Presurance Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the Periods Ended March 31, 2021 and 2020 The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements (Unaudited), related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K, filed on March 11, 2021 with the U. S. Securities and Exchange Commission. Forward-Looking Statements Certain statements contained in this Quarterly Report on Form 10-Q, which are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek” and similar terms and phrases, or the negative thereof, may be used to identify forward-looking statements. The forward-looking statements contained in this report are based on management’s good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks and uncertainties, many of which are beyond our control, that could cause our actual results to differ materially from those in the forward-looking statements, including those described in our Form 10-K (“Item 1A Risk Factors”) filed with the SEC on March 11, 2021 and subsequent reports filed with or furnished to the SEC. Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified herein. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable laws or regulations. Recent Developments COVID-19 (the “Pandemic”) is causing significant disruption to public health, the global economy, financial markets, and commercial, social and community activity generally. Our exposure to the Pandemic is manifold. The majority of our employees are now working remotely in observance of “shelter-in-place” or “stay-at-home” government orders. A significant portion of our revenues is generated from the hospitality sector of the U.S. economy which has seen unprecedented contraction, at least in the near term, in an effort to mitigate the effects of the Pandemic. We have continued to provide customer service, process new and renewal business, handle claims and otherwise manage all operations even though the vast majority of the staff is working remotely. At this time, however, we are not able to provide additional forward-looking guidance as there is significant uncertainty regarding the ultimate impact of the Pandemic. Business Overview We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 45 states, including the District of Columbia. We are also licensed to write insurance as an admitted carrier in 42 states, including the District of Columbia, and we offer our insurance products in all 50 states. Our revenues are primarily derived from premiums earned from our insurance operations. We also generate other revenues through investment income and other income which mainly consists of installment fees and policy issuance fees generally related to the policies we write. Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions, and other underwriting and administrative expenses. We organize our operations into three insurance businesses: commercial insurance lines, personal insurance lines, and wholesale agency business. Together, the commercial and personal lines refer to "underwriting" operations that take insurance risk, and the wholesale agency business refers to non-risk insurance business. Through our commercial insurance product lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers’ compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis. 21 Through our personal insurance product lines, we offer homeowners insurance and dwelling fire insurance policies to individuals in several states . Our specialty homeowners insurance product line is primarily comprised of low-value dwelling insurance tailored for owners of lower valued homes, which we offer in Illinois, Indiana and Texas . Due to recent Florida-based industry events, we have been de-emphasizing our Florida homeowners' business and reducing our exposures in that state, as well as other wind-exposed states like Texas and Hawaii. Through our wholesale agency business segment, we offer commercial and personal lines insurance products for our Insurance Company Subsidiaries as well as third-party insurers. We have expanded the wholesale agency business to develop more non-risk revenue streams, and provide our agents with more insurance product options. Critical Accounting Policies and Estimates In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions periodically on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operation will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. During the three months ended March 31, 2021, there were no material changes to our critical accounting policies and estimating methodologies, which are disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K filed with the SEC on March 11, 2021. Executive Overview We reported $30.4 million of gross written premiums in the first quarter of 2021, representing a 21.1% increase as compared to the same period in 2020. The increase was the result of growth in both commercial and personal lines business as we continue to penetrate markets where we have been the most successful while still reducing exposure to less profitable lines. We reported a net loss of $4.6 million, or $0.48 per share, for three months ended March 31, 2021, compared to a net loss of $4.7 million, or $0.49 per share for the