Item 1A. Risk Factors
Item 1A. Risk Factors
An investment in the Company’s common shares involves certain risks. The following is a discussion of material risks and uncertainties that may affect the Company’s business, financial condition, and future results.
Insurance Risks
The impact of COVID-19 and responses thereto, and related risks, could materially affect our results of operations, financial position, and/or liquidity.
Beginning in March 2020, the global pandemic related to novel coronavirus COVID-19 (“COVID-19”) began to impact the global and U.S. economy. We experienced a decrease in premiums in our non-standard auto segment due to the pandemic during 2020, along with experiencing generally flat premium growth across our private passenger auto segment. We expect future premium growth as individuals and businesses resume travel and the economy continues to recover.
Any future federal, state, and local government actions to address the impact of COVID-19 may adversely affect us. Regulatory restrictions or requirements could impact pricing, risk selection, and our rights and obligations with respect to our policies and insureds, including our ability to cancel policies or our right to collect premiums. It is also possible that changes in economic conditions and steps taken by federal, state, and local governments in response to COVID-19 could require an increase in taxes at the federal, state, and local levels, which would adversely impact our results of operations.
After the immediate economic impacts of the COVID-19 pandemic in the first half of the year, capital markets staged a strong rally during the second half of 2020, aided by significant fiscal and monetary support from world central banks to help the global economy. Despite rising slightly from mid-year, 10-year U.S. Treasury rates remained extremely depressed given the negative impact on economic growth from the current public health crisis and announcements from the U.S. Federal Reserve on its intention to maintain a near-zero interest rate policy for the foreseeable future. Our corporate fixed income portfolio may also be adversely impacted by ratings downgrades, increased bankruptcies, and credit spread widening in distressed industries. In addition, many state and local governments may be operating under deficits or projected deficits. These deficits may be exacerbated by the costs of responding to COVID-19 and reduced tax revenues due to adverse economic conditions. The severity and duration of these deficits could have an adverse impact on the collectability and valuation of our municipal bond portfolio. Our investment portfolio also includes residential and commercial mortgage-backed securities, which could be adversely impacted by declines in real estate valuations and/or financial market disruption, including a heightened collection risk on the underlying mortgages. Further disruptions in global financial markets due to the continuing impact of COVID-19 could result in additional net realized and unrealized investment losses. In addition, declines in fixed income yields would result in decreases in net investment income from future investment activity, including re-investments.
We expect that the impact of COVID-19 on general economic activity may continue to negatively impact our premium volumes, but the degree of the impact will depend on the extent and remaining duration of the economic contraction.
It is also possible that changes in economic conditions and additional steps taken by the federal government and the Federal Reserve in response to COVID-19 could lead to higher inflation than we had anticipated, which could in turn lead to an increase in our loss costs and the need to strengthen claims and claim adjustment expense reserves. These impacts of inflation on loss costs and claims and claim adjustment expense reserves could be more pronounced for those lines of business that require a relatively longer period of time to finalize and settle claims for a given accident year and, accordingly, are relatively more inflation sensitive. Inflation could also adversely impact our general and administrative expenses. Increased interest rates caused by inflation would likely have a negative effect on the carrying value of our fixed maturity investments and returns on our fixed maturity and short-term investments. Increased interest rates would also reduce the market value of existing fixed maturity investments, thereby negatively impacting our book value.
Catastrophic or other significant natural or man-made losses may negatively affect our financial condition and operating results.
As a property and casualty insurer, we are subject to claims from catastrophes that may have a significant negative impact on operating and financial results. We have experienced catastrophe losses, and can be expected to experience catastrophe losses in the future. Catastrophe losses can be caused by various events, including snow storms, ice storms, freezing temperatures, tropical storms and hurricanes, earthquakes, tornadoes, wind, hail, fires, and other natural or man-made disasters. In addition, longer-term natural catastrophe trends may be changing and new types of catastrophe losses may be developing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain, hail and snow. The frequency, number, and severity of these losses
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are unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event.
Approximately 45.7% of NI Holdings’ consolidated direct premiums written in 2020 were written in North Dakota, compared to 55.3% in 2019. Despite this reduction, NI Holdings’ business continues to have a concentration in North Dakota, thus adverse developments from severe weather events such as hailstorms, flooding, or droughts affecting a large portion of North Dakota would have a disproportionately greater effect on NI Holdings’ financial condition and results of operations than if its business were less geographically concentrated. The incidence and severity of such events are inherently unpredictable. In recent years, changing climate conditions have increased, and may continue to increase, the unpredictability, severity, and frequency of tornados and other storms, droughts, floods, and other extreme climatic events.
We attempt to reduce our exposure to catastrophe losses through the underwriting process and by obtaining reinsurance coverage. However, in the event that we experience catastrophe losses, we cannot assure you that our unearned premiums, liabilities for unpaid losses and LAE, and reinsurance will be adequate to cover these risks. In addition, because accounting rules do not permit insurers to reserve for catastrophic events until they occur, claims from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could have a material adverse effect on our financial condition or results of operations. Our ability to write new business also could be adversely affected.
