Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Periods Ended June 30, 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
COVID-19 (the “Pandemic”) continues to cause significant disruption to public health, the global economy, financial markets, and commercial, social and community activity in general. As there has been a significant reduction in reported cases and correspondingly a reduction in government restrictions, we see reduced risk to our business. We continue to monitor potential risks the Pandemic may present including a potential resurgence. Our exposure to the Pandemic is manifold. The majority of our employees continue to work remotely however strict “shelter-in-place” or “stay-at-home” orders have been lifted. A significant portion of our revenues are generated from the hospitality sector within the U.S. which remains under stress due to the threats of resurgence and resource shortages that resulted from 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. To date, we have not seen a major disruption in our business as a result of the Pandemic and currently do not expect to see a material negative impact to our financial position or results of operations as a result of the Pandemic.
Sale of Certain Agency Business
On June 30, 2021, our agency (Sycamore Insurance Agency) sold to Venture Holdings, Inc. the customer accounts and other related assets of some of its personal and commercial lines of business. Sycamore will continue to produce various personal and commercial lines that it did not sell which is substantially all produced for, and underwritten by, our Insurance Company Subsidiaries. We recognized an $8.9 million gain on the sale which is reflected in Other Gains on the Consolidated Statement of Operations.
The purchase price was $10.0 million of which $1 million was paid in cash on June 30, 2021, and $9 million was in the form of two promissory notes (one for $6 million and one for $3 million). Both notes require interest-only quarterly payments at a per annum rate of 7.0%, with a five-year maturity. However, we expect the $3 million note to be paid in full within the next quarter. There are no prepayment penalties.
The assets sold included the customer accounts (mainly agency-related new and renewal rights) of substantially all of the personal lines business and a small subset of the commercial lines business underwritten by our Insurance Company Subsidiaries, and all of the customer accounts Sycamore produced for third-party insurers. The transaction included the
24
transition of 21 employees from CHI to Venture as well as necessary systems and office functions to operate the business. Venture did not assume any in-force business or liabilities. The business will roll over to Venture as it produces new or renewal business effective July 1, 2021. We expect our Insurance Company Subsidiaries will continue to underwrite substantially all of the business we sold to Venture that we underwrote prior to the transaction. W e expect Venture to be able to grow both the business we underwrite plus the third-party business more effectively as a separate entity outside of CHI’s group. As of June 3 0 , 202 1 , we had a non-controlling 50% interest in Venture.
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.
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. However, as a result of the sale of certain agency business on June 30, 2021, going forward, our agency segment will not be producing any significant amounts of business for third party insurers and will produce approximately 50% less business for the Insurance Company Subsidiaries.
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 six months ended June 30, 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
The Company reported $35.0 million of gross written premiums in the second quarter of 2021, representing a 27.0% increase as compared to the same period in 2020. Gross written premiums were $65.4 million for the six months ended June 30, 2021, representing a 24.2% increase as compared to the same period in 2020. The increase in both periods 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.
The Company reported net income of $5.6 million, or $0.57 per share, and net income of $916,000, or $0.09 per share, for the three and six months ended June 30, 2021, respectively. The Company reported net income of $1.5 million, or $0.16 per share, and a net loss of $3.2 million, or $0.34 per share, for three and six months ended June 30, 2020, respectively.
25
Adjusted operating loss , a non-GAAP measure, was $ 3.9 million , or $0. 4 0 per share for the three months ended June 30 , 2021 . Adjusted operating loss was $10.9 million, or $1.13 per share for the six months ended June 30, 2021. Adjusted operating loss was $461,000, or $0.0 4 per share for the three months ended June 30, 2020. Adjusted operating loss was $3.1 million, or $0.33 per share for the six months ended June 30, 2020.
Our underwriting combined ratio was 113.2% and 120.8% for the three and six months ended June 30, 2021, compared to 100.5% and 106.1% for the three and six months ended June 30, 2020, respectively.
