Item 1. Financial Statements
ITEM 1 - FINANCIAL STATEMENTS
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands)
March 31,
2021
December 31,
2020
(Unaudited)
Assets
Investment securities:
Debt securities, at fair value (amortized cost of $148,434 and $149,954, respectively)
$
147,629
$
151,999
Equity securities, at fair value (cost of $19,217 and $16,912, respectively)
19,638
17,891
Short-term investments, at fair value
12,710
13,317
Total investments
179,977
183,207
Cash and cash equivalents
4,429
8,193
Premiums and agents' balances receivable, net
19,328
20,162
Reinsurance recoverables on unpaid losses
26,559
24,218
Reinsurance recoverables on paid losses
3,923
2,138
Prepaid reinsurance premiums
3,653
1,316
Deferred policy acquisition costs
12,459
12,243
Other assets
9,359
10,120
Total assets
$
259,687
$
261,597
Liabilities and Shareholders' Equity
Liabilities:
Unpaid losses and loss adjustment expenses
$
118,676
$
111,270
Unearned premiums
58,350
56,224
Debt
39,075
40,997
Accounts payable and accrued expenses
6,610
8,693
Total liabilities
222,711
217,184
Commitments and contingencies
—
—
Shareholders' equity:
Common stock, no par value (100,000,000 shares authorized; 9,681,728 issued and outstanding, respectively)
92,552
92,486
Accumulated deficit
(53,621
)
(48,985
)
Accumulated other comprehensive income (loss)
(1,955
)
912
Total shareholders' equity
36,976
44,413
Total liabilities and shareholders' equity
$
259,687
$
261,597
The accompanying notes are an integral part of the Consolidated Financial Statements.
3
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(dollars in thousands, except per share data)
Three Months Ended
March 31,
2021
2020
Revenue
Premiums
Gross earned premiums
$
28,247
26,053
Ceded earned premiums
(5,412
)
(4,036
)
Net earned premiums
22,835
22,017
Net investment income
532
954
Net realized investment gains
2,924
928
Change in fair value of equity securities
(540
)
(3,086
)
Other gains
—
115
Other income
556
658
Total revenue
26,307
21,586
Expenses
Losses and loss adjustment expenses, net
19,362
14,269
Policy acquisition costs
6,750
6,303
Operating expenses
4,349
5,045
Interest expense
721
731
Total expenses
31,182
26,348
Income (loss) before equity earnings in Affiliate and income taxes
(4,875
)
(4,762
)
Equity earnings in Affiliate, net of tax
248
50
Income tax expense
9
13
Net income (loss)
$
(4,636
)
$
(4,725
)
Earnings (loss) per common share, basic and diluted
$
(0.48
)
$
(0.49
)
Weighted average common shares outstanding, basic and diluted
9,681,728
9,592,774
The accompanying notes are an integral part of the Consolidated Financial Statements.
4
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(dollars in thousands)
Three Months Ended
March 31,
2021
2020
Net income (loss)
$
(4,636
)
$
(4,725
)
Other comprehensive income (loss), net of tax:
Unrealized investment gains (losses):
Unrealized investment gains (losses) during the period
(1,924
)
(1,315
)
Income tax (benefit) expense
—
—
Unrealized investment gains (losses), net of tax
(1,924
)
(1,315
)
Less: reclassification adjustments to:
Net realized investment gains (losses) included in net income (loss)
943
384
Income tax (benefit) expense
—
—
Total reclassifications included in net income (loss), net of tax
943
384
Other comprehensive income (loss)
(2,867
)
(1,699
)
Total comprehensive income (loss)
$
(7,503
)
$
(6,424
)
The accompanying notes are an integral part of the Consolidated Financial Statements.
5
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
(dollars in thousands)
No Par, Common Stock
Retained
Earnings
Accumulated
Other
Comprehensive
Total
Shareholders'
Shares
Amount
(Accumulated)
Income (Loss)
Equity
Balances at December 31, 2020
9,681,728
$
92,486
$
(48,985
)
$
912
$
44,413
Net income (loss)
—
—
(4,636
)
—
(4,636
)
Stock-based compensation expense
—
66
—
—
66
Other comprehensive income (loss)
—
—
—
(2,867
)
(2,867
)
Balances at March 31, 2021
9,681,728
$
92,552
$
(53,621
)
$
(1,955
)
$
36,976
Balances at December 31, 2019
9,592,861
$
91,816
$
(49,580
)
$
489
$
42,725
Net income (loss)
—
—
(4,725
)
—
(4,725
)
Repurchase of common stock
(700
)
(2
)
—
—
(2
)
Restricted stock unit expense
—
239
—
—
239
Other comprehensive income (loss)
—
—
—
(1,699
)
(1,699
)
Balances at March 31, 2020
9,592,161
$
92,053
$
(54,305
)
$
(1,210
)
$
36,538
The accompanying notes are an integral part of the Consolidated Financial Statements.
