Protective Insurance Corporation is a property-casualty insurer specializing in marketing and underwriting property, liability and workers' compensation coverage for trucking and public transportation fleets, as well as coverage for trucking industry independent contractors. We operate as one reportable property and casualty insurance segment, offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.
On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the "U.S. Tax Act") was signed into law, which lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. We finalized our accounting for the tax effects of the U.S. Tax Act during 2018. No material adjustments to income tax expense (benefit) were recorded during 2018.
On September 4, 2020, A.M. Best Company, Inc. ("A.M. Best") affirmed our financial strength rating of "A" (Excellent). A.M. Best continues to categorize our balance sheet as "very strong" and our operating performance as "adequate," but its outlook remains negative. On February 16, 2021, in connection with the announced Merger Agreement discussed below, A.M. Best placed our financial strength rating under review with positive implications.
The Board, at the unanimous recommendation of the Special Committee, unanimously determined that the Merger Agreement and the transactions contemplated thereby, including the Merger, are advisable and fair to, and in the best interests of, Protective and its shareholders, and approved, adopted and declared advisable the Merger Agreement and the transactions contemplated thereby. The Merger is expected to close prior to the end of the third quarter of 2021. At the effective time of the Merger, each issued and outstanding share of common stock, without par value, of Protective (other than each share of Protective's common stock that is owned by Protective as treasury stock or by any subsidiary of Protective and each share of Protective's common stock owned by Progressive, Merger Sub or any other subsidiary of Progressive immediately prior to the effective time of the Merger) will be automatically canceled and converted into the right to receive $23.30 in cash, without interest, for a total transaction value of approximately $338 million.
The Merger Agreement contains various customary representations and warranties from each of Protective, Progressive and Merger Sub. Protective has also agreed to various customary covenants, including but not limited to conducting its business in the ordinary course and not engaging in certain types of transactions during the period between the execution of the Merger Agreement and the closing of the Merger. However, the Merger Agreement permits Protective to continue to pay regular quarterly dividends not to exceed $0.10 per share of its common stock. The consummation of the Merger is subject to certain conditions, including approval of the Merger by Protective's Class A shareholders, legal and regulatory approvals including from the Indiana Department of Insurance and the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, as well as other customary closing conditions.
For additional information regarding the risks associated with the Merger, please see Part I, Item 1A, "Risk Factors," of this Annual Report on Form 10-K.
On February 14, 2021, Protective also entered into a Voting and Support Agreement (the “Voting Agreement”) with Progressive and certain of Protective's shareholders. The Voting Agreement requires that the Protective shareholders party to the Voting Agreement: (i) appear at the meeting of the holders of Protective's Class A common stock to consider resolutions to approve the Merger Agreement and the Merger or otherwise cause their shares of Protective's common stock to be counted as present for purposes of calculating a quorum, and (ii) vote their shares (a) in favor of the adoption of the Merger Agreement, the Merger and the other transactions contemplated thereby and any action reasonably requested by Progressive or the Board in furtherance of the foregoing, (b) against any action or agreement that would result in a material breach of any covenant, representation or warranty or other obligation or agreement of Protective contained in the Merger Agreement and (c) against any takeover proposal or superior proposal (provided, that if the Board changes its recommendation with respect to the Merger, any shares of Class A common stock owned by such shareholders in excess of approximately 35% of the outstanding shares of Class A common stock will be voted in the same proportion as those shares of Class A common stock voted by the holders of Protective's Class A common stock that are not party to the Voting Agreement).
The updated guidance in ASU 2016-13 also amended the previous other-than-temporary impairment ("OTTI") model for available-for-sale fixed income securities by requiring the recognition of impairments relating to credit losses through an allowance account and limiting the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. We adopted the guidance related to available-for-sale fixed income securities on January 1, 2020 using a prospective transition approach for available-for-sale fixed income securities that were purchased with credit deterioration or had recognized an OTTI write-down prior to the effective date. The effect of the prospective transition approach was to maintain the same amortized cost basis before and after the effective date. For those securities in an unrealized loss position where we intended to sell as of December 31, 2020, we recorded a write down to earnings of $1.8 million during the year ended December 31, 2020. We also analyzed securities in an unrealized loss position for credit losses and recorded an allowance for credit losses of $1.0 million as of December 31, 2020. We reviewed our remaining fixed income securities in an unrealized loss position as of December 31, 2020 and determined the losses were primarily the result of non-credit factors, such as the increase in market volatility due to the disruption in global financial markets as a result of the novel coronavirus ("COVID-19") pandemic and responses to it. We currently do not intend to sell nor do we expect to be required to sell these securities before recovery of their amortized cost.