Results of Operations For The Three Months Ended June 30, 2021 and 2020
The following table summarizes our operating results for the periods indicated (dollars in thousands):
Summary of Operating Results
Three Months Ended
June 30,
2021
2020
$ Change
% Change
Gross written premiums
$
34,981
$
27,545
$
7,436
27.0
%
Net written premiums
$
28,532
$
23,065
$
5,467
23.7
%
Net earned premiums
$
24,838
$
21,758
$
3,080
14.2
%
Other income
666
713
(47
)
(6.6
%)
Losses and loss adjustment expenses, net
17,926
11,945
5,981
50.1
%
Policy acquisition costs
6,896
6,395
501
7.8
%
Operating expenses
4,342
4,859
(517
)
(10.6
)%
Underwriting gain (loss)
(3,660
)
(728
)
(2,932
)
*
Net investment income
503
863
(360
)
(41.7
)%
Net realized investment gains
1,060
245
815
*
Change in fair value of equity securities
(525
)
1,576
(2,101
)
*
Other gains
8,910
145
8,765
*
Interest expense
732
731
1
0.1
%
Income (loss) before equity earnings in Affiliate and income taxes
5,556
1,370
4,186
*
Equity earnings in Affiliate, net of tax
180
179
1
*
Income tax expense
184
44
140
*
Net income (loss)
$
5,552
$
1,505
$
4,047
*
Book value per common share outstanding
$
4.53
$
4.51
Underwriting Ratios:
Loss ratio (1)
71.9
%
54.6
%
Expense ratio (2)
41.3
%
45.9
%
Combined ratio (3)
113.2
%
100.5
%
(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
26
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.
Our premiums are presented below for the three months ended June 30, 2021 and 2020 (dollars in thousands):
Summary of Premium Revenue
Three Months Ended
June 30,
2021
2020
$ Change
% Change
Gross written premiums
Commercial lines
$
30,947
$
25,600
$
5,347
20.9
%
Personal lines
4,034
1,945
2,089
107.4
%
Total
$
34,981
$
27,545
$
7,436
27.0
%
Net written premiums
Commercial lines
$
24,672
$
21,377
$
3,295
15.4
%
Personal lines
3,860
1,688
2,172
128.7
%
Total
$
28,532
$
23,065
$
5,467
23.7
%
Net earned premiums
Commercial lines
$
22,188
$
20,105
$
2,083
10.4
%
Personal lines
2,650
1,653
997
60.3
%
Total
$
24,838
$
21,758
$
3,080
14.2
%
Gross written premiums increased $7.4 million, or 27.0%, to $35.0 million for the three months ended June 30, 2021, as compared to $27.5 million for the same period in 2020.
Commercial lines gross written premiums increased $5.3 million, or 20.9%, to $30.9 million in the second quarter of 2021, as compared to $25.6 million for the second quarter of 2020. The increase was due to $7.1 million of additional gross written premium in the Company’s small business programs during the second quarter of 2021, as compared the second quarter of 2020. This increase was offset by a $1.8 million reduction of gross written premium in the Company’s hospitality programs during the second quarter of 2021, as compared to the second quarter of 2020.
Personal lines gross written premiums increased $2.1 million, or 107.4%, to $4.0 million in the second quarter of 2021, as compared to $1.9 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 $5.5 million, or 23.7%, to $28.5 million for the three months ended June 30, 2021, as compared to $23.1 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 16.2% to 17.8% in the second quarters of 2020 and 2021, respectively. 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; 3) we purchased more reinsurance as of January 1, 2021 to reduce our commercial property specific loss retention to $200,000, from $340,000, and we are writing more business in select areas that are mostly ceded under quota share agreements that skew the blended ceded earned premium to gross earned premium ratio.
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 June 30, 2021, decreased $47,000, or 6.6%, to $666,000 as compared to $713,000 for the same period in 2020. The decrease in other income was primarily due to a one-time item in 2020 that did not occur in 2021. However, revenue in the Agency operations in the second quarter of 2021 continued to grow moderately, compared to the same period in 2020.