Our financial condition and results of operations also are affected periodically by losses caused by natural perils such as those described above that are not deemed a catastrophe. If a number of these events occur in a short time period, it may materially affect our financial condition and results of operations.
Any downgrade in our A.M. Best rating could affect our ability to write new business or renew our existing business, which would lead to a decrease in revenue and net income.
Third-party rating agencies, such as A.M. Best, periodically assess and rate the claims-paying ability of insurers based on criteria established by the rating agencies. Ratings assigned by A.M. Best are an important factor influencing the competitive position of insurance companies. A.M. Best ratings, which are reviewed at least annually, represent independent opinions of financial strength and ability to meet obligations to policyholders and are not directed toward the protection of investors. Therefore, our A.M. Best rating should not be relied upon as a basis for an investment decision to purchase our common stock.
All of the Company’s insurance subsidiaries hold a financial strength rating of “A” (Excellent) by A.M. Best, the third highest rating out of 15 rating classifications. Our most recent rating by A.M. Best was issued on April 14, 2020. Financial strength ratings are used by producers, customers, lenders, and other insurance carriers as a means of assessing the financial strength and quality of insurance companies. If our financial position deteriorates, we may not maintain our favorable financial strength rating from A.M. Best. A downgrade of our rating could severely limit or prevent us from writing desirable business or from renewing our existing business. In addition, a downgrade could negatively affect our ability to implement our strategy because it could cause our current or potential producers to choose other more highly rated competitors or reduce our ability to obtain reinsurance. See “Item 1. Business — A.M. Best Rating.”
Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry.
Results of companies in the insurance industry, and particularly the property and casualty insurance industry, historically have been subject to significant fluctuations and uncertainties and have fluctuated in cyclical periods of low premium rates and excess underwriting capacity resulting from increased competition (a so-called “soft market”), followed by periods of high premium rates and a shortage of underwriting capacity resulting from decreased competition (a so-called “hard market”). The industry’s profitability can be affected significantly by:
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estimates of rising levels of actual costs that are not known by companies at the time they price their products;  
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volatile and unpredictable developments, including man-made and natural catastrophes;  
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changes in reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurers’ liability develop; and  
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fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested capital and may affect the ultimate payout of losses.  
Fluctuations in underwriting capacity, demand, competition, and the impact on our business of the other factors identified above, could have a negative impact on our results of operations, financial condition, and our ability to grow profitability.
We monitor the marketplace both on a regional and line of business basis. The private passenger marketplace continues to be a very competitive and challenging pricing environment. Rates for private passenger auto are competitive across the country. The
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non-standard auto market also remains competitive with more companies seeking to grow this line of business. Two large acquisitions took place in the non-standard auto segment during the third quarter, indicating that others in the marketplace are recognizing profitable opportunities associated with this segment and are seeking to grow their market share.
The commercial market has experienced significant hardening in recent years, allowing us to demand more premium while being more selective on individual risks.
Our success depends on the ability of our insurance company subsidiaries to underwrite risks accurately and to price our commercial and personal lines insurance products accordingly.
The nature of the insurance business is such that pricing must be determined before the underlying costs are fully known. This requires significant reliance on estimates and assumptions in setting prices. If our insurance subsidiaries fail to assess accurately the risks that they assume in our commercial and personal lines products, they may fail to charge adequate premium rates, which could affect our profitability and have a material adverse effect on our financial condition, results of operations, or cash flows. Their ability to assess their policyholder risks and to price their products accurately is subject to a number of risks and uncertainties, including, but not limited to:
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competition from other providers of property and casualty insurance;  
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price regulation by insurance regulatory authorities;  
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selection and implementation of appropriate rating formulae or other pricing methodologies;  
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availability of sufficient reliable data;  
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uncertainties inherent in estimates and assumptions generally;  
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adverse changes in claim results;  
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incorrect or incomplete analysis of available data;  
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our ability to accurately predict policyholder retention, investment yields, and the duration of liability for losses and LAE; and  
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unanticipated effects of court decisions, legislation, or regulation, including those related to legal liability for damages by our insureds.  
These risks and uncertainties could cause our insurance subsidiaries to underprice their policies, which would negatively affect their results of operations, or to overprice their policies, which could reduce their competitiveness. Either such event could have a material adverse effect on their financial condition, results of operations, and cash flows.
Under the federal crop insurance program, each insurer is required to accept every application for multi-peril crop insurance that they receive, and the premiums and the policy terms are set by the RMA, which is the federal government agency administering the federal crop insurance program. Accordingly, no policy underwriting is necessary in connection with our multi-peril crop insurance line of business. We rely on AFBIS to underwrite our crop hail insurance line of business. Unlike the multi-peril crop business, we have the ability to underwrite and price crop hail insurance. If we believe the policy will expose us to too much risk in a particular geographic area or if we are unwilling to insure the crop, we have the ability to decline to issue the policy.
Our results and financial condition may be affected by a failure to establish adequate liabilities for unpaid losses and LAE or by adverse development of prior year reserves.
