We also lease four additional office spaces to support regional underwriting, claims, and corporate and other operations. The St. Louis, Missouri lease is 4,375 square feet of office space and effective through June 2021. The Manhattan, New York lease is 1,796 square feet of office space and effective through February 2020. Upon completion of the Anchor acquisition, we assumed a lease for 25,396 square feet of office space in Melville, New York, which is effective through March 2022. The Scottsdale, Arizona lease is 2,107 square feet of office space and effective through November 2020.
These results include the acquisition of Anchor on March 11, 2015, which will affect the comparability of the data. See ‘Part II, Item 8, Note 3, Goodwill and Intangible Assets,’ in the Notes to Consolidated Financial Statements for further discussion of the impact of this acquisition.
In addition to the historical consolidated financial information, this report contains “forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995, which may include, but are not limited to, statements with respect to estimates of future expenses, revenue and profitability; trends affecting financial condition, cash flows and results of operations; the availability and terms of additional capital; dependence on key suppliers and other strategic partners; industry trends; the competitive and regulatory environment; the successful integration of acquisitions; the impact of losing one or more senior executives or failing to attract additional key personnel; and, other factors referenced in this report. Factors that could cause or contribute to these differences include those discussed below and elsewhere, particularly in ‘Part I, Item 1A, Risk Factors.’
The “light” commercial automobile sector is a subset of the broader commercial automobile insurance industry segment, which over the long term has been historically profitable. In more recent years, the commercial automobile insurance industry has seen profitability pressure. Data compiled by S&P Global also indicates that in 2018 the total market for commercial automobile liability insurance was approximately $40.4 billion. The size of the commercial automobile insurance market can be affected significantly by many factors, such as the underwriting capacity and underwriting criteria of automobile insurance carriers and general economic conditions. Historically, the commercial automobile insurance market has been characterized by periods of excess underwriting capacity and increased price competition followed by periods of reduced underwriting capacity and higher premium rates.
Other lines of business is comprised of our surety program, Gateway’s truck and workers’ compensation programs, American Service’s non-standard personal lines business, Atlas’ workers’ compensation related to taxi, other liability, Global Liberty’s homeowners program and assigned risk pool business. All of the other lines of business are currently in run-off except for other liability and assigned risk pool business.
Non-standard automobile insurance is principally provided to individuals who do not qualify for standard automobile insurance coverage because of their payment history, driving record, place of residence, age, vehicle type or other factors. Such drivers typically represent higher than normal risks and pay higher insurance rates for comparable coverage. Consistent with Atlas’ focus on commercial automobile insurance, Atlas has transitioned away from the non-standard auto line. Our Insurance Subsidiaries ceased writing new and renewal policies of this type in 2011, and earned premium discontinued in 2012, allowing surplus and resources to be devoted to the expected growth of the commercial automobile business.
Atlas’ workers’ compensation related to taxi and other liability are ancillary products that are offered only to insureds who purchase our commercial automobile insurance products. The workers’ compensation program was non-renewed in 2018 due to limited demand.
Under U.S. GAAP, with respect to an investment in an impaired debt security, other-than-temporary impairment (“OTTI”) occurs if (a) there is intent to sell the debt security, (b) it is more likely than not it will be required to sell the debt security before its anticipated recovery, or (c) it is probable that all amounts due will be unable to be collected such that the entire cost basis of the security will not be recovered. If Atlas intends to sell the debt security, or will more likely than not be required to sell the debt security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net realized gains (losses) on investments in the consolidated statements of (loss) income and comprehensive (loss) income. If Atlas determines that it is probable it will be unable to collect all amounts and Atlas has no intent to sell the debt security, a credit loss is recognized in net realized gains (losses) on investments in the consolidated statements of (loss) income and comprehensive (loss) income to the extent that the fair value is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in accumulated other comprehensive (loss) income, net of applicable income taxes.
Management utilizes independent actuaries to provide guidance for the establishment of the Company’s liabilities for unpaid claim, claim adjustment expenses, and IBNR. In establishing the ultimate claims liability, actuarial judgment is relied upon in order to make appropriate assumptions to determine a best estimate of ultimate claim liabilities. There are inherent uncertainties associated with this estimation process, especially when a company is undergoing changes in its claim settlement practices or when behaviors of policyholders are influenced by external factors and/or market dynamics. As an example, during calendar year 2016, the Company introduced predictive analytics in addition to making significant efforts to reduce claim tail risk by accelerating claim closure rates. These changes have had a material impact on claim development as described further in ‘Part II, Item 8, Note 11, Claims Liabilities’ in the Notes to Consolidated Financial Statements.
claim handling procedures, the ultimate liability may exceed or be less than these estimates. Claim liabilities are revised as additional information becomes available, and adjustments, if any, are reflected in earnings in the periods in which they are determined.
In selecting development factors and averages described in ‘Part II, Item 8, Note 11, Claims Liabilities’ in the Notes to Consolidated Financial Statements, due consideration is given to how the historical experience patterns change from one year to the next over the course of several consecutive years of recent history. Predictions surrounding these patterns drive the estimates that are produced by each method and are based on statistical techniques that follow standard actuarial practices.
Deferred taxes are recognized using the asset and liability method of accounting. Under this method, the future tax consequences attributable to temporary differences in the tax basis of assets, liabilities and items recognized directly in equity and the financial reporting basis of such items are recognized in the financial statements by recording deferred tax assets (“DTAs”) or deferred tax liabilities (“DTLs”).
Total revenue was $221.8 million in 2018 compared to $222.0 million in 2017.
Underwriting loss was $63.2 million in 2018 compared to an underwriting loss of $48.5 million in 2017.
Net loss was $80.0 million, or $6.67 loss per common share diluted, in 2018 compared to a net loss of $38.8 million, or $3.22 loss per common share diluted, in 2017, representing a decrease in earnings per common share diluted of $3.45.
Book value per common share decreased $6.94 to $0.48 as of December 31, 2018 from $7.42 as of December 31, 2017.