Other Gains
Other gains were $8.9 million for the three months ended June 30, 2021, compared to $145,000 for the same period in 2020. The Company sold a portion of its Agency business during the second quarter of 2021, resulting in an $8.9 million gain.
27
The $145,000 gain in the second quarter of 2020 was due to the repurchase of 9,761 units of the Notes at a discount to face value.
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 June 30, 2021 and 2020 (dollars in thousands).
Three months ended June 30, 2021
Commercial
Lines
Personal
Lines
Total
Accident year net losses and LAE
$
10,754
$
962
$
11,716
Net (favorable) adverse development
6,186
24
6,210
Calendar year net losses and LAE
$
16,940
$
986
$
17,926
Accident year loss ratio
48.4
%
35.7
%
47.0
%
Net (favorable) adverse development
27.8
%
0.9
%
24.9
%
Calendar year loss ratio
76.2
%
36.6
%
71.9
%
Three months ended June 30, 2020
Commercial
Lines
Personal
Lines
Total
Accident year net losses and LAE
$
8,218
$
690
$
8,908
Net (favorable) adverse development
3,057
(20
)
3,037
Calendar year net losses and LAE
$
11,275
$
670
$
11,945
Accident year loss ratio
40.7
%
40.8
%
40.7
%
Net (favorable) adverse development
15.2
%
(1.2
)%
13.9
%
Calendar year loss ratio
55.9
%
39.6
%
54.6
%
Net losses and LAE increased by $6.0 million, or 50.1%, to $17.9 million during the second quarter of 2021, compared to $11.9 million for the same period in 2020. The increase in losses was driven by adverse development that occurred during the second quarter of 2021. The Company experienced $6.2 million of adverse development for the three months ended June 30, 2021. Of the $6.2 million in adverse development, $1.9 million was related to 2017 and prior accident years, $2.4 million was related to the 2018 accident year, and $1.9 million was related to the 2019 and 2020 accident years. Substantially all of the development was from the Company’s commercial lines of business.
The Company's incurred losses during the three months ended June 30, 2020, included adverse prior-year reserve development of $3.0 million. The Commercial lines experienced $3.1 million of unfavorable reserve development mostly attributable to small business lines in 2018 and 2017 and prior accident years, most notably in commercial auto lines.
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.
28
The table below provides the expense ratio by major component.
Three Months Ended
June 30,
2021
2020
Commercial Lines
Policy acquisition costs
28.4
%
30.3
%
Operating expenses
12.8
%
15.5
%
Total
41.2
%
45.8
%
Personal Lines
Policy acquisition costs
27.5
%
30.0
%
Operating expenses
14.5
%
16.1
%
Total
42.0
%
46.1
%
Total Underwriting
Policy acquisition costs
28.3
%
30.3
%
Operating expenses
13.0
%
15.6
%
Total
41.3
%
45.9
%
Our expense ratio decreased by 4.6 percentage points in the second quarter of 2021 as compared to the same period of 2020. The decrease was largely due to underwriting revenue, which consists of net earned premiums and other underwriting income, increasing by $3.0 million, or 14.0% to $24.9 million for the three months ended June 30, 2021, compared to $21.9 million during the same period in 2020.
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 June 30, 2021 and 2020, the percentage of policy acquisition costs to net earned premiums and other underwriting income decreased by 2.0 percentage points to 28.3% compared to 30.3%, respectively. Acquisition costs are lower due to a combination of a change in mix of business with lower average acquisition costs, less expensive fronting arrangements, and more ceding commissions in select areas that are mostly ceded under quota share agreements.
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 underwriting income were 13.0% and 15.6% for the three months ended June 30, 2021 and 2020, respectively. The operating expense ratio was lower due to our expense reduction efforts, where there has been a real nominal dollar decrease in operating expenses, coupled with net earned premium growth.
