Item 7. Management’s Discussion and Analysis
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 2023 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 2023 and 2022 items and year-to-year comparisons
between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 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, 2022, filed with the SEC on March 8, 2023.
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. The property and casualty insurance industry has historically been characterized by soft markets
(periods of relatively high levels of price competition, less restrictive underwriting practices, and generally low premium rates) followed
by hard markets (periods of capital shortages resulting in a lack of insurance availability, relatively low levels of price competition,
more selective underwriting of risks, and relatively high premium rates). During soft markets, we may lose business to other carriers
offering competitive insurance at lower rates. We may also choose to reduce our premiums or limit premium increases leading to a reduction
in profit margins and revenues. Our industry is also influenced by general economic conditions, which could reduce overall premium volume
for us and our competitors. Additionally, the industry is impacted by changes in customer preferences, including customer demand for direct,
point-of-sale, or other non-traditional distribution channels. We 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
Years ended December 31, 2023, 2022, and 2021
The consolidated net loss for the Company was $5,226 for the year
ended December 31, 2023, compared to a net loss of $53,775 for the year ended December 31, 2022, and net income of $8,332 for the year
ended December 31, 2021.
The major components of our revenues and net income (loss) for the
three periods are shown below:
Year Ended December 31,
2023
2022
2021
Revenues:
Net premiums earned
$ 351,137
$ 328,290
$ 299,589
Fee and other income
1,978
1,453
1,775
Net investment income
10,456
7,820
7,131
Net investment gains (losses)
2,124
(13,126 )
15,479
Total revenues
$ 365,695
$ 324,437
$ 323,974
Components of net income (loss):
Net premiums earned
$ 351,137
$ 328,290
$ 299,589
Losses and loss adjustment expenses
244,412
294,432
216,379
Amortization of deferred policy acquisition costs and other underwriting and general expenses
118,790
99,034
96,289
Underwriting loss
(12,065 )
(65,176 )
(13,079 )
Fee and other income
1,978
1,453
1,775
Net investment income
10,456
7,820
7,131
Net investment gains (losses)
2,124
(13,126 )
15,479
Goodwill impairment charge
(6,756 )
—
—
Income (loss) before income taxes
(4,263 )
(69,029 )
11,306
Income tax expense (benefit)
963
(15,254 )
2,974
Net income (loss)
$ (5,226 )
$ (53,775 )
$ 8,332
31
Net Premiums Earned
Year Ended December 31,
2023
2022
2021
Net premiums earned:
Direct premium
$ 401,945
$ 368,886
$ 333,254
Assumed premium
3,570
6,550
8,035
Ceded premium
(54,378 )
(47,146 )
(41,700 )
Total net premiums earned
$ 351,137
$ 328,290
$ 299,589
Net premiums earned for the year ended December 31, 2023 increased
$22,847, or 7.0%, to $351,137, compared to $328,290 for the year ended December 31, 2022.
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.
Year Ended December 31,
2023
2022
2021
Net premiums earned:
Private passenger auto
$ 83,360
$ 77,605
$ 72,533
Non-standard auto
87,760
66,911
58,585
Home and farm
83,389
78,381
73,792
Crop
25,817
34,721
26,848
Commercial
64,476
61,431
57,285
All other
6,335
9,241
10,546
Total net premiums earned
$ 351,137
$ 328,290
$ 299,589
Below are comments regarding significant changes in net premiums earned
by business segment:
Private passenger auto – Net premiums earned for
2023 increased $5,755, or 7.4%, from 2022. This increase was driven by significant rate increases in North Dakota, South Dakota, and Nebraska,
partially offset by lower new business production as a result of underwriting actions taken to improve profitability.
Non-standard auto – Net premiums earned for 2023
increased $20,849, or 31.2%, from 2022. This increase was driven by new business growth, improved retention, and significant rate increases
in the Chicago market where our non-standard auto business is concentrated.
