NI Holdings, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion is intended to provide a more comprehensive review of our operating results and financial condition than can be obtained from reading the consolidated financial statements alone. The discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Part II, Item 8, “Financial Statements and Supplementary Data.” Some of the information contained in this discussion and analysis or set forth elsewhere in this 2022 Annual Report constitutes forward-looking information that involves risks and uncertainties. Please see “Forward-Looking Statements” and Part I, Item 1A, “Risk Factors” for a discussion of important factors that could cause actual results to differ materially from the results described, or implied by, the forward-looking statements contained herein. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this document generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this document can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on March 9, 2022. All dollar amounts, except per share amounts, are in thousands. Results of Operations Our consolidated financial statements are prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”). Management evaluates our operations by monitoring key measures of growth and profitability, which may include the disclosure of certain non-GAAP financial measures. Our results of operations are influenced by numerous factors affecting the U.S. property and casualty insurance industry including competition, weather, catastrophic events, innovation and emerging technologies, changes in regulations, inflation, general economic conditions, judicial trends, fluctuations in interest rates, and other changes in the financial markets. Our premium levels and underwriting results have been, and will continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle and makes it difficult to attract and retain properly priced business. During a hard market cycle, it is more likely that insurers will be able to increase their rates or profit margins. A hard market typically has a positive effect on premium growth. The markets that we serve are diversified, which requires us to regularly monitor our performance and competitive position by line of business and geographic market to determine appropriate rate actions. Premiums in the multi-peril crop insurance business are primarily influenced by the types of crops planted, number of acres insured, and commodity prices because the rates are established by the RMA rather than individual insurance carriers. The expected experience of this business for the calendar year may also significantly affect the reported net earned premiums and losses due to the risk-sharing arrangement with the federal government. Multi-peril crop insurance premiums are generally written in the second quarter, and earned ratably over the period of risk, which generally extends into the fourth quarter. Premiums in the crop hail insurance business are also generally written in the second quarter and earned ratably until the end of the third quarter. Premiums in our other lines of business are written and earned throughout the year based on their coverage periods. Losses on this business are also incurred throughout the year but are usually more frequent and/or severe during periods of elevated weather-related activity. Property Claims Service (“PCS”), a division of the Insurance Services Office, maintains industry loss data related to catastrophe loss events. PCS defines a catastrophe as an event that causes damage of $25 million or more in insured property losses and affects a significant number of insureds. When reporting on our losses from catastrophe events, we may include losses from those events that were defined as a catastrophe by PCS or those events which may include losses that we believe are, or will be, material to our operations, either in amount or in number of claims made. The frequency and severity of catastrophic losses we experience in any year may significantly affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance business, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. For more information on the Company’s results of operations by segment, see Part II, Item 8, Note 20 “Segment Information”. 30 Table of Contents Years ended December 31, 2022, 2021, and 2020 The consolidated net loss for the Company was $53,775 for the year ended December 31, 2022, compared to net income of $8,332 for the year ended December 31, 2021, and $41,344 for the year ended December 31, 2020. The major components of our revenues and net income (loss) for the three periods are shown below: Year Ended December 31, 2022 2021 2020 Revenues: Net premiums earned $ 328,290 $ 299,589 $ 283,661 Fee and other income 1,453 1,775 1,801 Net investment income 7,820 7,131 7,271 Net investment gains (losses) (13,126 ) 15,479 13,624 Total revenues $ 324,437 $ 323,974 $ 306,357 Components of net income (loss): Net premiums earned $ 328,290 $ 299,589 $ 283,661 Losses and loss adjustment expenses 294,432 216,379 168,473 Amortization of deferred policy acquisition costs and other underwriting and general expenses 99,034 96,289 85,068 Underwriting gain (loss) (65,176 ) (13,079 ) 30,120 Fee and other income 1,453 1,775 1,801 Net investment income 7,820 7,131 7,271 Net investment gains (losses) (13,126 ) 15,479 13,624 Income (loss) before income taxes (69,029 ) 11,306 52,816 Income tax expense (benefit) (15,254 ) 2,974 11,472 Net income (loss) $ (53,775 ) $ 8,332 $ 41,344 31 Table of Contents Net Premiums Earned Year Ended December 31, 2022 2021 2020 Net premiums earned: Direct premium $ 368,886 $ 333,254 $ 301,061 Assumed premium 6,550 8,035 6,459 Ceded premium (47,146 ) (41,700 ) (23,859 ) Total net premiums earned $ 328,290 $ 299,589 $ 283,661 Net premiums earned for the year ended December 31, 2022 increased $28,701, or 9.6%, to $328,290, compared to $299,589 for the year ended December 31, 2021. Net premiums earned for the year ended December 31, 2021 increased $15,928, or 5.6%, to $299,589, compared to $283,661 for the year ended December 31, 2020. Year Ended December 31, 2022 2021 2020 Net premiums earned: Private passenger auto $ 77,605 $ 72,533 $ 72,009 Non-standard auto 66,911 58,585 53,737 Home and farm 78,381 73,792 74,879 Crop 34,721 26,848 35,718 Commercial 61,431 57,285 38,288 All other 9,241 10,546 9,030 Total net premiums earned $ 328,290 $ 299,589 $ 283,661 Below are comments regarding significant changes in net premiums earned, by business segment: Private passenger auto – Net premiums earned for 2022 increased $5,072, or 7.0%, from 2021. Results were driven by rate increases in North Dakota, South Dakota, and Nebraska. Non-standard auto – Net premiums earned for 2022 increased $8,326, or 14.2%, from 2021. Results