Net claims incurred expenses are a function of the amount and type of insurance contracts we write and of the claims experience of the underlying risks. We record net claims incurred based on an actuarial analysis of the estimated claims we expect to be reported on contracts written. We seek to establish case reserves at the maximum probable exposure, based on our historical claims experience and, beginning in 2016, the use of claim related predictive analytics. Our ability to estimate net claims incurred accurately at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under net claims incurred in any period includes payments in the period net of the change in the value of the reserves for net claims incurred between the beginning and the end of the period, as well as estimation of potential future trends or changes. While the Company relies on independent actuarial professionals and internal controls in this regard, the estimation of reserves is inherently uncertain. We are committed to continuous improvement in this area of our business.
Gross premiums written were $276.0 million in 2017 compared to $225.1 million in 2016, representing a 22.6% increase. The increase primarily resulted from growth in livery/limousine and para-transit gross premiums written, primarily in New York, California and New Jersey, offset by a decrease in taxi gross premiums written in Louisiana and Nevada and in all lines in Minnesota and Michigan.
New premium business on our core lines represented approximately 31.6%, 40.7% and 33.9% of the total gross premiums written in 2018, 2017 and 2016, respectively. The decrease in new business premium growth from 2017 to 2018 occurred due to smaller fleet size in our livery/TNC business and less taxi business. The increase in new business growth from 2016 to 2017 primarily resulted from one large New York livery/TNC account written and growth in all products in the states of California and New Jersey.
Ceded premiums written is equal to premiums ceded under the terms of Atlas’ in force reinsurance treaties. Atlas generally purchases reinsurance in an effort to limit net exposure on any one claim to a maximum amount of $500,000 with respect to commercial automobile liability claims. This Excess of Loss reinsurance is primarily secured through General Reinsurance Corporation (“Gen Re”), a subsidiary of Berkshire Hathaway, Inc. Atlas also purchases reinsurance from Gen Re in an effort to protect against awards in excess of its policy limits. Effective July 1, 2014, Atlas implemented a quota share reinsurance agreement with Swiss Reinsurance America Corporation (“Swiss Re”) for its commercial auto and general liability lines of business (“Quota Share”) written by the ASI Pool Subsidiaries. The Quota Share agreement had an initial cession rate of 5%, which was increased to 15% effective April 1, 2015 and then was decreased to 5% effective July 1, 2016. Effective April 1, 2018, the Quota Share cession rate was increased to 30%. The Quota Share provides the Company with financial flexibility to manage expected growth and the timing of potential future capital raising activities. Global Liberty has a 25% quota share reinsurance agreement with Swiss Re for its commercial auto and general liability lines of business (“Global Quota Share”). The cession rate of the Global Quota Share remained at 25% for 2018, 2017 and 2016.
Ceded premiums written increased 92.8% to $86.4 million in 2018 compared to $44.8 million in 2017, primarily due to the increase in the Quota Share cession rate. Ceded premiums written decreased 0.5% to $44.8 million in 2017 compared to $45.0 million in 2016, primarily due to reductions in the cession rates of the Quota Share agreement and Global Liberty’s commercial automobile excess of loss reinsurance contracts, offset by premium growth as compared to the prior year period. As our limousine and para-transit business grows, we expect ceded premiums written to increase, because, under the current market conditions, the reinsurance costs are more expensive for these products.
Net premiums written is equal to gross premiums written less the ceded premiums written under the terms of Atlas’ in-force reinsurance treaties. Net premiums written totaled $200.2 million in 2018, a decrease of 13.4% from $231.1 million in 2017, following an increase of 28.4% in 2017 from $180.1 million in 2016. The changes are attributed to the combined effects of the reasons cited in the ‘Gross Premiums Written’ and ‘Ceded Premiums Written’ sections above.
Premiums are earned ratably over the term of the underlying policy. Net premiums earned totaled $218.2 million in 2018, an increase of 1.1% compared to $215.8 million in 2017, following an increase of 26.1% in 2017 compared to $171.1 million in 2016. The changes are attributed to the combined effects of the reasons cited in the ‘Gross Premiums Written’ and ‘Ceded Premiums Written’ sections above.
Remaining liability for non-New York Global Liberty business written prior to 2016 was expected to settle for greater amounts than previously expected.
Risk selection and pricing precision supported by predictive modeling in underwriting beginning in 2015 appears to have contributed improvement in expected loss ratio for premiums earned in 2016 and 2017.
Payment activity in calendar year 2017 attributed to the use of predictive modeling in claims was accelerated as expected. The Company believes that this represents an ultimate reduction in future expected losses, but it appears to be too early for credit to be given to this potential outcome from an actuarial perspective.
While the Company did see positive trends relating to more recent accident years in which predictive modeling had an impact, based on year-end work, the challenges from the past outpaced more recent benefits.
Gross commissions incurred excluding profit sharing commissions increased by $6.4 million in 2017 compared to 2016. The increase resulted from premium growth in business where higher commission rates applied. Gross profit sharing commissions incurred increased by $840,000 in 2017 compared to 2016 primarily as a result of new agents becoming eligible for profit sharing commissions and premium growth. Premium and other taxes incurred increased by $1.1 million in 2017 compared to 2016 as a result of premium growth.
Ceded commissions incurred excluding profit sharing commissions increased by $5.5 million in 2018 compared to 2017, primarily due to the increase in the Quota Share cession rate. Ceded profit sharing commissions incurred decreased by $2.3 million in 2018 compared to 2017. Ceded profit sharing commissions are based on loss experience. The decrease in ceded profit sharing commissions resulted from unfavorable loss ratios on the Quota Share and Global Quota Share.
The other underwriting expense ratio (including share-based compensation expenses and expenses incurred related to stock purchase agreements) was 16.0%, 15.1% and 13.1% in 2018, 2017 and 2016, respectively.
Professional fees increased by $1.1 million primarily due to an increase in legal fees.
Other underwriting expenses increased by approximately $10.0 million over the prior year period.
