We own our principal business office which has approximately 60,000 square feet of office space together with a 3,200 square foot warehouse facility located in DeRidder, Louisiana. AIIC and SOCI lease their corporate headquarters which has approximately 3,500 square feet of office space located in Omaha, Nebraska. The Company leases space at other locations for certain of our service and claims representatives, none of which are material.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion includes forward-looking statements that are subject to risks, uncertainties and other factors described in Item 1A of this report. These factors could cause our actual results in 2020 and beyond to differ materially from those expressed in, or implied by, those forward-looking statements.
Investment income is an important element of our net income. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in other lines of business that pay claims more quickly. At December 31, 2019, our investment portfolio, including cash and cash equivalents, was $1.2 billion and produced net investment income of $32.5 million in 2019, $30.5 million in 2018 and $29.3 million in 2017.
Our gross reserves for loss and loss adjustment expenses at December 31, 2019, 2018 and 2017 were $772.9 million, $798.4 million and $771.8 million, respectively. As a percentage of gross reserves at year end, IBNR represented 17.6% in 2019, 20.1% in 2018 and 16.8% in 2017.
On a quarterly basis, we review our reserves for loss and loss adjustment expenses to determine whether adjustments are required. Any resulting adjustments are included in the results for the current period. In establishing our reserves, we do not use loss discounting, which would involve recognizing the time value of money and offsetting estimates of future payments by future expected investment income. Additional information regarding our reserves for loss and loss adjustment expenses and the actuarial methods and other factors used in establishing these reserves can be found under the caption “Business-Loss Reserves” in Item 1 of this report.
Gross Premiums Written. Gross premiums written for 2019 were $333.5 million, compared to $351.7 million for 2018, a decrease of 5.2%. The decrease was attributable to a $22.9 million decrease in annual premiums on voluntary policies written during the period which was offset by a $5.0 million increase in premiums resulting from payroll audits and related premium adjustments for policies written in previous quarters. Related premium adjustments in 2019 include a $1.0 million increase in “earned but unbilled”, or EBUB, premium.
Net Realized Gains (Losses) on Investments. Net realized losses on investments in 2019 totaled $0.1 million, compared to losses of $1.5 million in 2018. In 2019, net realized losses of $0.2 million resulted from redemptions of fixed maturity securities offset by $0.1 million of realized gains on the sale of fixed maturity securities classified as available-for-sale. In 2018, net realized losses of $1.1 million resulted from the sale of equity securities and fixed maturity securities classified as available-for-sale.
The assumptions we used in establishing our reserves for these accident years were based on our historical claims data. However, as of December 31, 2019, actual results for these accident years have been better than our assumptions would have predicted. We do not presently intend to modify our assumptions for establishing reserves in light of recent results. However, if actual results for current and future accident years are consistent with, or different than, our results in these recent accident years, our historical claims data will reflect this change and, over time, will impact the reserves we establish for future claims.
Net cash provided by operating activities was $78.8 million in 2019, as compared to $98.3 million in 2018, and $130.8 million in 2017. Major components of cash provided by operating activities in 2019 were net premiums collected of $329.0 million and investment income collected of $41.6 million. These increases were offset in-part by claim payments of $189.8 million, $75.9 million of operating expenditures, federal taxes paid of $20.9 million, and dividends to policyholders paid of $3.5 million.
Major components of cash provided by operating activities in 2018 were net premiums collected of $354.0 million and investment income collected of $41.7 million. These increases were offset in-part by claim payments of $200.5 million, $74.2 millionof operating expenditures, federal taxes paid of $11.2 million, a $7.9 million increase in amounts held by others, and dividends to policyholders paid of $2.9 million.
Net cash used in financing activities was $87.0 million in 2019, as compared to $84.4 million in 2018 and $82.6 million in 2017. Major components of cash used in financing activities in 2019 included cash used for dividends paid to shareholders of $87.0 million.
AMERISAFE is a holding company that transacts business through its operating subsidiaries, including AIIC, SOCI and AIICTX. AMERISAFE’s primary assets are the capital stock of these insurance subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. Based upon the prescribed calculation, the insurance subsidiaries could pay to AMERISAFE dividends of up to $88.6 million in 2020 without seeking regulatory approval. See “Business-Regulation-Dividend Limitations” in Item 1 of this report.