were driven by new business growth, increased retention, and rate increases in the Chicago market where our non-standard auto business is concentrated. Home and farm – Net premiums earned for 2022 increased $4,589, or 6.2%, from 2021. Results were driven by increased insured property values, which were primarily the result of using higher inflationary factors, along with rate increases. Crop – Net premiums earned for 2022 increased $7,873, or 29.3%, from 2021. Results were driven by the impact of higher commodity prices on our multi-peril crop insurance direct written premiums. In addition, earned premiums increased as a result of ceding significantly less multi-peril crop insurance business into the Assigned Risk fund of the SRA in 2022 compared to the prior year. Commercial – Net premiums earned for 2022 increased $4,146, or 7.2%, from 2021. Results were driven by increased insured values which were primarily the result of higher inflationary factors as well as continued growth in rate and new business premiums. All other – Net premiums earned for 2022 decreased $1,305, or 12.4%, from 2021. Results were driven by the Company’s decision to non-renew its participation in an assumed domestic and international reinsurance pool of business as of January 1, 2022. 32 Table of Contents Losses and Loss Adjustment Expenses Year Ended December 31, 2022 2021 2020 Net losses and loss adjustment expenses: Direct losses and loss adjustment expenses $ 333,397 $ 280,998 $ 185,370 Assumed losses and loss adjustment expenses 2,369 6,899 3,308 Ceded losses and loss adjustment expenses (41,334 ) (71,518 ) (20,205 ) Total net losses and loss adjustment expenses $ 294,432 $ 216,379 $ 168,473 The Company’s net losses and loss adjustment expenses for the year ended December 31, 2022 increased $78,053, or 36.1%, to $294,432, compared to $216,379 for the year ended December 31, 2021. The Company’s net losses and loss adjustment expenses for the year ended December 31, 2021 increased $47,906, or 28.4%, to $216,379, compared to $168,473 for the year ended December 31, 2020. Year Ended December 31, 2022 2021 2020 Net losses and loss adjustment expenses: Private passenger auto $ 65,420 $ 59,721 $ 45,511 Non-standard auto 39,400 34,453 30,347 Home and farm 107,823 52,145 36,745 Crop 19,418 27,831 31,379 Commercial 57,216 34,779 20,430 All other 5,155 7,450 4,061 Total net losses and loss adjustment expenses $ 294,432 $ 216,379 $ 168,473 Year Ended December 31, 2022 2021 2020 Loss and loss adjustment expenses ratio: Private passenger auto 84.3% 82.3% 63.2% Non-standard auto 58.9% 58.8% 56.5% Home and farm 137.6% 70.7% 49.1% Crop 55.9% 103.7% 87.9% Commercial 93.1% 60.7% 53.4% All other 55.8% 70.6% 45.0% Total loss and loss adjustment expenses ratio 89.7% 72.2% 59.4% Below are comments regarding significant changes in net losses and loss adjustment expenses, and the net loss and loss adjustment expenses ratios, by business segment: Private passenger auto – The net loss and loss adjustment expenses ratio increased 2.0 percentage points in 2022 compared to 2021. This increase was driven by elevated loss costs due to continued high levels of inflation and increased weather-related comprehensive losses in Nebraska and South Dakota. We have addressed this increased frequency and severity through recent aggressive underwriting actions and rate increases. Non-standard auto – The net loss and loss adjustment expenses ratio increased 0.1 percentage points in 2022 compared to 2021. Loss and loss adjustment expenses were once again impacted by elevated loss costs due to continued high levels of inflation partially offset by successful implementation of various strategic initiatives in 2022 as well as rate increases taken throughout the year. Home and farm – The net loss and loss adjustment expenses ratio increased 66.9 percentage points in 2022 compared to 2021. This increase was driven by catastrophe losses in Nebraska, South Dakota, and North Dakota that occurred during second and third quarters of 2022. Catastrophe losses, net of reinsurance, for the segment accounted for 72.1 percentage points of the net loss and loss adjustment expense ratio for the year ended December 31, 2022, compared to 9.9 percentage points for the same period for 2021. We have addressed the increased loss and loss adjustment expenses ratio through recent aggressive underwriting actions and rate increases. 33 Table of Contents Crop – The net loss and loss adjustment expenses ratio decreased 47.8 percentage points in 2022 compared to 2021. This improvement was due to more favorable crop growing conditions in 2022 in comparison to the extreme drought conditions faced in 2021. Commercial – The net loss and loss adjustment expenses ratio increased 32.4 percentage points in 2022 compared to 2021. This increase was driven by increased frequency and severity of fire losses as well as increased liability claims in our commercial multi-peril line of business. In addition, our results were impacted by freezing claims from winter storm Elliott. Our North Dakota commercial business also experienced elevated weather-related losses which contributed to this increase. All other – The net loss and loss adjustment expenses ratio decreased 14.8 percentage points in 2022 compared to 2021. The decrease was driven by the Company’s decision to non-renew its participation in an assumed domestic and international reinsurance pool of business as of January 1, 2022. The loss and loss adjustment expense ratio was also impacted by favorable prior year development in our assumed domestic and international reinsurance pool of business. Underwriting and General Expenses and Expense Ratio Year Ended December 31, 2022 2021 2020 Underwriting and general expenses: Amortization of deferred policy acquisition costs $ 66,803 $ 64,574 $ 51,472 Other underwriting and general expenses 32,231 31,715 33,596 Total underwriting and general expenses 99,034 96,289 85,068 Expense ratio 30.2% 32.1% 30.0% The expense ratio is calculated by dividing other underwriting and general expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company’s operational efficiency in producing, underwriting, and administering its insurance business. The overall expense ratio decreased 1.9 percentage points in the year ended December 31, 2022, compared to the same period in 2021. This decrease was driven by the impact of the significantly higher multi-peril crop insurance net premiums earned during 2022 in our crop segment, which operates at a significantly lower expense ratio relative to our other segments. The overall expense ratio increased 2.1 percentage points in the year ended December 31, 2021, compared to the same period in 2020. 