The termination of Gateway’s workers’ compensation retroactive reinsurance agreement increased expenses by $1.7 million.
Directors fees increased by $30,000 over the prior year period due to the addition of a new board member.
Atlas recovered $520,000 of expenses pursuant to the contingent adjustments of the Anchor stock purchase agreements related to the claim reserve contingency in 2018. Atlas did not incur or recover any expenses pursuant to stock purchase agreements in 2017. Atlas recovered $6.3 million of expenses pursuant to the contingent adjustments of the Gateway and Anchor stock purchase agreements that included the redemption and cancellation of preferred shares in 2016.
Atlas’ combined ratio was 129.0%, 122.5% and 102.9% in 2018, 2017 and 2016, respectively.
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the claims and claims adjustment expense ratio, the acquisition cost ratio and the underwriting expense ratio. The change in the combined ratio is attributable to the factors described in the ‘Net Premiums Earned,’ ‘Net Claims Incurred,’ ‘Acquisition Costs’ and ‘Other Underwriting Expenses’ sections above.
greater interest. In 2017, the increase in gross yield on our cash investments was due to higher interest rates on certain new accounts and higher balances in accounts earning greater interest. Equity method investments and collateral loans generated investment losses of $470,000 in 2018 and investment income of $1.9 million in both 2017 and 2016.
Net realized investment gains is comprised of the gains and losses from the sales of investments. Net realized investment gains decreased 34.3% to $573,000 in 2018 from $872,000 in 2017, due to losses from the sale of fixed income securities, partially offset by gains from the sale of equity securities. Net realized investment gains decreased 29.1% to $872,000 in 2017 from $1.2 million in 2016, due to lower gains from the sale of fixed income securities, partially offset by higher gains on the sale of equity securities and equity method investments.
Atlas recorded other income of $526,000, $435,000 and $467,000 in 2018, 2017 and 2016, respectively.
Atlas recognized tax expense of $15.8 million in 2018 and income tax benefits of $5.3 million and $2.1 million in 2017 and 2016, respectively.
The effects of convertible instruments are excluded from the computation of earnings per common share diluted in periods in which the effect would be anti-dilutive. Convertible preferred shares are anti-dilutive when the amount of dividend declared or accumulated in the current period per common share obtainable upon conversion exceeds earnings per common share basic. In 2018 and 2017, all exercisable stock options were deemed to be anti-dilutive. The potentially dilutive impact for all exercisable stock options excluded from the calculation due to anti-dilution is 16,372 and 71,475 common shares for 2018 and 2017, respectively. In 2016, all exercisable stock options were deemed to be dilutive and all of the convertible preferred shares were deemed to be anti-dilutive. The potentially dilutive impact for the convertible preferred stock excluded from the calculation due to anti-dilution is 441,357 common shares for 2016.
The securities held by the Insurance Subsidiaries must comply with applicable regulations that prescribe the type, quality and concentration of securities. These regulations in the various jurisdictions in which the Insurance Subsidiaries are domiciled permit investments in government, state, municipal and corporate bonds, preferred and common equities, and other high quality
investments, within specified limits and subject to certain qualifications. The Company’s use of quota share reinsurance can impact the relationship between invested assets and premiums written over time as well as the desired duration of the portfolio.
Most of the Company’s holdings are impacted by the U.S. economy, and we anticipate a moderate impact from the effect of global economic conditions on the domestic economy. Global economic conditions may create brief periods of market volatility, but we do not believe it will meaningfully alter the fundamental outlook of the Company’s investment holdings.
Due to the timing of financial information of the Company’s equity method investments, certain investments are recorded on a financial reporting lag of one to three months.
until the price recovers or the security matures. In situations where facts emerge that might increase the risk associated with recapture of principal, Atlas may elect to sell securities at a loss.
Reinsurance ceded does not relieve Atlas of its ultimate liability to its insureds in the event that any reinsurer is unable to meet their obligations under its reinsurance contracts. Therefore, Atlas enters into reinsurance contracts with only those reinsurers deemed to have sufficient financial resources to provide the requested coverage. Reinsurance treaties are generally subject to cancellation by the reinsurers or Atlas on the anniversary date and are subject to renegotiation annually. Atlas regularly evaluates the financial condition of its reinsurers and monitors the concentrations of credit risk to minimize its exposure to significant claims as a result of the insolvency of a reinsurer. Atlas believes that the amounts it has recorded as reinsurance recoverables are appropriately established. Estimating amounts of reinsurance recoverables, however, is subject to various uncertainties, and the amounts ultimately recoverable may vary from amounts currently recorded. As shown in the below table, Atlas had $81.2 million recoverable from third party reinsurers (exclusive of amounts prepaid) as of December 31, 2018 compared to $61.4 million as of December 31, 2017. The increase in the amount recoverable from third party reinsurers resulted from an increase in ceded case and IBNR reserves and the timing of the collection of amounts recoverable on paid claims.
During 2019, the Company received notice from General Reinsurance Corporation that effective July 31, 2019, the XOL reinsurance coverage for the ASI Pool Companies would terminate on a cut-off basis. Additionally, effective September 30, 2019, the ASI Pool Companies Quota Share contract with Swiss Reinsurance America Corporation was terminated on a run-off basis.
On July 22, 2013, as a result of shareholder activity, a “triggering event” as determined under IRC Section 382 occurred. As a result, the use of the Company’s net operating loss and other carry-forwards generated prior to the “triggering event” will be limited as a result of this “ownership change” for tax purposes, which is defined as a cumulative change of more than 50% during any three-year period by shareholders owning 5% or greater portions of the Company’s shares.
Due to this triggering event, the Company estimates that it will retain total tax effected federal net operating loss carryforwards (“NOLs”) of approximately $25.3 million as of December 31, 2018. NOLs and other carryforwards generated in 2017 and 2018 are not limited by IRC Section 382.