same period in 2020. Adjusted operating loss, a non-GAAP measure, was $7.0 million, or $0.72 per share for the three months ended March 31, 2021, compared to an adjusted operating loss of $2.7 million, or $0.28 per share for the same period in 2020. Our underwriting combined ratio was 129.0% for the three months ended March 31, 2021, compared to 111.6% for the same period in 2020. Our combined ratio was higher in the first quarter of 2021, compared to the same period in 2020, due to catastrophe losses of $2.0 million, net of reinsurance recoverables, plus $318,000 of reinstatement reinsurance premiums, both related to Winter Storm Uri. We also had adverse development of $5.8 million during the first quarter of 2021, of which $5.2 million was related to the Company’s commercial lines. 22 Results of Operations For The Three Months Ended March 3 1 , 20 2 1 and 20 20 The following table summarizes our operating results for the periods indicated (dollars in thousands): Summary of Operating Results Three Months Ended March 31, 2021 2020 $ Change % Change Gross written premiums $ 30,373 $ 25,084 $ 5,289 21.1 % Net written premiums $ 24,483 $ 21,051 $ 3,432 16.3 % Net earned premiums $ 22,835 $ 22,017 $ 818 3.7 % Other income 556 658 (102 ) (15.5 %) Losses and loss adjustment expenses, net 19,362 14,269 5,093 35.7 % Policy acquisition costs 6,750 6,303 447 7.1 % Operating expenses 4,349 5,045 (696 ) (13.8 )% Underwriting gain (loss) (7,070 ) (2,942 ) (4,128 ) * Net investment income 532 954 (422 ) (44.2 )% Net realized investment gains 2,924 928 1,996 * Change in fair value of equity securities (540 ) (3,086 ) 2,546 * Other gains — 115 (115 ) * Interest expense 721 731 (10 ) (1.4 )% Income (loss) before equity earnings in Affiliate and income taxes (4,875 ) (4,762 ) (113 ) * Equity earnings (losses) in Affiliate, net of tax 248 50 198 * Income tax expense 9 13 (4 ) * Net income (loss) $ (4,636 ) $ (4,725 ) $ 89 * Book value per common share outstanding $ 3.82 $ 3.81 Underwriting Ratios: Loss ratio (1) 84.4 % 64.5 % Expense ratio (2) 44.6 % 47.1 % Combined ratio (3) 129.0 % 111.6 % (1) The loss ratio is the ratio, expressed as a percentage, of net losses and loss adjustment expenses to net earned premiums and other income from underwriting operations. (2) The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and other underwriting expenses to net earned premiums and other income from underwriting operations. (3) The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss. * Percentage change is not meaningful. Premiums Premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. Almost all commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over the terms of the policies. 23 Our premiums are presented below for the three months ended March 3 1 , 20 2 1 and 20 20 (dollars in thousands): Summary of Premium Revenue Three Months Ended March 31, 2021 2020 $ Change % Change Gross written premiums Commercial lines $ 27,221 $ 23,444 $ 3,777 16.1 % Personal lines 3,152 1,640 1,512 92.2 % Total $ 30,373 $ 25,084 $ 5,289 21.1 % Net written premiums Commercial lines $ 21,557 $ 19,687 $ 1,870 9.5 % Personal lines 2,926 1,364 1,562 114.5 % Total $ 24,483 $ 21,051 $ 3,432 16.3 % Net earned premiums Commercial lines $ 20,706 $ 20,431 $ 275 1.3 % Personal lines 2,129 1,586 543 34.2 % Total $ 22,835 $ 22,017 $ 818 3.7 % Gross written premiums increased $5.3 million, or 21.1%, to $30.4 million for the three months ended March 31, 2021, as compared to $25.1 million for the same period in 2020. Commercial lines gross written premiums increased $3.8 million, or 16.1%, to $27.2 million in the first quarter of 2021, as compared to $23.4 million for the first quarter of 2020. The increase was due to $5.1 million of additional gross written premium in the Company’s small business programs during the first quarter of 2021, compared the first quarter of 2020. This increase was offset by a reduction of $1.3 million of gross written premium in the Company’s hospitality programs during the first quarter of 2021, compared to the first quarter of 2020, as a result on the ongoing impact of the pandemic on restaurants, bars and taverns. Personal lines gross written premiums increased $1.5 million, or 92.2%, to $3.1 million in the first quarter of 2021, as compared to $1.6 million for the same period in 2020. The increased gross written premiums were due to continued growth in the Company’s low-value dwelling book of business. Net written premiums increased $3.4 million, or 16.3%, to $24.5 million for the three months ended March 31, 2021, as compared to $21.1 million for the same period in 2020. Net written premiums did not increase as much as gross written premiums due to a combination of factors that increased our ceded premium rates. Our blended ratio of ceded earned premiums to gross earned premiums increased from 15.5% to 19.2% in the first quarters of 2020 and 2021, respectively. Winter Storm Uri resulted in $318,000 of reinstatement premiums that increased the ceded rate by 1.0 percentage point in the first quarter. The remainder of the increase was due to a combination of: 1) a change in the mix of business to more property exposure which has a higher ceding rate; 2) general reinsurance rate increases; and 3) we purchased more reinsurance as of January 1, 2021 to reduce our commercial property specific loss retention to only $200,000, from $340,000. Other Income Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings and policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the three months ended March 31, 2021, decreased $102,000, or 15.5%, to $556,000 as compared to $658,000 for the same period in 2020. The decrease in other income was primarily due to a decrease in revenue in the Agency operations in the first quarter of 2021, compared to the same period in 2020. 