Beginning in March 2020 and continuing through the date of this Annual Report on Form 10-K, the global pandemic associated with COVID-19 and related economic conditions have impacted the global economy and our results of operations. For the year ended December 31, 2020, net premiums earned within our commercial automobile products, specifically public transportation, were negatively impacted due to a reduction in miles driven, which is the basis for premiums we receive, as well as an overall reduction in public transportation units insured. The declines in public transportation persisted throughout the year and have continued into 2021, but we saw a recovery in the third and fourth quarters within other commercial automobile products that has continued through the date of this Annual Report on Form 10-K. However, losses and loss expenses incurred during the same period reflected favorable impacts within all commercial automobile products as a result of declines in accident frequency due to lower traffic density. In addition to these impacts on our underwriting loss, as defined below, we incurred net realized and unrealized losses on investments of $9.2 million for the year ended December 31, 2020, primarily due to investment losses realized as a result of the significant declines in the global financial markets experienced during the first and second quarters due to the COVID-19 pandemic. As of December 31, 2020, both our fixed income and equity security investments have recovered to a net gain position. Additionally, insurance departments throughout the country have issued bulletins and regulations urging or requiring insurers to extend grace periods for the payment of policy premiums and to refrain from canceling or non-renewing policies for the non-payment of policy premiums for policyholders adversely affected by COVID-19; however, we have not seen a material decrease or slowdown in premium collection to date. Our liquidity and capital resources were not materially impacted by COVID-19 and related economic conditions during 2020. For further discussion regarding the potential impacts of COVID-19 and related economic conditions on our results, see Part I, Item 1A, "Risk Factors," of this Annual Report on Form 10-K.
We generally experience positive cash flows from operations. Premiums are collected on insurance policies in advance of the disbursement of funds for payment of claims. Operating costs of our property/casualty Insurance Subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, average less than one-third of net premiums earned on a consolidated basis and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided and the timing of the claim payments. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, become negative as loss settlements on claim reserves established in prior years exceed current revenues. Our cash flow relating to premiums is significantly affected by reinsurance programs in effect, whereby we cede both premium and risk to other insurance and reinsurance companies. These programs vary significantly among products and certain contracts call for reinsurance payment patterns, which do not coincide with the collection of premiums by us from our insureds.
For several years, our investment philosophy has emphasized the purchase of short-term bonds with high quality and liquidity. Our fixed income investment portfolio continues to emphasize shorter-duration instruments. If there was a hypothetical increase in interest rates of 100 basis points, the price of our fixed income portfolio, including cash, at December 31, 2020 would be expected to fall by approximately 2.8%. The credit quality of our fixed income securities remains high with a weighted average rating of AA-, including cash. The average contractual life of our fixed income and short-term investment portfolio was 7.1 years at December 31, 2020 compared to 6.9 years at December 31, 2019. The average duration of our fixed income portfolio remains shorter than the average duration of our liabilities. We also remain an active participant in the equity securities market. The long-term horizon for our equity investments allows us to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by our domestic property/casualty Insurance Subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners (the "NAIC"), which are designed to provide protection for both policyholders and shareholders.
Net cash used in financing activities for 2020 consisted of regular cash dividend payments to shareholders of $5.7 million ($0.40 per share) and $1.8 million to repurchase 126,764 shares of our Class B common stock. Financing activities for 2019 consisted of regular cash dividend payments to shareholders of $5.9 million ($0.40 per share) and $11.5 million to repurchase 677,088 shares of our Class A and Class B common stock. Financing activities for 2018 consisted of regular cash dividend payments to shareholders of $16.8 million ($1.12 per share) and $4.6 million to repurchase 199,668 shares of our Class A and Class B common stock.
Annualized net premiums written by our Insurance Subsidiaries for 2020 equaled approximately 126.9% of the combined statutory surplus of these subsidiaries. According to the NAIC, acceptable ranges for the ratio of net premiums written to statutory surplus include results of up to 300%. This ratio is designed to measure our ability to absorb above-average losses and our financial strength. Additionally, the statutory capital of each of our Insurance Subsidiaries substantially exceeded minimum risk-based capital requirements set by the NAIC as of December 31, 2020. As a result, we have the ability to increase our business without seeking additional capital to meet regulatory guidelines.
Consolidated shareholders' equity is composed largely of GAAP shareholders' equity of our Insurance Subsidiaries. As such, there are statutory restrictions on the transfer of substantial portions of this equity to Protective. At December 31, 2020, $50.6 million may be transferred by dividend or loan to Protective without approval by, or prior notification to, regulatory authorities. An additional $151.1 million of shareholders' equity of our Insurance Subsidiaries could be advanced or loaned to Protective with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical. We believe these restrictions pose no material liquidity concerns for us. We also believe the financial strength and stability of our Insurance Subsidiaries would permit access by Protective to short-term and long-term sources of credit when needed. Protective had cash and marketable securities valued at $12.9 million at December 31, 2020.
Other operating expenses for 2020 increased $5.0 million (3.6%) to $143.4 million compared to $138.5 million in 2019. This increase was primarily due to the $2.9 million of corporate charges incurred during 2020 for third party advisors to the Special Committee in connection with their review of the Contingent Sale Agreement as well as other strategic alternatives, as discussed above, and the $1.5 million increase to the CECL allowance related to our ongoing litigation with PSG recorded in the third quarter of 2020, as discussed above. The ratio of consolidated other operating expenses less commissions and other income to net premiums earned (the "expense ratio") was 30.6% during 2020, or 29.6% excluding the corporate charges and CECL allowance adjustment discussed above, compared to 28.9% during 2019.
