(3) During the fourth quarter of 2018, the TCJA was enacted, which lowered the federal corporate tax rate from 35% to 21% starting January 1, 2018. As a result of the TCJA enactment, deferred tax balances were remeasured to reflect the lower rate, which resulted in an increase to tax expense of $1.9 million for the year ended December 31, 2017.
(7) 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.
(10) The expense ratio is the ratio, expressed as a percentage, of underwriting, acquisition and insurance expenses to net earned premiums.
(13) Return on equity represents net income expressed as a percentage of average beginning and ending stockholders’ equity during the period.
We have one reportable segment, our Excess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2018, the percentage breakdown of our gross written premiums was 91.8% casualty and 8.2% property. Our commercial lines offerings include construction, small business, excess casualty, energy, product liability, general casualty, allied health, professional liability, life sciences, commercial property, management liability, health care, 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 4.4% of our gross written premiums in 2018.
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 (ceding percentage) 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
The effect of the MLQS on our results of operations is primarily reflected in our ceded written premiums, losses and loss adjustment expenses, as well as our underwriting, acquisition and insurance expenses. The following tables summarize the effect of the MLQS on our underwriting income for the years ended December 31, 2018, 2017 and 2016:
(2) Underwriting income is a non-GAAP financial measure. See "- Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income.
Ceded written premiums are the amount of gross written premiums ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential large losses as well as to provide additional capacity for growth. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premiums is impacted by the level of our gross written premiums and any decision we make to increase or decrease retention levels.
Net investment gains (losses) are a function of the difference between the amount received by us on the sale of a security and the security's recorded value, the unrealized gains and losses on our equity portfolio, as well as any "other-than-temporary" impairments recognized in earnings.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
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. The ceding percentage under the MLQS was 15% in 2016 until it was terminated and commuted effective October 1, 2016.
Currently all of our income tax expense relates to federal income taxes. Kinsale Insurance is generally not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect. Among other things, the Tax Cuts and Jobs Act of 2017 ("TCJA") enacted on December 22, 2017 lowers the federal corporate tax rate from 35% to 21% starting January 1, 2018. Our income tax expense for periods beginning in 2018 were based on the federal corporate income tax rate stipulated in the TCJA, and as a result, our 2018 annual effective tax rate was significantly lower than our prior-year effective tax rate.
We discuss certain key metrics, described below, which provide useful information about our business and the operational factors underlying our financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as pre-tax income, excluding net investment income, net investment gains and losses, and other income and expenses. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income.
Adjusted expense ratio is a non-GAAP financial measure. We define adjusted expense ratio as the expense ratio, excluding the effects of the MLQS. For additional detail on the impact of the MLQS on our results of operations, see "-Factors Affecting Our Results of Operations - The MLQS."
Return on equity is net income expressed as a percentage of average beginning and ending stockholders’ equity during the period. Our overall financial goal is to produce a return on equity in the mid-teens over the long-term.
Operating return on equity is net operating earnings, a non-GAAP financial measure, expressed as a percentage of average beginning and ending stockholders’ equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to operating income.
The following table summarizes our results of operations for the years ended December 31, 2018 and 2017:
Net income was $33.8 million for the year ended December 31, 2018 compared to $24.9 million for the year ended December 31, 2017, an increase of $8.9 million, or 35.7%. The increase in net income in 2018 over 2017 was due to a number of factors, including growth in the business, lower net catastrophe losses and a lower effective tax rate, largely resulting from the TCJA. These factors were offset in part by lower net favorable development of loss reserves related to prior accident years.
Products liability, which represented approximately 7.3% of our gross written premiums in 2018, increased by $5.8 million, or 40.3%, for the year ended December 31, 2018 over the prior year, and
Net written premiums increased by $46.1 million, or 24.4%, to $235.6 million for the year ended December 31, 2018 from $189.5 million for the year ended December 31, 2017. The increase in net written premiums was primarily due to higher gross written premiums for the year ended December 31, 2018. Our net retention ratio was 85.5% for the year ended December 31, 2018 compared to 84.9% for the year ended December 31, 2017. The increase in the net retention ratio was due to raising our retention on the excess casualty reinsurance treaty effective with the renewal in the latter half of 2017, and a change in the mix of business.
