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ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to assist in an understanding of our financial condition and results of operations and should be read in conjunction with our consolidated financial statements and accompanying notes in “Item 8—Financial Statements and Supplementary Data” below. Except for the historical information contained herein, the discussions in this MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed above under “Cautionary Note Regarding Forward-Looking Statements” and “Part I, Item 1A—Risk Factors.”
Overview
We are a vertically integrated holding company offering property and casualty insurance and value-added insurance services. We develop, market, and underwrite insurance products for consumers predominantly in the personal residential homeowners lines of business and perform substantially all other insurance-related services for our primary insurance entities, including risk management, claims management and distribution. Our primary insurance entities, UPCIC and APPCIC, offer insurance products through both our appointed independent agent network and our online distribution channels across 19 states (primarily in Florida), with licenses to write insurance in an additional two states. The Insurance Entities seek to produce an underwriting profit (defined as earned premium minus losses, LAE, policy acquisition costs and other operating costs) over the long term; maintain a conservative balance sheet to prepare for years in which the Insurance Entities are not able to achieve an underwriting profit; and generate investment income from invested assets.
Revenues
We generate revenue primarily from the collection of insurance premiums. Other sources of revenue include: commissions paid by our reinsurers to our reinsurance intermediary subsidiary BARC on reinsurance it places for the Insurance Entities; policy fees collected from policyholders by our managing general agent subsidiary, ERA (formerly Universal Risk Advisors, Inc.); and financing fees charged to policyholders who choose to defer premium payments. In addition, our subsidiary Alder receives fees from the Insurance Entities for claims-handling services. The Insurance Entities are reimbursed for these fees on claims that are subject to recovery under the Insurance Entities’ respective reinsurance programs. These fees, after expenses, are recorded in the consolidated financial statements as an adjustment to LAE. We also generate income by investing our assets.
The nature of our business tends to be seasonal during the year, reflecting consumer behaviors in connection with the Florida residential real estate market and the hurricane season. The amount of direct premiums written tends to increase just prior to the second quarter and tends to decrease approaching the fourth quarter.
Trends and Geographical Distribution
Florida Trends
We are currently working through a cycle to improve long-term rate adequacy and earnings for the Insurance Entities by increasing rates and managing exposures, while taking advantage of what we believe to be opportunities in a dislocated market. The Florida personal lines homeowners’ market currently can be characterized as a “hard market”, where insurance premium rates are escalating, insurers are reducing coverages, and underwriting standards are tightening as insurers closely monitor insurance rates and manage coverage capacity. Due to conditions in the Florida market and factors more generally affecting the U.S. and global reinsurance markets, reinsurance capacity in recent years has also been subject to less favorable pricing or terms. These market forces decrease competition among admitted insurers, and ultimately result in the increased use of Citizens, which was created to be the State’s residual property insurance market. In recent years, in response to adverse behaviors and conditions in the Florida residential market, most admitted market competitors have sought and often received approval for significant rate increases. Meanwhile, Citizens’ rate increases are limited by law, resulting in its policies, in a hard market, becoming priced lower than admitted market policies. This causes Citizens to become viewed as a desirable alternative to the admitted market as admitted market insurers manage through the hard market challenges. Our Insurance Entities likewise have taken and continue to take action to manage through this hard market by increasing rates and prudently managing exposures while also maintaining their competitive position in the market and supporting our current policyholders and agents.
While addressing rate adequacy for the Insurance Entities, we continue to experience inflated costs for losses and LAE in the Florida market, where an industry has developed around the solicitation, filing and litigation of personal residential claims. These dynamics have been made worse by the litigation financing industry which in some cases funds these actions. These behaviors are a chief contributing factor for the rate increases in this market. These behaviors result in a pattern of continued increases in year-over-year levels of represented claims, the inflation of purported claim amounts, and increased demands for attorneys’ fees. Active solicitation of personal residential claims in Florida by policyholder representatives, remediation companies and repair companies has led to an increase in the frequency and severity of personal residential claims in Florida exceeding historical levels and levels seen in other jurisdictions. Information prepared by the Florida Office of Insurance Regulation also shows that claims in Florida are litigated at a substantially disproportionate rate when compared to other states. This is largely due to a Florida statute providing a one-way right of attorneys’ fees against insurers which has, when coupled with certain other statutes and judicial rulings, produced a legal environment in Florida that encourages litigation, in many cases without regard to the underlying merits of the claims. The one-way right to attorneys’ fees essentially means that unless an insurer’s position is entirely upheld in litigation, the insurer must pay the plaintiff’s attorneys’ fees in addition to its own defense costs. This affects not only claims that are litigated to resolution, but also the settlement discussions that take place with nearly all litigated claims. This one-way right to attorney fees creates a nearly risk-free environment, and incentive, for attorneys to pursue litigation against insurers. The result has been a substantial increase in represented and litigated claims in Florida, far outpacing levels experienced in other states.
In April 2021, the Florida legislature passed a bill intending to curtail the adverse claim trends impacting the Florida homeowners’ insurance market. Most provisions of the bill went into effect on July 1, 2021. Among its provisions, the bill creates a new pre-suit notice requirement wherein an insured must make a formal monetary demand of a residential property insurer before commencing suit. The Company has established an internal team to review and respond to these pre-suit demands in a further effort to resolve disputes before litigation ensues. Another provision of the new law reduces the time period in which to file a new or reopened claim to two years following the date of loss. Other changes include attempting to curtail the solicitation of certain roof claims and to limit referral fees in connection with certain types of claims. Opponents of the reforms have challenged certain parts of the new law, including obtaining an injunction against provisions that limit the solicitation of roof claims. In light of the recent enactment of these reforms and the litigation that has ensued, it is premature to assess whether the reforms will have their intended effect. Whether these changes are beneficial to consumers, insurers, insurance company holding systems or the residential property insurance market as a whole may not be fully known for some time.
Despite our initiatives, such as those mentioned above, our costs to settle claims in Florida have increased for the reasons mentioned above. For example, the Company has previously increased its current year loss estimates and increased estimates associated with prior years’ claims. Over the past three years, even as we have increased our estimates of prospective losses each year, we have recorded adverse claim development on prior years’ loss reserves and further strengthened current year losses during the year to address the increasing impact Florida’s market disruptions, as well as the impact of rising costs of building materials and labor, have had on the claims process and the establishment of reserves for losses and LAE. The full extent and duration of these market disruptions and inflationary pressures are unknown and still unfolding, and we will monitor the impact of such disruptions on the recording and reporting of claim costs.
The Company has taken a series of steps over time to mitigate the financial impact of these negative trends in the Florida market. We also have closely monitored rate levels, especially in the Florida market, and have submitted rate filings based upon evolving data. However, because rate filings rely upon past loss and expense data and take time to develop, file and implement, we can experience significant delays between identifying needed rate adjustments, gaining approval of rate changes, and ultimately collecting the resulting increased premiums. In addition, the Company has implemented several initiatives in its claims department in response to the adverse market trends. We utilize our process called Fast Track, which is an initiative to handle straightforward, meritorious claims as promptly as possible to mitigate the adverse impacts that can be seen with claims
that remain open for longer periods. In addition, we increased our emphasis on subrogation to reduce our net losses while also recovering policyholders’ deductibles when losses are attributable to the actions of others. We have an internal staff of trained water remediation experts to address the extraordinary number of purported water damage claims filed by policyholders and vendors. We developed a specialized in-house unit for responding to the unique aspects of represented claims, and we have substantially increased our in-house legal staff in an effort to address the increase in litigated or represented claims as cost-effectively as possible.