In the fourth quarter of 2016, Atlas purchased a building and land for $9.3 million to serve as its corporate headquarters. The Company purchased furnishings and made improvements to this building of $1.1 million, $11.3 million and $139,00 in 2018, 2017 and 2016, respectively. See ‘Part II, Item 8, Note 9, Property and Equipment’ in the Notes to Consolidated Financial Statements for further discussion of the new corporate headquarters.
See ‘Part II, Item 7, MD&A, Overview’ section for further information regarding the other lines of business.
Atlas experienced $82.7 million in unfavorable prior accident year development in 2018 as reflected as incurred related to prior years in the table above. The unfavorable development is primarily from our core commercial automobile liability line and was mostly related to accident years 2013 through 2017.
Atlas experienced $75.4 million in unfavorable prior accident year development in 2017 as reflected as incurred related to prior years in the table above. The unfavorable development is primarily from our core commercial automobile liability line. Atlas previously identified that claim expenses in Michigan were significantly outpacing other states and took a significant charge. Although exposure in Michigan was reduced to approximately 1.4% of the Company’s insured vehicles inforce by year end 2017, payments for claims in this state continued to be disproportionate to historic premiums earned. In addition, the remaining liability for non-New York Global Liberty business written prior to 2016 is expected to settle for greater amounts than previously expected. Overall, the actuarially determined liability for remaining claims related to accident year 2015 and prior in general, across all jurisdictions, was indicated to be significantly higher than carried reserves.
As of December 31, 2018, there were 11,936,970 ordinary voting common shares outstanding and no preferred shares outstanding.
On March 21, 2017, the Company’s Board of Directors approved a Share Repurchase Program of up to 650,000 shares of common stock. The repurchases could be made from time to time in open market transactions, privately-negotiated transactions, block purchases, or otherwise in accordance with securities laws at the discretion of the Company’s management until March 21, 2018. The Share Repurchase Program was not extended. The Company’s decisions around the timing, volume, and nature of share repurchases, and the ultimate amount of shares repurchased, was dependent on market conditions, applicable securities laws, and other factors. The share repurchase program and the Board’s authorization of the program could have been modified, suspended, or discontinued at any time. During 2018, 255,505 shares were repurchased under this Share Repurchase Program.
On December 31, 2018, the Company awarded grants for ordinary voting common shares of the Company to its external directors pursuant to a director equity award agreement dated December 31, 2018. The awards, which were approved by the Company’s Board of Directors in March 2018, were valued at $40,000 per external director (“Aggregate Award”) and were made under the Company’s Equity Incentive Plan. The number of restricted stock units awarded was determined by dividing (A) the Aggregate Award by (B) the closing price of one share of Company ordinary voting common share at the close of market on April 4, 2018, which was $10.50 per share. For new directors, the Aggregate Award is proportionate to the director’s start date and priced as of that same day. During 2018, the Company awarded 17,524 Restricted Stock Unit (“RSU”) grants having an aggregate grant date fair value of $179,000. The RSUs will vest 33.3% on January 1 of each year for the next three years.
There were 24,932 and 14,816 non-vested RSUs issued as of December 31, 2018 and 2017, respectively. The RSUs are participative and are included in the computations of earnings per common share and book value per common share for these periods.
On September 30, 2016, Atlas paid $409,000 in dividends earned on the preferred shares to the former owner of Gateway, the cumulative amount to which they were entitled through September 15, 2016, leaving no accrued and unpaid dividends owed to the former owner of Gateway. During 2018, Atlas paid $333,000 in dividends earned on the preferred shares to the former owner of Anchor, the cumulative amount to which they were entitled through December 31, 2017, leaving no accrued or unpaid dividends.
The changes to book value per common share are attributed to the combined effects of the reasons cited in the ‘Net Premiums Earned,’ ‘Net Claims Incurred,’ ‘Acquisition Costs,’ ‘Other Underwriting Expenses,’ ‘Net Investment Income,’ ‘Goodwill Impairment Loss,’ ‘Interest Expense,’ ‘Loss from Change in Fair Value of Equity Securities,’ ‘Net Realized Investment Gains’ and ‘Other Income’ subsections of the ‘Operating Results’ section.
As a holding company, Atlas may derive cash from its subsidiaries generally in the form of dividends and in the future may charge management fees to the extent allowed by statute or other regulatory approval requirements to meet its obligations. The Insurance Subsidiaries fund their obligations primarily through premiums collected, investment income and proceeds from the sales and maturity of investments, and capital contributions from their parents. Refer also to the discussion above in the ‘Investments Overview and Strategy’ section. The Insurance Subsidiaries require regulatory approval for the return of capital and, in certain circumstances, payment of dividends. In the event that dividends and management fees available to the holding company are inadequate to service its obligations, the holding company would need to raise capital, sell assets or incur debt obligations. See “Risk Factors - Risks Related to 2019 Developments - Regulatory Developments” for certain developments with respect to the Insurance Subsidiaries subsequent to December 31, 2018.
The senior unsecured notes were issued under an indenture and supplemental indenture that contain covenants that, among other things, limit: (i) the ability of Atlas to merge or consolidate, or lease, sell, assign or transfer all or substantially all of its assets; (ii) the ability of Atlas to sell or otherwise dispose of the equity securities of certain of its subsidiaries; (iii) the ability of certain of Atlas’ subsidiaries to issue equity securities; (iv) the ability of Atlas to permit certain of its subsidiaries to merge or consolidate,
or lease, sell, assign or transfer all or substantially all of their respective assets; and (v) the ability of Atlas and its subsidiaries to incur debt secured by equity securities of certain of its subsidiaries.
Cash used in operations during 2018 was primarily a result of net loss and increases in (i) premiums receivable and unearned premium reserves due to premium growth, (ii) reinsurance recoverable on paid amounts, prepaid reinsurance premiums and reinsurance premiums payable due to changes in the Quota Share cession rate, and (iii) unpaid claims liabilities due to growth and the re-estimation of the ultimate claims incurred on prior accident years. Cash provided by operations during 2017 and 2016 was primarily a result of net income and increases in unpaid claims liabilities and unearned premium reserves. We receive most premiums in advance of the payment of claims. Our ability to generate positive operating cash flows depends on the frequency and severity of claims and the timing of collection of premiums receivable and reinsurance recoverables on paid claims.