Net earned premiums were $212.7 million for the year ended December 31, 2018 compared to $176.1 million for the year ended December 31, 2017, an increase of $36.6 million, or 20.8%. As previously discussed, the increase was due to growth in gross written premiums in 2018 compared to 2017.
The following tables summarize the effect of the factors indicated above on the loss ratios for the years ended December 31, 2018 and 2017:
The overall expense ratio was flat for the year ended December 31, 2018 compared to the year ended December 31, 2017. Net commissions incurred as a percentage of earned premiums increased year over year due to the change in the mix of ceded business, some of which has no contractual ceding commissions. This increase was offset in part by lower other underwriting expenses incurred as a percentage of earned premiums due to higher net earned premiums without a proportional increase in the amount of other underwriting expenses. Direct commissions paid as a percent of gross written premiums was 14.7% and 14.8% for the years ended December 31, 2018 and 2017, respectively.
The following table summarizes the components of net investment income and net investment gains for the years ended December 31, 2018 and 2017:
As discussed previously, effective January 1, 2018, we adopted a new accounting standard which required changes in the fair value of equity investments to be recognized in net income. During the year ended December 31, 2018, we recognized unrealized losses of $6.6 million related to our equity portfolio.
We perform quarterly reviews of all securities within our investment portfolio to determine whether any other-than-temporary impairment has occurred. Management concluded that there were no other-than-temporary impairments from fixed-maturity securities with unrealized losses for the year ended December 31, 2018. Management concluded that none of the fixed-maturity securities or equity securities with unrealized losses at December 31, 2017 experienced an other-than-temporary impairment.
Our return on equity was 13.5% for the year ended December 31, 2018 compared to 11.1% for the year ended December 31, 2017. Operating return on equity was 15.4% for the full year of 2018, an increase from 11.9% for the full year of 2017. The increase in the operating return on equity was due to a number of factors, including growth in the business year over year and the lower income tax rate resulting from the TCJA. Return on equity for the year ended December 31, 2018 was negatively impacted by unrealized losses on equity securities, net of taxes, recorded in accordance with the new accounting standard adopted in the beginning of 2018.
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 per 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:
Net earned premiums were $176.1 million for the year ended December 31, 2017 compared to $133.8 million for the year ended December 31, 2016, an increase of $42.2 million, or 31.6%. The increase was due to higher written premiums in 2017 compared to 2016 and from the non-renewal of the MLQS in 2017. Excluding the effects of the MLQS, net earned premiums were $150.8 million for the year ended December 31, 2016 a year-over-year increase of $25.2 million, or 16.7%.
Our expense ratio was 25.1% for the year ended December 31, 2017 compared to 21.3% for the year ended December 31, 2016. The expense ratio was lower for the year ended December 31, 2016 due to the ceding commissions earned under the MLQS. As previously discussed, the MLQS was not renewed for the 2017 calendar 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 effective tax rate for the year ended December 31, 2017 was approximately 35.4% compared to 33.8% for the year ended December 31, 2016. In 2017, our effective tax rate differed from the statutory tax rate of 35% due to the charge related to the TCJA enacted on December 22, 2017. Among other things, the TCJA lowered the federal corporate tax rate from 35% to 21% starting January 1, 2018. As a result of the TCJA enactment in the fourth quarter of 2017, we re-measured our deferred tax balances to reflect the lower rate as required by applicable accounting standards. The re-measurement resulted in an increase to our tax expense of $1.9 million for the year ended December 31, 2017. In addition, the effective tax rate for the year ended December 31, 2017 reflected tax benefits related to tax-exempt interest income from municipal bonds and the recognition of tax benefits from share-based compensation.
Our return on equity and operating return on equity was 11.1% and 11.9%, respectively, for the year ended December 31, 2017 compared to 16.2% and 16.1% for the year ended December 31, 2016. The decrease is primarily the result of higher average equity attributable to the additional equity raised in the IPO and lower net income.