34 Table of Contents Underwriting Gain (Loss) and Combined Ratio Year Ended December 31, 2022 2021 2020 Underwriting gain (loss): Private passenger auto $ (9,416 ) $ (7,704 ) $ 6,512 Non-standard auto 622 1,362 2,651 Home and farm (52,512 ) (475 ) 17,260 Crop 12,294 (9,195 ) (468 ) Commercial (17,958 ) 2,506 1,500 All other 1,794 427 2,665 Total underwriting gain (loss) $ (65,176 ) $ (13,079 ) $ 30,120 Year Ended December 31, 2022 2021 2020 Combined ratio: Private passenger auto 112.1% 110.6% 91.0% Non-standard auto 99.1% 97.7% 95.1% Home and farm 167.0% 100.7% 77.0% Crop 64.6% 134.3% 101.4% Commercial 129.2% 95.6% 96.1% All other 80.6% 95.9% 70.5% Total combined ratio 119.9% 104.3% 89.4% Underwriting gain (loss) measures the pre-tax profitability of our insurance operations. It is derived by subtracting losses and loss adjustment expenses, amortization of deferred policy acquisition costs, and other underwriting and general expenses from net premiums earned. The combined ratio represents the sum of these losses and expenses as a percentage of net premiums earned, and measures our overall underwriting profit. The total underwriting loss increased $52,097, or 398.3%, for the year ended December 31, 2022, compared to the same period in 2021. These results were driven by the factors discussed in the Losses and Loss Adjustment Expenses section above. The overall combined ratio increased 15.6 percentage points in the year ended December 31, 2022, compared to the same period in 2021. These results were driven by the factors discussed in the Losses and Loss Adjustment Expenses section above. Fee and Other Income The Company had fee and other income of $1,453 for the year ended December 31, 2022, compared to $1,775 for the year ended December 31, 2021, and $1,801 for the year ended December 31, 2020. Fee income attributable to the non-standard auto segment decreased to $831 for the year ended December 31, 2022, from $1,280 for the year ended December 31, 2021, due to a reduction in policies that generate fee income. 35 Table of Contents Net Investment Income The following table shows our average cash and invested assets, net investment income, and return on average cash and invested assets for the reported periods: Year Ended December 31, 2022 2021 2020 Average cash and invested assets $ 455,366 $ 502,375 $ 449,148 Net investment income $ 7,820 $ 7,131 $ 7,271 Gross return on average cash and invested assets 2.5% 2.1% 2.3% Net return on average cash and invested assets 1.7% 1.4% 1.6% Net investment income increased $689 for the year ended December 31, 2022, compared to the year ended December 31, 2021. This increase was primarily driven by an increase in the fixed income portfolio average book value (measured at cost or amortized cost), the rising interest rate environment, as well as a higher allocation of invested assets to private placement securities and high dividend yield equities. Net investment income decreased $140 for the year ended December 31, 2021, compared to the year ended December 31, 2020. The Company’s gross and net return on average cash and invested assets increased year-over-year, driven by a decrease in average cash and invested assets (measured at fair value) as a result of unfavorable market conditions for both fixed income and equity securities as well as higher net investment income. Net Investment Gains (Losses) Net investment gains (losses) consisted of the following: Year Ended December 31, 2022 2021 2020 Gross realized gains $ 7,195 $ 18,130 $ 9,740 Gross realized losses, excluding credit impairment losses (5,271 ) (362 ) (1,969 ) Net realized gains 1,924 17,768 7,771 Change in net unrealized gain on equity securities (15,050 ) (2,289 ) 5,853 Net investment gains (losses) $ (13,126 ) $ 15,479 $ 13,624 The Company had net realized gains of $1,924 for the year ended December 31, 2022, compared to $17,768 for the year ended December 31, 2021, and $7,771 for the year ended December 31, 2020. The Company reported no credit impairment losses during any of the periods presented. The Company experienced a decrease in net unrealized gains on equity securities of $15,050 during the year ended December 31, 2022, driven by changes in fair value attributable to unfavorable equity markets. In addition, the Company’s sales activity (and resulting gains and losses) impacts the level and direction of the change in the net unrealized gain or loss of its equity securities portfolio. The Company had net realized gains on the sale of equity securities of $2,075, $17,118, and $6,868 during the years ended December 31, 2022, 2021, and 2020, respectively. The Company’s fixed income securities are classified as available for sale because it will, from time to time, execute sales of securities that are not impaired to meet liquidity needs or for other strategic purposes, in accordance with our investment policy. The fixed income portfolio experienced an unfavorable change in net unrealized gains/losses of $46,362 during the year ended December 31, 2022, compared to a decrease in net unrealized gains of $9,796 during the year ended December 31, 2021. The changes were primarily the result of rising interest rates in the U.S. The change in the fair value of fixed income securities is not reflected in net income; rather it is reflected as a separate component (net of income taxes) of other comprehensive income. The fixed income portfolio experienced an increase in net unrealized gains of $9,264 during the year ended December 31, 2020. Income (Loss) before Income Taxes For the year ended December 31, 2022, the Company had pre-tax loss of $69,029, compared to pre-tax income of $11,306 and $52,816 for the years ended December 31, 2021 and 2020, respectively. The decrease in pre-tax income was largely attributable to the significant catastrophe losses in Nebraska, South Dakota, and North Dakota, along with the change in net investment gains/losses that was driven by the impact of unfavorable equity markets during 2022. 