Home and farm – Net premiums earned for 2023 increased
$5,008, or 6.4%, from 2022. This increase was driven by rate increases along with increased insured property values, which were primarily
the result of higher inflationary factors. These premium increases were partially offset by lower levels of new business production as
a result of underwriting actions taken to improve profitability.
Crop – Net premiums earned for 2023 decreased $8,904,
or 25.6%, from 2022. This decrease was driven by lower commodity prices and lower muti-peril crop insurance rates, combined with fewer
acres insured in the current year. In addition, the strong multi-peril crop results for the current year resulted in higher ceded premiums
as required by the SRA.
Commercial – Net premiums earned for 2023 increased
$3,045, or 5.0%, from 2022. This increase was driven by prior period new business growth, increased insured values which were primarily
the result of higher inflationary factors, and continued increases in rate, partially offset by higher ceded premiums and the impact of
underwriting actions taken to improve profitability.
All other – Net premiums earned for 2023 decreased
$2,906, or 31.4%, from 2022. This decrease was driven by the decision to non-renew our participation in an assumed domestic and international
reinsurance pool of business as of January 1, 2022.
32
Losses and Loss Adjustment Expenses
Year Ended December 31,
2023
2022
2021
Net losses and loss adjustment expenses:
Direct losses and loss adjustment expenses
$ 293,978
$ 333,397
$ 280,998
Assumed losses and loss adjustment expenses
1,140
2,369
6,899
Ceded losses and loss adjustment expenses
(50,706 )
(41,334 )
(71,518 )
Total net losses and loss adjustment expenses
$ 244,412
$ 294,432
$ 216,379
The Company’s net losses and loss adjustment expenses for the
year ended December 31, 2023 decreased $50,020, or 17.0%, to $244,412, compared to $294,432 for the year ended December 31, 2022.
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.
Year Ended December 31,
2023
2022
2021
Net losses and loss adjustment expenses:
Private passenger auto
$ 60,204
$ 65,420
$ 59,721
Non-standard auto
63,041
39,400
34,453
Home and farm
50,935
107,823
52,145
Crop
10,793
19,418
27,831
Commercial
58,745
57,216
34,779
All other
694
5,155
7,450
Total net losses and loss adjustment expenses
$ 244,412
$ 294,432
$ 216,379
Year Ended December 31,
2023
2022
2021
Loss and loss adjustment expenses ratio:
Private passenger auto
72.2%
84.3%
82.3%
Non-standard auto
71.8%
58.9%
58.8%
Home and farm
61.1%
137.6%
70.7%
Crop
41.8%
55.9%
103.7%
Commercial
91.1%
93.1%
60.7%
All other
11.0%
55.8%
70.6%
Total loss and loss adjustment expenses ratio
69.6%
89.7%
72.2%
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 decreased 12.1 percentage points in 2023 compared to 2022. This decrease was the result of recent significant
rate increases, lower loss frequency in the current year, and favorable prior year reserve development, partially offset by elevated loss
costs due to continued high levels of inflation.
Non-standard auto – The net loss and loss adjustment
expenses ratio increased 12.9 percentage points in 2023 compared to 2022. This increase was driven by elevated loss severity as a result
of inflationary factors as well as unfavorable prior year loss reserve development, partially offset by recent significant rate increases.
We continue to take significant rate and underwriting actions as a result of these elevated losses and challenging market conditions.
Home and farm – The net loss and loss adjustment
expenses ratio decreased 76.5 percentage points in 2023 compared to 2022. This decrease was driven by the much-improved loss experience
as a result of having no catastrophe losses during 2023 compared to 2022, combined with improved non-catastrophe weather losses and the
significant rate increases and underwriting actions we have implemented to address the profitability on these lines of business. Catastrophe
losses, net of reinsurance, for the Home and Farm segment accounted for 72.1 percentage points of the net loss and loss adjustment expense
ratio for the year ended December 31, 2022.
33
Crop – The net loss and loss adjustment expenses
ratio decreased 14.1 percentage points in 2023 compared to 2022. This decrease was due to improved crop growing conditions in 2023 in
comparison to 2022.