State insurance laws restrict the ability of Kinsale Insurance to declare stockholder dividends without prior regulatory approval. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. The maximum dividend distribution Kinsale Insurance may make absent the approval or non-disapproval of the insurance regulatory authority in Arkansas is limited by Arkansas law to the greater of (1) 10% of policyholder surplus as of December 31 of the previous year, or (2) net income, not including realized capital gains, for the previous calendar year. The Arkansas statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. The maximum amount of dividends Kinsale Insurance can pay us during 2019 without regulatory approval is $34.0 million. Insurance regulators have broad powers to ensure that statutory surplus remains at adequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. In the future, state insurance regulatory authorities that have jurisdiction over the payment of dividends by Kinsale Insurance may adopt statutory provisions more restrictive than those currently in effect. Kinsale Insurance paid $11.5 million of dividends to us during 2018. See also "Risk Factors - Risks Related to Our Business and Our Industry - Because we are a holding company and substantially all of our operations are conducted by our insurance subsidiary, our ability to pay dividends depends on our ability to obtain cash dividends or other permitted payments from our insurance subsidiary."
As of December 31, 2018, our holding company had $10.0 million in cash and investments, compared to $1.5 million as of December 31, 2017.
Our cash flows for the years ended December 31, 2018, 2017 and 2016 were:
We have generated positive operating cash flow in each of the last three years. The fluctuation of cash provided by operating activities in 2018, 2017 and 2016 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.
For the year ended December 31, 2018, property insurance represented 8.2% of our gross written premiums. When we 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, 2018, we purchased catastrophe reinsurance coverage of $45 million per event in excess of our $5 million per event retention.
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 $56.8 million at December 31, 2018.
At December 31, 2018, total stockholders' equity was $264.0 million and tangible stockholders' equity was $261.2 million, compared to total stockholders' equity of $238.2 million and tangible stockholders' equity of $235.4 million at December 31, 2017. The increase in both total and tangible stockholders' equity was primarily due to net income earned for the year ended December 31, 2018. The increase was offset in part by dividends paid during 2018 and unrealized losses related to available-for-sale securities, net of taxes. At December 31, 2016, our total stockholders' equity was $210.2 million and tangible stockholders' equity was $207.9 million. The increase in both total and tangible stockholders' equity was primarily due to net income earned for the year ended December 31, 2017 and the increase in unrealized gains related to available-for-sale securities, net of taxes. The increase was offset in part by dividends paid during 2017.
Stockholders' equity at December 31, 2018, 2017 and 2016, reconciles to tangible stockholders' equity as follows:
On July 28, 2016, we had outstanding grants of 1,783,858 restricted shares of Class B Common Stock. At that date, all restricted shares of Class B Common Stock were reclassified into 1,286,036 shares of common stock equal to a conversion ratio of 0.72095061. The conversion ratio was calculated based on the IPO price of $16.00 per share.
On December 6, 2016, the Company completed a follow-on offering of 3,864,000 shares of common stock at a price of $27.50 per share, which included 504,000 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.
During 2018, 94,270 shares of restricted stock awards were granted under the 2016 Incentive Plan to the Company’s employees and non-employee directors. The restricted stock had a weighted average fair value on the date of grant of $52.99 per share and vest over a term of 1 to 4 years.
On August 9, 2018, the Company’s Board of Directors declared a cash dividend of $0.07 per share of common stock. This dividend was paid on September 14, 2018 to all stockholders of record on August 31, 2018.
On November 14, 2018, the Company’s Board of Directors declared a cash dividend of $0.07 per share of common stock. This dividend was paid on December 14, 2018 to all stockholders of record on November 30, 2018.
Our investment portfolio, excluding cash equivalents, had a gross return of 3.0% as of December 31, 2018, compared to 2.4% as of December 31, 2017.
The table below summarizes the credit quality of our fixed-maturity securities as of December 31, 2018, as rated by Standard & Poor’s Financial Services, LLC ("Standard & Poor's"):
Net income for the years ended December 31, 2018, 2017 and 2016, reconciles to underwriting income as follows:
(1) Computed by adding the total equity as of the date indicated to the prior year-end total and dividing by two.
(3) Operating return on equity is net operating earnings expressed as a percentage of average beginning and ending stockholders’ equity during the period.
We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the "Notes to Consolidated Financial Statements" included in this Annual Report on Form 10-K.