We regularly review our investment portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of our investments. We consider various factors in determining if a decline in the fair value of an individual security is other-than-temporary. The key factors we consider are:
any reduction or elimination of preferred stock dividends, or nonpayment of scheduled principal or interest payments;
During 2019 and 2018, the Company had no impairment losses recognized for other-than-temporary declines in the fair value of our investments.
The pre-tax investment yield on our investment portfolio was 2.8% and 2.6% per annum during the twelve months ended December 31, 2019 and 2018, respectively.
We manage risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated life insurance companies. In the event these companies are unable to meet their obligations under these annuity contracts, we could be liable to the claimants, but our reinsurers remain obligated to indemnify us for all or part of these obligations in accordance with the terms of our reinsurance contracts. As of December 31, 2019, the present value of these annuities was $100.3 million, as estimated by our annuity providers. Substantially all of the annuities are issued or guaranteed by life insurance companies that have an A.M. Best rating of “A” (Excellent) or better. For additional information, see Note 16 to our consolidated financial statements in Item 8 of this report.
The Company has operating and finance leases for office space and equipment. Our leases have remaining lease terms of one month to 49 months, some of which include options to extend the leases for up to five years. The Company, in determining the present value of lease payments, utilizes either the rate implicit in the lease if that rate is readily determinable or the Company’s incremental secured borrowing rate commensurate with the term of the underlying lease.
Future minimum lease payments at December 31, 2019, were as follows:
Rental expense was $0.2 million in 2019 and 2018, and $0.1 million in 2017.
Audited Financial Statements as of December 31, 2019 and 2018 and for the three years in the period ended December 31, 2019:
In establishing a current expected credit allowance for held-to-maturity fixed income securities under the new accounting standard, the Company will use a probability of default and loss given default methodology based on the securities credit rating and maturity date of the specific security. The amount is currently estimated to be $308 thousand. This estimate is based on the Company’s portfolio of held-to-maturity fixed income securities, the credit ratings and maturity dates of those securities, at December 31, 2019.
All other issued but not yet effective accounting and reporting standards as of December 31, 2019 are either not applicable to the Company or are not expected to have a material impact on the Company.
Investment income is recognized as it is earned. The discount or premium on fixed maturity securities is amortized using the “constant yield” method. Anticipated prepayments, where applicable, are considered when determining the amortization of premiums or discounts. Realized investment gains and losses are determined using the specific identification method.
Cash equivalents include short-term money market funds with an original maturity of 90 days or less.
The direct costs of successfully acquiring and renewing business are capitalized to the extent recoverable and are amortized over the effective period of the related insurance policies in proportion to premium revenue earned. These capitalized costs consist mainly of sales commissions, premium taxes and other underwriting costs. The Company evaluates deferred policy acquisition costs for recoverability by comparing the unearned premiums to the estimated total expected claim costs and related expenses, offset by anticipated investment income. The Company would reduce the deferred costs if the unearned premiums were less than expected claims and expenses after considering investment income, and report any adjustments in amortization of deferred policy acquisition costs. There were no adjustments necessary in 2019, 2018 or 2017.
Reserves for loss and loss adjustment expenses represent the estimated ultimate cost of all reported and unreported losses incurred through December 31. The Company does not discount loss and loss adjustment expense reserves. In establishing our reserves for loss and loss adjustment expenses, we review the results of analyses using individual case-base valuations and statistical and actuarial methods that utilize historical loss data from our more than 34 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates. Although considerable variability is inherent in these estimates, management believes that the reserves for loss and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in income from current operations.
Experience-rated commissions are earned from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers. These commission revenues on reinsurance contracts are recognized during the related reinsurance treaty period and are based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and certain other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in income from current operations. Experience-rated commissions had no impact on underwriting and certain other operating costs in 2019 and increased underwriting and certain other operating costs by $0.2 million in 2018 and 2017.
In December 2019, the Company commuted reinsurance agreements with Hannover Reinsurance (Ireland) Limited (“Hannover”) covering portions of accident years 2009 through 2011. The Company received an $8.5 million payment effectuated solely through offset against the balance of the funds withheld and recoverable from reinsurers accounts under the reinsurance agreements in exchange for releasing Hannover from their reinsurance obligations under the commuted agreements. Hannover remains obligated to the subsidiaries of the Company under other reinsurance agreements. There was no effect on the Company’s net income in the year ended December 31, 2019 as a result of the commutation.