As a result of the factors discussed above, net income for 2020 was $4.5 million compared to net income of $7.3 million in 2019, a decrease of $2.8 million.
Premiums ceded to reinsurers on our insurance business averaged 21.3% of gross premiums written for 2019 compared to 23.7% for 2018. During 2018, we had reserve strengthening that resulted in ceding an additional $17.3 million in premium from prior treaty years related to the variable premium adjustment provisions in our historical reinsurance treaties. In comparison the 2019 period reflected the ceding of only an additional $1.6 million in commercial automobile premium from prior treaty years related to variable premium adjustment provisions in our historical reinsurance treaties. This was partially offset by higher gross premiums written in workers' compensation coverages, which carry a higher reinsurance ceding rate in 2019 compared to 2018.
Losses and loss expenses incurred during 2019 increased $2.6 million (0.8%) to $348.5 million compared to $345.9 million in 2018, while the loss ratio decreased to 77.9% for 2019 compared to 79.9% for 2018. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The increased losses and loss expenses incurred reflected an increase in current accident year losses driven by continued emergence of severity. This current accident year development was partially offset by prior accident year net savings of $0.6 million that developed during 2019, primarily due to favorable loss development in workers' compensation coverages. Including the impact of the additional $1.6 million of ceded premium discussed above, total prior accident years had an unfavorable impact of $1.0 million in 2019. Losses and loss expenses for 2018 reflected reserve adjustments of $16.8 million related to unfavorable prior accident year loss development in commercial automobile coverages. Including the impact of the additional $17.3 million of ceded premium discussed above, total prior accident years had an unfavorable impact of $34.1 million in 2018.
Commercial automobile products covered by our reinsurance treaty from July 2019 through June 2020 are also subject to an unlimited aggregate stop-loss provision. Once the aggregate stop-loss level is reached, for every $100 of additional loss, we are responsible for our $65 retention. This increase in our retention compared to recent years, reflects the combination of 1) a decreased need for stop loss reinsurance protection resulting from a significant decrease in our commercial automobile subject limits profile, 2) a higher cost for this cover and 3) our confidence in profitability improvements given the limits reductions and rate increases on our commercial automobile products.
Net investment income for 2019 increased 19.1% to $26.2 million compared to $22.0 million for 2018. The increase reflected an increase in average funds invested resulting from positive cash flow, as well as a reallocation from equity investments held in limited partnerships into short-duration, high-quality bonds.
Other operating expenses for 2019 increased $1.3 million (0.9%), to $138.5 million compared to 2018. The increase was driven primarily by higher commission expenses as a result of premium written mix and higher salary and benefit expenses during 2019, partially offset by a non-cash goodwill impairment charge of $3.2 million recorded in 2018, which did not recur in 2019. The expense ratio was 28.9% during 2019, compared to 28.7% for 2018.
All marketable securities are included in the Company's balance sheets at current fair market value.
Approximately 62% of the Company's assets are composed of investments at December 31, 2020. Approximately 93% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 7% of investments are composed primarily of mortgage loans and minority interests in several limited partnerships. These mortgage loans are originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. These limited partnerships are engaged in long-short equities, private equity, country-focused funds and real estate development as an alternative to direct equity investments. These partnerships do not have readily-determinable market values themselves. Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the limited partnerships. While a substantial portion of the underlying assets are publicly-traded securities, those which are not publicly-traded have been valued by the respective limited partnerships using their experience and judgment.
A discussion of the Company's reinsurance strategies is presented in Part I, Item 1, "Business," of this Annual Report on Form 10-K.
Amounts recoverable under the terms of reinsurance contracts comprised approximately 26% of total Company assets as of December 31, 2020. In order to be able to provide the high limits required by the Company's insureds, the Company shares a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts. Some reinsurance contracts provide that a loss will be shared among the Company and its reinsurers on a predetermined pro-rata basis ("quota share"), while other contracts provide that the Company will keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount ("excess of loss"). Some risks are covered by a combination of quota share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by certain of the Company's insurance policies for commercial automobile liability, workers' compensation and professional liability risks provide more variability in the estimation process than lines of business with lower coverage limits.
● The selection of loss development factors in the establishment of bulk reserves for incurred but not reported losses and loss expenses;
On December 22, 2017, the U.S. Tax Act was signed into law. The U.S. Tax Act lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. GAAP requires the impact of tax legislation to be recognized in the period in which the law was enacted. The Company finalized its accounting for the tax effects of the U.S. Tax Act during 2018. No material adjustments to income tax expense (benefit) were recorded in 2018.
Net deferred tax assets (liabilities) reported at December 31 are as follows (dollars in thousands):
FASB provides guidance for recognizing and measuring uncertain tax positions and prescribes a threshold condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in the consolidated financial statements. Based on this guidance, management regularly analyzes tax positions taken or expected to be taken in a tax return based on the threshold condition prescribed. Tax positions that do not meet or exceed this threshold condition are considered uncertain tax positions. Interest related to uncertain tax positions, if any, would be recognized in income tax expense. Penalties, if any, related to uncertain tax positions would be recorded in income tax expense (benefit).