36 Table of Contents Income Tax Expense (Benefit) The Company recorded income tax benefit of $15,254 for the year ended December 31, 2022, compared to income tax expense of $2,974 and $11,472 for the years ended December 31, 2021 and 2020, respectively. Our effective tax rate for 2022 was 22.1% compared to an effective tax rate of 26.3% and 21.7% for 2021 and 2020, respectively. A portion of the effective tax rate is due to state income taxes, which drove the higher effective tax rate in 2021. The valuation allowance against certain deferred income tax assets was $694 as of December 31, 2022 compared to $1,008 as of December 31, 2021. Net Income (Loss) For the year ended December 31, 2022, the Company had a net loss before non-controlling interest of $53,775, compared to income of $8,332 and $41,344 for the years ended December 31, 2021 and 2020, respectively. The decrease was largely attributable to the significant catastrophe losses in Nebraska, South Dakota, and North Dakota, along with the change in net investment gains/losses that was driven by the impact of unfavorable equity markets during 2022. Return on Average Equity For the year ended December 31, 2022, the Company had annualized return on average equity, after non-controlling interest, of (17.9)%, compared to annualized return on average equity, after non-controlling interest, of 2.4% and 12.4% for the years ended December 31, 2021 and 2020, respectively. Average equity is calculated as the average between beginning and ending shareholders’ equity, excluding non-controlling interest, for the period. Principal Revenue Items The Company derives its revenue primarily from net premiums earned, net investment income, and net investment gains (losses). Gross and net premiums written Gross premiums written is equal to direct premiums written and assumed premiums before the effect of ceded reinsurance. Gross premiums written are recognized upon sale of new insurance contracts or renewal of existing contracts. Net premiums written is equal to gross premiums written less premiums ceded to reinsurers. Premiums earned Premiums earned is the earned portion of net premiums written. Gross premiums written include all premiums recorded by an insurance company during a specified policy period. Insurance premiums on property and casualty policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies or, in the case of crop insurance, over the period of risk to the Company. At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and is realized as revenue in subsequent periods over the remaining term of the policy or period of risk. The Company’s property and casualty policies, other than some of our auto lines and the non-standard auto policies, typically have a term of twelve months. Due to the nature of the crop planting and harvesting cycle and the deadlines for filing and processing claims under the federal crop insurance program, insurance premiums for multi-peril crop insurance are recognized and earned during the period of risk, which usually begins in spring and ends with harvest in the fall. Under the federal crop insurance program, farmers must purchase crop insurance with respect to spring planted crops by March 15. By July 15, the farmer must report the number of acres planted in each crop. On September 1, the insurer bills the farmer for the insurance premium, which is due and payable by the farmer by October 1. If the farmer does not pay the premium by such date, the insurer will charge interest at a rate of 15% because the insurer is required to pay the farmer’s portion of the premium to the FCIC by November 15, regardless of whether the farmer pays the premium to the insurer. Except for claims occurring in the spring (primarily for prevented planting and required replanting claims), claims are required to be filed with the FCIC by December 15. A different cycle exists for crops planted in the fall, such as winter wheat, but the vast majority of crop insurance written by the Company covers crops planted in the spring. Net investment income and net investment gains (losses) The Company invests its excess cash in fixed income and equity securities. Investment income includes interest and dividends earned on invested assets, and is reported net of investment-related expenses. Net investment gains (losses) are reported separately from net investment income. The Company recognizes realized gains when investments are sold for an amount greater than their cost or 37 Table of Contents amortized cost (in the case of fixed income securities) and realized losses when investments are sold for an amount less than their cost or amortized cost or when credit impairments are recorded, as applicable. The Company recognizes changes in unrealized gains and losses of equity securities in net income as part of net investment gains (losses). These gains and losses may be significant given the fair market value of the equity portfolio and the inherent volatility in equity markets. The changes in unrealized gains and losses on fixed income securities are recorded in other comprehensive income (loss), net of income taxes. Therefore, these changes have no impact on net income but do impact shareholders’ equity. The portfolio of investments for NI Holdings and its insurance subsidiaries is managed by Conning, Inc. and Disciplined Growth Investors. These investment managers have discretion to buy and sell securities in accordance with the investment policy approved by our Board of Directors. Principal Expense Items The Company’s expenses consist primarily of losses and loss adjustment expenses, amortization of deferred policy acquisition costs, other underwriting and general expenses, and income taxes. Losses and Loss Adjustment Expenses Losses and loss adjustment expenses represent the largest expense item and include (1) claim payments made, (2) estimates for future claim payments and changes in those estimates from prior periods, and (3) costs associated with investigating, defending, and adjusting claims, including legal fees. Amortization of deferred policy acquisition costs and other underwriting and general expenses Expenses incurred to underwrite risks are referred to as policy acquisition costs. Policy acquisition costs consist of commission expenses, state premium taxes, and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business. These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies. Other underwriting and general expenses consist of salaries, professional fees, office supplies, depreciation, and all other operating expenses not otherwise classified separately. Income taxes Current income taxes represent amounts paid to the federal government and certain states whose payment is based upon net income (subject to regulatory adjustments) generated by the Company. As noted above, it does not include state premium taxes that are based purely on the collection of policyholder premiums. We use the asset and liability method of accounting for deferred income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the income tax bases of its assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred income tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date. Total income taxes reflect both current income taxes and the change in the net deferred income tax asset or liability, excluding amounts attributed to accumulated other comprehensive income. Critical Accounting Policies General The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in its consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an ongoing basis based on historical developments, market conditions, industry trends, and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to these estimates and assumptions and that reported results of operations would not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments. 