As a holding company, Atlas could derive cash from its Insurance Subsidiaries generally in the form of dividends to meet its obligations, which will primarily consist of operating expense payments and debt payments. Atlas’ Insurance Subsidiaries fund their obligations primarily through premium and investment income and maturities in the securities portfolio. The Insurance Subsidiaries require regulatory approval for the return of capital, loans or advances and, in certain circumstances, prior to the payment of dividends. In the event that dividends available to the holding company are inadequate to cover its operating expenses and debt payments, the holding company would need to raise capital, sell assets or incur future debt.
As disclosed in Note 20 to the consolidated financial statements, Atlas Financial Holdings, Inc. has been exploring strategic alternatives to its business model as all three of its Illinois domesticated insurance companies were placed into rehabilitation with the Illinois Department of Insurance in 2019. The Company plans to reduce its risk as an insurance carrier and transition to a managing general agency business model. The Company will utilize its existing managing general agency platform to effectuate this change in its business model and work with strategic external insurance and reinsurance partners. Our opinion is not modified with respect to this matter.
We have audited Atlas Financial Holdings, Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, because of the effect of the material weakness described in the following paragraph on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
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 Annual Report on Form 10-K. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance
Atlas Financial Holdings, Inc. (“Atlas” or “We” or the “Company”) commenced operations on December 31, 2010. The primary business of Atlas is underwriting commercial automobile insurance in the United States (“U.S.”), with a niche market orientation and focus on insurance for the “light” commercial automobile sector. This sector includes taxi cabs, non-emergency para-transit, limousine, livery, including certain transportation network companies (“TNC”) drivers/operators, and business autos. Automobile insurance products provide insurance coverage in three major areas: liability, accident benefits and physical damage. Liability insurance provides coverage subject to policy terms and conditions where the insured is determined to be responsible and/or liable for an automobile accident, for the payment for injuries and property damage to third parties. Accident benefit policies or personal injury protection policies provide coverage for loss of income, medical and rehabilitation expenses for insured persons who are injured in an automobile accident, regardless of fault. Physical damage coverage subject to policy terms and conditions provides for the payment of damages to an insured automobile arising from a collision with another object or from other risks such as fire or theft. In the short run, automobile physical damage and liability coverage generally provides more predictable results than automobile accident benefit or personal injury insurance.
Atlas’ business is carried out through its “Insurance Subsidiaries”: American Country Insurance Company (“American Country”), American Service Insurance Company, Inc. (“American Service”), Gateway Insurance Company (“Gateway”), and Global Liberty Insurance Company of New York (“Global Liberty”); and other non-insurance company subsidiaries: Anchor Group Management Inc. (“AGMI”), Plainview Premium Finance Company, Inc. (“Plainview Delaware”), UBI Holdings Inc. (“UBI Holdings”) and UBI Holdings’ wholly-owned subsidiaries, optOn Digital IP Inc. (“OOIP”) and optOn Insurance Agency Inc. (“optOn” and together with OOIP and UBI Holdings, “UBI”).
These statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of Atlas and the entities it controls. All significant intercompany accounts and transactions have been eliminated.
Plainview Premium Finance Company, Inc. (Delaware), merged into American Insurance Acquisition during 2018
Financial instruments are recognized and unrecognized using trade date accounting, since that is the date Atlas contractually commits to the purchase or sale with the counterparty.
Short-term investments consist of investments with original maturities between three months and one year and are reported at cost, which approximates fair value.
Atlas employs specific control processes to determine the reasonableness of the fair value of its financial assets. These processes are designed to supplement those performed by Atlas’ investment adviser to ensure that the values received from them are accurately recorded and that the data inputs and the valuation techniques utilized are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, Atlas assesses the reasonableness of individual security values that have stale prices or whose changes exceed certain thresholds as compared to previous values received from Atlas’ investment adviser or to expected prices. The portfolio is reviewed routinely for transaction volumes, new issuances, any changes in spreads, as well as the overall movement of interest rates along the yield curve to determine if sufficient activity and liquidity exists to provide a credible source for market valuations. When fair value determinations are expected to be more variable, they are validated through reviews by members of management or the Board of Directors who have relevant expertise and who are independent of those charged with executing investment transactions.
Premiums receivable include premium balances due and uncollected and installment premiums not yet due from agents and insureds.
Atlas defers producers’ commissions, premium taxes and other underwriting costs directly relating to the successful acquisition of premiums written to the extent they are considered recoverable. These costs are then expensed as the related premiums are earned. The method followed in determining the deferred policy acquisitions costs (“DPAC”) limits the deferral to its realizable value by giving consideration to estimated future claims and expenses to be incurred as premiums are earned. Changes in estimates, if any, are recorded in the accounting period in which they are determined. Anticipated investment income is included in determining the realizable value of the DPAC. Atlas’ DPAC are reported net of deferred ceding commissions.
Income tax expense (benefit) includes all taxes based on taxable (loss) income of Atlas and its subsidiaries, and is recognized in the statements of (loss) income and comprehensive (loss) income except to the extent that they relate to items recognized directly in other comprehensive income, in which case the income tax effect is also recognized in other comprehensive (loss) income.
Deferred taxes are recognized based on the differences in the tax basis of assets, liabilities and items recognized directly in equity and the financial reporting basis of such items.
Atlas recognized intangible assets as part of the acquisitions of Gateway and Anchor Holdings Group, Inc. The intangible assets are classified as either indefinite-lived or definite-lived depending on whether the useful lives can be identified. Atlas indefinite-lived intangible assets consist of state insurance licenses, and these intangible assets are reviewed for impairment at least annually. Definite-lived intangible assets are amortized over their useful lives on a straight-line basis except for customer related intangibles, which are on an accelerated basis. Atlas definite-lived intangible assets consist of trade names and trademarks with useful lives of 15 years and customer relationships with useful lives of 10 years.