NI Holdings maintains reserves to cover amounts it estimates will be needed to pay for unpaid losses and for the expenses necessary to settle insured claims. Estimating liabilities for unpaid losses and LAE is a difficult and complex process involving many variables and subjective judgments. The liability for unpaid losses and LAE is the largest liability of NI Holdings and represents the financial statement item most sensitive to estimation and judgment. In developing its estimates of unpaid losses and LAE, NI Holdings has evaluated and considered actuarial projection techniques based on its assessment of facts and circumstances then known, historical loss experience data, and estimates of anticipated trends. This process assumes that past experience, adjusted for the effects of current developments, changes in operations, and anticipated trends, constitutes an appropriate basis for predicting future events. While NI Holdings believes that its liability for unpaid losses and LAE is appropriate, to the extent that such reserves prove to be inadequate or excessive in the future, we would adjust them and incur a charge or credit to earnings, as the case may be, in the period the reserves are adjusted. Any such adjustment could have a material impact on our financial condition and results of operations. There can be no assurance that the estimates of such liabilities will not change in the future. For additional information on our liability for unpaid losses and LAE, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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Our ability to manage our exposure to underwriting risks depends on the availability and cost of reinsurance coverage.
Reinsurance is the practice of transferring part of an insurance company’s liability and premium under an insurance policy to another insurance company. NI Holdings uses reinsurance arrangements to limit and manage the amount of risk it retains, to stabilize its underwriting results, and to increase its underwriting capacity. The availability and cost of reinsurance are subject to current market conditions and may vary significantly over time. Any decrease in the amount of reinsurance maintained will increase our risk of loss. We may be unable to maintain our desired reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew the current coverage maintained by NI Holdings or obtain new coverage, it may be difficult for us to manage our underwriting risks and operate our business profitably.
If we cannot collect loss recoveries from our reinsurers in accordance with our reinsurance agreements, we may incur additional losses.
We are subject to loss and credit risk with respect to the reinsurers with whom NI Holdings deals because buying reinsurance does not relieve us of our liability to policyholders. If such reinsurers were not capable of fulfilling their financial obligations to us, our insurance losses would increase. NI Holdings secures reinsurance coverage from a number of reinsurers. The lowest A.M. Best rating issued to any of our current reinsurers is “A-” (Excellent), which is the fourth highest of fifteen ratings. See “Item 1. Business — Reinsurance.”
Operational Risks
Competition for potential acquisitions from other property and casualty insurers could increase the price that NI Holdings will be required to pay in connection with future acquisitions.
Over-capacity in the property and casualty market has led other market participants to seek acquisitions in order to generate revenue growth. These market conditions may cause significant competition for acquisitions and increase the price for acquisitions. This competitive market could impede execution of NI Holdings’ external growth strategy.
Integration of existing businesses and future acquisitions may require a significant investment of management’s time.
NI Holdings previously spent considerable time and effort integrating Battle Creek and Primero in the areas of sales and marketing, operations, financial reporting, and employee benefits. Direct Auto, Westminster, and future acquisitions will require additional integration, particularly to realize the anticipated coordination designed to drive revenue growth, reduce costs, and ensure operational efficiency and compliance. While NI Holdings’ management staff is experienced, there can be no assurance that acquisitions will be successfully executed and integrated in a timely manner.
We may not be able to grow our business if our insurance company subsidiaries cannot maintain and grow their agent relationships, provide new products for their agents to offer to their customers, or if consumers seek other distribution methods offered by our competitors.
Our ability to retain existing agents, and to attract new agents, is essential to the continued growth of our business. If independent agents find it easier to do business with our competitors, our agent base may erode and, as a result, be unable to retain existing business or generate sufficient new business. While we believe that we have good relationships with our independent agents, we cannot be certain that these agents will continue to sell our products instead of our competitors’ products.
While our products are sold through either independent or captive agents, our competitors may sell insurance through other delivery models, including the internet, direct marketing, or other emerging alternative distribution methods. To the extent that current and potential policyholders change their insurance shopping preferences, this may have an adverse effect on our ability to grow, our financial position, and our results of operations.
Future acquisitions could disrupt our business and harm our financial condition or results of operations.
As part of our growth strategy, we will continue to evaluate opportunities to acquire other property and casualty insurers. Acquisitions that we may make or implement in the future entail a number of risks that could materially adversely affect our business and operating results, including:
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problems integrating the acquired operations with our existing business;  
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operating and underwriting results of the acquired operations not meeting our expectations;  
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diversion of management’s time and attention from our existing business;  
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need for financial resources above our planned investment levels;  
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difficulties in retaining business relationships with agents and policyholders of the acquired company;  
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risks associated with entering markets in which we lack extensive prior experience;  
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tax issues associated with acquisitions;  
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acquisition-related disputes, including disputes over contingent consideration and escrows;  
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potential loss of key employees of the acquired company; and  
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potential impairment of related goodwill and intangible assets.  
We could be adversely affected by the loss of our existing management or key employees.
The success of our business is dependent, to a large extent, on our ability to attract and retain key employees, in particular our senior officers. Our business may be adversely affected if labor market conditions make it difficult for us to replace our current key officers with individuals having equivalent qualifications and experience at compensation levels competitive for our industry. Our key officers include:
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Michael J. Alexander, our President and Chief Executive Officer;  
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Brian R. Doom, our Executive Vice President and Chief Financial Officer; and  
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Patrick W. Duncan, our Vice President of Operations.  