Additionally, we have taken steps to implement claim settlement rules associated with the Florida legislation passed in 2019 designed to reduce the negative effects of claims involving assignments of benefits (“AOB”). See “Part I— Item 1—Business—Government Regulation.” An AOB is a document signed by a policyholder that allows a third party to be paid for services performed for an insured homeowner who would normally be reimbursed by the insurance company directly after making a claim. Prior to the AOB reform legislation, the Company experienced an increase in the use of AOBs involving litigation by Florida policyholders. Claims paid under an AOB often involve unnecessary litigation, with the Company required to pay both its own defense costs and those of the plaintiff, and, as a result, cost the Company significantly more than claims settled when an AOB is not involved. In 2019, the Florida legislature passed legislation designed to increase consumer protections against AOB abuses and reduce AOB-related litigation. While the Florida legislation addressing abuses associated with AOBs may be beneficial in reducing one aspect of the concerns affecting the Florida market, the overall impact of the deterioration in claims-related tactics and behaviors, including other first-party litigation, thus far has continued to outpace benefits arising from the 2019 AOB reform legislation. More recently, following legislation adopted in Florida’s 2021 legislative session, we have established procedures and dedicated personnel to a new pre-suit notice and offer process. The new process requires policyholders or their attorneys to notify insurers at least ten days before commencing litigation and allows insurers an opportunity to make pre-suit settlement offers. The policyholders’ ability to recover attorneys’ fees is determined according to a scale that compares the ultimate outcomes of the cases to the insurers’ pre-suit offers. Although this new process is intended to reduce claims litigation and encourage settlements, it is too early to evaluate whether it will be successful in limiting the types of settlement demands and litigation that have plagued the Florida market or in offsetting other factors adversely affecting the market such as increased costs of building materials and labor.
Geographical Distribution
Direct premiums written continue to increase across the states in which we conduct business. As a result of our business strategy, rate changes and disciplined underwriting initiatives, we have seen a decrease in policy count, but an increase in in-force premium and total insured value in almost all states for the past three years. Direct premiums written for states outside of Florida increased 6.1%, representing a $16.2 million increase during 2021. Direct premiums written for Florida increased 11.0%, representing a $137.6 million increase during 2021. The following table provides direct premiums written for Florida and other states for the years ended December 31, 2021 and 2020 (dollars in thousands):
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| | For the Years Ended | | Growth Year Over Year |
| | December 31, 2021 | | December 31, 2020 | | | | |
State | | Direct Premiums Written | | % | | Direct Premiums Written | | % | | $ | | % |
Florida | | $ | 1,388,318 | | | 83.1 | % | | $ | 1,250,748 | | | 82.4 | % | | $ | 137,570 | | | 11.0 | % |
Other states | | 282,934 | | | 16.9 | % | | 266,731 | | | 17.6 | % | | 16,203 | | | 6.1 | % |
Grand total | | $ | 1,671,252 | | | 100.0 | % | | $ | 1,517,479 | | | 100.0 | % | | $ | 153,773 | | | 10.1 | % |
We seek to grow and generate long-term rate adequate premium in each state where we offer policies. Our diversification strategy seeks to increase business outside of Florida and to improve geographical distribution within Florida. Premium growth outside Florida is a measure monitored by management in its efforts to meet that objective.
The geographical distribution of our policies in force, premium in force and total insured value across all states were as follows, as of December 31, 2021, 2020 and 2019 (dollars in thousands, rounded to the nearest thousand):
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| | As of December 31, 2021 |
| | | | | | Premium | | | | Total Insured | | |
State | | Policy Count | | % | | In Force | | % | | Value | | % |
Florida | | 695,533 | | | 73.7 | % | | $ | 1,395,476 | | | 83.1 | % | | $ | 203,062,948 | | | 63.3 | % |
North Carolina | | 58,644 | | | 6.2 | % | | 57,534 | | | 3.4 | % | | 22,703,801 | | | 7.1 | % |
Georgia | | 41,097 | | | 4.4 | % | | 53,956 | | | 3.2 | % | | 19,057,338 | | | 5.9 | % |
Massachusetts | | 16,793 | | | 1.8 | % | | 23,790 | | | 1.4 | % | | 11,467,490 | | | 3.6 | % |
Virginia | | 23,306 | | | 2.5 | % | | 21,069 | | | 1.3 | % | | 13,854,648 | | | 4.3 | % |
Alabama | | 14,484 | | | 1.5 | % | | 19,966 | | | 1.2 | % | | 5,725,381 | | | 1.8 | % |
Indiana | | 17,744 | | | 1.9 | % | | 19,018 | | | 1.1 | % | | 6,810,107 | | | 2.1 | % |
Minnesota | | 11,934 | | | 1.2 | % | | 18,216 | | | 1.1 | % | | 6,372,221 | | | 2.0 | % |
New Jersey | | 14,844 | | | 1.6 | % | | 18,054 | | | 1.1 | % | | 9,523,904 | | | 3.0 | % |
South Carolina | | 17,563 | | | 1.8 | % | | 17,976 | | | 1.1 | % | | 6,860,210 | | | 2.1 | % |
Pennsylvania | | 13,930 | | | 1.5 | % | | 14,688 | | | 0.9 | % | | 6,528,352 | | | 2.0 | % |
Maryland | | 6,615 | | | 0.7 | % | | 6,003 | | | 0.4 | % | | 2,802,756 | | | 0.9 | % |
Michigan | | 3,476 | | | 0.4 | % | | 4,572 | | | 0.3 | % | | 1,585,940 | | | 0.5 | % |
New York | | 2,808 | | | 0.3 | % | | 3,814 | | | 0.2 | % | | 1,898,297 | | | 0.6 | % |
Delaware | | 1,819 | | | 0.2 | % | | 2,316 | | | 0.1 | % | | 1,061,987 | | | 0.3 | % |
Hawaii | | 1,773 | | | 0.2 | % | | 1,974 | | | 0.1 | % | | 903,844 | | | 0.3 | % |
Illinois | | 786 | | | 0.1 | % | | 1,006 | | | — | % | | 409,660 | | | 0.1 | % |
New Hampshire | | 369 | | | — | % | | 301 | | | — | % | | 235,154 | | | 0.1 | % |
Iowa | | 75 | | | — | % | | 92 | | | — | % | | 34,396 | | | — | % |
Total | | 943,593 | | | 100.0 | % | | $ | 1,679,821 | | | 100.0 | % | | $ | 320,898,434 | | | 100.0 | % |
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| | As of December 31, 2020 |
| | | | | | Premium | | | | Total Insured | | |
State | | Policy Count | | % | | In Force | | % | | Value | | % |
Florida | | 728,211 | | | 73.9 | % | | $ | 1,252,916 | | | 82.4 | % | | $ | 192,504,430 | | | 63.6 | % |
Georgia | | 46,678 | | | 4.7 | % | | 57,251 | | | 3.8 | % | | 20,141,751 | | | 6.7 | % |
North Carolina | | 62,849 | | | 6.4 | % | | 55,307 | | | 3.6 | % | | 21,500,109 | | | 7.1 | % |
Virginia | | 23,546 | | | 2.4 | % | | 20,226 | | | 1.3 | % | | 12,959,884 | | | 4.3 | % |
Massachusetts | | 15,090 | | | 1.5 | % | | 20,161 | | | 1.3 | % | | 9,507,917 | | | 3.1 | % |
Indiana | | 19,839 | | | 2.0 | % | | 18,328 | | | 1.2 | % | | 7,171,623 | | | 2.4 | % |
Minnesota | | 12,730 | | | 1.3 | % | | 17,863 | | | 1.2 | % | | 6,252,822 | | | 2.1 | % |
Alabama | | 13,632 | | | 1.4 | % | | 17,409 | | | 1.2 | % | | 4,953,449 | | | 1.6 | % |
South Carolina | | 17,877 | | | 1.8 | % | | 16,886 | | | 1.1 | % | | 6,297,270 | | | 2.1 | % |
Pennsylvania | | 17,183 | | | 1.7 | % | | 14,540 | | | 1.0 | % | | 7,394,773 | | | 2.4 | % |
New Jersey | | 11,576 | | | 1.2 | % | | 12,915 | | | 0.9 | % | | 6,684,386 | | | 2.2 | % |
Maryland | | 5,664 | | | 0.6 | % | | 4,816 | | | 0.3 | % | | 2,226,324 | | | 0.7 | % |
Michigan | | 3,494 | | | 0.4 | % | | 4,290 | | | 0.3 | % | | 1,478,595 | | | 0.5 | % |
New York | | 1,936 | | | 0.2 | % | | 2,251 | | | 0.2 | % | | 1,159,105 | | | 0.4 | % |
Hawaii | | 2,031 | | | 0.2 | % | | 1,983 | | | 0.1 | % | | 901,401 | | | 0.3 | % |
Delaware | | 1,581 | | | 0.2 | % | | 1,908 | | | 0.1 | % | | 870,728 | | | 0.3 | % |
Illinois | | 497 | | | 0.1 | % | | 580 | | | — | % | | 235,593 | | | 0.1 | % |
New Hampshire | | 409 | | | — | % | | 312 | | | — | % | | 238,121 | | | 0.1 | % |
Iowa | | 7 | | | — | % | | 7 | | | — | % | | 2,774 | | | — | % |
Total | | 984,830 | | | 100.0 | % | | $ | 1,519,949 | | | 100.0 | % | | $ | 302,481,055 | | | 100.0 | % |