6
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(dollars in thousands)
Three Months Ended March 31,
2021
2020
Cash Flows From Operating Activities
Net income (loss)
(4,636
)
$
(4,725
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization
109
42
Amortization of bond premium and discount, net
120
127
Net realized investment (gains) losses
(2,924
)
(928
)
Change in fair value of equity securities
540
3,086
Stock based compensation expenses
66
239
Equity earnings in Affiliate, net of tax
(248
)
(50
)
Changes in operating assets and liabilities:
(Increase) decrease in:
Premiums and agents' balances and other receivables
827
1,676
Reinsurance recoverables
(6,126
)
1,966
Prepaid reinsurance premiums
(2,337
)
253
Deferred policy acquisition costs
(216
)
398
Other assets
197
(756
)
Increase (decrease) in:
Unpaid losses and loss adjustment expenses
9,406
2,411
Unearned premiums
2,126
(969
)
Reinsurance premiums payable
—
833
Accounts payable and other liabilities
(397
)
412
Net cash provided by (used in) operating activities
(3,493
)
4,015
Cash Flows From Investing Activities
Purchase of investments
(61,370
)
(105,045
)
Proceeds from maturities and redemptions of investments
5,416
6,216
Proceeds from sales of investments
57,703
94,742
Purchases of property and equipment
(20
)
(46
)
Net cash provided by (used in) investing activities
1,729
(4,133
)
Cash Flows From Financing Activities
Repurchase of common stock
—
(2
)
Repurchase of senior unsecured notes
—
(244
)
Borrowings under debt arrangements
3,000
1,000
Repayment of borrowings under debt arrangements
(5,000
)
—
Net cash provided by (used in) financing activities
(2,000
)
754
Net increase (decrease) in cash
(3,764
)
636
Cash at beginning of period
8,193
7,464
Cash at end of period
$
4,429
$
8,100
Supplemental Disclosure of Cash Flow Information:
Interest paid
$
722
$
643
The accompanying notes are an integral part of the Consolidated Financial Statements.
7
CONIFER HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
1. Summary of Significant Accounting Policies
Basis of Presentation and Management Representation
The consolidated financial statements include accounts, after elimination of intercompany accounts and transactions, of Conifer Holdings, Inc. (the “Company” or “Conifer”), its wholly owned subsidiaries, Conifer Insurance Company ("CIC"), White Pine Insurance Company ("WPIC"), Red Cedar Insurance Company ("RCIC"), and Sycamore Insurance Agency, Inc. ("SIA"). CIC, WPIC, and RCIC are collectively referred to as the "Insurance Company Subsidiaries." On a stand-alone basis, Conifer Holdings, Inc. is referred to as the "Parent Company."
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which differ from statutory accounting practices prescribed or permitted for insurance companies by regulatory authorities. The Company has applied the rules and regulations of the United States Securities and Exchange Commission (“SEC”) regarding interim financial reporting and therefore the consolidated financial statements do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, all adjustments, consisting of items of a normal recurring nature, necessary for a fair presentation of the consolidated interim financial statements, have been included.
These consolidated financial statements and the notes thereto should be read in conjunction with the Company's audited consolidated financial statements and related notes included in its Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the SEC.
The results of operations for the three months ended March 31, 2021, are not necessarily indicative of the results expected for the year ended December 31, 2021. In addition, there are risks and uncertainties associated with the novel coronavirus ("COVID-19") and the impact it may have on our business, results of operations and financial condition. The COVID-19 pandemic has negatively impacted the U.S. and global economies, created significant volatility and disruption in the capital markets, dramatically increased unemployment levels and has fueled concerns that it has led to a global recession. Depending on the duration and severity of the pandemic, we foresee the potential for adverse impacts related to, among other things: (i) sales results; (ii) insurance product margin; (iii) net investment income; (iv) invested assets; (v) regulatory capital; (vi) liabilities for insurance products; (vii) access to capital markets; and (viii) the present value of future profits. The full extent to which COVID-19 will impact our business, results of operations and financial condition remains uncertain.
Business
The Company is engaged in the sale of property and casualty insurance products and has organized its principal operations into three types of insurance businesses: commercial lines, personal lines, and agency business. The Company underwrites a variety of specialty insurance products, including property, general liability, liquor liability, automobile, and homeowners and dwelling policies. The Company markets and sells its insurance products through a network of independent agents, including managing general agents, whereby policies are written in all 50 states in the United States of America (“U.S.”). The Company’s corporate headquarters are located in Birmingham, Michigan with additional office facilities in Florida, Michigan and Pennsylvania.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes the amounts included in the consolidated financial statements reflect management's best estimates and assumptions, actual results may differ from these estimates.
Cash, Cash Equivalents, and Short-term Investments
Cash consists of cash deposits in banks, generally in operating accounts. Cash equivalents consist of money-market funds that are specifically used as overnight investments tied to cash deposit accounts. Short-term investments, consisting of money-market funds, are classified as investments in the consolidated balance sheets as they relate to the Company’s investment activities.
8
Recently Issued Accounting Guidance
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) , which amends the current methodology and timing for recognizing credit losses. This amendment will replace the current GAAP "incurred loss" methodology for credit losses with a methodology based on expected credit losses. The new guidance will also require expanded consideration of a broader range of reasonable and increased supportable information for the credit loss estimates. This ASU is effective for annual and interim reporting periods beginning after December 15, 2022. Management is currently evaluating the impact of the guidance. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting . This guidance provides optional expedients and exceptions that are intended to ease the burden of updating contracts to contain a new reference rate due to the discontinuation of the London Inter-Bank Offered Rate (LIBOR). This guidance is available immediately and may be implemented in any period prior to the guidance expiration on December 31, 2022. Management does not expect the new guidance to have a material impact on the Company’s consolidated financial statements.