Premium income is recognized on a pro rata basis over the terms of the respective insurance contracts. Unearned premium reserves represent the portion of premiums written that are related to the unexpired terms of the policies in force.
The provision for unpaid claims represent the estimated liabilities for reported claims reported prior to the close of the accounting period, estimates for unreported claims based on industry data and actuarial estimates, plus related estimated claim adjustment expenses based on the experience of the Company. Unpaid claim adjustment expenses are determined using case-basis evaluations and statistical analyses, including insurance industry claims data, and represent estimates of the ultimate cost of all claims incurred.
Pertinent Accounting Standard Updates (“ASUs”) are issued from time to time by the FASB and are adopted by the Company as they become effective. All recently issued accounting pronouncements with effective dates prior to January 1, 2019 have been adopted by the Company.
In March 2019, December 2018, July 2018 and February 2016, the FASB issued ASU 2019-01 Leases (Topic 842) Codification Improvements, ASU 2018-20 Leases (Topic 842) Narrow-Scope Improvements for Lessors, ASU 2018-11 Leases (Topic 842): Targeted Improvements and ASU 2018-10 Codification Improvements to Topic 842, Leases and ASU 2016-02, Leases (Topic 842), respectively. The provisions of these updates impact the classification criteria, disclosure requirements, and other specific transactions in lease accounting. The update requires either the use of a modified retrospective approach, which requires leases to be measured at the beginning of the earliest period presented, or the transition method, which requires entities to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. For public entities, this guidance is effective for years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted. The Company plans on adopting the update on the required effective date using the transition method with no change to comparative periods. See ‘Part II, Item 8, Note 8, Commitments and Contingencies’ in the Notes to Consolidated Financial Statements for further discussion of the future lease commitments. The adoption of this update will result in the recognition of both a right-of-use asset and lease liability equal to the present value of the lease payments on the date of adoption, which will be less than 1% of total assets and total liabilities. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements. There is no expected impact to any of Atlas’ current financial covenants as a result of the increase to reported liabilities.
In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This guidance shortens the amortization period to the earliest call date for certain purchased callable debt securities held at a premium that have explicit, noncontingent call features and are callable at a fixed price and preset date. For public entities, this guidance is effective for years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted. The Company plans on adopting the update on the required effective date. The adoption of this ASU is not expected to have an impact on the Company’s consolidated financial statements because Atlas’ callable debt securities, that are held at a premium, are amortized to the earliest call date, which is consistent with current accounting treatment.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). The provisions of this update require an entity to broaden the information that it considers in developing its allowance for credit losses for assets. For public entities, this guidance is effective for years beginning after December 15, 2019, including interim periods within those years. Early adoption is permitted. Atlas does not currently have any investments with credit losses recorded or other significant credit allowance, therefore the provisions of this update are not expected to have a material impact on the consolidated financial statements upon adoption. The Company plans on adopting the update on the required effective date.
All other recently issued pronouncements with effective dates after December 31, 2018 are not expected to have a material impact on the consolidated financial statements.
Goodwill and indefinite-lived intangible assets are tested for impairment annually or when a triggering even occurs. During the fourth quarter of 2018, the Company performed an assessment of the recoverability of goodwill related to Anchor Group Holdings, Inc. as of December 31, 2018. Based on the assessment, the Company reduced the carrying value of goodwill to $0, which resulted in a goodwill impairment loss of $2.7 million for 2018. There were no goodwill impairment losses during 2017 and 2016.
Atlas concluded that there was no indefinite-lived intangible asset impairment in 2018, 2017 or 2016.
Atlas assesses, on a quarterly basis, whether there is evidence that a financial asset or group of financial assets is impaired. An investment is considered impaired when the fair value of the investment is less than its cost or amortized cost. When an investment is impaired, the Company must make a determination as to whether the impairment is other-than-temporary.
identifying all security holdings in unrealized loss positions that have existed for at least six months or other circumstances that management believes may impact the recoverability of the security;
assessing whether declines in market value are other-than-temporary for debt security holdings based on credit ratings from third party security rating agencies; and
Under the ASC, with respect to an investment in an impaired debt security, other-than-temporary impairment (“OTTI”) occurs if (a) there is intent to sell the debt security, (b) it is more likely than not it will be required to sell the debt security before its anticipated recovery, or (c) it is probable that all amounts due will be unable to be collected such that the entire cost basis of the security will not be recovered. If Atlas intends to sell the debt security, or will more likely than not be required to sell the debt security before the anticipated recovery, a loss in the entire amount of the impairment is reflected in net investment gains (losses) on investments in the consolidated statements of (loss) income. If Atlas determines that it is probable it will be unable to collect all amounts and Atlas has no intent to sell the debt security, a credit loss is recognized in net investment gains (losses) on investments in the consolidated statements of (loss) income to the extent that the present value of expected cash flows is less than the amortized cost basis; any difference between fair value and the new amortized cost basis (net of the credit loss) is reflected in other comprehensive (loss) income, net of applicable income taxes.
There were no other-than-temporary impairments recorded in 2018, 2017 or 2016 as a result of the OTTI analysis performed by management.
As of December 31, 2018, we held 391 individual fixed income securities that were in an unrealized loss position, of which 246 individual fixed income securities were in a continuous loss position for longer than 12 months. As of December 31, 2017, we held 346 and 2 individual fixed income and equity securities, respectively, that were in an unrealized loss position, of which 103 individual fixed income securities were in a continuous loss position for longer than 12 months. We did not recognize the unrealized losses in earnings on these fixed income securities in 2018 or 2017, because we neither intend to sell the securities nor do we believe that it is more likely than not that we will be required to sell these securities before recovery of their amortized costs.
The proceeds from sales and calls, gross realized investment gains and gross realized investment losses on fixed income securities in 2016 were restated to include both voluntary and involuntary calls.
partnership. The carrying values of the collateral loans were $1.0 million and $6.2 million as of December 31, 2018 and 2017, respectively.