These key officers have extensive experience in the property and casualty and crop insurance industry. Our employment and other agreements with our key officers do not include covenants not to compete or non-solicitation provisions because they are unenforceable under North Dakota law.
NI Holdings has announced the impending retirement of Mr. Doom, effective May 25, 2021. Upon Mr. Doom’s departure, Seth C. Daggett will assume the role of Executive Vice President, Treasurer and Chief Financial Officer, and Timothy J. Milius will assume the role of Vice President, Chief Accounting Officer and Secretary. Mr. Daggett is currently the Executive Vice President of Strategy and Mr. Milius is currently the Vice President of Finance.
We rely on our systems and employees, and those of certain third-party vendors and service providers, in conducting our operations, and certain failures, including internal or external fraud, operational errors, systems malfunctions, or cyber-security incidents, could materially adversely affect our operations.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical and recordkeeping errors, and computer or telecommunications systems malfunctions. Our business depends on our ability to process a large number of increasingly complex transactions. If any of our operational, accounting, or other data processing systems fail or have other significant shortcomings, we could be materially adversely affected. Similarly, we depend on our employees. We could be materially adversely affected if one or more of our employees cause a significant operational breakdown or failure, either as a result of human error or intentional sabotage or fraudulent manipulation of our operations or systems.
Third parties with whom we do business, including vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns, failures, or capacity constraints of their own systems or employees. While we attempt to manage the informational and operational risks that arise from our use of third party providers by reviewing and assessing such providers’ cybersecurity controls, as appropriate, we cannot assure that our attempts to do so will always be successful. Any problems caused by third party providers could diminish our ability to operate our business, or cause financial loss, potential liability to insureds, inability to secure insurance, reputational damage, or regulatory intervention, which could materially adversely affect us.
We rely heavily on our operating systems in connection with issuing policies, paying claims, and providing the information we need to conduct our business. We also rely on the operating systems of AFBIS in connection with various processes with respect to our multi-peril crop line of business. We may be subject to disruptions of such operating systems arising from events that are wholly or partially beyond our control, which may include, for example, electrical or telecommunications outages, natural or man-made disasters, such as earthquakes, floods or tornados, hurricanes, or events arising from terrorist acts. Such disruptions may give rise to losses in service to insureds and loss or liability to us. In addition, there is the risk that our controls and procedures as well as
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our business continuity, disaster recovery, and data security systems prove to be inadequate. The computer systems and network systems others and we use could be vulnerable to unforeseen problems. These problems may arise in both our internally developed systems and the systems of third-party service providers. In addition, our computer systems and network infrastructure present security risks and could be susceptible to hacking, computer viruses, or data breaches. Any such failure could affect our operations and could materially adversely affect our results of operations by requiring us to expend significant resources to correct the defect, as well as by exposing us to litigation or losses not covered by insurance. Although we have business continuity plans and other safeguards in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems and those of third-party service providers that support our business. As we continue to expand internet and mobile strategies and to build and maintain an integrated digital enterprise, these risks are likely to increase.
Our operations rely on the secure processing, transmission, and storage of confidential information in our computer systems and networks. Our technologies, systems, and networks may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our insureds’ confidential, proprietary and other information, or otherwise disrupt our or our insureds’ or other third parties’ business operations, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure, and the loss of customers. Although to date we have not experienced any information security breaches nor any losses relating to cyber-attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature and increasing frequency and sophistication of these threats and the outsourcing of some of our business operations. As a result, cyber-security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage, or unauthorized access remain a priority. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems, or devices that our customers use to access our products and services could result in customer attrition, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our financial condition or results of operations.
The compromise of personal, confidential or proprietary information could also subject us to legal liability or regulatory action, including fines, penalties or intervention, under evolving cyber-security, data protection and privacy laws and regulations enacted by the U.S. federal and state governments. Such laws and regulations have become increasingly widespread and demanding in recent years. As noted above, in October 2017, the NAIC adopted the IDSML, which would require insurers and other regulated insurance entities to comply with detailed information security obligations. Enactment of the IDSML or similar statute by the legislatures of the states in which we or our subsidiaries operate may result in increased compliance costs and the risk of regulatory enforcement actions and penalties. If incurred, such regulatory penalties could harm our reputation. Any such events could have an adverse impact on our business, financial condition or results of operations.
We face uncertainties related to the effectiveness of internal controls, particularly with regard to our operating subsidiaries’ financial reporting controls and information technology security.
It should be noted that any system of internal controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any internal control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of internal control systems, there can be no assurance that any design will achieve its stated goal under all potential future conditions, regardless of how remote. Deficiencies or weaknesses that are not yet identified could emerge, and the identification and correction of these deficiencies or weaknesses could have a material impact on our results of operations.
We will be required to publicly report on deficiencies or weaknesses in our internal controls that meet a materiality standard. Management may, at a point in time, categorize a deficiency or weakness as immaterial or minor and therefore not be required to publicly report such deficiency or weakness. Such determination, however, does not preclude a change in circumstances such that the deficiency or weakness could, at a later time, become a reportable condition that could have a material impact on our results of operations.