2. Investments
The cost or amortized cost, gross unrealized gain or loss, and estimated fair value of the investments in securities classified as available for sale at March 31, 2021 and December 31, 2020, were as follows (dollars in thousands):
March 31, 2021
Cost or
Gross Unrealized
Estimated
Amortized Cost
Gains
Losses
Fair Value
Debt Securities:
U.S. Government
$
22,015
$
172
$
(27
)
$
22,160
State and local government
31,896
584
(601
)
31,879
Corporate debt
16,379
172
(410
)
16,141
Asset-backed securities
31,905
36
(118
)
31,823
Mortgage-backed securities
36,724
184
(861
)
36,047
Commercial mortgage-backed securities
1,849
40
(32
)
1,857
Collateralized mortgage obligations
7,666
91
(35
)
7,722
Total debt securities available for sale
$
148,434
$
1,279
$
(2,084
)
$
147,629
December 31, 2020
Cost or
Gross Unrealized
Estimated
Amortized Cost
Gains
Losses
Fair Value
Debt Securities:
U.S. Government
$
30,743
$
225
$
(1
)
$
30,967
State and local government
32,253
1,040
(28
)
33,265
Corporate debt
19,015
311
(23
)
19,303
Asset-backed securities
20,987
49
(73
)
20,963
Mortgage-backed securities
38,512
345
(3
)
38,854
Commercial mortgage-backed securities
2,083
65
(22
)
2,126
Collateralized mortgage obligations
6,361
161
(1
)
6,521
Total debt securities available for sale
$
149,954
$
2,196
$
(151
)
$
151,999
9
The following table summarizes the aggregate fair value and gross unrealized losses, by security type, of the available-for-sale securities in unrealized loss positions. The table segregates the holdings based on the length of time that individual securities have been in a continuous unrealized loss position (dollars in thousands):
March 31, 2021
Less than 12 months
Greater than 12 months
Total
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
Debt Securities:
U.S. Government
5
$
7,664
$
(27
)
—
$
—
$
—
5
$
7,664
$
(27
)
State and local government
70
14,758
(601
)
—
—
—
70
14,758
(601
)
Corporate debt
13
9,144
(410
)
—
—
—
13
9,144
(410
)
Asset-backed securities
14
17,644
(114
)
7
4,578
(4
)
21
22,222
(118
)
Mortgage-backed securities
9
28,941
(861
)
—
—
—
9
28,941
(861
)
Commercial mortgage-backed securities
—
—
—
1
888
(32
)
1
888
(32
)
Collateralized mortgage obligations
9
3,427
(34
)
1
81
(1
)
10
3,508
(35
)
Total debt securities available for sale
120
$
81,578
$
(2,047
)
9
$
5,547
$
(37
)
129
$
87,125
$
(2,084
)
December 31, 2020
Less than 12 months
Greater than 12 months
Total
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
No. of
Issues
Fair Value of
Investments
with Unrealized
Losses
Gross
Unrealized
Losses
Debt Securities:
U.S. Government
2
$
6,764
$
(1
)
—
$
—
$
—
2
$
6,764
$
(1
)
State and local government
16
3,905
(28
)
—
—
—
16
3,905
(28
)
Corporate debt
2
1,051
(23
)
—
—
—
2
1,051
(23
)
Asset-backed securities
7
6,050
(34
)
11
6,551
(39
)
18
12,601
(73
)
Mortgage-backed securities
2
1,652
(3
)
—
—
—
2
1,652
(3
)
Commercial mortgage-backed securities
1
899
(22
)
—
—
—
1
899
(22
)
Collateralized mortgage obligations
2
195
(1
)
—
—
—
2
195
(1
)
Total debt securities available for sale
32
$
20,516
$
(112
)
11
$
6,551
$
(39
)
43
$
27,067
$
(151
)
The Company analyzed its investment portfolio in accordance with its other-than-temporary impairment ("OTTI") review procedures and determined the Company did not need to record a credit-related OTTI loss in net income, nor recognize a non-credit related OTTI loss in other comprehensive income for the three months ended March 31, 2021 and 2020.
The Company’s sources of net investment income and losses are as follows (dollars in thousands):
Three Months Ended
March 31,
2021
2020
Debt securities
$
600
$
867
Equity securities
48
55
Cash, cash equivalents and short-term investments
1
119
Total investment income
649
1,041
Investment expenses
(117
)
(87
)
Net investment income
$
532
$
954
10
The following table summarizes the gross realized gains and losses from sales, calls and maturities of available-for-sale debt and equity securities (dollars in thousands):
Three Months Ended
March 31,
2021
2020
Debt securities:
Gross realized gains
$
27
$
720
Gross realized losses
(6
)
(4
)
Total debt securities
21
716
Equity securities:
Gross realized gains
2,903
344
Gross realized losses
—
(132
)
Total equity securities
2,903
212
Total net realized investment gains (losses)
$
2,924
$
928
Proceeds from the sales of available-for-sale debt securities were $14.2 million and $23.2 million for the three months ended March 31, 2021 and 2020, respectively. The gross realized gains and losses from the sales of available-for-sale debt securities for the three months ended March 31, 2021, were $27,000 and $6,000, respectively. The gross realized gains and losses from the sales of available-for-sale debt securities for the three months ended March 31, 2020, were $719,000 and $0, respectively.
As of March 31, 2021 and 2020, there were $0 and $6.5 million of payables from securities purchased, respectively. There were $3,000 and $7,000 of receivables from securities sold as of March 31, 2021, and 2020, respectively.