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| | As of December 31, 2019 |
| | | | | | Premium | | | | Total Insured | | |
State | | Policy Count | | % | | In Force | | % | | Value | | % |
Florida | | 662,343 | | | 74.6 | % | | $ | 1,070,034 | | | 82.5 | % | | $ | 164,654,848 | | | 64.3 | % |
Georgia | | 42,637 | | | 4.8 | % | | 49,615 | | | 3.8 | % | | 17,536,031 | | | 6.9 | % |
North Carolina | | 58,283 | | | 6.6 | % | | 49,420 | | | 3.8 | % | | 19,150,001 | | | 7.5 | % |
Massachusetts | | 13,596 | | | 1.5 | % | | 17,991 | | | 1.4 | % | | 8,312,929 | | | 3.2 | % |
Indiana | | 18,291 | | | 2.1 | % | | 16,643 | | | 1.3 | % | | 6,458,310 | | | 2.5 | % |
Minnesota | | 12,466 | | | 1.4 | % | | 16,035 | | | 1.2 | % | | 5,881,338 | | | 2.3 | % |
South Carolina | | 16,682 | | | 1.9 | % | | 15,705 | | | 1.2 | % | | 5,575,934 | | | 2.2 | % |
Virginia | | 16,313 | | | 1.8 | % | | 14,111 | | | 1.1 | % | | 8,415,470 | | | 3.3 | % |
Pennsylvania | | 16,874 | | | 1.9 | % | | 13,726 | | | 1.1 | % | | 6,922,815 | | | 2.7 | % |
Alabama | | 11,186 | | | 1.3 | % | | 12,998 | | | 1.0 | % | | 3,923,446 | | | 1.5 | % |
New Jersey | | 7,145 | | | 0.8 | % | | 7,554 | | | 0.6 | % | | 3,824,506 | | | 1.5 | % |
Michigan | | 3,417 | | | 0.4 | % | | 4,089 | | | 0.3 | % | | 1,399,470 | | | 0.5 | % |
Maryland | | 4,181 | | | 0.5 | % | | 3,474 | | | 0.3 | % | | 1,600,113 | | | 0.6 | % |
Hawaii | | 2,090 | | | 0.2 | % | | 1,930 | | | 0.2 | % | | 881,476 | | | 0.3 | % |
Delaware | | 1,273 | | | 0.1 | % | | 1,500 | | | 0.1 | % | | 673,331 | | | 0.3 | % |
New York | | 1,183 | | | 0.1 | % | | 1,244 | | | 0.1 | % | | 646,130 | | | 0.3 | % |
New Hampshire | | 249 | | | — | % | | 181 | | | — | % | | 135,254 | | | 0.1 | % |
Illinois | | 152 | | | — | % | | 166 | | | — | % | | 65,006 | | | — | % |
Total | | 888,361 | | | 100.0 | % | | $ | 1,296,416 | | | 100.0 | % | | $ | 256,056,408 | | | 100.0 | % |
Also see “Results of Operations” below and “Part I—Item 1A—Risk Factors—Risks Relating to Our Business and Operations—Because we conduct the majority of our business in Florida, our financial results depend on the regulatory, economic and weather conditions in Florida” for discussion on geographical diversification.
KEY PERFORMANCE INDICATORS
The Company considers the measures and ratios in the following discussion to be key performance indicators for its businesses. Management believes that these indicators are helpful in understanding the underlying trends in the Company’s businesses. Some of these indicators are reported on a quarterly basis and others on an annual basis. Please also refer to “Item 8—Note 2 (Summary of Significant Accounting Policies)” for definitions of certain other terms we use when describing our financial results.
These indicators may not be comparable to other performance measures used by the Company’s competitors and should only be evaluated together with our consolidated financial statements and accompanying notes.
Definitions of Key Performance Indicators
Book Value Per Common Share ― total stockholders’ equity, adjusted for preferred stock liquidation, divided by the number of common shares outstanding as of a reporting period. Book value per common share is the excess of assets over liabilities at a reporting period attributed to each share of stock. Changes in book value per common share informs shareholders of retained equity in the Company on a per share basis which may assist in understanding market value trends for the Company’s stock.
Combined Ratio ― the combined ratio is a measure of underwriting profitability for a reporting period and is calculated by dividing total operating costs and expenses (which is made up of losses and LAE and general and administrative expenses) by premiums earned, net, which is net of ceded premiums earned. Changes to the combined ratio over time provide management with an understanding of costs to operate its business in relation to net premiums it is earning and the impact of rate, underwriting and other business management actions on underwriting profitability. A combined ratio below 100% indicates underwriting profit; a combined ratio above 100% indicates underwriting losses.
Core Loss Ratio ― a common operational metric used in the insurance industry to describe the ratio of current accident year expected losses and LAE to premiums earned. Core loss ratio is an important measure identifying profitability trends of premiums in force. Core losses consists of all other losses and LAE, excluding weather events beyond those expected and prior years’ reserve development. The financial benefit from the management of claims, including claim fees ceded to reinsurers, is recorded in the consolidated financial statements as a reduction to core losses.
Debt-to-Equity Ratio ― long-term debt divided by stockholders’ equity. This ratio helps management measure the amount of financing leverage in place in relation to equity and future leverage capacity.
Debt-to-Total Capital Ratio ― long-term debt divided by the sum of total stockholders’ equity and long-term debt (often referred to as total capital resources). This ratio helps management measure the amount of financing leverage in place (long-term debt) in relation to total capital resources and future leverage capacity.
Direct Premiums Written (“DPW”) ― reflects the total value of policies issued during a period before considering premiums ceded to reinsurers. Direct premiums written, comprised of renewal premiums, endorsements and new business, is initially recorded as unearned premium in the balance sheet which is then earned pro-rata over the next year or remaining policy term. Direct premiums written reflects current trends in the Company’s sale of property and casualty insurance products and amounts that will be recognized as earned premiums in the future.
DPW (Florida) ― includes only DPW in the state of Florida. This measure allows management to analyze growth in our primary market and is also a measure of business concentration risk.
Expense Ratio (Including Policy Acquisition Cost Ratio and Other Operating Cost Ratio) ― calculated as general and administrative expenses as a percentage of premiums earned, net. General and administrative expenses is comprised of policy acquisition costs and other operating costs, which includes such items as underwriting costs, facilities and corporate overhead. The expense ratio, including the sub-expense ratios of policy acquisition cost ratio and other operating cost ratio, are indicators to management of the Company’s cost efficiency in acquiring and servicing its business and the impact of expense items to overall profitability.
Losses and Loss Adjustment Expense Ratio or Loss and LAE Ratio ― a measure of the cost of claims and claim settlement expenses incurred in a reporting period as a percentage of premiums earned in that same reporting period. Losses and LAE incurred in a reporting period includes both amounts related to the current accident year and prior accident years, if any, referred to as development. Ultimate losses and LAE are based on actuarial estimates with changes in those estimates recognized in the period the estimates are revised. Losses and LAE consist of claim costs arising from claims occurring and settling in the current period, an estimate of claim costs for reported but unpaid claims, an estimate of unpaid claim costs for incurred-but-not-reported claims and an estimate of claim settlement expenses associated with reported and unreported claims which occurred during the reporting period. The loss and LAE ratio can be measured on a direct basis, which includes losses and LAE divided by direct earned premiums, or on a net basis, which includes losses and LAE after amounts have been ceded to reinsurers divided by net earned premiums (i.e., direct premium earned less ceded premium earned). The net loss and LAE ratio is a measure of underwriting profitability after giving consideration to the effect of reinsurance. Trends in the net loss and LAE ratio are an indication to management of current and future profitability.