We categorize our reserves for unpaid losses and loss adjustment expenses into two types: case reserves and reserves for incurred but not yet reported losses ("IBNR"). Our gross reserves for losses and loss adjustment expenses at December 31, 2018 were $369.2 million, and of this amount, 82.2% related to IBNR. Our reserves for losses and loss adjustment expenses, net of reinsurance, at December 31, 2018 were $313.8 million, and of this amount, 82.3% related to IBNR. A 5% change in net IBNR reserves at December 31, 2018 would equate to an $12.9 million change in the reserve for losses and loss adjustment expenses at such date, as well as $10.2 million change in net income, a 3.9% change in stockholders' equity and a 3.9% change in tangible equity, in each case at or for the year ended December 31, 2018.
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.
Under current accounting guidance, changes in the fair value of investments classified as available-for-sale are not recognized as income during the period, but rather are recognized as a separate component of stockholders’ equity until
realized. Prior to the adoption of ASU 2016-01, our investments in fixed maturities and equity securities were classified as available-for-sale and reported at fair value. ASU 2016-01 eliminated the available-for-sale classification for equity securities and required changes in unrealized gains and losses in fair value of these investments to be recognized in net income. On a quarterly basis, we review all available-for-sale securities with unrealized losses on a quarterly basis to assess whether the decline in the securities’ fair value is deemed to be other-than-temporary. The determination that an investment has incurred an other-than-temporary loss in value requires judgment, and we consider a number factors in completing our impairment review, including the length of time and the extent to which fair value has been below cost and the financial condition and near-term prospects of the issuer. For fixed maturities, we consider whether we intend to sell the security, or if it is more likely than not that we will be required to sell the security before recovery, or have the ability to recover all amounts outstanding when contractually due. For equity securities, we evaluate the near-term prospects of these investments in relation to the severity and duration of the impairment and, we consider our ability and intent to hold the security for a period of time sufficient to allow for anticipated recovery.
When assessing whether we intend to sell a fixed-maturity security, or if it is more likely than not that we will be required to sell a fixed-maturity security before recovery of its amortized cost, we evaluate facts and circumstances including, but not limited to, decisions to reposition the investment portfolio and potential sales of investments to meet cash flow needs. The day-to-day management of our investment portfolio is outsourced to a third-party investment manager. For securities with unrealized losses, our investment manager may believe that the preferred course of action is to hold those securities until such losses are recovered. However, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss based upon a change in the market and other factors described above. Our investment manager notifies us of rating agency downgrades of securities in their portfolios as well as any potential investment valuation issues at the end of each quarter. Our investment manager is also required to notify us of, and receive approval for, any other-than-temporary impairments it has identified. For the year ended December 31, 2018, there were no other-than-temporary impairments recognized. See Note 2 of the notes to the consolidated financial statements for further discussion regarding our investments.
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 deferred acquisition costs, the transition adjustment for loss reserve discounting, resulting from the enactment of the TCJA, and unrealized gains in the investment portfolio. 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.
Refer to Note 1 - "Summary of significant accounting policies" of the Notes to Consolidated Financial Statements for further discussion.
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
KPMG LLP, our independent registered public accounting firm, has issued an opinion on the effectiveness of the Company's internal control over financial reporting, as stated in their report which is included herein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, 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, 2018, and the related notes and financial statement schedules I, II and V (collectively, the consolidated financial statements), and our report dated February 28, 2019 expressed an unqualified opinion on those consolidated financial statements.
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on
We have audited the accompanying consolidated balance sheets of Kinsale Capital Group, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, 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, 2018, and the related notes and financial statement schedules I, II, and V (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
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, 2018 or December 31, 2017.
were recorded as a separate component of comprehensive income and stockholders’ equity, net of deferred income taxes. In accordance with new accounting guidance, the available-for-sale classification was eliminated for equity securities and changes in unrealized gains and losses in fair value of these investments are recognized in net income. For a more detailed discussion of the new accounting guidance, see "Recently adopted accounting pronouncements," below. Prior periods have not been restated to conform to the current presentation.