The Company carries other equity investments that do not have a readily determinable fair value at cost, less impairment or observable changes in price. We review these investments for impairment during each reporting period. There were no impairments or observable changes in price recorded during 2021 related to the Company's equity securities without readily determinable fair value. These investments are included in Other Assets in the Consolidated Balance Sheets and amounted to $1.3 million and $1.2 million as of March 31, 2021 and December 31, 2020, respectively.
The table below summarizes the amortized cost and fair value of available-for-sale debt securities by contractual maturity at March 31, 2021. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties (dollars in thousands):
Amortized
Cost
Estimated
Fair Value
Due in one year or less
$
9,062
$
9,175
Due after one year through five years
29,289
29,744
Due after five years through ten years
13,602
13,324
Due after ten years
18,337
17,937
Securities with contractual maturities
70,290
70,180
Asset-backed securities
31,905
31,823
Mortgage-backed securities
36,724
36,047
Commercial mortgage-backed securities
1,849
1,857
Collateralized mortgage obligations
7,666
7,722
Total debt securities
$
148,434
$
147,629
At March 31, 2021 and December 31, 2020, the Insurance Company Subsidiaries had $8.8 million on deposit in trust accounts to meet the deposit requirements of various state insurance departments. At March 31, 2021 and December 31, 2020, the Company had $67.2 million and $67.6 million, respectively, held in trust accounts to meet collateral requirements with other third-party insurers, relating to various fronting arrangements. There are withdrawal and other restrictions on these deposits, including the type of investments that may be held, however, the Company may generally invest in high-grade bonds and short-term investments and earn interest on the funds.
11
3. Fair Value Measurements
The Company’s financial instruments include assets and liabilities carried at fair value, as well as assets and liabilities carried at cost or amortized cost but disclosed at fair value in these consolidated financial statements. Fair value is defined as the price that would be received for an asset or paid to transfer a liability in the principally most advantageous market for the asset or liability in an orderly transaction between market participants. In determining fair value, the Company applies the market approach, which uses prices and other relevant data based on market transactions involving identical or comparable assets and liabilities. The inputs to valuation techniques used to measure fair value are prioritized into a three-level hierarchy. The hierarchy gives the highest priority to quoted prices from sources independent of the reporting entity (“observable inputs”) and the lowest priority to prices determined by the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”). The fair value hierarchy is as follows:
Level 1 —Valuations that are based on quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 —Valuations that are based on observable inputs (other than Level 1 prices) such as quoted prices for similar assets or liabilities at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. The Level 2 financial instruments also include our line of credit and our Paycheck Protection Program loan.
Level 3 —Unobservable inputs that are supported by little or no market activity. The unobservable inputs represent the Company’s best assumption of how market participants would price the assets or liabilities.
Net Asset Value (NAV) —The fair values of investment company limited partnership investments are based on the capital account balances reported by the investment funds subject to their management review and adjustment. These capital account balances reflect the fair value of the investment funds.
The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis, classified by the valuation hierarchy as of March 31, 2021 and December 31, 2020 (dollars in thousands):
March 31, 2021
Fair Value Measurements
Total
Level 1
Level 2
Level 3
Assets:
Debt Securities:
U.S. Government
$
22,160
$
—
$
22,160
$
—
State and local government
31,879
—
31,879
—
Corporate debt
16,141
—
16,141
—
Asset-backed securities
31,823
—
31,823
—
Mortgage-backed securities
36,047
—
36,047
—
Commercial mortgage-backed securities
1,857
—
1,857
—
Collateralized mortgage obligations
7,722
—
7,722
—
Total debt securities
147,629
—
147,629
—
Equity Securities
19,086
18,803
283
—
Short-term investments
12,710
12,710
—
—
Total marketable investments measured at fair value
$
179,425
$
31,513
$
147,912
$
—
Investments measured at NAV:
Investment in limited partnership
552
Total assets measured at fair value
$
179,977
Liabilities:
Senior Unsecured Notes *
$
24,381
$
—
$
24,381
$
—
Subordinated Notes *
11,593
—
—
11,593
Line of credit *
3,000
—
3,000
—
Paycheck Protection Program loan *
2,745
—
2,745
—
Total Liabilities measured at fair value
$
41,719
$
—
$
30,126
$
11,593
*
Carried at face value of debt net of unamortized debt issuance costs on the consolidated balance sheets
12
December 31, 2020
Fair Value Measurements
Total
Level 1
Level 2
Level 3
Assets:
Debt Securities:
U.S. Government
$
30,967
$
—
$
30,967
$
—
State and local government
33,265
—
33,265
—
Corporate debt
19,303
—
19,303
—
Asset-backed securities
20,963
—
20,963
—
Mortgage-backed securities
38,854
—
38,854
—
Commercial mortgage-backed securities
2,126
—
2,126
—
Collateralized mortgage obligations
6,521
—
6,521
—
Total debt securities
151,999
—
151,999
—
Equity securities
17,336
17,053
283
—
Short-term investments
13,317
13,317
—
—
Total marketable investments measured at fair value
$
182,652
$
30,370
$
152,282
$
—
Investments measured at NAV:
Investment in limited partnership
555
Total assets measured at fair value
$
183,207
Liabilities:
Senior Unsecured Notes *
$
20,675
$
—
$
20,675
$
—
Subordinated Notes *
11,616
—
—
11,616
Line of Credit *
5,000
—
5,000
—
Paycheck Protection Program loan *
2,745
—
2,745
—
Total Liabilities measured at fair value
$
40,036
$
—
$
28,420
$
11,616
*
Carried at face value of debt net of unamortized debt issuance costs on the consolidated balance sheets
Level 1 investments consist of equity securities traded in an active exchange market. The Company uses unadjusted quoted prices for identical instruments to measure fair value. Level 1 also includes money market funds and other interest-bearing deposits at banks, which are reported as short-term investments. The fair value measurements that were based on Level 1 inputs comprise 17.5% of the fair value of the total investment portfolio as of March 31, 2021.