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Regulatory Risks
A portion of NI Holdings’ written premiums and net profits are generated from its multi-peril crop insurance business, and the loss of such business as a result of a termination of or substantial changes to the Federal crop insurance program could have an adverse effect on our revenues and net income.
In 2020, 2019 and 2018, NI Holdings’ direct premiums written generated from its multi-peril crop insurance line of business were 11.5%, 13.3%, and 18.5%, respectively, of total written premiums. Through the FCIC, the United States government subsidizes insurance companies by assuming an increasingly higher portion of losses incurred by farmers as a result of weather-related and other perils as well as commodity price fluctuations. The United States government also subsidizes the premium cost to farmers for multi-peril crop yield and revenue insurance. Without this risk assumption, losses incurred by insurance companies would be higher. Without the premium subsidy, the number of farmers purchasing multi-peril crop insurance would decline significantly. Periodically, members of the United States Congress propose to reduce significantly the government’s involvement in the federal crop insurance program in an effort to reduce government spending. If legislation is adopted to reduce the amount of risk the government assumes, the amount of insurance premium subsidy provided to farmers or otherwise reduce the coverage provided under multi-peril crop insurance policies, losses would increase and purchases of multi-peril crop insurance could experience a significant decline nationwide and in our market area. Such changes could have an adverse effect on our revenues and income.
Assessments and premium surcharges for state guaranty funds and other mandatory pooling arrangements may reduce our profitability.
Most states require insurance companies authorized to do business in their state to participate in guaranty funds, which require the insurance companies to bear a portion of the unfunded obligations of impaired, insolvent, or failed insurance companies. These obligations are funded by assessments, which are expected to continue in the future. State guaranty associations levy assessments, up to prescribed limits, on all insurance companies doing business in the state based on their proportionate share of premiums written in the lines of business in which the impaired, insolvent, or failed insurance companies are engaged. Accordingly, the assessments levied on us may increase as we increase our written premiums. See “Item 1. Business — Regulation.”
In addition, as a condition to conducting business in some states, insurance companies are required to participate in residual market programs to provide insurance to those who cannot procure coverage from an insurance carrier on a negotiated basis. Insurance companies generally can fulfill their residual market obligations by, among other things, participating in a reinsurance pool where the results of all policies provided through the pool are shared by the participating insurance companies. Although we price our insurance to account for our potential obligations under these pooling arrangements, we may not be able to accurately estimate our liability for these obligations. Accordingly, mandatory pooling arrangements may cause a decrease in our profits. As we write policies in new states that have mandatory pooling arrangements, we will be required to participate in additional pooling arrangements. Further, the impairment, insolvency, or failure of other insurance companies in these pooling arrangements would likely increase the liability for other members in the pool. The effect of assessments and premium surcharges or increases in such assessments or surcharges could reduce our profitability in any given period or limit our ability to grow our business. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
If we fail to comply with insurance industry regulations, or if those regulations become more burdensome, we may not be able to operate profitably.
Nodak Insurance and American West are currently regulated by the North Dakota Insurance Department. Battle Creek is regulated by the Nebraska Insurance Department. Primero is regulated by the Nevada Insurance Department. Direct Auto is regulated by the Illinois Department of Insurance. Westminster is regulated by the Maryland Insurance Administration. All six companies are also subject to regulation, to a more limited extent, by the insurance departments of other states in which they do business. The failure to comply with the laws and regulations of each jurisdiction could subject NI Holdings to sanctions and fines, including the cancellation or suspension of its license. Because approximately 45.7% of our 2020 consolidated direct premiums written originate in North Dakota, the cancellation or suspension of our license in North Dakota, as a result of any failure to comply with the applicable insurance laws and regulations, would impact our financial condition and results of operations.
Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations relate to, among other things:
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approval of policy forms and premium rates;  
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standards of solvency, including establishing requirements for minimum capital and surplus, and for risk-based capital;  
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classifying assets as admissible for purposes of determining solvency and compliance with minimum capital and surplus requirements;  
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licensing of insurers and their producers;  
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advertising and marketing practices;  
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restrictions on the nature, quality, and concentration of investments;  
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assessments by guaranty associations and mandatory pooling arrangements;  
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restrictions on the ability to pay dividends;  
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restrictions on transactions between affiliated companies;  
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restrictions on the size of risks insurable under a single policy;  
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requiring deposits for the benefit of policyholders;  
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requiring certain methods of accounting;  
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periodic examinations of our operations and finances;  
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claims practices;  
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prescribing the form and content of reports of financial condition required to be filed; and  
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requiring reserves for unearned premiums, losses and other purposes.  
State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues, and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. The last examination of both Nodak Insurance and American West by the North Dakota Insurance Department was as of December 31, 2016. The last examination of Battle Creek by the Nebraska Insurance Department was as of December 31, 2016, and the last examination by the Nevada Insurance Department of Primero was as of December 31, 2016. The last examination of Direct Auto by the Illinois Department of Insurance was as of December 31, 2017. The last examination of Westminster by the Maryland Insurance Administration was as of December 31, 2017.
In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.
Risks Related to Our Common Stock
Additional expenses from new stock-based benefit plans may adversely affect our profitability.