Atlas’ short-term investments are comprised of fixed income securities. As of December 31, 2018, short-term investments totaled $4.7 million. Atlas had no short-term investments as of December 31, 2017.
The Company had no fair value investments classified as Level 3 as of December 31, 2018 and 2017. There were no transfers in or out of Level 2 or Level 3 during 2018 and 2017.
On July 22, 2013, due to shareholder activity, a “triggering event” as determined under IRC Section 382 occurred. As a result, under IRC Section 382, the use of the Company’s net operating loss and other carryforwards generated prior to the “triggering event” will be limited as a result of this “ownership change” for tax purposes, which is defined as a cumulative change of more than 50% during any three-year period by shareholders owning 5% or greater portions of the Company’s shares. Due to this triggering event, the Company estimates that it will retain total tax effected federal net operating loss carryforwards (“NOLs”) of approximately $25.3 million as of December 31, 2018.
NOLs and other carryforwards generated in 2017 and 2018 are not limited by IRC Section 382.
evidence that is difficult to overcome in determining that a valuation allowance is not needed against DTAs. Based on Atlas’ cumulative loss in recent years, Atlas has established a valuation allowance of $29.4 million for its gross future deferred tax assets as of December 31, 2018. The Company had no valuation allowance as of December 31, 2017.
Atlas accounts for uncertain tax positions in accordance with the income taxes accounting guidance. Atlas has analyzed filing positions in the federal and state jurisdictions where it is required to file tax returns, as well as the open tax years in these jurisdictions. Atlas believes that its federal and state income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. Therefore, no reserves for uncertain federal and state income tax positions have been recorded. Atlas would recognize interest and penalties related to unrecognized tax benefits as a component of the provision for federal income taxes. Atlas did not incur any federal income tax related interest income, interest expense or penalties in 2018, 2017 or 2016. Tax years 2015 and years thereafter are subject to examination by the Internal Revenue Service (“IRS”).
The Company has entered into subscription agreements to allow for participation by the Company in limited liability investments, which invest in income-producing real estate, equities and insurance linked securities. As of December 31, 2018, the unfunded commitments are $6.0 million.
Depreciation expense and amortization was $2.9 million, $1.4 million and $1.0 million in 2018, 2017 and 2016, respectively.
Net realized gains on the disposal and sales of equipment were $2,000 in 2018, and net realized losses on the disposal and sales of equipment were $12,000 in 2017. There were no realized gains or losses on the disposal of property or equipment in 2016.
Atlas monitors the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Letters of credit are maintained for any unauthorized reinsurer to cover ceded unearned premium reserves, ceded claims and claims adjustment expense reserve balances and ceded paid claims. These policies mitigate the risk of credit quality or dispute from becoming a danger to financial strength. To date, the Company has not experienced any material difficulties in collecting reinsurance recoverables.
Atlas experienced $82.7 million in unfavorable prior accident year development in 2018 as reflected as incurred related to prior years in the table above. The unfavorable development is primarily from our core lines with $66.4 million of the development related to claims from accident years 2015 through 2017. Year-end 2018 reserve estimates for the Insurance Subsidiaries were strengthened to the high point of the actuarial range established by the outside independent actuaries for each entity based on December 31, 2018 data, claim settlement activities, and other factors evaluated subsequent to the receipt of the 2018 actuarial opinions. While the Company believes that the changes made to its claim process will result in better outcomes than would have otherwise been the case, uncertainty regarding the ultimate outcome exists, and it cannot be assumed that reserve estimates will be adequate. Primarily as a result of regulatory concerns regarding reserve levels, the ASI Pool Companies were placed into rehabilitation in 2019. See ‘Item 1, 2019 Developments’ and “Item 1A, Risk Factors - Risks Related to 2019 Developments - Regulatory Developments” for certain developments with respect to the Company and the Insurance Subsidiaries subsequent to December 31, 2018. Incremental claim outcomes and other factors could result in future adjustments to reserves and reserve estimates.
Atlas experienced $75.4 million in unfavorable prior accident year development in 2017 as reflected as incurred related to prior years in the table above. The unfavorable development is primarily from our core commercial automobile liability line. Atlas previously identified that claim expenses in Michigan were significantly outpacing other states and took a significant charge. Although exposure in Michigan was reduced to approximately 1.4% of the Company’s insured vehicles inforce by year end 2017, payments for claims in this state continued to be disproportionate to historic premiums earned. In addition, the remaining liability for non-New York Global Liberty business written prior to 2016 is expected to settle for greater amounts than previously expected. Overall, the actuarially determined liability for remaining claims related to accident year 2015 and prior, in general, across all jurisdictions, was indicated to be higher than carried reserves.
Atlas experienced $32.6 million in unfavorable prior accident year development in 2016 as reflected as incurred related to prior years in the table above. The unfavorable development is primarily from our core commercial automobile liability line. Excluding
The following is information about incurred and paid claims and claims adjustment expenses development for the year ended December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of incurred but not reported liabilities plus expected development on reported claims included within the net incurred claims amounts. The information about incurred and paid claims development for the years ended December 31, 2009 to 2015, is presented as unaudited supplementary information.
On January 6, 2011, Atlas adopted a stock option plan (“Stock Option Plan”) in order to advance the interests of Atlas by providing incentives to eligible persons defined in the plan. In the second quarter of 2013, a new equity incentive plan (“Equity Incentive Plan”) was approved by the Company’s common shareholders at the Annual General Meeting, and Atlas ceased to grant new stock options under the preceding Stock Option Plan. The Equity Incentive Plan is a securities based compensation plan, pursuant to which Atlas may issue restricted stock grants for ordinary voting common shares, restricted stock, stock grants for ordinary voting common shares, stock options and other forms of equity incentives to eligible persons as part of their compensation. The Equity Incentive Plan is considered an amendment and restatement of the Stock Option Plan, although outstanding stock options issued pursuant to the Stock Option Plan will continue to be governed by the terms of the Stock Option Plan.