The Company's loss and loss expense reserves do not have contractual maturity dates, and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, the above table presents an estimate of when the Company might expect its direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid. Timing of the collection of the related reinsurance recoverable, estimated to be $455.6 million at December 31, 2020, or 42% of the loss and loss expense reserves presented in the above table, would approximate that of the above projected direct reserve payout but could lag behind such payments by several months in some instances.
The investment commitment in the above table relates to a maximum unfunded capital obligation for a limited partnership investment at December 31, 2020. The actual call dates for such funding could vary from that presented.
We have audited the accompanying consolidated balance sheets of Protective Insurance Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedules listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
Auditing management’s best estimate of IBNR was complex and required the involvement of our actuarial specialists due to the significant measurement uncertainty associated with the estimation and high degree of subjectivity in management’s determination of the expected loss ratio assumption. Management’s expected loss ratio assumption has a significant effect on the valuation of IBNR.
Auditing management’s best estimate of the Personnel Staffing Group recoverable allowance (the allowance) required the involvement of our valuation specialists due to the significant measurement uncertainty associated with management’s estimation. The uncertainty is primarily driven by the high degree of subjectivity in management’s determination of the default and recovery in default assumptions.
Basis of Presentation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Inter-company transactions and accounts have been eliminated in consolidation.
Investments: Carrying amounts for fixed income securities represent fair value and are based on quoted market prices, where available, or broker/dealer quotes for specific securities where quoted market prices are not available. Equity securities are carried at quoted market prices (fair value).
Commercial mortgage loans are carried primarily at amortized cost along with an allowance for losses when necessary. These investments represent interests in commercial mortgage loans originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. The Company recorded an allowance of $195 on its commercial mortgage loans as of December 31, 2020 in conjunction with the adoption of the credit losses accounting standard discussed below.
The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to record its proportionate share of the limited partnership's net income. To the extent the limited partnerships include both realized and unrealized investment gains or losses in the determination of net income or loss, then the Company would also recognize, through its consolidated statements of operations, its proportionate share of the investee's unrealized, as well as realized, investment gains or losses within net unrealized gains (losses) on equity securities and limited partnership investments.
Fixed income securities are considered to be available-for-sale. The related unrealized net gains or losses (net of applicable tax effects) on fixed income securities are reflected directly in other comprehensive income (loss) within shareholders' equity. Included within available-for-sale fixed income securities are convertible debt securities. A portion of the changes in the fair values of convertible debt securities is reflected as a component of net realized gains (losses) on investments, excluding impairment losses within the consolidated statements of operations. Realized gains and losses on disposals of fixed income securities are recorded on the trade date. Realized gains and losses on fixed income securities are determined by the specific identification of the cost of investments sold and are included in net realized gains (losses) on investments, excluding impairment losses.
Investment Impairments: For a fixed income security in an unrealized loss position where the Company has the intent to sell the fixed income security, or it is more likely than not that the Company will have to sell the fixed income security before recovery of its amortized cost basis, the decline in value is recorded within impairment losses on investments in the consolidated statements of operations. The new cost basis of the investment is the previous amortized cost basis less the impairment recognized. The new cost basis is not adjusted for any subsequent recoveries in fair value.
For a fixed income security that the Company does not intend to sell or in cases where it is more likely than not that the Company will not have to sell the security, the Company separates the credit loss component of the impairment from the amount related to all other factors and reports the credit loss component within net realized gains (losses) on investments, excluding impairment losses in the consolidated statements of operations. The impairment related to all other factors (non-credit factors) is reported in other comprehensive income (loss). The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted.
The Company considers the extent to which fair value is below amortized cost in determining whether a credit-related loss exists. The Company also considers the credit quality rating of the security, focusing on those below investment grade, with emphasis on securities downgraded below investment grade. The credit loss is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed income security. The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the appropriate effective interest rate. Additionally, the Company may conclude that a qualitative analysis is sufficient to support its conclusion that the present value of the expected cash flows equals or exceeds a security’s amortized cost.
Goodwill and Other Intangible Assets: In the fourth quarter of 2018, the Company concluded the entire goodwill balance was impaired, resulting in an impairment loss of $3,152. See Note M for further discussion. This impairment charge is included within other operating expenses in the consolidated statement of operations for the year ended December 31, 2018. Intangible assets determined to have finite lives, such as customer relationships and employment agreements, are amortized over their estimated useful lives in a manner that best reflects the economic benefits of the intangible asset. In addition, impairment testing is performed on these amortizing intangible assets if impairment indicators are noted..
Earnings (Loss) Per Share: Diluted earnings (loss) per share of common stock are based on the average number of shares of Class A and Class B Common Stock outstanding during the year, adjusted for the dilutive effect, if any, of restricted stock awards outstanding. Basic earnings (loss) per share are presented exclusive of the effect of share-based awards outstanding.