Monthly Weighted Average Renewal Retention Rate ― measures the monthly average of policyholders that renew their policies over the period of a calendar year. This measure allows management to assess customer retention.
Premiums Earned, Net ― the pro-rata portion of current and previously written premiums that the Company recognizes as earned premium during the reporting period, net of ceded premium earned. Ceded premiums are premiums paid or payable by the Company for reinsurance protection. Written premiums are considered earned and are recognized pro-rata over the policy coverage period. Premiums earned, net is a measure that allows management to identify revenue trends.
Policies in Force ― represents the number of active policies with coverage in effect as of the end of the reporting period. The change in the number of policies in force is a growth measure and provides management with an indication of progress toward achieving strategic objectives. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Premium in Force ― is the amount of the annual direct written premiums previously recorded by the Company for policies which are still active as of the reporting date. This measure assists management in measuring the level of insured exposure and progress toward meeting revenue goals for the current year, and provides an indication of business available for renewal in the next twelve months. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Return on Average Equity (“ROAE”) ― calculated by dividing earnings (loss) per common share by average book value per common share. Average book value per common share is computed as the sum of book value per common share at the beginning and the end of a period, divided by two. ROAE is a capital profitability measure of how effectively management creates profits per common share.
Total Insured Value ― represents the amount of insurance limits available on a policy for a single loss based on all policies active as of the reporting date. This measure assists management in measuring the level of insured exposure.
Unearned Premiums ― represents the portion of direct premiums corresponding to the time period remaining on an insurance policy and available for future earning by the Company. Trends in unearned premiums generally indicate expansion, if growing, or contraction, if reducing, which are important indicators to management. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Weather events ― an estimate of losses and LAE from weather events occurring during the current accident year that exceed initial estimates of expected weather events when establishing the core loss ratio for each accident year. This metric informs management of factors impacting overall current year profitability.
REINSURANCE
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events. Reinsurance contracts are typically classified as treaty or facultative contracts. Treaty reinsurance provides coverage for all or a portion of a specified group or class of risks ceded by the primary insurer, while facultative reinsurance provides coverage for specific individual risks. Within each classification, reinsurance can be further classified as quota share or excess of loss. Quota-share reinsurance is where the primary insurer and the reinsurer share proportionally or pro-rata in the direct premiums and losses of the insurer. Excess-of-loss reinsurance indemnifies the direct insurer or reinsurer for all or a portion of the loss in excess of an agreed upon amount or retention.
Developing and implementing our reinsurance strategy to adequately protect our balance sheet and Insurance Entities in the event of one or more catastrophes while maintaining efficient reinsurance costs has been a key strategic priority for us. In order to limit the Insurance Entities’ potential exposure to catastrophic events, we purchase significant reinsurance from third-party reinsurers and the Florida Hurricane Catastrophe Fund (“FHCF”). The Florida Office of Insurance Regulation (“FLOIR”) requires the Insurance Entities, like all residential property insurance companies doing business in Florida, to have a certain amount of capital and reinsurance coverage in order to cover losses upon the occurrence of a single catastrophic event and a series of catastrophic events occurring in the same hurricane season. The Insurance Entities’ respective 2021-2022 reinsurance programs meet the FLOIR’s requirements, which are based on, among other things, successfully demonstrating cohesive and comprehensive reinsurance programs that protect the policyholders of our Insurance Entities as well as satisfying a series of stress test catastrophe loss scenarios based on past historical events. Similarly, the Insurance Entities’ respective 2021-2022 reinsurance programs meet the stress test and review requirements of Demotech, Inc., for maintaining Financial Stability Ratings® of A (Exceptional).
We believe the Insurance Entities’ retentions under their respective reinsurance programs are appropriate and structured to protect policyholders. We test the sufficiency of the reinsurance programs by subjecting the Insurance Entities’ personal residential exposures to statistical testing using a third-party hurricane model, RMS RiskLink v18.1 (Build 1945). This model combines simulations of the natural occurrence patterns and characteristics of hurricanes, tornadoes, earthquakes and other catastrophes with information on property values, construction types and occupancy classes. The model outputs provide information concerning the potential for large losses before they occur, so companies can prepare for their financial impact. Furthermore, as part of our operational excellence initiatives, we continually look to enable new technology to refine our data intelligence on catastrophe risk modeling.
Effective June 1, 2021, the Insurance Entities entered into multiple reinsurance agreements comprising our 2021-2022 reinsurance program. See “Item 1—Note 4 (Reinsurance).”
UPCIC’s 2021-2022 Reinsurance Program
•First event All States retention of $45 million during the 2021 Atlantic hurricane season; first event Non-Florida retention of $15 million.
•All States first event reinsurance protection extends to $3.364 billion with no co-participation in any of the layers and no limitation on loss adjustment expenses for the non-catastrophe bond Cosaint Re Pte. Ltd. traditional reinsurance while maintaining the same favorable historical deposit premium payment schedules.
•Assuming a first event completely exhausts the $3.364 billion tower, the second event exhaustion point would be $1.101 billion.
•Full reinstatement available on $1.06 billion of the $1.356 billion of non-FHCF first event catastrophe coverage for guaranteed second event coverage. For all layers purchased between $45 million and the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased enough reinstatement premium protection ("RPP") limit to pay the premium necessary for the reinstatement of these coverages.
•Specific 3rd and 4th event private market catastrophe excess of loss coverage of $86 million in excess of $25 million provides frequency protection for multiple events during the treaty period.
•For the FHCF Reimbursement Contract effective June 1, 2021, UPCIC has continued the election of the 90% coverage level. We estimate the FHCF layer will provide approximately $1.963 billion of coverage for UPCIC, which inures to the benefit of the open market coverage secured from private reinsurers.
•Secured $383 million of new catastrophe capacity with contractually agreed limits that extend coverage to include the 2022 and 2023 wind seasons. This amount does not include the single limit of $150 million of protection for named windstorm events, which now definitively includes the 2022 wind season and potentially could include the 2023 wind season depending on loss activity in the 2022 wind season, that UPCIC obtained in March 2021 when it entered into a three-year reinsurance agreement with Cosaint Re Pte. Ltd., a reinsurance entity incorporated in Singapore that correspondingly issued notes in a Rule 144A offering to raise proceeds to collateralize its obligations under this agreement.
The first-event All States program described above for UPCIC includes coverage from a captive insurance arrangement that UVE established which inures to the benefit of UPCIC. This intercompany transaction provides UPCIC approximately $13.2 million of reinsurance protection on the first layer of UPCIC’s first-event All States program. This transaction eliminates in consolidation effectively increasing the first event retention noted above to $58.2 million for the consolidated group in the event this limit is exhausted.
The captive insurance arrangement effective June 1, 2021 through May 31, 2022 was terminated effective December 1, 2021, pursuant to the terms of the agreement. In connection with the termination of the agreement, and according to its terms, certain funds held in trust were released to the beneficiary (i.e., UPCIC) and the balance was remitted to the grantor (i.e., UVE) in December 2021. The termination of the agreement results in a first-event All States retention of $58.2 million for UPCIC for the period of December 1, 2021 to May 31, 2022, which is outside of the traditional Atlantic hurricane season.
Reinsurers
The table below provides the A.M. Best and S&P financial strength ratings for each of the largest third-party reinsurers in UPCIC’s 2021-2022 reinsurance program:
| | | | | | | | | | | | | | |
Reinsurer | | A.M. Best | | S&P |
Allianz Risk Transfer | | A+ | | AA |
Everest Re | | A+ | | A+ |
Chubb Tempest Reinsurance Ltd. | | A++ | | AA |
Munich Re | | A+ | | AA- |
Renaissance Re | | A+ | | A+ |
Various Lloyd’s of London Syndicates | | A | | A+ |
Florida Hurricane Catastrophe Fund (1) | | N/A | | N/A |
(1)No rating is available, because the fund is not rated.
APPCIC’s 2021-2022 Reinsurance Program
•First event All States retention of $2.5 million.