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 June 30, 2021 and 2020 (dollars in thousands):
Segment Gain (Loss)
Three Months Ended
June 30,
2021
2020
$ Change
Commercial Lines
$
(3,878
)
$
(352
)
$
(3,526
)
Personal Lines
577
241
336
Total Underwriting
(3,301
)
(111
)
(3,190
)
Wholesale Agency
(87
)
(103
)
16
Corporate
(255
)
(574
)
319
Eliminations
(17
)
60
(77
)
Total segment gain (loss)
$
(3,660
)
$
(728
)
$
(2,932
)
29
Results of Operations For The Six Months Ended June 30, 2021 and 2020
The following table summarizes our operating results for the periods indicated (dollars in thousands):
Six months ended
June 30,
2021
2020
$ Change
% Change
Gross written premiums
$
65,354
$
52,629
$
12,725
24.2
%
Net written premiums
$
53,015
$
44,116
$
8,899
20.2
%
Net earned premiums
$
47,673
$
43,775
$
3,898
8.9
%
Other income
1,222
1,371
(149
)
(10.9
)%
Losses and loss adjustment expenses, net
37,288
26,214
11,074
42.2
%
Policy acquisition costs
13,646
12,698
948
7.5
%
Operating expenses
8,691
9,904
(1,213
)
(12.2
)%
Underwriting gain (loss)
(10,730
)
(3,670
)
(7,060
)
(192.4
)%
Net investment income
1,035
1,817
(782
)
(43.0
)%
Net realized investment gains
3,984
1,173
2,811
239.6
%
Change in fair value of equity securities
(1,065
)
(1,510
)
445
*
Other gains
8,910
260
8,650
*
Interest expense
1,453
1,462
(9
)
(0.6
)%
Income (loss) before equity earnings in Affiliate and income taxes
681
(3,392
)
4,073
*
Equity earnings in Affiliate, net of tax
428
229
199
*
Income tax expense
193
57
136
*
Net income (loss)
$
916
$
(3,220
)
$
4,136
*
Book value per common share outstanding
$
4.53
$
4.51
Underwriting Ratios:
Loss ratio (1)
77.9
%
59.6
%
Expense ratio (2)
42.9
%
46.5
%
Combined ratio (3)
120.8
%
106.1
%
(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.
30
Our premiums are presented below for the six months ended June 30, 2021 and 2020 (dollars in thousands):
Six months ended
June 30,
2021
2020
$ Change
% Change
Gross written premiums
Commercial lines
$
58,168
$
49,044
$
9,124
18.6
%
Personal lines
7,186
3,585
3,601
100.4
%
Total
$
65,354
$
52,629
$
12,725
24.2
%
Net written premiums
Commercial lines
$
46,229
$
41,064
$
5,165
12.6
%
Personal lines
6,786
3,052
3,734
122.3
%
Total
$
53,015
$
44,116
$
8,899
20.2
%
Net earned premiums
Commercial lines
$
42,894
$
40,536
$
2,358
5.8
%
Personal lines
4,779
3,239
1,540
47.5
%
Total
$
47,673
$
43,775
$
3,898
8.9
%
Gross written premiums increased $12.7 million, or 24.2%, to $65.4 million for the six months ended June 30, 2021, as compared to $52.6 million for the same period in 2020.
Commercial lines gross written premiums increased $9.1 million, or 18.6%, to $58.2 million for the six months ended June 30, 2021, as compared to $49.0 million for the same period in 2020. There was a $12.2 million increase in the small business programs particularly in areas we have seen the most profitability. This was offset by a $2.8 million, or 48.9%, decrease in our quick service restaurant line which has seen some of the larger losses within the hospitality lines of business.
The increase was due to $12.3 million of additional gross written premium in the Company’s small business programs during the six months ended June 30, 2021, as compared to the same period in 2020. This increase was offset by a reduction in gross written premium of $3.1 million in the Company’s hospitality programs during the six months ended June 30, 2021, as compared to the same period in 2020.
Personal lines gross written premiums increased $3.6 million, or 100.4%, to $7.2 million for the six months ended June 30, 2021, as compared to $3.6 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 $8.9 million, or 20.2%, to $53.0 million for the six months ended June 30, 2021, as compared to $44.1 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 15.8% to 18.5% in six months ended June 30, 2020 and 2021, respectively.