Commercial – The net loss and loss adjustment expenses
ratio decreased 2.0 percentage points in 2023 compared to 2022. This decrease was driven by higher ceded losses in the current year, partially
offset by higher levels of unfavorable prior year reserve development and elevated loss severity in the current year. We continue to take
significant rate and underwriting actions to improve the segment’s profitability.
All other – The net loss and loss adjustment expenses
ratio decreased 44.8 percentage points in 2023 compared to 2022. This decrease was driven by improved loss experience related to the excess
liability lines of business.
Underwriting and General Expenses and Expense Ratio
Year Ended December 31,
2023
2022
2021
Underwriting and general expenses:
Amortization of deferred policy acquisition costs
$ 82,991
$ 66,803
$ 64,574
Other underwriting and general expenses
35,799
32,231
31,715
Total underwriting and general expenses
$ 118,790
$ 99,034
$ 96,289
Expense ratio
33.8%
30.2%
32.1%
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 increased 3.6
percentage points in the year ended December 31, 2023, compared to the same period in 2022. The increase in amortization of deferred
policy acquisition costs was driven by higher deferrable costs resulting from overall premium growth compared to the prior year, including
significant growth in the non-standard auto segment which generally pays higher agent commissions than our other segments. The increase
in other underwriting and general expenses was due to the impact of continued high levels of inflation and 2022 expenses being favorably
impacted by multi-peril crop insurance final settlements.
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Underwriting Gain (Loss) and Combined Ratio
Year Ended December 31,
2023
2022
2021
Underwriting gain (loss):
Private passenger auto
$ (1,341 )
$ (9,416 )
$ (7,704 )
Non-standard auto
(12,654 )
622
1,362
Home and farm
7,752
(52,512 )
(475 )
Crop
8,762
12,294
(9,195 )
Commercial
(18,576 )
(17,958 )
2,506
All other
3,992
1,794
427
Total underwriting loss
$ (12,065 )
$ (65,176 )
$ (13,079 )
Year Ended December 31,
2023
2022
2021
Combined ratio:
Private passenger auto
101.6%
112.1%
110.6%
Non-standard auto
114.4%
99.1%
97.7%
Home and farm
90.7%
167.0%
100.7%
Crop
66.1%
64.6%
134.3%
Commercial
128.8%
129.2%
95.6%
All other
37.0%
80.6%
95.9%
Total combined ratio
103.4%
119.9%
104.3%
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 decreased $53,111, or 81.5%, for the year
ended December 31, 2023, compared to the same period in 2022. These results were driven by the factors discussed in the Losses and Loss
Adjustment Expenses section above.
The overall combined ratio decreased 16.5 percentage points in the
year ended December 31, 2023, compared to the same period in 2022. These results were driven by the factors discussed in the Losses and
Loss Adjustment Expenses section above.
Fee and Other Income
We had fee and other income of $1,978 for the year ended December 31,
2023, compared to $1,453 for the year ended December 31, 2022, and $1,775 for the year ended December 31, 2021. Fee income is largely
attributable to the non-standard auto segment and is a key component in measuring its profitability. Fee and other income for non-standard
auto increased to $1,293 for the year ended December 31, 2023, from $831 for the year ended December 31, 2022, due to an increase in policies
that generate fee income.
Goodwill Impairment Charge
We had a goodwill impairment charge of $6,756 for the year ended December
31, 2023, compared to $0 for the years ended December 31, 2022 and 2021. See Part II, Item 8, Note 10 “Goodwill and Other Intangibles”
for additional information.
35
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,
2023
2022
2021
Average cash and invested assets
$ 408,845
$ 455,366
$ 502,375
Net investment income
$ 10,456
$ 7,820
$ 7,131
Gross return on average cash and invested assets
3.4%
2.5%
2.1%
Net return on average cash and invested assets
2.6%
1.7%
1.4%
Net investment income increased $2,636 for the year ended December
31, 2023, compared to the year ended December 31, 2022. This increase was primarily driven by higher reinvestment rates as well as a strategic
increased allocation to fixed income securities in our investment portfolio. Net investment income increased $689 for the year ended December
31, 2022, compared to the year ended December 31, 2021.