Level 2 investments include debt securities, which consist of U.S. government agency securities, state and local municipal bonds (including those held as restricted securities), corporate debt securities, mortgage-backed and asset-backed securities. The fair value of securities included in the Level 2 category were based on the market values obtained from a third party pricing service that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other observable market information. The third party pricing service monitors market indicators, as well as industry and economic events. The fair value measurements that were based on Level 2 inputs comprise 82.2% of the fair value of the total investment portfolio as of March 31, 2021.
The Company obtains pricing for each security from independent pricing services, investment managers or consultants to assist in determining fair value for its Level 2 investments. To validate that these quoted prices are reasonable estimates of fair value, the Company performs various quantitative and qualitative procedures, such as (i) evaluation of the underlying methodologies, (ii) analysis of recent sales activity, (iii) analytical review of our fair values against current market prices and (iv) comparison of the pricing services’ fair value to other pricing services’ fair value for the same investment. No markets for the investments were determined to be inactive at period-ends. Based on these procedures, the Company did not adjust the prices or quotes provided from independent pricing services, investment managers or consultants. The Level 2 financial instruments also include the Company's senior debt. The fair value of the borrowings under the senior revolving credit facility approximates its carrying amount because interest is based on a short-term, variable, market-based rate.
As of March 31, 2021 and December 31, 2020, Level 3 is entirely comprised of the Company's subordinated debt. In determining the fair value of the subordinated debt outstanding at March 31, 2021 and December 31, 2020, the security attributes (issue date, maturity, coupon, calls, etc.) and market rates on September 24, 2018 (the date of the restated and amended agreement which was repriced at that time) were entered into a valuation model. A lognormal trinomial interest rate
13
lattice was created within the model to compute the option adjusted spread (“OAS”) which is the amount, in basis points, of interest rate required to be paid under the debt agreement over the risk-free U.S . Treasury rates . The OAS was then fed back into the model along with the March 31, 2021 and December 31, 2020 U.S . Treasury rates . A new lattice was generated and the fair value was computed from the OAS . There were no changes in assumptions of credit risk from the issuance date.
4. Deferred Policy Acquisition Costs
The Company defers costs incurred which are incremental and directly related to the successful acquisition of new or renewal insurance business, net of corresponding amounts of ceded reinsurance commissions. Net deferred policy acquisition costs are amortized and charged to expense in proportion to premium earned over the estimated policy term. The Company anticipates that its deferred policy acquisition costs will be fully recoverable and there were no premium deficiencies for the three months ended March 31, 2021 and 2020. The activity in deferred policy acquisition costs, net of reinsurance transactions, is as follows (dollars in thousands):
Three Months Ended
March 31,
2021
2020
Balance at beginning of period
$
12,243
$
11,906
Deferred policy acquisition costs
6,966
5,905
Amortization of policy acquisition costs
(6,750
)
(6,303
)
Net change
216
(398
)
Balance at end of period
$
12,459
$
11,508
5. Unpaid Losses and Loss Adjustment Expenses
The Company establishes reserves for unpaid losses and loss adjustment expenses ("LAE") which represent the estimated ultimate cost of all losses incurred that were both reported and unreported (i.e., incurred but not yet reported losses; or “IBNR”) and LAE incurred that remain unpaid at the balance sheet date. The Company’s reserving process takes into account known facts and interpretations of circumstances and factors including the Company’s experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. In the normal course of business, the Company may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.
Reserves are estimates of unpaid portions of losses that have occurred, including IBNR losses; therefore, the establishment of appropriate reserves is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimates. The highest degree of uncertainty is associated with reserves for losses incurred in the current reporting period as it contains the greatest proportion of losses that have not been reported or settled. The Company regularly updates its reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in reserve estimates, which may be material, are reported in the results of operations in the period such changes are determined to be needed and recorded.
Management believes that the reserve for losses and LAE, net of reinsurance recoverables, is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by the date of the consolidated financial statements based on available facts and in accordance with applicable laws and regulations.
14
The table below provides the changes in the reserves for losses and LAE, net of reinsurance recoverables , for the periods indicated as follows (dollars in thousands):
Three months ended
March 31,
2021
2020
Gross reserves - beginning of period
$
111,270
$
107,246
Less: reinsurance recoverables on unpaid losses
(24,218
)
(22,579
)
Net reserves - beginning of period
87,052
84,667
Add: incurred losses and LAE, net of reinsurance:
Current period
13,584
10,520
Prior period
5,778
3,749
Total net incurred losses and LAE
19,362
14,269
Deduct: loss and LAE payments, net of reinsurance:
Current period
3,180
874
Prior period
11,117
10,427
Total net loss and LAE payments
14,297
11,301
Net reserves - end of period
92,117
87,635
Plus: reinsurance recoverables on unpaid losses
26,559
22,022
Gross reserves - end of period
$
118,676
$
109,657
The Company’s incurred losses during the three months ended March 31, 2021 include prior-year adverse reserve development of $5.8 million. Of the $5.8 million of adverse development, $5.2 million was related to the Company’s commercial lines of business, while $612,000 was related to the Company’s personal lines of business. Of the $5.2 million of adverse development in the Company’s commercial lines of business, $2.7 million was experienced in the Company’s hospitality lines of business, while $2.5 million was experienced in the Company’s small business lines of business.