Atlas has a defined contribution 401(k) plan covering all qualified employees of Atlas and its subsidiaries. Contributions to this plan are limited based on IRS guidelines. Atlas matches 100% of the employee contribution up to 2.5% of annual earnings, plus 50% of additional contributions up to 2.5% of annual earnings, for a total maximum expense of 3.75% of annual earnings per participant. Atlas’ matching contributions are discretionary. Employees are 100% vested in their own contributions and vest in Atlas contributions based on years of service equally over 5 years with 100% vested after 5 years. Company contributions were $543,000, $441,000 and $424,000 in 2018, 2017 and 2016, respectively.
During 2017, the 128,191 restricted voting common shares that were beneficially owned or controlled by Kingsway Financial Services, Inc. (including its subsidiaries and affiliated companies, “Kingsway”) were sold to non-affiliates of Kingsway. The restricted voting common shares are entitled to vote at all meetings of shareholders, except at meetings of holders of a specific class that are entitled to vote separately as a class. The restricted voting common shares as a class shall not carry more than 30% of the aggregate votes eligible to be voted at a general meeting of common shareholders. The Kingsway-owned restricted voting common shares automatically converted to ordinary voting common shares upon their sale to non-affiliates of Kingsway. There are no restricted voting common shares outstanding as of December 31, 2018.
There were 24,932 and 14,816 non-vested RSUs as of December 31, 2018 and 2017, respectively. These RSUs are participative and are included in the computations of earnings per common share and book value per common share for these periods.
On March 21, 2017, the Company’s Board of Directors approved a Share Repurchase Program of up to 650,000 shares of common stock. The repurchases could be made from time to time in open market transactions, privately-negotiated transactions, block purchases, or otherwise in accordance with securities laws at the discretion of the Company’s management until March 21, 2018. The Share Repurchase Program was not extended. The Company’s decisions around the timing, volume, and nature of share repurchases, and the ultimate amount of shares repurchased, was dependent on market conditions, applicable securities laws and
Atlas did not declare or pay any dividends to its common shareholders during 2018 or 2017.
On September 30, 2016, Atlas paid $409,000 in dividends earned on the preferred shares to the former owner of Gateway, the cumulative amount to which they were entitled through September 15, 2016, leaving no accrued and unpaid dividends owed to the former owner of Gateway. During 2018, Atlas paid $333,000 in dividends earned on the preferred shares to the former owner of Anchor, the cumulative amount to which they were entitled through December 31, 2017, leaving no accrued or unpaid dividends. The paid claims development on Global Liberty’s pre-acquisition claims reserves was in excess of $4.0 million, and as a result, pursuant to the terms of the Anchor stock purchase agreement, dividends will no longer accrue to the former owner of Anchor.
Policy acquisition costs are deferred and amortized over the period in which the related premiums written are earned, typically 12 months.
Additional requirements include risk-based capital (“RBC”) rules, thresholds intended to enable state insurance regulators to assess the level of risk inherent in an insurance company’s business and consider items such as asset risk, credit risk, underwriting risk and other business risks relevant to its operations. The NAIC RBC formula generates the regulatory minimum amount of capital that a company is required to maintain to avoid regulatory action. There are four levels of action that a company can trigger under the formula: company action, regulatory action, authorized control and mandatory control levels. Each RBC level requires some particular action on the part of the regulator, the company, or both. For example, an insurer that breaches the Company Action Level must produce a plan to restore its RBC levels. As of December 31, 2018, the total adjusted capital of three of our Insurance Subsidiaries exceeded the minimum levels required under RBC requirements, with one subsidiary breaching the Company Action Level. We are working with the appropriate regulators to restore its RBC levels. We do not expect that this restoration will impede our ability to execute on strategic plans. See “Risk Factors - Risks Related to 2019 Developments - Regulatory Developments” for certain developments with respect to the Insurance Subsidiaries subsequent to December 31, 2018.
Dividends may only be paid from statutory unassigned surplus, and payments may not be made if such surplus is less than a stipulated amount. The dividend restriction for the ASI Pool Subsidiaries is the greater of statutory net income or 10% of total statutory capital and surplus. The dividend restriction for Global Liberty is the lower of 10% of statutory surplus or 100% of adjusted net investment income for the preceding twelve months. Atlas' Insurance Subsidiaries did not declare or pay any dividends to Atlas during 2018 or 2017.
During 2019, the Illinois Department of Insurance (the “Department”) placed all three of the ASI Pool Companies (after Gateway was redomesticated in Illinois) into rehabilitation with the Director of the Department as the statutory rehabilitator. While in rehabilitation, the operations of such insurance subsidiaries will be overseen by the statutory rehabilitator although Atlas continues to maintain its legal ownership of the stock of the ASI Pool Companies. Management’s overriding strategic plan continues to include a transition of business from these insurance companies to alternative markets within a reasonable period of time utilizing the existing platform of the MGA to work with strategic external insurance and reinsurance partners.
Effective August 15, 2019, no new business was written by the ASI Pool Companies, and only New York area new business was written by Global Liberty, which is focusing its resources on New York area business to leverage the subsidiary’s heritage in this large and specific market. The ASI Pool Companies and Global Liberty continued to write renewal business that met their underwriting standards during 2019. Non-renewals related to ASI Pool Companies’ insurance policies began towards the end of 2019.
On January 22, 2020, the Company announced a non-binding letter of intent with Buckle, a technology-driven financial services company, to purchase the stock of Atlas’ indirect subsidiary Gateway Insurance Company (“Gateway”) and its corporate charter and forty-seven (47) state insurance licenses as well as state statutory deposits, subject to regulatory and other necessary approvals, for $4.7 million plus the value of all purchased deposits, such amount to be paid to the Rehabilitator for the benefit of the rehabilitation estate of Gateway, with a tentative closing date in March of 2020. The Company anticipates that Buckle will engage the MGA and certain other subsidiaries of the Company to provide services to Buckle and that Buckle will lease space at the Company’s headquarters and its Melville, NY office.