38 Table of Contents Unpaid Losses and Loss Adjustment Expenses How reserves are established With respect to its traditional property and casualty insurance products, the Company maintains reserves for the payment of claims (indemnity losses) and expenses related to adjusting those claims (loss adjustment expenses). The Company’s liability for unpaid losses and loss adjustment expenses consists of (1) case reserves, which are reserves for claims that have been reported to the Company, and (2) IBNR, which are reserves for claims that have been incurred but have not yet been reported and for the future development of reported claims. As some claims may not be reported for several years, the liability for unpaid losses and loss adjustment expenses includes significant estimates for IBNR. Loss adjustment expenses consist of two components – allocated loss adjustment expenses and unallocated loss adjustment expenses. Allocated loss adjustment expenses are defense and cost containment expenses, including legal fees, court costs, and investigation fees, which are linked to the settlement of specific individual claims or losses. Unallocated loss adjustment expenses are expenses that generally cannot be associated with a specific claim, including internal costs such as salaries and other overhead costs, and also represent estimates of future costs to administer claims. When a claim is reported to one of the insurance companies, its claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated. The amount of the loss reserve for the reported claim is based primarily upon an evaluation of coverage, liability, damages suffered, and any other information considered pertinent to estimating the exposure presented by the claim. Each claim is contested or settled individually based upon its merits, and some property and casualty claims may take years to resolve, especially in situations where legal action may be involved. Case reserves are reviewed on a regular basis and are updated as new information becomes available. When a catastrophe occurs, which in the Company’s case usually involves the weather perils of wind and hail, we utilize mapping technology through geographic coding of its property risks to overlay the path of the storm. This enables the Company to establish estimated damage amounts based on the wind speed and size of the hail for case or per claim loss amounts. This process allows us to determine within a reasonable time (5 – 7 days) an estimated number of claims and estimated losses from the storm. If we estimate the damages to be in excess of the retained catastrophe amount, reinsurers are notified immediately of a potential loss so that the Company can quickly recover reinsurance payments once the retention is exceeded. The Company estimates multi-peril crop insurance losses on a quarterly basis based upon historical loss patterns, current crop conditions, current weather patterns, and input from crop loss adjusters. These estimates have proven to be reasonably accurate indicators of the Company’s anticipated losses for this line of business. The Company’s actuaries assist with the estimation of the liability for unpaid losses and loss adjustment expenses. The actuaries prepare estimates by first deriving an actuarially based estimate of the ultimate cost of total losses and loss adjustment expenses incurred as of the financial statement date based on established actuarial methods as described below. We then reduce the estimated ultimate loss and loss adjustment expenses by loss and loss adjustment expenses payments and case reserves carried as of the financial statement date. The actuarially determined estimate is based upon indications from one of the following actuarial methodologies, weighted averages of the methods, and judgment. The specific method used to estimate the ultimate losses varies depending on the judgment of the actuaries as to what is the most appropriate for the property and casualty business. Management reviews these estimates and supplements the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and internal company processes. Management may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the consolidated financial statements. The Company determines its ultimate liability for unpaid losses and loss adjustment expenses by using the following actuarial methodologies: Bornhuetter-Ferguson Method — The Bornhuetter-Ferguson Method is a blended method that explicitly considers both actual loss development to date and expected future loss emergence. This method is applied on both a paid loss basis and an incurred loss basis. This method uses selected loss development patterns to calculate the expected percentage of losses unpaid (or unreported). The expected future loss component of the method is calculated by multiplying earned premium for the given exposure period by a selected a priori (i.e. deductive) loss ratio. The resulting dollars are then multiplied by the expected percentage of unpaid (or unreported) losses described above. This provides an estimate of future paid (or reported) losses that is then added to actual paid (or incurred) loss data to produce the estimated ultimate loss. Paid and Case Incurred Loss Development Method — The Paid and Case Incurred Loss Development Method utilizes ratios of cumulative paid or case incurred losses or loss adjustment expenses at each age of development as a percent of the preceding development age. Selected ratios are then multiplied together to produce a set of loss development factors which when applied to the 39 Table of Contents most current data value, by accident year, develop the estimated ultimate losses or loss adjustment expenses. Ultimate losses or loss adjustment expenses are then selected for each accident year from the various methods employed. Ratio of Paid Allocated Loss Adjustment Expenses to Paid Loss Method — The Ratio of Paid Allocated Loss Adjustment Expenses to Paid Loss Method utilizes the ratio of paid allocated loss adjustment expenses to paid losses and is similar to the Paid and Case Incurred Loss Development Method described above, except that the data projected are the ratios of paid allocated loss adjustment expenses to paid losses. The projected ultimate ratio is then multiplied by the selected ultimate losses, by accident year, to yield the ultimate allocated loss adjustment expenses. Allocated loss adjustment expenses reserves are calculated by subtracting paid losses from ultimate allocated loss adjustment expenses. The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, inflation, legal trends, increases in the state-dictated minimum liability limits in the recent cases of nonstandard auto insurance, weather, and