The increase in the ceded earned premium to gross earned premium ratio was due to a number of factors. There was a $1.1 million increase in gross earned premiums relating to additional premiums generated from a commercial umbrella liability program that is almost entirely ceded under a quota share agreement. This increased the ratio by 1.3 percentage points. However, we also received a ceding commission from this business that has reduced our acquisition costs. There was also $201,000 more reinstatement costs on catastrophe reinsurance in the first six months of 2021 as compared to the same period in 2020, which increased the ratio by 30 basis points. The additional reinstatement costs were due to Winter Storm Uri during the first quarter of 2021. 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 six months ended June 30, 2021, decreased $149,000, or 10.9%, to $1.2 million, as compared to $1.4 million for the same period in 2020. The decrease in other income was primarily due to a one-time item in 2020 that did not occur in 2021. However, revenue in the Agency operations for the six months ended June 30, 2021 continued to grow moderately, compared to the same period in 2020.
31
Other Gains
Other gains were $8.9 million for the six months ended June 30, 2021, compared to $260,000 for the same period in 2020. The Company sold a portion of its Agency business during the second quarter of 2021, resulting in an $8.9 million gain. The $260,000 gain for the six months ended June 30, 2020 was due to the repurchase of 36,761 units of the Notes at a discount to face value.
Losses and Loss Adjustment Expenses
The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the six months ended June 30, 2021 and 2020 (dollars in thousands).
Six months ended June 30, 2021
Commercial
Lines
Personal
Lines
Total
Accident year net losses and LAE
$
22,543
$
2,757
$
25,300
Net (favorable) adverse development
11,352
636
11,988
Calendar year net losses and LAE
$
33,895
$
3,393
$
37,288
Accident year loss ratio
52.4
%
56.7
%
52.9
%
Net (favorable) adverse development
26.4
%
13.1
%
25.0
%
Calendar year loss ratio
78.8
%
69.8
%
77.9
%
Six months ended June 30, 2020
Commercial
Lines
Personal
Lines
Total
Accident year net losses and LAE
$
17,996
$
1,432
$
19,428
Net (favorable) adverse development
6,740
46
6,786
Calendar year net losses and LAE
$
24,736
$
1,478
$
26,214
Accident year loss ratio
44.2
%
43.2
%
44.2
%
Net (favorable) adverse development
16.6
%
1.4
%
15.4
%
Calendar year loss ratio
60.8
%
44.6
%
59.6
%
Net losses and LAE increased by $11.1 million, or 42.2%, to $37.3 million for the six months ended June 30, 2021, compared to $26.2 million for the same period in 2020. The Company experienced $2.0 million of catastrophe losses, net of reinsurance recoverables, during the first quarter of 2021 from Winter Storm Uri. The Company also experienced $12.0 million of adverse development for the six months ended June 30, 2021, which increased losses further. Of the $12.0 million in adverse development, $11.4 million was related to commercial lines, while $636,000 was related to personal lines. The adverse development was mostly attributable to the 2018 and 2017 and prior accident years.
The Company's incurred losses during the six months ended June 30, 2020, included adverse prior-year reserve
development of $6.8 million. The Commercial lines experienced $6.7 million of unfavorable reserve development for the six
months ended June 30, 2020. Of the $6.7 million in adverse development experienced in commercial lines, $5.6 million was
incurred in our hospitality programs, while $1.1 million was experienced in our small business programs. The adverse development was mostly attributable to the 2018 and 2017 and prior 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.
32
The table below provides the expense ratio by major component.
Six months ended
June 30,
2021
2020
Commercial Lines
Policy acquisition costs
29.4
%
30.2
%
Operating expenses
13.5
%
16.3
%
Total
42.9
%
46.5
%
Personal Lines
Policy acquisition costs
27.6
%
30.1
%
Operating expenses
15.2
%
16.5
%
Total
42.8
%
46.6
%
Total Underwriting
Policy acquisition costs
29.2
%
30.2
%
Operating expenses
13.7
%
16.3
%
Total
42.9
%
46.5
%
Our expense ratio decreased by 3.6 percentage points for the six months ended June 30, 2021, as compared to the same period in 2020.