Insurance Company-Owned Life Insurance: Included within other assets on the consolidated balance sheets at December 31, 2020 and 2019 was $11,458 and $11,049 of company-owned life insurance. The carrying value of the company-owned life insurance policies represents the cash surrender value as reported by the respective insurer, which approximates fair value.
Recently Adopted Accounting Pronouncements: In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 changed the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income. Previously, the Company's equity securities were classified as available-for-sale and changes in fair value were recognized in accumulated other comprehensive income (loss) as a component of shareholders' equity. The Company adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective approach and recorded a cumulative-effect adjustment to reclassify unrealized gains on equity securities of $71,012 ($46,157, net of tax) from other comprehensive income (loss) to retained earnings within the consolidated balance sheet as of December 31, 2018. Unrealized gains or losses on equity securities are now recognized in the consolidated statements of operations within net unrealized gains (losses) on equity securities and limited partnership investments.
In February 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842), or ASU 2016-02. ASU 2016-02 superseded the prior lease guidance in ASC Topic 840, Leases. Under the new guidance, lessees are required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis. Concurrently, lessees are required to recognize a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The guidance provided for a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, or ASU 2018-11, which provided adopters an additional transition method by allowing entities to initially apply ASU 2016-02, and subsequent related standards, at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company adopted the new guidance on January 1, 2019 utilizing the transition method allowed per ASU 2018-11, and accordingly, comparative period financial information was not adjusted for the effects of the new guidance. No cumulative-effect adjustment was required to the opening balance of retained earnings on the adoption date. The Company's adoption of the new standard did not have any impact on the Company's consolidated statements of operations or cash flows. As of December 31, 2020 the Company had a right-of-use asset and a lease liability recorded within the consolidated balance sheet, each of approximately $120, which are included within other assets and accounts payable and other liabilities.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU 2016-13. ASU 2016-13 introduced a current expected credit loss (CECL) model for measuring expected credit losses for certain types of financial instruments held at the reporting date requiring significant judgment in application based on historical experience, current conditions and reasonable supportable forecasts, but is not prescriptive about certain aspects of estimating expected losses. The guidance replaced the current incurred loss model for measuring expected credit losses and provided for additional disclosure requirements. Subsequently, the FASB issued additional ASUs on Topic 326 that did not change the core principle of the guidance in ASU 2016-13, but provided clarification and implementation guidance on certain aspects of ASU 2016-13, and have the same effective date and transition requirements as ASU 2016-13. The Company adopted the guidance using a modified retrospective approach as of January 1, 2020 and recognized an pre-tax cumulative effect adjustment of $15,545 ($12,281, net of tax), to the opening balance of retained earnings. The adjustment was primarily related to estimating credit losses on the Company’s accounts receivable balances, reinsurance recoverable balances and commercial mortgage loans at the date of adoption with $15,000 ($11,850, net of tax) attributed to the ongoing litigation with Personnel Staffing Group ("PSG") discussed in Note T - Litigation, Commitments and Contingencies.
Recently Issued Accounting Pronouncements: In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, or ASU 2019-12. Among other items, the amendments in ASU 2019-12 simplify the accounting treatment of tax law changes and year-to-date losses in interim periods. An entity generally recognizes the effects of a change in tax law in the period of enactment; however, there is an exception for tax laws with delayed effective dates. Under current guidance, an entity may not adjust its annual effective tax rate for a tax law change until the period in which the law is effective. This exception was removed under ASU 2019-12, thereby providing that all effects of a tax law change are recognized in the period of enactment, including adjustment of the estimated annual effective tax rate. Regarding year-to-date losses in interim periods, an entity is required to estimate its annual effective tax rate for the full fiscal year at the end of each interim period and use that rate to calculate its income taxes on a year-to-date basis. However, current guidance provides an exception that when a loss in an interim period exceeds the anticipated loss for the year, the income tax benefit is limited to the amount that would be recognized if the year-to-date loss were the anticipated loss for the full year. ASU 2019-12 removes this exception and provides that in this situation, an entity would compute its income tax benefit at each interim period based on its estimated annual effective tax rate. ASU 2019-12 became effective on January 1, 2021 and is not expected to have a material effect on the Company's consolidated financial statements.
The following table summarizes, for available-for-sale fixed income securities in an unrealized loss position at December 31, 2020 and December 31, 2019, the aggregate fair value and gross unrealized loss categorized by the duration individual securities have been continuously in an unrealized loss position.
The fair value and the cost or amortized costs of fixed income investments at December 31, 2020, organized by contractual maturity, are shown below. Actual maturities may ultimately differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.
Major categories of investment income for the years ended December 31, 2020, 2019 and 2018 are summarized as follows:
(1) During 2018, the Company sold $149,195 in equity securities, resulting in a gain on sale of $51,900. The majority of these gains were included in unrealized gains within other comprehensive income (loss) at December 31, 2017 and, as a result of the adoption of ASU 2016-01, were reclassified to retained earnings as of January 1, 2018 and were therefore not recognized in the consolidated statements of operations for the year ended December 31, 2018.