During 2020, our shareholders approved the adoption of our 2020 Stock and Incentive Plan (“the Plan”). Under the Plan, we may award participants restricted shares of our common stock, options to purchase shares of our common stock, or other forms of awards. Restricted stock awards will be made at no cost to the participants. The maximum number of shares of common stock that may be issued is set forth in the Plan.
We consider the reasonableness of the awards under these programs in evaluating the fairness of the total compensation paid to our employees, including our executives. We use our equity-type plans to assist us in aligning the interests of the management team and other employees with those of our shareholders. Any additional compensation expense resulting from the ESOP and the Plan may adversely affect our profitability. We cannot determine the actual future amount of these new stock-related compensation and benefit expenses at this time because applicable accounting practices require that they be based on the fair market value of the shares of common stock at specific points in the future; however, we expect them to be material. We will recognize expenses for our ESOP when shares are committed to be released to participants’ accounts and will recognize expenses for restricted stock awards and stock options over the vesting period of awards made to recipients. See our Consolidated Financial Statements for the actual amount of expenses to date.
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Nodak Mutual Group’s majority control of our common stock will enable it to exercise voting control over most matters put to a vote of shareholders and will prevent shareholders from forcing a sale or a second-step conversion transaction you may find advantageous.
Nodak Mutual Group owns a majority of our outstanding common stock and, through its Board of Directors, is able to exercise voting control over most matters put to a vote of shareholders. The votes cast by Nodak Mutual Group may not be in your personal best interests as a shareholder. For example, Nodak Mutual Group may exercise its voting control to defeat a shareholder nominee for election to the Board of Directors of NI Holdings. Moreover, Nodak Mutual Group’s ability to elect the Board of Directors of NI Holdings restricts the ability of the minority shareholders of NI Holdings to effect a change of control of management. Some shareholders may desire a sale or merger transaction, since shareholders typically receive a premium for their shares, or a second-step conversion transaction, since fully converted institutions tend to trade at higher multiples than mutual holding companies.
Our status as an insurance holding company with no direct operations could adversely affect our ability to fund operations, conduct future share repurchases, or meet our debt obligations.
We are an insurance holding company. A significant source of funds available to us for the payment of operating expenses, share repurchases, and debt-related amounts are net proceeds from our initial public offering retained at the holding company, management fees, and dividends from our subsidiaries. The payment of dividends by Nodak Insurance to NI Holdings will be restricted by North Dakota’s insurance law. American West and Primero historically have not paid dividends to Nodak Insurance, but would be restricted by laws in the domiciliary states. The payment of dividends by Direct Auto to NI Holdings will be restricted by Illinois’ insurance law. The payment of dividends by Westminster to NI Holdings will be restricted by Maryland’s insurance law.
Statutory provisions and provisions of our Articles of Incorporation and Bylaws may discourage takeover attempts of NI Holdings that you may believe are in your best interests or that might result in a substantial profit to you.
We are subject to provisions of North Dakota corporate and insurance law that hinder a change of control. North Dakota law requires the North Dakota Insurance Department’s prior approval of a change of control of an insurance holding company. Under North Dakota law, the acquisition of 10% or more of the outstanding voting stock of an insurer or its holding company is presumed to be a change in control. Approval by the North Dakota Insurance Department may be withheld even if the transaction would be in the shareholders’ best interest if the North Dakota Insurance Department determines that the transaction would be detrimental to policyholders.
Our Articles of Incorporation and Bylaws also contain provisions that may discourage a change in control. These provisions include:
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a prohibition on a person, including a group acting in concert, other than Nodak Mutual Group, from acquiring voting control of more than 10% of our outstanding stock without prior approval of our Board of Directors;  
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a classified Board of Directors divided into three classes serving for successive terms of three years each;  
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the prohibition of cumulative voting in the election of directors;  
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the requirement that nominations for the election of directors made by shareholders and any shareholder proposals for inclusion on the agenda at any shareholders’ meeting must be made by notice (in writing) delivered or mailed to us not less than 90 days prior to the meeting;  
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the prohibition of shareholders’ action without a meeting (except for actions taken by Nodak Mutual Group) and of shareholders’ right to call a special meeting;  
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the requirement imposing a mandatory tender offer requirement on a shareholder other than Nodak Mutual Group that has a combined voting power of 35% or more of the votes that our shareholders are entitled to cast, unless acquisition of such voting power by such shareholder was approved by our Board of Directors;  
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the requirement that the foregoing provisions of our Articles of Incorporation can only be amended by an affirmative vote of shareholders entitled to cast at least 80% of all votes that shareholder are entitled to cast, unless approved by an affirmative vote of at least 80% of the members of the Board of Directors; and  
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the requirement that certain provisions of our Bylaws can only be amended by an affirmative vote of shareholders entitled to cast at least 66 2/3%, or in certain cases 80%, of all votes that shareholders are entitled to cast.  