The Company computes earnings per share (“EPS”) in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 260, Earnings Per Share. The Company applies the treasury stock method in computing basic and diluted earnings per share.
The gross unrealized gains and losses on, and the amortized cost and fair value of, those investments classified as available-for-sale at December 31, 2019 are summarized as follows:
At December 31, 2019, the Company held 59 individual fixed maturity securities that were in an unrealized loss position, of which 11 were in a continuous unrealized loss position for longer than 12 months.
any reduction or elimination of preferred dividends, or nonpayment of scheduled principal or interest payments;
the likelihood of being forced to sell the security before the recovery of its value; and
Included in premiums receivable at December 31, 2019, 2018 and 2017 is the Company’s estimate for EBUB premium of $8.5 million, $7.5 million and $6.3 million, respectively.
Accumulated depreciation and amortization includes $179,000 that is related to equipment held under finance leases at December 31, 2019. Furniture and equipment included property held under capital leases of $184,000 at December 31, 2018. Accumulated depreciation includes $120,000 that is related to these properties at December 31, 2018. The lease liabilities related to these properties are included in accounts payable and other liabilities.
The Company cedes certain premiums and losses to various reinsurers under excess-of-loss treaties. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers on a continual basis. The effect of reinsurance on premiums written and earned in 2019, 2018 and 2017 was as follows:
Amounts recoverable from reinsurers consists of ceded case reserves, ceded incurred but not reported (“IBNR”) reserves, paid losses recoverable and experience-rated commissions recoverable. Ceded case and ceded IBNR reserves represent the portion of gross loss and loss adjustment expense liabilities that are recoverable under reinsurance agreements, but are not yet due from reinsurers. Paid losses recoverable are receivables currently due from reinsurers for ceded paid losses. The Company considers paid losses recoverable outstanding for more than 90 days to be past due. At December 31, 2019, there were no paid losses recoverable past due.
As of December 31, 2019, the Company had a valuation allowance of $2.0 million against its deferred income tax benefits. During 2018 and 2017, there was no valuation allowance on the Company’s deferred income tax assets and liabilities.
In December 2018, the IRS released its guidance for determining the Tax Act transition adjustment related to the discounting of loss reserves. During the period ended December 31, 2018, the Company recorded an increase in its deferred tax assets and a corresponding increase in its deferred tax liabilities as a result of the transition adjustment, which had no impact on tax expense recognized in 2018.
The Company has an agreement providing for a line of credit in the maximum amount of $20.0 million with Frost Bank. The agreement expires in December 2022. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue at interest rates based upon prime rate, LIBOR or equivalent. Under the agreement, the Company pays a fee of 0.25% on the unused portion of the loan in arrears quarterly, or a fee of $50,000 annually, assuming the line of credit is not used during the calendar year. The line of credit is unsecured. No borrowings or letters of credit were outstanding under the line of credit arrangement at December 31, 2019 or 2018.
The following development tables provide the incurred and paid losses and allocated loss adjustment expenses, net of reinsurance, for workers’ compensation and general liability for accident years 2010 through 2019. The incurred but not reported (“IBNR”) losses and claims frequency is included for each accident year presented.
Reserves established for workers’ compensation insurance includes the exposure to occupational disease or accidents related to asbestos or environmental claims. The exposure to asbestos claims emanate from the direct sale of workers’ compensation insurance. These claims resulted from industry workers who were exposed to tremolite asbestos dust and electricians and carpenters who were exposed to products that contained asbestos. There has been no known exposure to asbestos claims arising from assumed business. The emergence of these claims is slow and highly unpredictable. The Company estimates full impact of the asbestos exposure by establishing full case basis reserves on all known losses. Reserves for losses incurred but not reported (IBNR) include a provision for development of reserves on reported losses. Reserves are established for loss adjustment expenses (LAE) associated with these case and IBNR loss reserves.
The anticipated effect of inflation is implicitly considered when estimating liabilities for loss and loss adjustment expenses. In establishing our reserves for loss and loss adjustment expenses, we review the results of analyses using individual case-base valuations and statistical and actuarial methods that utilize historical loss data from our more than 34 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates. These anticipated trends are monitored based on actual development and are modified if necessary.