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 six months ended June 30, 2021 and 2020, the percentage of policy acquisition costs to net earned premiums and other underwriting income decreased by 1.0 percentage points to 29.2% compared to 30.2%, respectively. Acquisition costs are lower due to a combination of a change in mix of business with lower average acquisition costs, less expensive fronting arrangements, and more ceding commissions in select areas that are mostly ceded under quota share agreements.
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 underwriting income were 13.7% and 16.3% for the six months ended June 30, 2021 and 2020, respectively. The operating expense ratio was lower due to our expense reduction efforts. The operating expense ratio was lower due to our expense reduction efforts, where there has been a real nominal dollar decrease in operating expenses, coupled with net earned premium growth.
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 six months ended June 30, 2021 and 2020 (dollars in thousands):
Segment Gain (Loss)
Six months ended
June 30,
2021
2020
$ Change
Commercial Lines
$
(9,344
)
$
(2,975
)
$
(6,369
)
Personal Lines
(610
)
291
(901
)
Total Underwriting
(9,954
)
(2,684
)
(7,270
)
Wholesale Agency
(232
)
(282
)
50
Corporate
(513
)
(905
)
392
Eliminations
(31
)
201
(232
)
Total segment gain (loss)
$
(10,730
)
$
(3,670
)
$
(7,060
)
33
Liquidity and Capital Resources
Sources and Uses of Funds
At June 30, 2021, we had $16.1 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 six months ended June 30, 2021 and 2020.
Cash Flows
Operating Activities . Cash used in operating activities for the six months ended June 30, 2021, was $4.5 million, compared to $4.6 million used for the same period in 2020. There was $8.7 million more premiums collected, net of reinsurance costs, in 2021, compared to 2020, as we continue to increase gross written premiums. This was offset by $5.1 million more claim payments made in 2021, net of reinsurance recovered (in part due to Winter Storm Uri), $2.8 million more acquisition costs paid in 2021, compared to 2020, as gross written premiums increased. Investment income decreased by $782,000 for the six months ended June 30, 2021, as compared to the same period in 2020, due to lower yields on the bond portfolio.
Investing Activities. Cash provided by investing activities for the six months ended June 30, 2021, was $4.9 million, as compared to $861,000 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 six months of 2021, compared to the same period in 2020. There was a significant repositioning of the Company’s portfolio during the six months 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 six months ended June 30, 2021, was $4.0 million, compared to $2.8 million of cash provided by financing activities for the same period in 2020. The $6.8 million decrease in cash provided by financing activities was mostly due to the Company paying down a net amount of $4.0 million of its outstanding balance on its line of credit during the first six months 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 $62.5 million and $64.1 million at June 30, 2021 and December 31, 2020, respectively.
34
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
June 30,
Six months ended
June 30,
2021
2020
2021
2020
Net income (loss)
$
5,552
$
1,505
$
916
$
(3,220
)
Exclude:
Net realized investment gains and other gains, net of tax
9,970
390
12,894
1,433
Change in fair value of equity securities, net of tax
(525
)
1,576
(1,065
)
(1,510
)
Adjusted operating income (loss)
$
(3,893
)
$
(461
)
$
(10,913
)
$
(3,143
)
Weighted average common shares diluted
9,686,631
9,595,668
9,684,193
9,594,221
Diluted income (loss) per common share:
Net income (loss)
$
0.57
$
0.16
$
0.09
$
(0.34
)
Exclude:
Net realized investment gains and other gains, net of tax
1.03
0.04
1.33
0.15
Change in fair value of equity securities, net of tax
(0.06
)
0.16
(0.11
)
(0.16
)
Adjusted operating income (loss) per share
$
(0.40
)
$
(0.04
)
$
(1.13
)
$
(0.33
)
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.
35
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.