•All States first event tower of $38 million with no co-participation in any of the layers and no limitation on loss adjustment expenses while maintaining the same favorable historical deposit premium payment schedules.
•Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For the layer purchased between $2.5 million and the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased enough RPP limit to pay the premium necessary for the reinstatement of this coverage.
•APPCIC also purchases extensive multiple line excess per risk reinsurance with various reinsurers due to the high-value risks it insures in both the personal residential and commercial multiple peril lines of business. Under this multiple line excess per risk contract, APPCIC has coverage of $8.5 million in excess of $0.5 million ultimate net loss for each risk and each property loss, and $1 million in excess of $0.3 million for each casualty loss. A $19.5 million aggregate limit applies to the term of the contract for property-related losses and a $2 million aggregate limit applies to the term of the contract for casualty-related losses. This contract also contains a profit-sharing feature if specific performance measures are met.
•For the FHCF Reimbursement Contract effective June 1, 2021, APPCIC has continued the election of the 90% coverage level. We estimate the FHCF layer will provide approximately $18.4 million of coverage for APPCIC, which inures to the benefit of the open market coverage secured from private reinsurers.
Reinsurers
The table below provides the A.M. Best and S&P financial strength ratings for each of the largest third-party reinsurers in APPCIC’s 2021-2022 reinsurance program:
| | | | | | | | | | | | | | |
Reinsurer | | A.M. Best | | S&P |
Chubb Tempest Reinsurance Ltd. | | A++ | | AA |
Lancashire Insurance Company Limited | | A | | A- |
Various Lloyd’s of London Syndicates | | A | | A+ |
Florida Hurricane Catastrophe Fund (1) | | N/A | | N/A |
(1)No rating is available, because the fund is not rated.
The total cost of the 2021-2022 reinsurance programs for UPCIC and APPCIC, excluding internal reinsurance discussed above, is projected to be $584 million, representing approximately 35% of estimated direct premium earned for the 12-month treaty period.
The following selected historical consolidated financial data should be read in conjunction with our consolidated financial statements and notes thereto and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth elsewhere in the Annual Report on Form 10-K. The historical results are not necessarily indicative of the results to be expected in any future period.
The following tables present historical selected consolidated financial data of Universal Insurance Holdings, Inc. and Subsidiaries for the five years ended December 31, 2021 (in thousands, except per share data):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2021 | | 2020 | | 2019 | | 2018 | | 2017 |
Statement of Income Data: | | | | | | | | | | |
Revenue: | | | | | | | | | | |
Direct premiums written | | $ | 1,671,252 | | | $ | 1,517,479 | | | $ | 1,292,721 | | | $ | 1,190,875 | | | $ | 1,055,886 | |
Change in unearned premium | | (74,634) | | | (121,856) | | | (59,600) | | | (69,235) | | | (56,688) | |
Direct premium earned | | 1,596,618 | | | 1,395,623 | | | 1,233,121 | | | 1,121,640 | | | 999,198 | |
Ceded premium earned | | (561,155) | | | (472,060) | | | (390,619) | | | (353,258) | | | (310,405) | |
Premiums earned, net | | 1,035,463 | | | 923,563 | | | 842,502 | | | 768,382 | | | 688,793 | |
Net investment income (1) | | 12,535 | | | 20,393 | | | 30,743 | | | 24,816 | | | 13,460 | |
Other revenues (2) | | 71,993 | | | 65,437 | | | 55,633 | | | 49,876 | | | 47,093 | |
Total revenue | | 1,121,851 | | | 1,072,770 | | | 939,351 | | | 823,816 | | | 751,916 | |
Costs and expenses: | | | | | | | | | | |
Losses and loss adjustment expenses | | 779,205 | | | 758,810 | | | 603,406 | | | 414,455 | | | 350,428 | |
Policy acquisition costs | | 226,167 | | | 199,102 | | | 177,530 | | | 157,327 | | | 138,846 | |
Other operating costs | | 88,066 | | | 90,627 | | | 94,898 | | | 99,161 | | | 92,158 | |
Total expenses | | 1,093,438 | | | 1,048,539 | | | 875,834 | | | 670,943 | | | 581,432 | |
Income before income taxes | | 28,413 | | | 24,231 | | | 63,517 | | | 152,873 | | | 170,484 | |
Income tax expense | | 8,006 | | | 5,126 | | | 17,003 | | | 35,822 | | | 63,549 | |
Net income | | $ | 20,407 | | | $ | 19,105 | | | $ | 46,514 | | | $ | 117,051 | | | $ | 106,935 | |
Per Share Data: | | | | | | | | | | |
Basic earnings per common share | | $ | 0.65 | | | $ | 0.60 | | | $ | 1.37 | | | $ | 3.36 | | | $ | 3.07 | |
Diluted earnings per common share | | $ | 0.65 | | | $ | 0.60 | | | $ | 1.36 | | | $ | 3.27 | | | $ | 2.99 | |
Dividends declared per common share | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.77 | | | $ | 0.73 | | | $ | 0.69 | |
| | | | | | | | | | |
| | | | | | | | | | |
| | As of December 31, |
| | 2021 | | 2020 | | 2019 | | 2018 | | 2017 |
Balance Sheet Data: | | | | | | | | | | |
Total invested assets | | $ | 1,093,680 | | | $ | 919,924 | | | $ | 914,586 | | | $ | 908,154 | | | $ | 730,023 | |
Cash and cash equivalents | | 250,508 | | | 167,156 | | | 182,109 | | | 166,428 | | | 213,486 | |
Total assets | | 2,056,141 | | | 1,758,741 | | | 1,719,852 | | | 1,858,390 | | | 1,454,999 | |
Unpaid losses and loss adjustment expenses | | 346,216 | | | 322,465 | | | 267,760 | | | 472,829 | | | 248,425 | |
Unearned premiums | | 857,769 | | | 783,135 | | | 661,279 | | | 601,679 | | | 532,444 | |
Long-term debt (3) | | 103,676 | | | 8,456 | | | 9,926 | | | 11,397 | | | 12,868 | |
Total liabilities | | 1,626,439 | | | 1,309,479 | | | 1,225,951 | | | 1,356,757 | | | 1,015,011 | |
Total stockholders’ equity | | $ | 429,702 | | | $ | 449,262 | | | $ | 493,901 | | | $ | 501,633 | | | $ | 439,988 | |
Shares outstanding end of period | | 31,221 | | | 31,137 | | | 32,638 | | | 34,783 | | | 34,735 | |
Book value per share | | $ | 13.76 | | | $ | 14.43 | | | $ | 15.13 | | | $ | 14.42 | | | $ | 12.67 | |
Return on average equity (ROE) | | 4.6 | % | | 4.1 | % | | 9.2 | % | | 24.1 | % | | 25.7 | % |
| | | | | | | | | | |
Selected Data: | | | | | | | | | | |
Loss and loss adjustment expense ratio (4) | | 75.3 | % | | 82.2 | % | | 71.6 | % | | 53.9 | % | | 50.9 | % |
General and administrative expense ratio (5) | | 30.2 | % | | 31.4 | % | | 32.3 | % | | 33.4 | % | | 33.5 | % |
Combined Ratio (6) | | 105.5 | % | | 113.6 | % | | 103.9 | % | | 87.3 | % | | 84.4 | % |
(1)Net investment income excludes net realized gains (losses) on sale of investments and net change in unrealized gains (losses) of equity securities.
(2)Other revenue consists of commission revenue, policy fees, and other revenue.
(3)For the year ended December 31, 2021, long-term debt includes a private placement of $100 million of 5.625% Senior Unsecured Notes due 2026. See “Part II—Item 8—Note 7 (Long-term debt).”
(4)The loss and loss adjustment expense ratio is calculated by dividing losses and loss adjustment expenses by premiums earned, net.
(5)The general and administrative expense ratio is calculated by dividing general and administrative expense, excluding interest expense, by premiums earned, net. Interest expense was $652 thousand, $102 thousand, $248 thousand, $346 thousand and $348 thousand for the years ended December 31, 2021, 2020, 2019, 2018 and 2017, respectively.