The Company’s incurred losses during the three months ended March 31, 2020 included prior-year adverse reserve development of $3.7 million related to the Company’s commercial lines of business.
6. Reinsurance
In the normal course of business, the Company participates in reinsurance agreements in order to limit losses that may arise from catastrophes or other individually severe events. The Company primarily ceded all specific commercial liability risks in excess of $400,000 in 2021 and 2020. The Company ceded specific commercial property risks in excess of $200,000 in 2021. The Company ceded 40% of specific commercial property risks in excess of $400,000, and 60% in excess of $300,000 in 2020. The Company ceded homeowners specific risks in excess of $300,000 in both 2021 and 2020.
A "treaty" is a reinsurance agreement in which coverage is provided for a class of risks and does not require policy by policy underwriting of the reinsurer. "Facultative" reinsurance is where a reinsurer negotiates an individual reinsurance agreement for every policy it will reinsure on a policy by policy basis. A loss is covered under a reinsurance contract if the loss occurs within the effective dates of the agreement notwithstanding when the loss is reported.
Reinsurance does not discharge the direct insurer from liability to its policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors the concentration of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. To date, the Company has not experienced any significant difficulties in collecting reinsurance recoverables.
The Company assumes written premiums under a few fronting arrangements. The fronting arrangements are with unaffiliated insurers who write on behalf of the Company in markets that require a higher A.M. Best rating than the Company’s current rating, where the policies are written in a state where the Company is not licensed or for other strategic reasons.
15
The following table presents the effects of reinsurance and assumption transactions on written premiums, earned premiums and losses and LAE (dollars in thousands):
Three Months Ended
March 31,
2021
2020
Written premiums:
Direct
$
23,433
$
19,629
Assumed
6,940
5,455
Ceded
(5,890
)
(4,033
)
Net written premiums
$
24,483
$
21,051
Earned premiums:
Direct
$
20,990
$
17,458
Assumed
7,257
8,595
Ceded
(5,412
)
(4,036
)
Net earned premiums
$
22,835
$
22,017
Losses and LAE:
Direct
$
20,750
$
12,326
Assumed
6,781
5,458
Ceded
(8,169
)
(3,515
)
Net Losses and LAE
$
19,362
$
14,269
7. Debt
The Company's debt is comprised of four instruments: $24.4 million of publicly traded senior unsecured notes which were issued in September and October of 2018, a $10.0 million line of credit which commenced in June 2018, $10.5 million of privately placed subordinated notes (the “Subordinated Notes”), and a $2.7 million Paycheck Protection Program loan (the “PPP loan”) issued as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. A summary of the Company's outstanding debt is as follows (dollars in thousands):
March 31,
2021
December 31,
2020
Senior unsecured notes
$
23,731
$
23,665
Subordinated notes
9,599
9,587
Line of credit
3,000
5,000
Paycheck Protection Program loan *
2,745
2,745
Total
$
39,075
$
40,997
*
The PPP loan was embedded into the line of credit facility. See below.
Senior unsecured notes
The Company issued $25.3 million of public senior unsecured notes (the "Notes") in 2018. The Notes bear an interest rate of 6.75% per annum, payable quarterly at the end of March, June, September and December and mature on September 30, 2023. The Company may redeem the Notes, in whole or in part, at face value at any time after September 30, 2021.
The Company did not repurchase any of the Notes for the three months ended March 31, 2021. During the first quarter of 2020, the Company repurchased 9,761 units of the Notes in the public market with a face value of $244,000. The Notes were repurchased at a discount to face value, which resulted in a $115,000 gain on extinguishment. This gain is reflected in the Consolidated Statement of Operations as Other gains.
16
Subordinated notes
The Company also has outstanding $10.5 million of Subordinated Notes maturing on September 30, 2038. The Subordinated Notes bear an interest rate of 7.5% per annum until September 30, 2023, and 12.5% thereafter, and allow for four quarterly interest payment deferrals. Interest is payable quarterly at the end of March, June, September and December. Beginning September 30, 2021, the Company may redeem the Subordinated Notes, in whole or in part, for a call premium of $1.1 million. The call premium escalates each quarter to ultimately $1.75 million on September 30, 2023, then steps up to $3.05 million on December 31, 2023, and increases quarterly at a 12.5% per annum rate thereafter.
As of March 31, 2021, the carrying value of the Notes and Subordinated Notes are offset by $650,000 and $900,000 of debt issuance costs, respectively. The debt issuance costs will be amortized through interest expense over the life of the loans.
The Subordinated Notes contain various restrictive financial debt covenants that relate to the Company’s minimum tangible net worth, minimum fixed-charge coverage ratios, dividend paying capacity, reinsurance retentions, and risk-based capital ratios. At March 31, 2021, the Company was in compliance with all of its financial covenants.