24 Losses and Loss Adjustment Expenses The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the three months ended March 31, 2021 and 2020 (dollars in thousands). Three months ended March 31, 2021 Commercial Lines Personal Lines Total Accident year net losses and LAE $ 11,789 $ 1,795 $ 13,584 Net (favorable) adverse development 5,166 612 5,778 Calendar year net losses and LAE $ 16,955 $ 2,407 $ 19,362 Accident year loss ratio 56.8 % 82.8 % 59.2 % Net (favorable) adverse development 24.9 % 28.2 % 25.2 % Calendar year loss ratio 81.7 % 111.0 % 84.4 % Three months ended March 31, 2020 Commercial Lines Personal Lines Total Accident year net losses and LAE $ 9,778 $ 742 $ 10,520 Net (favorable) adverse development 3,683 66 3,749 Calendar year net losses and LAE $ 13,461 $ 808 $ 14,269 Accident year loss ratio 47.7 % 45.8 % 47.6 % Net (favorable) adverse development 17.9 % 4.0 % 16.9 % Calendar year loss ratio 65.6 % 49.8 % 64.5 % Net losses and LAE increased by $5.1 million, or 35.7%, to $19.4 million for the first three months in 2021, compared to $14.3 million for the same period in 2020. As discussed in the Executive Overview, the Company experienced $2.0 million of catastrophe losses, net of reinsurance recoverables, during the first quarter of 2021 from Winter Storm Uri. In addition to these losses, the Company experienced $5.8 million of adverse development for the three months ended March 31, 2021. Of the $5.8 million in adverse development, $5.2 million was related to commercial lines, and $612,000 was related to personal lines. The Company's incurred losses for the three months ended March 31, 2020, included adverse prior-year reserve development of $3.7 million from the commercial lines, mostly attributable to hospitality liability in 2018 and 2019 accident years. Expense Ratio Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses. 25 The table below provides the expense ratio by major component. Three Months Ended March 31, 2021 2020 Commercial Lines Policy acquisition costs 30.4 % 30.1 % Operating expenses 14.2 % 17.1 % Total 44.6 % 47.2 % Personal Lines Policy acquisition costs 27.7 % 30.2 % Operating expenses 16.1 % 16.9 % Total 43.8 % 47.1 % Total Underwriting Policy acquisition costs 30.2 % 30.0 % Operating expenses 14.4 % 17.1 % Total 44.6 % 47.1 % Our expense ratio decreased by 2.5 percentage points in the first quarter of 2021 as compared to the same period of 2020. We saw the most improvement in the operating expense ratios. Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. For the three months ended March 31, 2021 and 2020, the percentage of policy acquisition costs to net earned premiums and other underwriting income increased to 30.2% compared to 30.0%, respectively. Acquisition costs as a percent of gross earned premiums were lower by 1.0 percentage point in the first quarter of 2021 as compared to the same period in 2020. However, the acquisition cost ratio (which is based on net earned premiums) was higher due to higher ceded premium rates discussed above. Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other income were 14.4% and 17.1% for the three months ended March 31, 2021 and 2020, respectively. The operating expense ratio was lower due to our expense reduction efforts, partially offset by higher ceded premium rates discussed above. Segment Results We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the three months ended March 31, 2021 and 2020 (dollars in thousands): Segment Gain (Loss) Three Months Ended March 31, 2021 2020 $ Change Commercial Lines $ (5,466 ) $ (2,623 ) $ (2,843 ) Personal Lines (1,187 ) 50 (1,237 ) Total Underwriting (6,653 ) (2,573 ) (4,080 ) Wholesale Agency (145 ) (179 ) 34 Corporate (258 ) (331 ) 73 Eliminations (14 ) 141 (155 ) Total Segment gain (loss) $ (7,070 ) $ (2,942 ) $ (4,128 ) 26 Liquidity and Capital Resources Sources and Uses of Funds At March 31, 2021, we had $17.1 million in cash, cash equivalents and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturities and sales of invested assets and installment fees. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt. We believe that our existing cash, cash equivalents, short-term investments and investment securities balances will be adequate to meet our capital and liquidity needs and the needs of our subsidiaries on a short-term and long-term basis. We conduct our business operations primarily through our Insurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the Parent Company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the Parent Company. Secondarily, the Parent Company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the Parent Company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the Parent Company. There were no dividends paid from our Insurance Company Subsidiaries during the three months ended March 31, 2021 and 2020. Cash Flows Operating Activities . Cash used in operating activities for the three months ended March 31, 2021, was $3.5 million, compared to $4.0 million provided by operating activities for the same period in 2020. The differences in cash used in operating activities was primarily due to a $6.2 million increase in paid claims and $1.7 million of additional acquisition costs paid in 2021. These increases in cash used in operating activities was partially offset by a $1.1 million increase in premiums collected, net of reinsurance premiums. Investing Activities. Cash provided by investing activities for the three months ended March 31, 2021, was $1.7 million, as compared to $4.1 million of cash used in investing activities for the same period in 2020. The $5.8 million increase in cash provided by investing activities was driven by a reduction in the purchases of investments in the first quarter of 2021, compared to the first quarter of 2020. There was a significant repositioning of the Company’s portfolio during the first quarter of 2020 from the COVID-19 pandemic, which caused an increase in the purchases of investments. Financing Activities. Cash used in financing activities for the three months ended March 31, 2021, was $2.0 million, compared to $754,000 of cash provided financing activities for the same period in 2020. The $2.8 million increase in cash used in financing activities was mostly due to the Company paying down a net amount of $2.0 million of its outstanding balance on its line of credit during the first quarter of 2021. Statutory Capital and Surplus Our Insurance Company Subsidiaries are required to file quarterly and annual financial reports with state insurance regulators. These financial reports are prepared using statutory accounting practices promulgated by the Insurance Company Subsidiaries’ state of domiciliary, rather than GAAP. The Insurance Company Subsidiaries’ aggregate statutory capital and surplus (which is a statutory measure of equity) was $58.7 million and $64.1 million at March 31, 2021 and December 31, 2020, respectively. 27 Non-GAAP Financial Measures Adjusted Operating Income and Adjusted Operating Income Per Share Adjusted operating income and adjusted operating income per share are non-GAAP measures that represent net income allocable to common shareholders excluding net realized investment gains or losses, changes in fair value of equity securities, and other gains or losses; all net of tax. The most directly comparable financial GAAP measures to adjusted operating income and adjusted operating income per share are net income and net income per share, respectively. Adjusted operating income and adjusted operating income per share are intended as supplemental information and are not meant to replace net income or net income per share. Adjusted operating income and adjusted operating income per share should be read in conjunction with the GAAP financial results. Our definition of adjusted operating income may be different from that used by other companies. The following is a reconciliation of net income (loss) to adjusted operating income (loss) (dollars in thousands), as well as net income (loss) per share to adjusted operating income (loss) per share: Three Months Ended March 31, 2021 2020 Net income (loss) $ (4,636 ) $ (4,725 ) Exclude: Net realized investment gains and other gains, net of tax 2,924 1,043 Change in fair value of equity securities, net of tax (540 ) (3,086 ) Adjusted operating income (loss) $ (7,020 ) $ (2,682 ) Weighted average common shares diluted 9,681,728 9,592,774 Diluted income (loss) per common share: Net income (loss) $ (0.48 ) $ (0.49 ) Exclude: Net realized investment gains and other gains, net of tax 0.30 0.11 Change in fair value of equity securities, net of tax (0.06 ) (0.32 ) Adjusted operating income (loss) per share $ (0.72 ) $ (0.28 ) We use adjusted operating income and adjusted operating income per share to assess our performance and to evaluate the results of our overall business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized gains and losses as a result of our market risk sensitive instruments, which primarily relate to debt securities that are available for sale and not held for trading purposes. The change in fair value of equity securities and realized gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, adjusted operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying results of our business. We believe that it is useful for investors to evaluate adjusted operating income and adjusted operating income per share, along with net income and net income per share, when reviewing and evaluating our performance. Recently Issued Accounting Pronouncements Refer to Note 1 ~ Summary of Significant Accounting Policies – Recently Issued Accounting Guidance of the Notes to the Consolidated Financial Statements for detailed information regarding recently issued accounting pronouncements. 28