(6)The combined ratio is the sum of the losses and loss adjustment expense ratio and the general and administrative expense ratio.
RESULTS OF OPERATIONS AND ANALYSIS OF FINANCIAL CONDITION
2021 Financial and Business Highlights (comparisons are to 2020 unless otherwise specified)
•Direct premiums written overall grew by $153.8 million, or 10.1%, to $1,671.3 million.
•Policies in force decreased by 41,237, or 4.2%, to 943,593, at December 31, 2021 from 984,830 at December 31, 2020.
•In Florida, direct premiums written grew by $137.6 million, or 11.0%, and in our other states, direct premiums written grew by $16.2 million, or 6.1%.
•Premiums earned, net grew by $111.9 million, or 12.1%, to $1,035.5 million during the year ended December 31, 2021.
•FLOIR approved an overall 14.9% rate increase in September 2021 for UPCIC on Florida personal residential homeowners’ line of business, effective September 2021 for new business and November 2021 for renewals. FLOIR approved an overall 3.9% additional rate increase due to higher reinsurance expenses effective January 2022 for new business and March 2022 for renewal business. Rate increases are in the process of being implemented in other states (Minnesota, Virginia, North Carolina, Alabama) with an average increase of 17.8%.
•Net investment income was $12.5 million compared to $20.4 million.
•Net realized gains on investments were $5.9 million compared to $63.4 million in the prior period. Prior period gains were the result of management’s efforts to realize gains on securities, which was intended to boost statutory surplus in UPCIC.
•Total revenues increased by $49.1 million, or 4.6%, to $1,121.9 million.
•Net loss and LAE ratio decreased to 75.3% during the year ended December 31, 2021 compared to 82.2% during the year ended December 31, 2020.
•Diluted earnings per common share (“EPS”) was $0.65 compared to $0.60 in the prior period.
•Weighted average diluted common shares outstanding were lower by 2.1% to 31.3 million shares as of December 31, 2021 from 32.0 million shares as of December 31, 2020.
•Book value per share decreased by $0.67, or 4.6%, to $13.76 at December 31, 2021 from $14.43 at December 31, 2020.
•Declared and paid dividends per common share of $0.77, including a $0.13 special dividend in December 2021.
•Repurchased 116,886 shares in 2021 at an aggregate cost of $1.6 million.
•Offered Clovered.com in all 19 states in which the Company writes policies as of December 31, 2021.
•Entered into a committed, unsecured $35 million revolving credit line with JP Morgan Chase.
•Completed private placement of $100 million of 5.625% Senior Unsecured Notes due 2026 to support growth.
YEAR ENDED DECEMBER 31, 2021 COMPARED TO YEAR ENDED DECEMBER 31, 2020
Net income was $20.4 million for the year ended December 31, 2021, compared to net income of $19.1 million for the same period in 2020, an increase of $1.3 million, or 6.8%. Diluted EPS for 2021 was $0.65 compared to $0.60 in 2020, an increase of $0.05, or 8.3%. Weighted average diluted common shares outstanding for the year ended December 31, 2021 were lower by 2.1% to 31.3 million shares from 32.0 million shares for the same period of the prior year. Benefiting the year ended December 31, 2021 were increases in premiums earned, net, an increase in commission revenue, partially offset by a decrease in net investment income, a decrease in realized gains year over year and unrealized losses during 2021 compared to modest unrealized gains in 2020, policy fees and other revenue and an increase in operating costs and expenses. Direct premium earned and premiums earned, net were up 14.4% and 12.1%, respectively, due to direct premium written growth in 16 of the 19 states in which we are licensed and writing during the past 12 months as a result of rate increases implemented during 2020 and 2021, partially offset by higher costs for reinsurance flowing through to premiums earned, net. The net loss and LAE ratio was 75.3% for the year ended December 31, 2021, compared to 82.2% for the same period in 2020 reflecting a decrease in excess weather events beyond those expected and lower prior years reserve development, partially offset by higher core net losses. As a result of the above and further explained below, the combined ratio for the year ended December 31, 2021 was 105.6% compared to 113.5% for the year ended December 31, 2020. See “Overview—Trends and Geographical Distribution—Florida Trends” regarding our response to the Florida market.
A detailed discussion of our results of operations follows the table below (in thousands, except per share data).
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (in thousands) | | | | |
| | Years Ended December 31, | | Change |
| | 2021 | | 2020 | | $ | | % |
PREMIUMS EARNED AND OTHER REVENUES | | | | | | | | |
Direct premiums written | | $ | 1,671,252 | | | $ | 1,517,479 | | | $ | 153,773 | | | 10.1 | % |
Change in unearned premium | | (74,634) | | | (121,856) | | | 47,222 | | | (38.8) | % |
Direct premium earned | | 1,596,618 | | | 1,395,623 | | | 200,995 | | | 14.4 | % |
Ceded premium earned | | (561,155) | | | (472,060) | | | (89,095) | | | 18.9 | % |
Premiums earned, net | | 1,035,463 | | | 923,563 | | | 111,900 | | | 12.1 | % |
Net investment income | | 12,535 | | | 20,393 | | | (7,858) | | | (38.5) | % |
Net realized gains (losses) on investments | | 5,892 | | | 63,352 | | | (57,460) | | | (90.7) | % |
Net change in unrealized gains (losses) of equity securities | | (4,032) | | | 25 | | | (4,057) | | | NM |
Commission revenue | | 41,649 | | | 33,163 | | | 8,486 | | | 25.6 | % |
Policy fees | | 22,713 | | | 23,773 | | | (1,060) | | | (4.5) | % |
Other revenue | | 7,631 | | | 8,501 | | | (870) | | | (10.2) | % |
Total premiums earned and other revenues | | 1,121,851 | | | 1,072,770 | | | 49,081 | | | 4.6 | % |
OPERATING COSTS AND EXPENSES | | | | | | | | |
Losses and loss adjustment expenses | | 779,205 | | | 758,810 | | | 20,395 | | | 2.7 | % |
General and administrative expenses | | 314,233 | | | 289,729 | | | 24,504 | | | 8.5 | % |
Total operating costs and expenses | | 1,093,438 | | | 1,048,539 | | | 44,899 | | | 4.3 | % |
INCOME BEFORE INCOME TAXES | | 28,413 | | | 24,231 | | | 4,182 | | | 17.3 | % |
Income tax expense | | 8,006 | | | 5,126 | | | 2,880 | | | 56.2 | % |
NET INCOME | | $ | 20,407 | | | $ | 19,105 | | | $ | 1,302 | | | 6.8 | % |
Other comprehensive income (loss), net of taxes | | (18,911) | | | (17,618) | | | (1,293) | | | 7.3 | |
COMPREHENSIVE INCOME | | $ | 1,496 | | | $ | 1,487 | | | $ | 9 | | | 0.6 | % |
DILUTED EARNINGS PER SHARE DATA: | | | | | | | | |
Diluted earnings per common share | | $ | 0.65 | | | $ | 0.60 | | | $ | 0.05 | | | 8.3 | % |
Weighted average diluted common shares outstanding | | 31,307 | | | 31,972 | | | (665) | | | (2.1) | % |
| | | | | | | | |
Direct premiums written increased by $153.8 million, or 10.1%, for the year ended December 31, 2021, driven by premium growth within our Florida business of $137.6 million, or 11.0%, and premium growth in our other states business of $16.2 million, or 6.1%, as compared to the same period of the prior year. Rate increases approved in 2020 and 2021 for Florida and for certain other states, as discussed below, were the principal driver of higher written premiums. In total, policies in force declined 41,237, or 4.2%, from 984,830 at December 31, 2020 to 943,593 at December 31, 2021. A summary of the recent rate increases which are driving increases in written premium are as follows:
•In May 2020, the FLOIR approved an overall 12.4% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective May 2020 for new business and July 2020 for renewals.
•In October 2020, the FLOIR approved an overall 7.6% rate increase for UPCIC on Florida personal residential dwelling lines of business, effective October 2020 for new business and December 2020 for renewals.
•In December 2020, the FLOIR approved an overall 7.0% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective December 2020 for new business and March 2021 for renewals.
•In September 2021, the FLOIR approved an overall 14.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective September 2021 for new business and November 2021 for renewals.