legislative changes, among others. The impact of many of these items on ultimate costs for losses and loss adjustment expenses is difficult to estimate. Loss reserve estimation is also affected by the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. We continually refine our estimates of unpaid losses and loss adjustment expenses in a regular ongoing process as historical loss experience develops, and additional claims are reported and settled. We consider all significant facts and circumstances known at the time the liabilities for unpaid losses and loss adjustment expenses are established. There is an inherent amount of uncertainty in the establishment of liabilities for unpaid losses and loss adjustment expenses. This uncertainty is greatest in the current and most recent accident years due to the more recent nature of the claims being reported and relatively small percentage of these claims that have been reported, investigated, and adjusted by the Company’s claims staff. Therefore, the reserves carried in these more recent accident years are generally more conservative than those carried for older accident years. As the Company has the opportunity to investigate and adjust the reported claims, both the case and IBNR reserves are adjusted to more closely reflect the ultimate expected loss. Other factors that may have an impact on the Company’s case and IBNR reserves include, but are not limited to, those described below. Changes in liability law and public attitudes regarding damage awards Laws governing liability claims and judicial interpretations thereof can change over time, which can expand the scope of coverage anticipated by insurers when initially establishing reserves for claims. In addition, public attitudes regarding damage awards can result in judges and juries granting higher recoveries for damages than expected by claims personnel when reserves are established. In addition, these changes can result in both increased claim frequency and severity as both plaintiffs and their legal counsel perceive the opportunity for higher damage awards. Reserves established for claims that occurred in prior years would not have anticipated these legal changes and, therefore, could prove to be inadequate for the ultimate losses paid by the Company, causing the Company to experience adverse development and higher loss payments in future years. Change in claims handling and/or setting case reserves Changes in Company personnel and/or the approach to how claims are reported, adjusted, and reserved may affect the reserves established by the Company. As discussed above, the setting of IBNR reserves is not an exact science and involves the expert judgment of an actuary. One actuary’s reserve opinion may differ slightly from another actuary’s opinion. This is the primary reason why the IBNR reserve estimate is customarily reported as a range by a company’s actuary, which provides a company with an acceptable range to use in establishing its best estimate for IBNR reserves. Economic inflation A sudden and extreme increase in the economic inflation rate could have a significant impact on the Company’s case and IBNR reserves. When establishing case reserves, claims personnel generally establish an amount that in their opinion will provide a conservative amount to settle the loss. If the time to settle the claim extends over a period of years, which is possible but unlikely as the Company usually settles claims in less than 50 days on average, the initial reserve may not anticipate an economic inflation rate that is significantly higher than the current inflation rate. This can also apply to IBNR reserves. Should the economic inflation rate increase significantly, the Company may not anticipate the need to adjust the IBNR reserves accordingly, which could lead to the Company being deficient in its IBNR reserves. 40 Table of Contents Increases or decreases in claim severity for reasons other than inflation Factors exist that can drive the cost to settle claims for reasons other than standard inflation. For example, demand surge caused by a significant catastrophe, such as a hurricane, has an impact on not only the availability and cost of building materials such as roofing and other materials, but also the availability and cost of labor. Numerous other factors could also cause claim severity to increase beyond what the Company’s historic reserves would reflect. In addition, unexpected increases in labor, healthcare, or building material costs and other factors may cause fluctuations in the ultimate development of the case reserves. Actual settlement experience different from historical data trends When establishing IBNR reserves, the Company’s actuaries consider many of the factors discussed above. One of the more important factors that is considered when setting reserves is the past or historical claim settlement experience. Our actuaries consider factors such as the number of files entering litigation, payment patterns, length of time it takes Company claims personnel to settle the claims, and average payment amounts when estimating reserve amounts. Should future settlement patterns change due to the legal environment, Company claims handling philosophy, or personnel, it may have an impact on the future claims payments, which could cause existing reserves to either be redundant (excessive) or deficient (below) compared to the actual loss amount. Change in Reporting Lag As discussed above, the Company and its actuaries utilize historical patterns to provide an accurate estimate of what will take place in the future. Should we experience an unexpected delay in reporting time (claims are slower to be reported than in the past), we may underestimate the anticipated number of future claims, which could cause the ultimate loss we may experience to be underestimated. A lag in reporting may be caused by changes in how claims are reported, the types or lines of business the Company writes, the Company’s distribution system, and the geographic area where the Company chooses to insure risk. Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for unpaid losses and loss adjustment expenses may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. The Company reflects adjustments to the liability for unpaid losses and loss adjustment expenses in the results of operations during the period in which the estimates are changed. Investments The Company’s fixed income securities and equity securities are classified as available-for-sale and carried at estimated fair value as determined by management based upon quoted market prices or a recognized independent pricing service at the reporting date for those or similar investments. Changes in unrealized investment gains or losses on the fixed income securities, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of other comprehensive income (loss) and, accordingly, have no effect on net income (loss). Changes in unrealized investments gains or losses on equity securities are reported in net income (loss). Investment income from fixed income securities is recognized when earned, and realized investment gains (losses) are recognized when investments are sold, the fair value of equity securities change, or credit impairments are recognized. For additional information on the Company’s investments, see Part II, Item 8, Note 5 “Investments” and Note 6 “Fair Value Measurements”. Deferred Policy Acquisition Costs and Value of Business Acquired Certain direct policy acquisition costs consisting of commissions, state premium taxes, and other direct underwriting expenses that vary with and are primarily related to the production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. As in the case of previous acquisitions, no deferred policy acquisition costs (“DAC”) were recorded in the acquisition of Westminster in accordance with purchase accounting guidance. Rather, a separate intangible asset representing the value of business acquired (“VOBA”) was valued at $4,750 and established at the closing date. This VOBA intangible asset was amortized into expense as the acquired unearned premiums were reported into income, in the same way as DAC, and was fully amortized at December 31, 2020. Policy acquisition costs relating to new business written by Westminster were deferred following the closing date. The release of the VOBA asset and the establishment of new DAC generally offset each other over the twelve months following the acquisition of Westminster. 41 Table of Contents At December 31, 2022 and 2021, deferred policy acquisition costs and the related liability for unearned premiums were as follows: December 31, 2022 2021 Deferred policy acquisition costs $ 29,768 $ 24,947 Liability for unearned premiums 148,513 127,789 There were no VOBA intangible assets remaining at December 31, 2022 or 2021. The method followed in computing DAC limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to DAC. If the estimation of net realizable value indicates that DAC are not recoverable, they would be written off or a premium deficiency reserve would be established. Income Taxes Current income taxes represent amounts paid to the federal government and certain states whose payment is based upon net income (subject to regulatory adjustments) generated by the Company. The Company uses the asset and liability method of accounting for deferred income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the income tax bases of our assets and liabilities. A valuation allowance is established when it is more likely than not that some portion of the deferred income tax asset will not be realized. Total income taxes reflect both current income taxes and the change in the net deferred income tax asset or liability, excluding amounts attributed to accumulated other comprehensive income. The Company had gross deferred income tax assets of $17,900 at December 31, 2022, and $10,070 at December 31, 2021, arising primarily from unearned premiums, loss reserve discounting, net unrealized investment losses, and net operating loss carryforwards. A valuation allowance is required to be established for any portion of the deferred income tax asset for which the Company believes it is more likely than not that it will not be realized. A valuation allowance of $694 and $1,008 was maintained at December 31, 2022, and December 31, 2021, respectively. The Company had gross deferred income tax liabilities of $8,201 at December 31, 2022, and $14,568 at December 31, 2021, arising primarily from deferred policy acquisition costs, net unrealized investment gains, and other intangible assets. The Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting income tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining its deferred income tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against its deferred income tax assets. As of December 31, 2022, the Company had no material unrecognized income tax benefits or accrued interest and penalties. Federal income tax returns for the years 2019 through 2021 are open for examination. Changing Climate Conditions 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 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. Our ability to effectively manage catastrophe risk is dependent, in part, on our reliance on various catastrophe models, which may produce unreliable output as a result of inaccurate or incomplete data, along with the inherent uncertainty of future frequency and severity of losses. The impact of changing climate conditions on the overall insurance industry may also materially affect the availability and cost of reinsurance to us. In addition, these changes could impact the creditworthiness of issuers of securities in which the Company invests, subjecting our investment portfolio to increased credit and interest rate risk, with the potential for reduced investment returns and/or material realized or unrealized losses. 42 Table of Contents Liquidity and Capital Resources The Company generates sufficient funds from its operations and maintains a high degree of liquidity in its investment portfolio to meet the demands of claim settlements and operating expenses. The primary sources of funds are premium collections, investment earnings, and fixed income maturities. In 2017, we raised $93,145 in net proceeds from our IPO, which we planned to use for strategic acquisitions. In 2018, we used $17,000 for the acquisition of Direct Auto, which was paid at closing. On January 1, 2020, we acquired Westminster for $40,000. We paid $20,000 at the time of closing. The terms of the acquisition agreement included payment of the remaining $20,000, subject to certain adjustments, in three equal installments on each of the first and second anniversaries of the closing, and on the first business day of the month preceding the third anniversary of the closing. The first two installments were paid in January 2021 and January 2022, and the final installment was paid in December 2022 with no adjustments from the originally anticipated amount. The Company used net proceeds from the IPO to satisfy these obligations. We currently anticipate that cash generated from our operations and available from our investment portfolio, along with the remaining IPO net proceeds, will be sufficient to fund our operations. The Company’s philosophy is to provide sufficient cash flows from operations to meet its obligations in order to minimize the forced sales of investments. The Company maintains a portion of its investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds. The changes in cash and cash equivalents for the years