Interest on fixed-maturity securities is credited to earnings as it accrues. Premiums and discounts are amortized or accreted over the lives of the related fixed maturities. Dividends on equity securities are included in earnings on the ex-dividend date. Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the trade date.
Premiums receivable balances are carried at face value, net of any allowance for doubtful accounts. The allowance for doubtful accounts represents an estimate of amounts considered uncollectible based on the Company’s assessment of the collectability of receivables that are past due. The Company recorded an allowance for doubtful accounts of $2.6 million and $2.1 million at December 31, 2018 and 2017, respectively, and believes that all other amounts due are collectible.
Reserves for unpaid losses and loss adjustment expenses represent management's best estimate of ultimate unpaid cost of all reported and unreported losses and loss adjustment expenses incurred prior to the financial statement date. The estimates are based on an actuarial method that uses management’s initial expected loss ratios, expected reporting patterns for losses based on industry data and the Company’s actual reported losses and loss adjustment expenses. All estimates are regularly reviewed and, as experience develops and new information becomes known, the reserves for unpaid losses and loss adjustment expenses are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are determined. Although management believes that the reserves for losses and loss adjustment expenses are reasonable, due to the inherent uncertainty in estimating reserves for unpaid losses and loss adjustment expenses, it is possible that the Company’s actual incurred losses and loss adjustment expenses will not develop in a manner consistent with the assumptions inherent in the determination of these reserves. If actual liabilities exceed recorded amounts, there will be an increase to the Company’s reserves resulting in a reduction in net income and stockholders’ equity in the period in which the deficiency is identified. Furthermore, management may determine that recorded reserves are more than adequate to cover expected losses which will result in a reduction to the reserves. The Company believes that the reserves for unpaid losses and loss adjustment expenses at December 31, 2018 and 2017 are adequate and represent a reasonable estimate of the Company's future obligations. See Note 7 for a further discussion of reserves for unpaid losses and loss adjustment expenses.
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 other fixed-maturity securities, the pricing vendors use a pricing methodology involving the market approach, including pricing models which use prices and relevant market information regarding a particular security or securities with similar characteristics to establish a valuation. The estimates of fair value of these fixed-maturity investments are included in the amounts disclosed as Level 2. For those bonds where significant inputs are unobservable, Level 3 inputs, the Company's investment manager obtains valuations from pricing vendors using the market approach and income approach valuation techniques.
For equity securities, the Company’s investment manager uses prices from independent pricing vendors to estimate fair value. The fair value estimates of exchange traded funds are based on quoted prices in an active market and are disclosed as Level 1.The fair value estimates of preferred stock are based on observable market data and, as a result, are disclosed as Level 2.
In January 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-01, "Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities" ("ASU 2016-01"), which eliminated the available-for-sale classification for equity investments, required changes in unrealized gains and losses in fair value of equity investments to be recognized in net income, required public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminated the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost. Effective January 1, 2018, the Company adopted this ASU and recorded a cumulative-effect adjustment, which reclassified unrealized gains of $6.5 million, net of $1.7 million of taxes, on equity investments from accumulated other comprehensive income ("AOCI") to retained earnings. Prior periods have not been restated to conform to the current presentation.
In February 2018, the FASB issued ASU 2018-02, "Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," which permitted companies to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (the "TCJA") on items within AOCI to retained earnings. The FASB refers to these amounts as "stranded tax effects." The guidance is effective for all companies for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. Effective January 1, 2018, the Company elected to
early adopt this ASU and to reclassify the stranded income tax effects for available-for-sale securities of $1.3 million from AOCI to retained earnings. Other than those effects related to the TCJA, the Company uses the portfolio approach to release stranded tax effects in AOCI related to its available-for-sale fixed-maturity securities and its available-for-sale equity securities (prior to the adoption of ASU 2016-01). Under this approach, stranded tax effects remaining in AOCI are released only when the entire portfolio of the available-for-sale fixed-maturity securities and available-for-sale equity securities are liquidated, sold or extinguished.
The Company has a limited number of leases subject to the new standard and does not anticipate the standard will have a material effect on our consolidated financial statements. While the Company continues to assess the impact of the new standard as of the effective date of January 1, 2019, we expect the adoption of the standard to result in the recognition of a ROU asset and corresponding lease liability of approximately $0.9 million. The Company will use the modified retrospective transition method through a cumulative-effect adjustment as of the beginning of the fiscal year of adoption.