Line of credit
The Company maintains a $10.0 million line of credit with a national bank (the “Lender”). The line of credit bears interest at the London Interbank rate ("LIBOR") plus 2.75% per annum, payable monthly. The agreement includes several financial debt covenants, including a minimum tangible net worth, a minimum fixed-charge coverage ratio, and minimum statutory risk-based capital levels. As of March 31, 2021, the Company had $5.7 million outstanding on the line of credit (including the PPP loan described below), and was in compliance with all of its financial debt covenants. On June 19, 2020, the line of credit was renewed with a maturity of June 18, 2021.
Paycheck Protection Program loan
On April 24, 2020, the Company received a $2,745,000 loan from the line of credit Lender pursuant to the Paycheck Protection Program of the CARES Act administered by the U.S. Small Business Administration (“SBA”). The PPP loan was incorporated into the existing line of credit facility and utilizes a portion of the line of credit’s limit. However, the PPP loan has a different maturity date (April 24, 2022) in accordance with the SBA requirements and bears interest at a rate of 1.0% per annum. The Company amended its $10.0 million line of credit facility with the Lender to incorporate this loan as a reduction of the available line of credit. The loan may be prepaid by the Company at any time prior to maturity with no prepayment penalties. This loan may be subject to forgiveness under the CARES Act provisions. The Company applied for forgiveness of the loan in 2020, at which point the principal and interest payments were deferred until the SBA remits the loan forgiveness amount to the Lender. As of March 31, 2021, the loan remains on the Company’s balance sheet as a liability.
8. Shareholders’ Equity
On December 5, 2018, the Company's Board of Directors authorized a stock repurchase program, under which the Company may repurchase up to one million shares of the Company's common stock. The Company did not repurchase any shares of stock for the three months ended March 31, 2021 related to the stock repurchase program. The Company repurchased 700 shares valued at approximately $2,000 related to the stock repurchase program for the three months ended March 31, 2020.
For the three months ended March 31, 2021 and 2020, the Company did not repurchased any shares of stock related to the vesting of the Company’s restricted stock units.
As of March 31, 2021 and December 31, 2020, the Company had 9,681,728 issued and outstanding shares of common stock, respectively. Holders of common stock are entitled to one vote per share and to receive dividends only when and if declared by the board of directors. The holders have no preemptive, conversion or subscription rights.
17
9. Accumulated Other Comprehensive Income (Loss)
The following table presents changes in accumulated other comprehensive income (loss) for unrealized gains and losses on available-for-sale securities (dollars in thousands):
Three months ended
March 31,
2021
2020
Balance at beginning of period
$
912
$
489
Other comprehensive income (loss) before reclassifications
(1,924
)
(1,315
)
Less: amounts reclassified from accumulated other comprehensive income (loss)
943
384
Net other comprehensive income (loss)
(2,867
)
(1,699
)
Balance at end of period
$
(1,955
)
$
(1,210
)
10. Earnings Per Share
Basic and diluted earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. The following table presents the calculation of basic and diluted earnings (loss) per common share, as follows (dollars in thousands, except per share amounts):
Three Months Ended
March 31,
2021
2020
Net income (loss)
$
(4,636
)
$
(4,725
)
Weighted average common shares, basic and diluted *
9,681,728
9,592,774
Earnings (loss) per common share, basic and diluted
$
(0.48
)
$
(0.49
)
*
The nonvested shares of the restricted stock units and stock options were anti-dilutive as of March 31, 2021 and 2020. Therefore, the basic and diluted weighted average common shares are equal for the three months ended March 31, 2021 and 2020.
11. Stock-based Compensation
On June 30, 2020, the Company issued options to purchase 280,000 shares of the Company’s common stock, to certain executive officers and other employees. The right to exercise the options will vest over a five-year period on a straight-line basis. The options have a strike price of $3.81 per share and expire on June 30, 2030. The estimated value of these options is $290,000, which will be expensed ratably over the vesting period.
In 2015, 2016, and 2018, the Company issued 390,352, 111,281, and 70,000, respectively, of restricted stock units (“RSUs”) to various employees to be settled in shares of common stock, which were valued at $4.1 million, $909,000, and $404,000, respectively, on the dates of grant.
The Company recorded $54,000 and $239,000 of compensation expense related to the RSUs for the three months ended March 31, 2021 and 2020, respectively. There were 51,941 unvested RSUs as of March 31, 2021, which will generate an estimated future expense of $204,000.
The Company recorded $12,000 of compensation expense for the three months ended March 31, 2021 related to the stock options granted on June 30, 2020. There were 265,000 unvested options as of March 31, 2021, which will generate an estimated future expense of $233,000.
18
12. Commitments and Contingencies
Legal proceedings
The Company and its subsidiaries are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, and other business transactions arising in the ordinary course of business. Where appropriate, the Company vigorously defends such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the insurance policy at issue. We account for such activity through the establishment of unpaid losses and LAE reserves. In accordance with accounting guidance, if it is probable that a liability has been incurred as of the date of the financial statements and the amount of loss is reasonably estimable; then an accrual for the costs to resolve these claims is recorded by the Company in the accompanying consolidated balance sheets. Periodic expenses related to the defense of such claims are included in the accompanying consolidated statements of operations. On the basis of current information, the Company does not believe that there is a reasonable possibility that any material loss exceeding amounts already accrued, if any, will result from any of the claims, lawsuits and proceedings to which the Company is subject to, either individually or in the aggregate.