The Company is authorized to issue 50,000,000 shares of common stock, par value $0.01 per share. At December 31, 2019, there were 20,560,833 shares of common stock issued and 19,302,583 shares outstanding.
The AMERISAFE 2005 Equity Incentive Plan (the “2005 Incentive Plan”) is administered by the Compensation Committee of the Board and was designed to provide incentive compensation to executive officers and other key management personnel. The 2005 Incentive Plan permitted awards in the form of incentive stock options, as defined in Section 422(b) of the Internal Revenue Code of 1986, non-qualified stock options, restricted shares of common stock and restricted stock units. In connection with the approval of the 2012 Equity and Incentive Compensation Plan by the Company’s shareholders, no further grants were made under the 2005 Incentive Plan. As of December 31, 2019, there are no outstanding options or restricted stock awards under the 2005 Incentive Plan.
The following table summarizes information about the stock option activity under the 2005 Incentive Plan:
The following table summarizes information about the restricted stock activity under the 2005 Incentive Plan:
In 2019, 9,391 shares of common stock and 13,322 shares of restricted stock were granted under the 2012 Incentive Plan, which will vest through 2024. In 2018, 3,304 shares of common stock were granted under the 2012 Incentive Plan. At December 31, 2019, there were 320,434 shares of common stock available for future awards under the 2012 Incentive Plan.
The AMERISAFE Non-Employee Director Restricted Stock Plan (the “Restricted Stock Plan”) is administered by the Compensation Committee of the Board and provides for the automatic grant of restricted stock awards to non-employee directors of the Company. Awards to non-employee directors are generally subject to terms including non-transferability, immediate vesting upon death or total disability of a director, forfeiture of unvested shares upon termination of service by a director and acceleration of vesting upon a change of control of the Company. The maximum number of shares of common stock that may be issued pursuant to restricted stock awards under the Restricted Stock Plan is 150,000 shares, subject to the authority of the Board to adjust this amount in the event of a merger, consolidation, reorganization, stock split, combination of shares, recapitalization or similar transaction affecting the common stock. At December 31, 2019, there were 53,017 shares of common stock available for future awards under the Restricted Stock Plan.
The Company recognized compensation expense of $317,000 in 2019, $351,000 in 2018 and $355,000 in 2017 related to the Non-Employee Director Restricted Stock Plan.
The calculation of basic and diluted EPS for the years ended December 31, 2019, 2018 and 2017 are presented below.
The Company manages risk on certain long-duration claims by settling these claims through the purchase of annuities from unaffiliated carriers. In the event these carriers are unable to meet their obligations under these contracts, the Company could be liable to the claimants. The following table summarizes the fair value of the annuities at December 31, 2019, that the Company has purchased to satisfy its obligations.
The following is a maturity analysis of the annual undiscounted cash flows of the operating and finance lease liabilities as of December 31, 2019:
Net premiums earned during 2019, 2018 and 2017 for the top ten states in 2019 and all others are shown below:
The fair values of the Company’s investments are based upon prices provided by an independent pricing service. The Company has reviewed these prices for reasonableness and has not adjusted any prices received from the independent provider. Securities reported at fair value utilizing Level 1 inputs represent assets whose fair value is determined based upon observable unadjusted quoted market prices for identical assets in active markets. Level 2 securities represent assets whose fair value is determined using observable market information such as previous day trade prices, quotes from less active markets or quoted prices of securities with similar characteristics. There were no transfers between Level 1 and Level 2 during the year ended December 31, 2019.
Assets measured at fair value on a recurring basis as of December 31, 2019 and 2018 are as follows:
Assets measured at amortized cost as of December 31, 2019 and 2018 are as follows:
In 2013, the Company’s Board of Directors initiated a regular quarterly dividend. During 2019, the Company’s Board of Directors declared a quarterly dividend of $0.25 per share compared to $0.22 per share in 2018, $0.20 per share in 2017, $0.18 per share in 2016, and $0.15 per share in 2015. The Company declared extraordinary dividends totaling $3.50 per share in 2019, 2018 and 2017, $3.25 per share in 2016, and $3.00 per share in 2015.
On February 18, 2020 the Company declared a regular quarterly cash dividend of $0.27 per share payable on March 27, 2020 to shareholders of record as of March 13, 2020. The Board considers the payment of a regular cash dividend each calendar quarter.