The Company regularly reviews all available-for-sale securities with unrealized losses to assess whether the decline in the securities’ fair value is deemed to be an other-than-temporary impairment ("OTTI"). The Company considers a number of factors in completing its OTTI review, including the length of time and the extent to which fair value has been below cost and the financial condition of an issuer. In addition to specific issuer information, the Company also evaluates the current market and interest rate environment. Generally, a change in a security’s value caused by a change in the market or interest rate environment does not constitute an OTTI, but rather a temporary decline in fair value.
For fixed maturities, the Company considers whether it intends to sell the security or if it is more likely than not that it will be required to sell the security before recovery, the credit quality of the issuer and the ability to recover all amounts
outstanding when contractually due. When assessing whether it intends to sell a fixed-maturity security or if it is likely to be required to sell a fixed-maturity security before recovery of its amortized cost, the Company evaluates facts and circumstances including, but not limited to, decisions to reposition the investment portfolio, potential sales of investments to meet cash flow needs and potential sales of investments to capitalize on favorable pricing. For equity securities prior to the adoption of ASU 2016-01, the Company considered the near-term prospects of an issuer and its ability and intent to hold the security for a period of time sufficient to allow for anticipated recovery.
At December 31, 2018, the Company held 317 fixed-maturity securities with a total estimated fair value of $350.9 million and gross unrealized losses of $6.9 million. Of those securities, 158 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, 2018, 86.4% 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 there were no other-than-temporary impairments from fixed-maturity securities with unrealized losses for the year ended December 31, 2018.
The amortized cost and estimated fair value of available-for-sale fixed-maturity securities at December 31, 2018 are summarized, by contractual maturity, as follows:
The change in net unrealized losses for fixed-maturity securities was $6.9 million for the year ended December 31, 2018. The change in net unrealized gains for fixed-maturity securities was $5.2 million for the year ended December 31, 2017. The change in net unrealized losses for fixed-maturity securities was $3.0 million for the year ended December 31, 2016. For the years ended December 31, 2017 and 2016, the changes in net unrealized gains for equity securities were $4.2 million and $2.0 million, respectively.
The Company recorded a payable for investments purchased, not yet settled, of $1.0 million at December 31, 2017. This payable balance was included in the "other liabilities" line item of the balance sheet and was treated as a non-cash transaction for purposes of cash flow presentation.
The following tables present the balances of assets measured at fair value on a recurring basis as of December 31, 2018 and 2017, by level within the fair value hierarchy.
The Company paid $9.9 million, $13.5 million and $13.3 million in federal income taxes during the years ended December 31, 2018, 2017 and 2016, respectively. Current income taxes receivable was $0.8 million at December 31, 2018 and December 31, 2017, and included in "other assets" in the accompanying consolidated balance sheets.
U.S. GAAP requires companies to recognize the effect of tax law changes in the period of enactment. At the time of enactment, the application and interpretation of certain elements of the legislation were not specified, particularly as they related to the loss payment patterns and the corporate bond yield curve used to compute discounted loss reserves. The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant did 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. In accordance with SAB 118, the Company recognized the provisional tax impacts of $3.5 million related to the transition adjustment for loss reserve discounting, which were included as components of deferred tax assets and liabilities as part of its consolidated financial statements for the year ended December 31, 2017. During the year ended December 31, 2018, the Company finalized its accounting for the enactment of the TCJA and the provisional amounts decreased by approximately $1.1 million.
The prevailing federal income tax rate was 21% in 2018 and 35% in 2017 and 2016. 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, 2018 and 2017, the Company had state net operating loss carryforwards ("NOLS") of $14.9 million and $13.6 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, 2018 and 2017, 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, 2018 and 2017, 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 was as follows:
The information about incurred and paid claims development for the years ended December 31, 2010 to December 31, 2017, is presented as unaudited supplementary information.
