GAAP. In converting from statutory accounting principles to GAAP, typical adjustments include deferral of policy acquisition costs, the inclusion of statutory nonadmitted assets
Statutory net income and statutory capital and surplus for Kinsale Insurance as of December 31, 2017, 2016, and 2015 and for the years then ended are summarized as follows:
On June 9, 2017, cash dividends of $4.5 million were paid to Kinsale Capital Group, Inc. by its wholly-owned subsidiary, Kinsale Insurance Company.