13. Segment Information
The Company is engaged in the sale of property and casualty insurance products and has organized its business model around three classes of insurance businesses: commercial lines, personal lines, and wholesale agency business. Within these three businesses, the Company offers various insurance products and insurance agency services. Such insurance businesses are engaged in underwriting and marketing insurance coverages, and administering claims processing for such policies. The Company views the commercial and personal lines segments as underwriting business (business that takes on insurance underwriting risk). The wholesale agency business provides non-risk bearing revenue through commissions and policy fees. The wholesale agency business increases the product options to the Company’s independent retail agents by offering both insurance products from the Insurance Company Subsidiaries as well as products offered by other insurers.
The Company defines its operating segments as components of the business where separate financial information is available and used by the chief operating decision maker in deciding how to allocate resources to its segments and in assessing its performance. In assessing performance of its operating segments, the Company’s chief operating decision maker, the Chief Executive Officer, reviews a number of financial measures including gross written premiums, net earned premiums, losses and LAE, net of reinsurance recoveries, and other revenue and expenses. The primary measure used for making decisions about resources to be allocated to an operating segment and assessing its performance is segment underwriting gain or loss which is defined as segment revenues, consisting of net earned premiums and other income, less segment expenses, consisting of losses and LAE, policy acquisition costs and operating expenses of the operating segments. Operating expenses primarily include compensation and related benefits for personnel, policy issuance and claims systems, rent and utilities. The Company markets, distributes and sells its insurance products through its own insurance agencies and a network of independent agents. All of the Company’s insurance activities are conducted in the United States with a concentration of activity in Michigan, Florida, Texas and California. For the three months ended March 31, 2021 and 2020 gross written premiums attributable to these four states were 53.5% and 52.6%, respectively, of the Company’s total gross written premiums.
The Agency business sells insurance products on behalf of the Company’s commercial and personal lines businesses as well as to third-party insurers. Certain acquisition costs incurred by the commercial and personal lines businesses are reflected as commission revenue for the Agency business and are eliminated in the Eliminations category.
In addition to the reportable operating segments, the Company maintains a Corporate category to reconcile segment results to the consolidated totals. The Corporate category includes: (i) corporate operating expenses such as salaries and related benefits of the Company’s executive management team and finance and information technology personnel, and other corporate headquarters expenses, (ii) interest expense on the Company’s debt obligations; (iii) depreciation and amortization on property and equipment, and (iv) all investment income activity. All investment income activity is reported within net investment income, net realized investment gains, and change in fair value of equity securities on the consolidated statements of operations. The Company’s assets on the consolidated balance sheet are not allocated to the reportable segments.
19
The following tables present information by reportable operating segment (dollars in thousands):
Three months ended
March 31, 2021
Commercial Lines
Personal
Lines
Total
Underwriting
Wholesale
Agency
Corporate
Eliminations
Total
Gross written premiums
$
27,221
$
3,152
$
30,373
$
—
$
—
$
—
$
30,373
Net written premiums
$
21,557
$
2,926
$
24,483
$
—
$
—
$
—
$
24,483
Net earned premiums
$
20,706
$
2,129
$
22,835
$
—
$
—
$
—
$
22,835
Other income
56
40
96
1,726
43
(1,309
)
556
Segment revenue
20,762
2,169
22,931
1,726
43
(1,309
)
23,391
Losses and LAE, net
16,955
2,407
19,362
—
—
—
19,362
Policy acquisition costs
6,318
600
6,918
1,127
—
(1,295
)
6,750
Operating expenses
2,955
349
3,304
744
301
—
4,349
Segment expenses
26,228
3,356
29,584
1,871
301
(1,295
)
30,461
Segment gain (loss)
$
(5,466
)
$
(1,187
)
$
(6,653
)
$
(145
)
$
(258
)
$
(14
)
$
(7,070
)
Investment income
532
532
Net realized investment gains
2,924
2,924
Change in fair value of equity securities
(540
)
(540
)
Other gains
—
—
Interest expense
(721
)
(721
)
Income (loss) before equity earnings in Affiliate and income taxes
$
(5,466
)
$
(1,187
)
$
(6,653
)
$
(145
)
$
1,937
$
(14
)
$
(4,875
)
Three months ended
March 31, 2020
Commercial
Lines
Personal
Lines
Total
Underwriting
Wholesale
Agency
Corporate
Eliminations
Total
Gross written premiums
$
23,444
$
1,640
$
25,084
$
—
$
—
$
—
$
25,084
Net written premiums
$
19,687
$
1,364
$
21,051
$
—
$
—
$
—
$
21,051
Net earned premiums
$
20,431
$
1,586
$
22,017
$
—
$
—
$
—
$
22,017
Other income
74
36
110
1,934
31
(1,417
)
658
Segment revenue
20,505
1,622
22,127
1,934
31
(1,417
)
22,675
Losses and LAE, net
13,461
808
14,269
—
—
—
14,269
Policy acquisition costs
6,164
489
6,653
1,208
—
(1,558
)
6,303
Operating expenses
3,503
275
3,778
905
362
—
5,045
Segment expenses
23,128
1,572
24,700
2,113
362
(1,558
)
25,617
Segment gain (loss)
$
(2,623
)
$
50
$
(2,573
)
$
(179
)
$
(331
)
$
141
$
(2,942
)
Investment income
954
954
Net realized investment gains
928
928
Change in fair value of equity securities
(3,086
)
(3,086
)
Other gains
115
115
Interest expense
(731
)
(731
)
Income (loss) before equity earnings in Affiliate and income taxes
$
(2,623
)
$
50
$
(2,573
)
$
(179
)
$
(2,151
)
$
141
$
(4,762
)
20
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.