•In December 2021, the FLOIR approved an overall 3.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective January 2022 for new business and March 2022 for renewals.
•In addition, during the past year, rate increases for UPCIC were approved in Alabama, Georgia, Indiana, Minnesota, North Carolina, and Virginia.
These rate increases are applied on new business submissions and renewals from the effective date of their renewal, and then are earned subsequently over the policy period. The recent rate increases in Florida are in response to rising claim costs driven by higher costs of material and labor associated with claims, the cost of weather events, the rising cost of catastrophe and other reinsurance protecting policyholders and, more importantly, the impact of “social inflation” on claims as claim settlements increasingly have involved inflated demands, representation and litigation. In addition, the Insurance Entities’ policies provide for coverage limits to be adjusted at renewal based on third-party data sources that monitor factors such as changes in costs for residential building materials and labor.
During 2021, management continued efforts to prudently manage policy counts and exposures and implemented new measures intended to slow the growth of written premiums relating to new business compared to prior years while the above rate increases were taking effect. Reduced new business writings, when coupled with natural attrition among policies and selected policy non-renewals, resulted in a decrease in policies in force during 2021. In total we wrote policies in 19 states during 2021 and 2020. In addition, we are authorized to do business in Tennessee and Wisconsin and are proceeding with product filings in those states. At December 31, 2021, premium in force increased $159.9 million, or 10.5%, and total insured value increased $18.4 billion, or 6.1%, compared to December 31, 2020.
Direct premium earned increased by $201.0 million, or 14.4%, for the year ended December 31, 2021, reflecting the earning of premiums written over the past 12 months, including the benefit of rate changes and the changes in policies in force during that time.
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events and other covered events. Ceded premium represents premiums paid to reinsurers for this protection and is a cost which reduces net written and net earned premiums. Ceded premium earned increased $89.1 million, or 18.9%, for the year ended December 31, 2021 as compared to the same period of the prior year. The increase in reinsurance costs reflects an increase in the value of exposures we insure; increased pricing when compared to the expired reinsurance program and differences in the structure and design of the respective programs. Reinsurance costs, as a percentage of direct premium earned, increased from 33.8% in 2020 to 35.1% in 2021 primarily due to the general increase in the pricing of reinsurance which generally takes effect prior to primary rate increases. Reinsurance costs associated with each year’s reinsurance program are earned over the annual policy period which typically runs from June 1st to May 31st. See the discussion above for the Insurance Entities’ 2021-2022 reinsurance program and “Part II—Item 8— Note 4 (Reinsurance).”
Premiums earned, net of ceded premium earned, grew by 12.1%, or $111.9 million, to $1,035.5 million for the year ended December 31, 2021, reflecting an increase in direct premium earned offset by increased costs for reinsurance.
Net investment income was $12.5 million for the year ended December 31, 2021, compared to $20.4 million for the same period in 2020, a decrease of $7.9 million, or 38.5%. This decrease is largely attributable to significantly lower yields on the reinvested portfolio following the sale of a majority of available-for-sale debt securities in the portfolio that were in an unrealized gain position in the third and fourth quarters of 2020. In the first quarter of 2020, our investment portfolio was adversely impacted by the COVID-19 pandemic-induced market dislocation, but subsequently recovered, generating unrealized gains that were substantially higher than amounts prior to the pandemic. During the third and fourth quarters of 2020, we took advantage of the recovery by monetizing the increase in fair value, generating $56.4 million in net realized gains from the sale of available-for-sale debt securities.
Market rates during the reinvestment of our portfolio in the second half of 2020 were considerably lower than the book yields of the portfolio prior to the sale. Additionally, interest income was down $0.9 million in 2021 compared to the same period of the prior year due to significantly lower yields on cash sweep and short-term cash investing.
Total invested assets were $1,093.7 million as of December 31, 2021 compared to $919.9 million as of December 31, 2020. The increase is attributable to the reinvestment of investment returns and additional contributions to the investment portfolio from excess cash, partially offset by dispositions of equity securities and investment real estate. Cash and cash equivalents were $250.5 million at December 31, 2021 compared to $167.2 million at December 31, 2020, an increase of 49.9%. This increase is largely attributable to the receipt of $100.0 million in proceeds from the private placement of the 5.625% Senior Unsecured Notes and payment of related debt issuance costs of approximately $3.3 million. See “Part II—Item 8—Note 7 (Long-term debt)” and below “Analysis of Financial Condition” for more information. Cash and cash equivalents are invested short term
until needed to settle loss and LAE payments, reinsurance premium payments and operating cash needs or until they are deployed by our investment advisors.
Yields from cash and cash equivalents, short-term investments and the available-for-sale debt portfolio are dependent on the composition of the portfolio, future market forces, monetary policy and interest rate policy from the Federal Reserve. During most of 2021, the Federal Reserve has broadly been maintaining lower interest rates, which has impacted the effective yields on newly purchased available-for-sale securities and overnight cash purchases and short-term investments. This trend changed in late 2021 as inflation worries began to impact the financial markets, including the markets’ concern over future Federal Reserve actions of rate hikes and other actions to address inflation concern. As a result, we saw increased yields on securities purchased in late 2021 and increased unrealized losses on our portfolio as increased market yields negatively impact the fair value of much of our debt securities. As discussed above, due to the significant sale of our securities during the third quarter and fourth quarter of 2020, it is expected that future portfolio returns will reflect book yields based on the low yielding market conditions when the portfolio was reinvested.
We sell investments, including securities, from our investment portfolio from time to time to meet our investment objectives or take advantage of market opportunities. During the year ended December 31, 2021, sales of available-for-sale debt securities resulted in a net realized gain of $0.2 million, sales of equity securities resulted in a net realized gain of $2.8 million, the sale of two investment real estate properties, which includes one classified as assets held for sale in 2021, resulted in a realized gain of $2.7 million, and one real estate property classified as assets held for sale in 2021 resulted in a realized gain of $0.2 million, in total generating a net realized gain of $5.9 million. During the year ended December 31, 2020, sales of available-for-sale debt securities resulted in a net realized gain of $56.9 million and sales of equity securities resulted in a net realized gain of $6.5 million, in total generating a net realized gain of $63.4 million. In 2020, we took the opportunity to realize the increase in fair value of available-for-sale debt securities to increase the statutory surplus of UPCIC. See “Part II—Item 8—Note 3 (Investments).”
There was a $4.0 million net unrealized loss in equity securities during the year ended December 31, 2021 compared to a nominal net unrealized gain during the year ended December 31, 2020. Net change in unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held at the end of the reported period and the reversal of unrealized gains or losses for securities sold during the period. See “Part II—Item 8—Note 3 (Investments).”
Commission revenue is comprised principally of brokerage commissions we earn from third-party reinsurers (excluding the FHCF) on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1st to May 31st of the following year. For the year ended December 31, 2021, commission revenue was $41.6 million, compared to $33.2 million for the year ended December 31, 2020. The increase in commission revenue of $8.5 million, or 25.6%, for the year ended December 31, 2021 was primarily due to increased commissions from third-party reinsurers earned on increased reinsurance premiums which is attributable due to growth in our insured values, as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year.
Policy fees for the year ended December 31, 2021 were $22.7 million compared to $23.8 million for the same period in 2020. The decrease of $1.1 million, or 4.5%, was the result of a decrease in the combined total number of new and renewal policies written during the year ended December 31, 2021 compared to the same period in 2020 in states where we are permitted to charge this fee.
Other revenue, representing revenue from policy installment fees, premium financing and other miscellaneous income, was $7.6 million for the year ended December 31, 2021 compared to $8.5 million for the same period in 2020.