Gross and net return on average cash and invested assets increased
year-over-year, driven by the higher net investment income and a higher proportion of the equity portfolio being invested in high dividend
yield equities in 2023, along with a decrease in average cash and invested assets (measured at fair value). This decrease in average cash
and invested assets was driven by challenging equity market conditions, particularly during the middle and later stages of 2022, combined
with investment sales as a result of an unusually high number of weather-related losses in 2022.
Net Investment Gains (Losses)
Net investment gains (losses) consisted of the following:
Year Ended December 31,
2023
2022
2021
Gross realized gains
$ 13,975
$ 7,195
$ 18,130
Gross realized losses, excluding credit impairment losses
(1,924 )
(5,271 )
(362 )
Net realized gains
12,051
1,924
17,768
Change in net unrealized gain on equity securities
(9,927 )
(15,050 )
(2,289 )
Net investment gains (losses)
$ 2,124
$ (13,126 )
$ 15,479
We had net realized gains of $12,051 for the year ended December 31,
2023, compared to $1,924 for the year ended December 31, 2022, and $17,768 for the year ended December 31, 2021. The year-to-date increase
in net realized gains was primarily the result of a strategic liquidation of a portfolio of equity securities in the first quarter of
2023. The gross realized gains from the sale of these securities were largely offset by the elimination of the unrealized gain position
of these securities. No credit impairment losses were reported during any of the periods presented.
We experienced a decrease in net unrealized gains on equity securities
of $9,927 during the year ended December 31, 2023. The current period change in net unrealized gains on equity securities was driven by
the equity portfolio liquidation noted above and the impact of changes in fair value attributable to equity market volatility. The prior
year decreases were driven by the impact of changes in fair value attributable to unfavorable equity markets. We had net realized gains
on the sale of equity securities of $12,633, $2,075, and $17,118 during the years ended December 31, 2023, 2022, and 2021, respectively.
Our fixed income securities are classified as available for sale because
we will, from time to time, execute sales of securities that are not impaired, consistent with our investment goals and policies. The
fixed income portion of the portfolio experienced net unrealized gains of $10,654 during the year ended December 31, 2023, compared to
net unrealized losses of $46,362 during the year ended December 31, 2022. The changes were primarily the result of changes in U.S. interest
rates. 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 a decrease in net unrealized gains of $9,796
during the year ended December 31, 2021.
36
Income (Loss) before Income Taxes
We had a pre-tax loss of $4,263 for the year ended December 31, 2023,
a pre-tax loss of $69,029 for the year ended December 31, 2022, and pre-tax income of $11,306 for the year ended December 31, 2021. The
year-over-year improvement in 2023 compared to 2022 was largely attributable to the significant catastrophe losses and significantly higher
investment losses during 2022, partially offset by higher unfavorable prior year reserve development during 2023.
Income Tax Expense (Benefit)
We recorded income tax expense of $963 for the year ended December
31, 2023, an income tax benefit of $15,254 for the year ended December 31, 2022, and income tax expense of $2,974 for the year ended December
31, 2021. Our effective tax rate for 2023 was (22.6)% compared to an effective tax rate of 22.1% and 26.3% for 2022 and 2021, respectively.
Our 2023 effective tax rate was impacted by several factors, but the current year non-taxable goodwill impairment charge was the most
significant driver of the variance from the statutory rate. The valuation allowance against certain deferred income tax assets was $505
as of December 31, 2023 compared to $694 as of December 31, 2022.
Net Income (Loss)
We had a net loss before non-controlling interest of $5,226 for the
year ended December 31, 2023, a net loss of $53,775 for the year ended December 31, 2022, and net income of $8,332 for the year ended
December 31, 2021. The year-over-year improvement in 2023 compared to 2022 was largely attributable to the significant catastrophe losses
and significantly higher investment losses during 2022, partially offset by higher unfavorable prior year reserve development during 2023.