The fair value of regulatory deposits with various insurance departments in the United States and Canada totaled $122,896 and $99,763 at December 31, 2020 and 2019, respectively.
Short-term investments at December 31, 2020 included $1,000 in certificates of deposit issued by a Bermuda bank.
The table above shows that a reserve savings of $311 developed during 2020 in the settlement of claims occurring on or before December 31, 2019, compared to a reserve savings of $550 in 2019 and reserve deficiencies of $16,786 in 2018. The developments for each year are composed of individual claim savings and deficiencies which, in the aggregate, have resulted from the settlement of claims at amounts higher or lower than previously reserved and from changes in estimates of losses incurred but not reported as part of the normal reserving process.
The following table reconciles the triangles presented in this note to the total (savings) / deficiency for the Company of $311 shown in the table above:
The $311 prior accident year savings that developed during 2020 related to favorable loss development in the Company's occupational accident business, partially offset by unfavorable loss development in commercial automobile coverages. This 2020 savings compares to savings of $550 for 2019 related to favorable loss development in the Company's workers' compensation business, and a deficiency of $16,786 for 2018 related to unfavorable development from commercial automobile coverages. This unfavorable loss development was the result of increased claim severity due to a more challenging litigation environment, as well as an unexpected increase in the time to settle claims leading to an unfavorable change in claim settlement patterns.
Loss reserves have been reduced by estimated salvage and subrogation recoverable of approximately $4,000 and $4,000 at December 31, 2020 and 2019, respectively.
(1) The majority of physical damage claims settle within a two-year period. The triangles above have been abbreviated to reflect the short-tail nature of this business.
The following is supplementary information about average historical claims duration as of December 31, 2020:
For the Company's commercial automobile risks, which are covered by regularly updated reinsurance agreements and which contain wide-ranging self-insured retentions ("SIR"), traditional actuarial methods are supplemented by other methods, as described below, in consideration of the Company's exposures to loss. In situations where the Company's reinsurance structure, the insured's SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous enough with historical loss data to allow for reliable projection of future developed losses. Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from the Company's proprietary databases to arrive at the reserve for incurred but not reported losses for the calendar/accident period under review. As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a monthly and quarterly basis and adjusts reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses. This process continues until all losses are settled for each period subject to this method. The Company notes there is more inherent uncertainty in 2020 than normal due to COVID-19, which could lead to either favorable or unfavorable impacts to its loss development that are currently unknown.
Net losses and loss expenses incurred include expenses of $432 for 2020, expenses of $193 for 2019 and a savings of $1,300 for 2018, relating to reinsurance assumed from non-affiliated insurance or reinsurance companies.
Components of reinsurance recoverable at December 31, 2020 and 2019 are as follows:
Deferred income taxes are calculated to account for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 2020 and 2019 are as follows:
In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income or availability to carryback the losses to taxable income during the periods in which those temporary differences become deductible. The Company considered several factors when analyzing the need for a valuation allowance, including the Company's current three year cumulative GAAP loss through December 31, 2020, the increase in deferred tax assets due to the adoption of CECL at January 1, 2020 discussed in Note A, the change in unrealized gains and losses and the loss of a high taxable income year from the carryback period. The three year cumulative loss limits the Company's ability to use projected income beyond 2020 in the analysis. As of December 31, 2020 and 2019, the Company had no valuation allowance. However, the application of intra-period tax allocation rules to benefits associated with deferred tax assets resulted in a charge to continuing operations as of December 31, 2020 of $1,264 in the consolidated statement of operations, offset by a corresponding benefit in shareholders' equity within accumulated other comprehensive income.
In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act of 2020, as amended (the “CARES Act”), was signed into law on March 27, 2020, to provide national emergency economic relief measures. The CARES Act, among other things, permits net operating loss (“NOL”) carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company has evaluated the impact of the CARES Act, noting it does not have a material impact.
The Company has no uncertain tax positions as of December 31, 2020 or 2019. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in income tax expense (benefit) and changes in such accruals would impact the Company's effective tax rate. There were no amounts accrued for the payment of interest at December 31, 2020, 2019 and 2018. As of December 31, 2020, calendar years 2019, 2018 and 2017 remain subject to examination by the Internal Revenue Service.
The Company's Class A and Class B Common Stock has a stated value of approximately $0.04 per share. The Company paid a total of $5,692, or $0.40 per share, in dividends during 2020, $5,857, or $0.40 per share, during 2019 and $16,835, or $1.12 per share, during 2018.
On August 31, 2017, the Company's Board of Directors authorized the reinstatement of its share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B Common Stock. No duration has been placed on the Company's share repurchase program, and the Company reserves the right to amend, suspend or discontinue it at any time. The share repurchase program does not commit the Company to repurchase any shares of its common stock.
During the year ended December 31, 2020, the Company paid $1,782 to repurchase 126,764 shares of Class B Common Stock at an average share price of $14.07 under the share repurchase program. No share repurchases have been made by the Company since March 20, 2020.
A reconciliation of the components of accumulated other comprehensive income (loss) at December 31, 2020 and 2019 is as follows:
(1) Includes the $1,264 valuation allowance benefit recorded in other comprehensive income. See Note E - Income Taxes for additional information.