These provisions may serve to entrench management and may discourage a takeover attempt that you may consider to be in your best interest or in which you would receive a substantial premium over the current market price. These provisions may make it extremely difficult for any one person, entity, or group of affiliated persons or entities to acquire voting control of NI Holdings, with
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the result that it may be extremely difficult to bring about a change in the Board of Directors or management. Some of these provisions also may perpetuate present management because of the additional time required to cause a change in the control of the Board of Directors. Other provisions make it difficult for shareholders owning less than a majority of the voting stock to be able to elect even a single director.
Ownership of a majority of our stock by Nodak Mutual Group will make removal of the management difficult.
Nodak Mutual Group owns greater than 55% of our outstanding common stock. Therefore, it has the power to take actions that nonaffiliated shareholders may deem to be contrary to the shareholders’ best interests. In addition, certain provisions of our Articles of Incorporation, such as the existence of a classified Board of Directors, the prohibition of cumulative voting for the election of directors, and the prohibition on any person or group acquiring and having the right to vote in excess of 10% of our outstanding stock without the prior approval of the Board of Directors will make removal of NI Holdings’ management difficult.
If our subsidiaries are not sufficiently profitable, our ability to pay dividends will be limited.
We are a separate entity with no operations of our own other than holding the common stocks of Nodak Insurance, Direct Auto, Westminster, and our other subsidiaries. We depend primarily on dividends paid by directly-owned subsidiaries, and the proceeds from our initial public offering that were not contributed to Nodak Insurance or otherwise deployed or committed, to carry out our business plan, including future acquisitions, and to provide funds for the payment of any future dividends.
We may receive dividends from Nodak Insurance only after all of Nodak Insurance’s obligations and regulatory requirements with the North Dakota Insurance Department have been satisfied. North Dakota law sets the maximum amount of dividends that may be paid by Nodak Insurance during any twelve-month period after notice to, but without prior approval of, the North Dakota Insurance Department. This amount cannot exceed the lesser of (i) 10% of the insurance company’s surplus as regards policyholders as of the preceding December 31, or (ii) the insurance company’s statutory net income for the preceding calendar year (excluding realized capital gains), less any prior dividends paid during such twelve-month period. In addition, in the state of North Dakota, any insurance company other than a life insurance company may carry forward net income from the preceding two calendar years, not including realized capital gains, less any dividends actually paid during those two calendar years.
Illinois law sets the maximum amount of dividends that may be paid by Direct Auto during any twelve-month period after notice to, but without prior approval of, the Illinois Department of Insurance. This amount cannot exceed the greater of (i) 10% of the Company’s surplus as regards policyholders as of the preceding December 31, or (ii) the Company’s statutory net income for the preceding calendar year (excluding realized capital gains).
We will have the ability to receive dividends from Westminster only after all of Westminster's obligations and regulatory requirements with the Maryland Insurance Administration have been satisfied. In general, under Maryland law an insurer may pay dividends after providing notice to the Maryland Insurance Commissioner within five business days after declaration of the dividend or at least 10 days prior to payment of the dividend. However, Maryland law imposes additional limitations on “extraordinary dividends”. Maryland law defines an extraordinary dividend as a dividend that, when combined with the value of other dividends made in the preceding 12 months, exceeds the lesser of (i) 10% of the insurer’s surplus as regards policyholders as of the preceding December 31, or (ii) the insurer’s net investment income not including (a) realized capital gains for the 12-month period ending December 31 of the preceding year and (b) pro rata distributions of any class of the insurer’s own securities. An insurer may not pay an extraordinary dividend unless the insurer provides notice of the declaration to the Maryland Insurance Commissioner at least 30 days before the declaration is made and the Maryland Insurance Commissioner has approved or not disapproved the declaration within 30 days.
If Nodak Insurance, Direct Auto, and Westminster are not sufficiently profitable, our ability to pay dividends to you in the future will be limited.
We are an “emerging growth company” and have elected to comply with reduced public company reporting requirements.
We are an EGC as defined by the JOBS Act. For as long as we continue to be an EGC, we may choose to take advantage of exemptions from various public company reporting requirements. These exemptions include, but are not limited to, (i) not being required to comply with the auditor attestation requirements of Section 404 of SOX, (ii) reduced disclosure obligations regarding executive compensation in our periodic reports, proxy statements, and registration statements, and (iii) exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In this Annual Report on Form 10-K, we have elected to take advantage of certain of the reduced disclosure obligations regarding financial statements and executive compensation. In addition, Section 107(b) of the JOBS Act provides that an EGC can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Exchange Act for complying with new or revised accounting standards. In other words, an EGC can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We are choosing to “opt in” to such extended transition period
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election under Section 107(b). Therefore, we are electing to delay adoption of certain new or revised accounting standards, and as a result, we may choose to not comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. As a result of such election, our financial statements may not be comparable to the financial statements of other public companies. See Note 5 to our Consolidated Financial Statements for more information regarding new or revised accounting standards.
We could be an EGC for up to five years, which such fifth anniversary will occur in 2022. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenues exceed $1.07 billion, or we issue more than $1.0 billion of non-convertible debt in any three-year period, we would cease to be an EGC prior to the end of such five-year period. We have taken advantage of certain of the reduced disclosure obligations regarding executive compensation in this Annual Report on Form 10-K and may elect to take advantage of other reduced burdens in future filings. As a result, the information that we provide to holders of our common stock may be different than the information you might receive from other public reporting companies in which you hold equity interests. We cannot predict if investors will find our common stock less attractive as a result of our reliance on these exemptions. If some investors find our common stock less attractive as a result of any choice we make to reduce disclosure, there may be a less active trading market for our common stock and the price for our common stock may be more volatile.