Return on Average Equity
For the year ended December 31, 2023, we had annualized return on
average equity, after non-controlling interest, of (2.2)%, compared to annualized return on average equity, after non-controlling interest,
of (17.9)% and 2.4% for the years ended December 31, 2022 and 2021, respectively.
Average equity is calculated as the average between beginning and
ending equity, excluding non-controlling interest, for the period.
Principal Revenue Items
Revenue is primarily derived 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. Our 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
37
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 we write covers crops planted in the spring.
Net Investment Income and Net Investment
Gains (Losses)
We invest our 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. We recognize realized gains when investments are sold for an amount greater
than their cost or 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. We recognize 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., which has discretion to buy and sell securities in accordance with the investment policy approved by our
Board of Directors.
Principal Expense Items
Our 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 or owed
to the federal government and certain states whose payment is based upon net income (subject to regulatory adjustments) generated by the
Company. The generation of net losses may result in income tax benefits. 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. We are required
to make estimates and assumptions in certain circumstances that affect amounts reported in our 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
38
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.
Unpaid Losses and Loss Adjustment Expenses
How reserves are established
With respect to our traditional property and casualty insurance products,
we maintain reserves for the payment of claims (indemnity losses) and expenses related to adjusting those claims (loss adjustment expenses).
Our liability for unpaid losses and loss adjustment expenses consists of (1) case reserves, which are reserves for claims that have been
reported to us, and (2) IBNR, which represents 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 our case usually involves the weather
perils of wind and hail, we utilize mapping technology through geographic coding of our property risks to overlay the path of the storm.
This enables us 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. We have also begun reviewing the results of the predicted cost of the claim generated by the catastrophe models as a reasonability
check on the anticipated cost of 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 we can quickly recover reinsurance payments once the retention is exceeded.
We estimate 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 our anticipated losses for this line of business.
Our 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 various actuarial
methodologies including paid chain-ladder, incurred chain-ladder, Bornhuetter-Ferguson, 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 line of 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.
A further discussion of the actuarial methodologies used follows:
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
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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 (Chain-Ladder) 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 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 (Chain-Ladder) 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/staffing, inflation, weather, legal trends, and regulatory and legislative changes. 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 our claims staff. Therefore, the reserves carried in these more recent accident years are generally more conservative
than those carried for older accident years. As we have 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 our 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 us 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 we establish. 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 our 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 we usually settle claims in less than 50 days on average, the initial reserve may not anticipate
an economic inflation rate that is significantly higher than the
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current inflation rate. This can also apply to IBNR reserves. Should
the economic inflation rate increase significantly, we may not anticipate the need to adjust the IBNR reserves accordingly, which could
lead to deficient IBNR reserves.
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 our 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, our 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
our claims personnel to settle the claims, and average payment amounts when estimating reserve amounts. Should future settlement patterns
change due to the legal environment, our 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, we 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 we write,
our distribution system, and the geographic area where we choose 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. We reflect 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
Our 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 investment 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 our investments, see
Part II, Item 8, Note 4 “Investments” and Note 5 “Fair Value Measurements”.
Deferred Policy Acquisition Costs
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.
At December 31, 2023 and 2022, deferred policy acquisition
costs (“DAC”) and the related liability for unearned premiums were as follows:
December 31,
2023
2022
Deferred policy acquisition costs
$ 34,120
$ 29,768
Liability for unearned premiums
164,100
148,513
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
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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 or owed
to the federal government and certain states whose payment is based upon net income (subject to regulatory adjustments) generated by the
Company. The generation of net losses may result in income tax benefits, a portion of which may be in the form of refunds of prior income
taxes paid to taxing authorities. 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 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.
We had gross deferred income tax assets of $18,172
at December 31, 2023, and $17,900 at December 31, 2022, 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 we believe it is more likely than not that it will not be realized. A valuation allowance of $505 and $694
was maintained at December 31, 2023, and December 31, 2022, respectively.
We had gross deferred income tax liabilities of $9,254 at December
31, 2023, and $8,201 at December 31, 2022, arising primarily from deferred policy acquisition costs and other intangible assets.