The Company issues shares of restricted Class B Common Stock to the Company's outside directors as part of their annual retainer compensation. The shares are distributed to the outside directors on the vesting date, which, with the exception of pro-rated annual retainers granted to outside directors, is one year following the date of grant. On May 17, 2019, the Company granted shares of restricted Class B Common Stock in connection with the election of a new outside director, reflecting such director’s pro-rated annual retainer compensation, which shares vested and were distributed on May 7, 2020. Additionally, effective May 22, 2019, John D. Nichols, Jr. ceased serving as the Company's Interim Chief Executive Officer and principal executive officer, but continued to serve as Chairman of the Company's Board of Directors. On May 22, 2019, the Company granted shares of restricted Class B Common Stock to Mr. Nichols in connection with this transition, reflecting his pro-rated annual retainer compensation, which shares also vested and were distributed on May 7, 2020. The table below provides details of the restricted stock issuances to directors for 2020, 2019 and 2018:
Director compensation expense associated with these restricted stock grants of $598, $518 and $464 was charged against income for the restricted stock awards granted in 2020, 2019 and 2018, respectively.
On November 5, 2019, the Board of the Company, upon the recommendation of the Committee, approved equity compensation awards to be granted to seven members of senior management as of November 12, 2019 under the Long-Term Incentive Plan. The Board approved a total of $1,100 in grants of restricted shares of the Company’s Class B Common Stock, which will vest on January 1, 2023, subject to the recipient’s continued employment with the Company through the vesting date. The Company incurred $352 of expense during the year ended December 31, 2020 related to this grant.
The Company has one reportable business segment in its operations: Property and Casualty Insurance. The property and casualty insurance segment provides multiple lines of insurance coverage primarily to commercial automobile companies, as well as to independent contractors who contract with commercial automobile companies.
The Company writes policies of excess insurance attaching above SIRs and also writes policies that contain per-claim deductibles. Those losses and claims that fall within the SIR limits are obligations of the insured; however, the Company writes surety bonds in favor of various regulatory agencies guaranteeing the insureds' payment of claims within the SIR. Further, specified portions of losses and claims incurred under large deductible policies, while obligations of the Company, are contractually reimbursable to the Company from the insureds. The Company requires collateral from its insureds to serve as a source of reimbursement if the Company is obligated to pay claims within the SIR by reason of an insured's default or if the insured fails to reimburse the Company for deductible amounts paid by the Company. Acceptable collateral may be provided in the form of letters of credit on Company-approved banks, Company-approved marketable securities or cash.
The amount of collateral required of an insured is determined by the financial condition of the insured, the type of obligations guaranteed by the Company, estimated reserves for incurred losses within the SIR or deductible that have been reported to the insured or the Company, estimated incurred but not reported losses, and estimated losses that are expected to occur within the SIR or be deductible prior to the next collateral adjustment date. In general, the Company attempts to hold collateral equal to 100% of the ultimate losses that would be paid by or due the Company in the event of an insured's default. Periodic audits are conducted by the Company to evaluate its exposure and the collateral required. If a deficiency in collateral is noted as the result of an audit, additional collateral is requested immediately. Because collateral amounts contain numerous estimates of the Company's exposure, are adjusted only periodically and are sometimes reduced based on the superior financial condition of the insured, the amount of collateral held by the Company at a given point in time may not be sufficient to fully reimburse the Company for all amounts due in the event of an insured's default. In that regard, the Company is not fully collateralized for the potential maximum exposure relating to FedEx Corporation and certain of its subsidiaries and related entities ("FedEx"). However, the Company believes that an event of default in excess of the collateralized amounts is remote.
On October 31, 2008, the Company purchased a commercial lines specialty insurance agency for a cash purchase price of $3,500. As part of the purchase, the Company recorded goodwill of $3,152 and intangible assets of $179. Accumulated amortization of intangible assets was $179 as of both December 31, 2020 and 2019.
During the fourth quarter of 2018, the Company conducted its annual impairment review. Based on the results of that review, the Company concluded that its entire goodwill balance was impaired, resulting in an impairment loss of $3,152. The Company utilized a market approach, which considered revenue and earnings multiples of its own and comparable company information. In the analysis, the Company considered the significant decline in its stock price and the decline in overall financial performance during 2018, particularly in more recent periods, as well as the downgrade to its A.M. Best Company, Inc. rating in late 2018.
Short-term borrowings: The fair value of the Company's short-term borrowings is based on quoted market prices for the same or similar debt, or, if no quoted market prices are available, on the current market interest rates available to the Company for debt of similar terms and remaining maturities.
Net income of the Insurance Subsidiaries, all of which are wholly-owned, as determined in accordance with statutory accounting practices, was $3,881, $25,302 and $36,236 for 2020, 2019 and 2018, respectively. Consolidated statutory capital and surplus for these Insurance Subsidiaries was $347,489 and $371,793 at December 31, 2020 and 2019, respectively, of which $50,584 may be transferred by dividend or loan to Protective during calendar year 2021 with proper notification to, but without approval from, regulatory authorities.