General Risks
Our revenues and financial results may fluctuate with interest rates, investment results, equity market fluctuations, and developments in the securities markets.
NI Holdings invests the premiums it receives from policyholders until cash is needed to pay insured claims or other expenses. Investment securities represent one of the largest categories of assets of NI Holdings. The fair value of its investment holdings is affected by general economic conditions, and changes in the financial and credit markets. NI Holdings relies on the investment income produced by its investment portfolio to contribute to its profitability. Changes in interest rates and credit quality may result in fluctuations in the income derived from, the valuation of, and in the case of declines in credit quality, payment defaults on our fixed income securities. Such conditions could give rise to significant realized and unrealized investment losses or the impairment of securities whose decreases in value are deemed other-than-temporary.
The Company continues to allocate a portion of its investment portfolio to equity securities, as we believe the long-term investment returns remain attractive. These securities are subject to general economic conditions, specific industry dynamics, and individual company financial results. Recent history has also demonstrated that these securities are subject to short-term market fluctuations, more so than fixed income securities. Effective January 1, 2019, the changes in the market values of our equity securities began to be reported as a component of our net income. Prior to this time, these changes, along with the corresponding changes in our fixed income securities, were recorded, net of income taxes, in other comprehensive income. This accounting standard change creates an increased level of volatility in our reported operating results going forward and may distract from the long-term investment philosophy that we currently employ to achieve steady returns on our investments.
Any significant or long-running negative changes in the fixed income or equity markets could have a material adverse effect on our financial condition, results of operations, or cash flows. The investment portfolio of NI Holdings is also subject to credit and cash flow risk, including risks associated with its investments in asset-backed and mortgage-backed securities. Because the Company’s investment portfolio is the largest component of its assets and a multiple of its equity, adverse changes in economic conditions could result in other-than-temporary impairments that are material to our financial condition and operating results. Such economic changes could arise from overall changes in the financial markets or specific changes to industries, companies, or municipalities in which we maintain investment holdings. See “Item 7. Quantitative and Qualitative Information About Market Risk.”
We may not be able to manage our growth effectively.
We intend to grow our business in the future, which could require additional capital, systems development, and skilled personnel. We cannot assure you that we will be able to locate profitable business opportunities, meet our capital needs, expand our systems and our internal controls effectively, innovate our products and technology to remain competitive, allocate our human resources optimally, identify qualified employees or agents, or incorporate effectively the components of any businesses we may acquire in our effort to achieve growth. The failure to manage our growth effectively, obtain efficiencies in our business processes, and maintain underwriting discipline could have a material adverse effect on our business, financial condition, and results of operations.
We could be adversely affected by any interruption to our ability to conduct business at our current locations.
Our business operations could be substantially interrupted by flooding, snow, ice, wind, and other weather-related incidents, or from fire, power loss, telecommunications failures, terrorism, or other such events. In such an event, we may not have sufficient
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redundant facilities to cover a loss or failure in all aspects of our business operations and to restart our business operations in a timely manner. Any damage caused by such a failure or loss may cause interruptions in our business operations that may adversely affect our service levels and business. See “Item 1. Business — Technology.”
Future changes in financial accounting standards or practices may adversely affect our reported results of operations.
Financial accounting standards in the United States are constantly under review and may be changed from time to time. We would be required to apply these changes when adopted. Once implemented, these changes could materially affect our financial condition and results of operations and/or the way in which such financial condition and results of operations are reported.
Similarly, we are subject to taxation in the United States and a number of state jurisdictions. Rates of taxation, definitions of income, exclusions from income, and other tax policies are subject to change over time. Accounting standards would require that we recognize the effects of changes in tax rates and laws on deferred income tax balances in the period in which the legislation is enacted.
Enactment of significant income tax laws may adversely affect our reported results of operations.
Federal and state income tax laws are also constantly under review and may be changed from time to time. The Tax Cuts and Jobs Act (the “TCJA”), signed into law in 2017, significantly reformed the U.S. Internal Revenue Code. The TCJA, among other things, included changes to U.S. federal income tax rates, allowed for increased expensing of capital expenditures, and modified or repealed many business deductions and credits.
The new Biden Administration has proposed to raise U.S. federal income tax rates for corporations. Higher corporate income tax rates, as well as other potential tax reforms, may adversely impact our financial condition and results of operations.
The estimated impact of all past and any potential income tax actions is based on our management’s current knowledge and assumptions and recognized impacts could be materially different from current estimates based on our actual results and further guidance released on the new law. Additional tax-related impacts on holders of common shares is uncertain and could be adverse. This Form 10-K does not discuss any such tax legislation or the manner in which it might affect purchasers of common shares. We urge our stockholders, including purchasers of common shares, to consult with their own legal and tax advisors with respect to such legislation and the potential tax consequences of investing in common shares.
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Item 1B. Unresolved Staff Comments
None
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.