We exercise 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 our 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
us to record a valuation allowance against our deferred income tax assets.
As of December 31, 2023, we had no material unrecognized
income tax benefits or accrued interest and penalties. Federal income tax returns for the years 2020 through 2022 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 we invest, 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.
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Liquidity and Capital Resources
We expect to generate sufficient funds from our operations and maintain
a high degree of liquidity in our investment portfolio to meet the demands of claim settlements and operating expenses for the foreseeable
future. Our primary sources of funds are premium collections, investment earnings, and fixed income maturities.
We also have a $3,000 line of credit with Wells Fargo
Bank, N.A. The terms of the line of credit include a floating interest rate of 2.50% above the daily simple secured overnight financing
rate. There were no outstanding amounts during the years ended December 31, 2023, 2022, or 2021. This line of credit is scheduled to expire
on December 13, 2024.
The changes in cash and cash equivalents for the
years ended December 31, 2023, 2022, and 2021 were as follows:
Year Ended December 31,
2023
2022
2021
Net cash flows from operating activities
$ 25,970
$ (30,388 )
$ 29,168
Net cash flows from investing activities
(8,813 )
25,048
(48,151 )
Net cash flows from financing activities
(7,466 )
(18,281 )
(11,471 )
Net increase (decrease) in cash and cash equivalents
$ 9,691
$ (23,621 )
$ (30,454 )
For the year ended December 31, 2023, net cash provided by operating
activities totaled $25,970 compared to $30,388 net cash used by operating activities a year ago. This change was primarily driven by lower
claim payments and the receipt of a significant income tax refund during the current period.
For the year ended December 31, 2023, net cash used by investing activities
totaled $8,813 compared to $25,048 net cash provided by investing activities a year ago. This change was primarily attributable to a decrease
in maturities and sales of fixed income securities and an increase in purchases of fixed income securities in the current year compared
to the prior year, partially offset by an increase in sales of equity securities and a decrease in purchases of equity securities.
For the year ended December 31, 2023, net cash used by financing activities
totaled $7,466 compared to $18,281 a year ago. This decrease in cash used was attributable to installment payments on the Westminster
consideration payable during 2022, partially offset by an increase in share repurchases during 2023 compared to 2022.
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.
As a holding company, a principal source of long-term liquidity will
be dividend payments from our directly-owned subsidiaries.
Nodak Insurance is restricted by the insurance laws of North Dakota
as to the amount of dividends 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 2024 without the prior approval of the North Dakota Insurance Department. 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
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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 to NI Holdings during the year ended December 31, 2022. No
dividends were declared or paid by Nodak Insurance during the years ended December 31, 2023 and 2021.
Direct Auto re-domesticated from Illinois to North Dakota during 2021
and is now subject to the same dividend restrictions as Nodak Insurance. The amount available for payment of dividends from Direct Auto
to NI Holdings during 2024 without the prior approval of the North Dakota Insurance Department is approximately $90 as of December 31,
2023. No dividends were declared or paid by Direct Auto during the years ended December 31, 2023, 2022, or 2021.
Westminster re-domesticated from Maryland to North Dakota during 2021
and is now subject to the same dividend restrictions as Nodak Insurance. The amount available for payment of dividends from Westminster
to NI Holdings during 2024 without the prior approval of the North Dakota Insurance Department is approximately $1,200 as of December
31, 2023. No dividends were declared or paid by Westminster during the years ended December 31, 2023, 2022 or 2021.
Contractual Obligations
The primary contractual obligations of the Company
include gross loss and loss adjustment expenses payments as well as operating and finance lease obligations.
The Company’s unpaid losses and loss adjustment
expenses were $217,119 as of December 31, 2023. Historical payment experience indicates that approximately 48% of this amount will be
paid during 2024 and another 36% will be paid over the subsequent two years. The actual timing and amounts of these payments in the future
may vary.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements,
see Part II, Item 8, Note 2 “Recent Accounting Pronouncements”.
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