The Company purchases reinsurance from other insurance companies ("reinsurers") in order to limit its exposure to large losses and enable it to underwrite policies with sufficient limits to meet policyholder needs. In a reinsurance transaction, an insurance company transfers, or cedes, part or all of its exposure to the reinsurer that receives a portion of the premium. The ceding of insurance does not legally discharge the Company from its primary liability for the full amount of the policy coverage, and therefore the Company will be required to pay the loss and bear collection risk if the reinsurer fails to meet its obligations under the reinsurance agreement.
Incurred losses and loss adjustment expenses were net of reinsurance recoverables (ceded incurred losses and loss adjustment expenses) of $25.5 million, $12.2 million and $13.7 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Credit risk exists with reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. Reinsurance recoverables for unpaid losses were $55.4 million and $48.2 million, at December 31, 2018 and 2017, respectively. Reinsurance recoverables for paid losses were $1.4 million at December 31, 2018 and 2017. Ceded unearned premiums related to reinsurance were $16.1 million and $13.9 million, at December 31, 2018 and 2017, respectively. Allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit
risk arising from its exposure to individual reinsurers. All reinsurance receivables are from companies with A.M. Best ratings of "A" (Excellent) or better. To further reduce credit exposure to reinsurance recoverable balances, the Company has received letters of credit from certain reinsurers that are not authorized as reinsurers under U.S. state insurance regulations. The Company has not recorded an allowance for doubtful accounts related to its reinsurance balances at December 31, 2018 and 2017 and believes this to be appropriate after consideration of all currently available information; however, the deterioration in the credit quality of existing reinsurers or disputes over reinsurance agreements could result in future charges.
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.
The total intrinsic value of options exercised was $4.7 million during the year ended December 31, 2018 and $1.5 million during the year ended December 31, 2017. As of December 31, 2018, the Company had $1.0 million of unrecognized share-based compensation expense expected to be charged to earnings over a weighted-average period of 1.6 years.
The following table represents a reconciliation of the numerator and denominator of the basic and diluted earnings per share computations contained in the consolidated financial statements:
Prior to the reclassification of common stock on July 28, 2016, all of the earnings of the Company were allocated to Class A and Class B common stock and earnings per share was calculated using the two-class method. Under the two-class method, earnings attributable to Class A and Class B common stockholders were determined by allocating undistributed earnings to each class of stock. The undistributed earnings attributable to common stockholders were allocated based on the contractual participation rights of the Class A common stock and Class B common stock as if those earnings for the period had been distributed. Earnings attributable to Class A common stockholders equaled the sum of dividends at the rate per annum of 12% compounding annually during the period ("Accruing Dividends") plus seventy-five percent of any remaining assets of the Company available for distribution to its stockholders in the event of a liquidation, dissolution, winding up or sale of the Company after payment of the Accruing Dividends ("Residual Proceeds"). Earnings attributable
Interest on the term loan accrued daily at a rate equal to the 3-month LIBOR plus a margin. The margin was 2.75% as of December 31, 2016. Total interest expense on the Credit Agreement was $1.3 million for the year ended December 31, 2016. Interest expense was included in "other expenses" on the accompanying statements of income and comprehensive income. Interest paid was $1.0 million for the year ending December 31, 2016.
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 2018, $0.3 million in 2017, and $0.4 million in 2016.
Minimum future rental payments, excluding taxes, insurance and other operating expenses, under the noncancelable operating leases in effect at December 31, 2018 are as follows (in thousands):
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, $1.0 million and $0.9 million in 2018, 2017 and 2016, respectively.
equity investments and required changes in unrealized gains and losses in the fair value of equity securities to be
Products liability underwrites commercial general liability on manufacturers, distributors and importers of a wide array of consumer, commercial and industrial products.
Management liability underwrites directors and officers liability, employment practices liability and fiduciary liability coverage on a variety of commercial and government risks.
Environmental underwrites commercial general liability, pollution liability and professional liability on a wide range of commercial risks where environmental exposures exist that are operational in nature or related to the premises.
Statutory net income and statutory capital and surplus for Kinsale Insurance as of December 31, 2018, 2017, and 2016 and for the years then ended are summarized as follows:
During 2018, cash dividends of $11.5 million were paid to Kinsale Capital Group, Inc. by its wholly-owned subsidiary, Kinsale Insurance Company.