ended December 31, 2022, 2021, and 2020 were as follows: Year Ended December 31, 2022 2021 2020 Net cash flows from operating activities $ (30,388 ) $ 29,168 $ 51,010 Net cash flows from investing activities 25,048 (48,151 ) 200 Net cash flows from financing activities (18,281 ) (11,471 ) (12,265 ) Net increase (decrease) in cash and cash equivalents $ (23,621 ) $ (30,454 ) $ 38,945 For the year ended December 31, 2022, net cash used by operating activities totaled $30,388 compared to $29,168 net cash provided by operating activities a year ago. This decrease was primarily driven by higher claim payments related to catastrophe losses during the current year and higher levels of premiums and agents’ balances receivable and federal income tax recoverable. For the year ended December 31, 2022, net cash provided by investing activities totaled $25,048 compared to $48,151 net cash used by investing activities a year ago. This decrease in cash used was attributable to the significant catastrophe losses in Nebraska and South Dakota, which resulted in more sales of securities to pay losses and less available cash for investment purchases. The decrease was also attributable to the Company investing a higher level of excess cash during the first quarter of 2021. For the year ended December 31, 2022, net cash used by financing activities totaled $18,281 compared to $11,471 a year ago. This increase in cash used was primarily attributable to the Company making two installment payments for the Westminster purchase during 2022 for $13,333 compared to one installment payment in 2021 for $6,667. For the year ended December 31, 2021, net cash provided by operating activities totaled $29,168 compared to $51,010 in the year prior. The decrease in net cash provided by operating activities was primarily driven by higher claim payments related to a return to average loss frequency in the private passenger auto segment while pandemic-related restrictions were removed as well as above average weather-related losses and a catastrophe event in the home and farm segment. The higher claim payments were partially offset by increased premium receipts due to premium growth. For the year ended December 31, 2021, net cash used by investing activities totaled $48,151 compared to net cash provided by investing activities of $200 in the year prior. In 2021, the Company invested excess cash generated from operations and the implementation of the intercompany reinsurance pooling agreement into longer term investments. For the year ended December 31, 2021, net cash used by financing activities totaled $11,471 compared to $12,265 in the year prior. The Company paid the first installment of $6,667 of the additional consideration for Westminster during the first quarter of 2021. The Company repurchased shares of its own common stock for $4,316 during 2021 compared to $12,234 during 2020. As a standalone entity, and outside of the net proceeds from the IPO, the Company’s principal source of long-term liquidity will be dividend payments from its directly-owned subsidiaries. 43 Table of Contents Nodak Insurance is restricted by the insurance laws of North Dakota as to the amount of liquid or other distributions it may pay to NI Holdings. 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 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 investment gains), less any prior dividends paid during such twelve-month period. In addition, any insurance company other than a life insurance company may carry forward net income from the preceding two calendar years, not including realized investment gains, less any dividends actually paid during those two calendar years. Dividends in excess of this amount are considered “extraordinary” and are subject to the approval of the North Dakota Insurance Department. There is no amount available for payment of dividends from Nodak Insurance to NI Holdings during 2023 without the prior approval of the North Dakota Insurance Department based upon the net loss of Nodak Insurance as of December 31, 2022. Prior to its payment of any dividend, Nodak Insurance will be required to provide notice of the dividend to the North Dakota Insurance Department. This notice must be provided to the North Dakota Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The North Dakota Insurance Department has the power to limit or prohibit dividend payments if an insurance company is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity. The Nodak Insurance Board of Directors declared and paid dividends of $3,000 and $6,000 to NI Holdings during the years ended December 31, 2022 and 2020, respectively. No dividends were declared or paid by Nodak Insurance during the year ended December 31, 2021. Direct Auto re-domesticated from Illinois to North Dakota during 2021, and is now subject to the same dividend restrictions as Nodak Insurance. There is no amount available for payment of dividends from Direct Auto to NI Holdings during 2023 without the prior approval of the North Dakota Insurance Department based upon the net loss of Direct Auto as of December 31, 2022. No dividends were declared or paid by Direct Auto during the years ended December 31, 2022, 2021, or 2020. Westminster re-domesticated from Maryland to North Dakota during 2021, and is now subject to the same dividend restrictions as Nodak Insurance. There is no amount available for payment of dividends from Westminster to NI Holdings during 2023 without the prior approval of the North Dakota Insurance Department based upon the net loss of Westminster as of December 31, 2022. No dividends were declared or paid by Westminster during the years ended December 31, 2022, 2021 or 2020. 44 Table of Contents Contractual Obligations The primary contractual obligations of the Company include gross loss and loss adjustment expenses payments, consideration due relating to the acquisition of Westminster, and operating lease obligations. The Company’s unpaid losses and loss adjustment expenses were $190,459 as of December 31, 2022. Historical payment experience indicates that approximately 49% of this amount will be paid during 2023 and another 35% will be paid over the subsequent two years. The actual timing and amounts of these payments in the future may vary. Westminster was acquired on January 1, 2020, for a purchase price of $40,000, subject to certain adjustments. The Company paid $20,000 from the net proceeds from the IPO at time of closing, with another $20,000 payable in three equal installments. We paid the first two installments on the first two anniversaries of the closing, in January 2021 and January 2022, and paid the final installment in December 2022. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, see Part II, Item 8, Note 2 “Recent Accounting Pronouncements”. 45 Table of Contents