State regulatory authorities prescribe calculations of the minimum amount of statutory capital and surplus necessary for each insurance company to remain authorized. These computations are referred to as risk-based capital requirements and are based on a number of complex factors taking into consideration the quality and nature of assets, the historical adequacy of recorded liabilities and the specific nature of business conducted. At December 31, 2020, the minimum statutory capital and surplus requirements of the Insurance Subsidiaries was $136,544. Actual consolidated statutory capital and surplus at December 31, 2020 exceeded this requirement by $210,946.
The Company leases certain computer and related equipment using noncancelable operating leases. Lease expense for 2020, 2019 and 2018 was $135, $302 and $204, respectively. At December 31, 2020, future lease payments for operating leases with initial or remaining noncancelable terms of one year or more consisted of the following:
The Company recorded a right-of-use asset and lease liability on the consolidated balance sheet at December 31, 2020 of $120, which are included within other assets and accounts pyable and other liabilities.
On August 9, 2018, the Company entered into a credit agreement providing a revolving credit facility with a $40,000 limit, with the option for up to an additional $35,000 in incremental loans at the discretion of the lenders. This credit agreement has an expiration date of August 9, 2022. Interest on this revolving credit facility is referenced to the London Interbank Offered Rate and can be fixed for periods of up to one year at the Company's option. Outstanding drawings on this revolving credit facility were $20,000 as of December 31, 2020. At December 31, 2020, the effective interest rate was 1.25%, and the Company had $20,000 remaining under the revolving credit facility. The current outstanding borrowings were used to repay the Company's previous line of credit. The Company's revolving credit facility has two financial covenants, each of which were met as of December 31, 2020. These covenants require the Company to have a minimum U.S. generally accepted accounting principles net worth and a maximum consolidated debt to equity ratio of 0.35.
In July 2019, Protective Insurance Company (“Protective”) was named as a defendant in an action brought by a former insured, Personnel Staffing Group d/b/a MVP Staffing (“PSG”), in the U.S. District Court for the Central District of California (the “California Action”) alleging that Protective had breached its workers’ compensation insurance policy and had breached the duties of good faith and fair dealing. Protective provided workers’ compensation insurance to PSG from January 1, 2017 through June 30, 2018, which was subject to a $500 per claim deductible to be paid by PSG. No specific damages were included in the complaint. In August 2019, Protective filed a motion to dismiss or stay the action. On April 28, 2020, Protective's motion to dismiss the California Action was granted without prejudice on grounds that Indiana is the more appropriate forum. On May 4, 2020, PSG filed a notice of appeal in the 9th Circuit Court of Appeals, challenging the order of dismissal in the California Action.
In August 2019, Protective filed a lawsuit against PSG in Marion County Superior Court, in Indianapolis, Indiana (the “Indiana Court”) alleging breach of contract, breach of the parties' collateral agreement, breach of the parties' indemnity agreement, and seeking a declaratory judgment regarding PSG’s obligation to fund its ongoing claim deductible obligations and adequately collateralize Protective’s current and ongoing claims exposure pursuant to terms of the parties' agreements (the “Indiana Action”). In October 2019, Protective amended the complaint to include allegations of misrepresentation as to source of coverage, negligent misrepresentation, fraud and racketeering and seeking injunctive relief. In November 2019, PSG filed a motion to dismiss the Indiana Action on the basis of comity with the California Action, claiming that California was the proper forum for Protective’s claims.
On February 14, 2021, the Company also entered into a Voting and Support Agreement (the “Voting Agreement”) with Progressive and certain of the Company's shareholders. The Voting Agreement requires that the Company shareholders party to the Voting Agreement: (i) appear at the meeting of the holders of the Company's Class A common stock to consider resolutions to approve the Merger Agreement and the Merger or otherwise cause their shares of the Company's common stock to be counted as present for purposes of calculating a quorum, and (ii) vote their shares (a) in favor of the adoption of the Merger Agreement, the Merger and the other transactions contemplated thereby and any action reasonably requested by Progressive or the Board in furtherance of the foregoing, (b) against any action or agreement that would result in a material breach of any covenant, representation or warranty or other obligation or agreement of the Company contained in the Merger Agreement and (c) against any takeover proposal or superior proposal (provided, that if the Board changes its recommendation with respect to the Merger, any shares of Class A common stock owned by such shareholders in excess of approximately 35% of the outstanding shares of Class A common stock will be voted in the same proportion as those shares of Class A common stock voted by the holders of the Company’s Class A common stock that are not party to the Voting Agreement).
There can be no assurance that the Merger will occur or, if it does occur, of its terms or timing. For additional information regarding the risks associated with the Merger, please see Part I, Item 1A, "Risk Factors," of this Annual Report on Form 10-K.
On February 22, 2021, the Company's Board of Directors declared a regular quarterly dividend of $0.10 per share on the Company's Class A and Class B Common Stock. The dividend per share will be payable March 10, 2021 to shareholders of record on March 5, 2021.