The following table presents losses and LAE incurred on a direct, ceded and net basis expressed in dollars and as a percent of the respective amounts of premiums earned. These amounts are further categorized as (i) core losses, (ii) weather events for the current accident year and (iii) prior years’ reserve development (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Year Ended December 31, 2021 |
| | | | Loss | | | | Loss | | | | Loss |
| | Direct | | Ratio | | Ceded | | Ratio | | Net | | Ratio |
Premiums earned | | $ | 1,596,618 | | | | | $ | 561,155 | | | | | $ | 1,035,463 | | | |
Losses and loss adjustment expenses: | | | | | | | | | | | | |
Core losses | | $ | 696,775 | | | 43.6 | % | | $ | 20 | | | — | % | | $ | 696,755 | | | 67.3 | % |
Weather events* | | 28,000 | | | 1.8 | % | | — | | | — | % | | 28,000 | | | 2.7 | % |
Prior years’ reserve development | | 464,669 | | | 29.1 | % | | 410,219 | | | 73.1 | % | | 54,450 | | | 5.3 | % |
Total losses and loss adjustment expenses | | $ | 1,189,444 | | | 74.5 | % | | $ | 410,239 | | | 73.1 | % | | $ | 779,205 | | | 75.3 | % |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Year Ended December 31, 2020 |
| | | | Loss | | | | Loss | | | | Loss |
| | Direct | | Ratio | | Ceded | | Ratio | | Net | | Ratio |
Premiums earned | | $ | 1,395,623 | | | | | $ | 472,060 | | | | | $ | 923,563 | | | |
Losses and loss adjustment expenses: | | | | | | | | | | | | |
Core losses | | $ | 538,826 | | | 38.6 | % | | $ | 316 | | | 0.1 | % | | $ | 538,510 | | | 58.3 | % |
Weather events* | | 256,917 | | | 18.4 | % | | 94,954 | | | 20.1 | % | | 161,963 | | | 17.6 | % |
Prior years’ reserve development | | 284,315 | | | 20.4 | % | | 225,978 | | | 47.9 | % | | 58,337 | | | 6.3 | % |
Total losses and loss adjustment expenses | | $ | 1,080,058 | | | 77.4 | % | | $ | 321,248 | | | 68.1 | % | | $ | 758,810 | | | 82.2 | % |
| | | | | |
* | Includes only weather events beyond expected. |
See “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for change in liability for unpaid losses and LAE.
Management looks at losses and LAE in three areas, as described below and represented in the tables above, each of which has different drivers that impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were $779.2 million resulting in a 75.3% net loss and LAE ratio for the year ended December 31, 2021. This compares to $758.8 million resulting in a 82.2% net loss and LAE ratio for the year ended December 31, 2020. Increased ceded premiums also impact the ratio calculations such that the net loss and LAE ratio for the year ended December 31, 2021 also reflects higher relative reinsurance costs compared to the same period in 2020, which contributed an overall increase of 1.5 percentage points to the net loss and LAE ratio. See the discussion above for the Insurance Entities’ 2021-2022 reinsurance programs and “Part II—Item 8—Note 4 (Reinsurance).”
The factors impacting losses and LAE are as follows:
•Core losses
◦Our core losses consist of all losses and LAE for the current year excluding both weather events for the current year beyond those anticipated in our regular accrual process and prior years’ reserve development. Core losses were 67.3% of net premium earned for the year ended December 31, 2021 compared to 58.3% for the same period in 2020. These losses and loss ratios benefit from the potential profits generated through the management of claims by our claims adjusting affiliate, including claim fees ceded to reinsurers, which are described below, reducing core losses. The core loss ratio for 2020 and 2021 reflects actions taken by management to increase its loss pick to accrue for current accident year reserves. Core losses also increase as premium volume increases year over year. Although the Insurance Entities received rate increases in Florida and certain other states, management has elected not to decrease the core loss ratio compared to the prior year but to increase it and to monitor results until management sees loss costs stabilize in Florida and certain other states. During 2021, management increased the core loss ratio in the second quarter of 2021 by one loss ratio point, in the third quarter of 2021 by an additional one loss ratio point and then in the fourth quarter by an additional two and one half loss ratio points ending the year at a 44.5% loss ratio before the benefit of claim service fees. These increases in the expected ultimate losses made during 2021 were retroactive to January 1, 2021 in all three cases. These increases reflect recent and ongoing trends in weather-related claims, higher expected costs for building materials and labor as a result of inflationary pressure as well as the continuing prevalence of solicited, represented, and litigated claims in Florida resulting in increased claims frequencies, losses and loss adjustment expenses.
•Weather events beyond those expected
◦During 2021 there were a number of weather events which in total exceeded amounts included in our core loss ratio by $28.0 million and are reflected in the above chart.
◦During the year ended December 31, 2020, there were a significant number of storms including Hurricane Sally which in the aggregate significantly exceeded core loss ratio expectations. The number of adverse weather events and resulting claims during the fourth quarter of 2020 exceeded weather event claims reported during the first three quarters. Reported losses from Hurricane Sally significantly benefited from our catastrophe reinsurance protection. Our reinsurance program reduced our direct estimate of Hurricane Sally ultimate losses of $133.4 million to $43.0 million on a net basis after estimated reinsurance recoveries. Other weather events resulting in losses with only limited benefit from our catastrophe reinsurance protection included Hurricanes Isaias, Eta, Delta and Zeta and other unnamed storms tracked by an industry numerically assigned identifier. These weather events during 2020 resulted in direct losses of $123.5 million and $119.0 million net after reinsurance. In 2020 the Company experienced the highest level of unnamed weather events when compared to the previous three years.
•Prior years’ reserve development
◦Two drivers influence the amounts recorded as prior years’ reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes to prior estimates of direct and net ultimate losses on hurricanes.
▪For the year ended December 31, 2021, prior years’ reserve development totaled $464.7 million of direct losses and $54.5 million of net unfavorable loss development after the benefit of reinsurance.
•For hurricanes, prior years’ reserve development for the year ended December 31, 2021 was the result of a direct increase in the ultimate losses for several hurricanes of $420.4 million offset by ceded hurricane losses of $410.8 million resulting in net unfavorable development of $9.6 million. Direct losses increased for Hurricanes Irma, Sally, Michael, Matthew and Florence. Net development for Hurricane Irma was $20.6 million as a result of limitations on loss adjustment expenses on losses ceded to the Florida Hurricane CAT Fund and the exhaustion of third party coverage on Hurricane Irma and favorable development on Hurricanes Sally and Michael of $11.0 million as a result of changes in amounts ceded to the All States reinsurance coverage which has a lower retention.
•Excluding hurricanes, there was $44.3 million of direct and $44.9 million net prior years’ reserve development during the year ended December 31, 2021. This development, primarily from the 2020, 2019 and 2017 accident years, primarily resulted from the settlement on litigated claims exceeding prior estimated amounts.
•For the year ended December 31, 2020 prior years’ reserve development totaled $284.3 million of direct losses and $58.3 million of net losses after the benefit of reinsurance.
•Prior years’ reserve development, excluding hurricanes described below, was $42.1 million direct and $40.2 million net of reinsurance for the year ended December 31, 2020. This development largely resulted from increased prior-year non-hurricane companion claims in the run up to the expiration of limitations period for Hurricane Irma claims, the emergence of claims associated with AOB litigated claims, and an increase in reopened claims. In 2019, the Florida legislature enacted legislation intended to reduce abuses with claims involving AOB. Prior to the effective date of the new law, the Company experienced an increase in claims reported by vendors seeking to pursue their claims under the prior law. In many instances, these claims have since further developed into litigated claims during 2020. Also, Hurricane Irma made landfall in 2017. In accordance with Florida law, the deadline for filing Hurricane Irma claims expired three years later in September 2020. As a result, in 2020 the Company experienced adverse development due to non-hurricane companion claims reported with new Hurricane Irma claims reported as the deadline approached. In 2020, claims associated with these issues continued to adversely develop; and Florida’s one-way attorneys’ fee statute and overall negative legal environment have led to increased litigation and higher losses and LAE.
•For the year ended December 31, 2020, development of direct and net losses on previously reported hurricanes was $242.2 million direct and $18.1 million net after the benefit of reinsurance. This was principally driven by continued adverse development of previous estimated losses and LAE on Hurricanes Irma, Michael, Florence and Matthew. Net development for the year ended December 31, 2020 principally resulted from an increase in our previously estimated losses and LAE on Hurricane Irma for claims which are not eligible for recovery from the FHCF.
•Florida law in effect at the time of Hurricane Irma barred new, supplemental or reopened claims for loss caused by the peril of windstorm or hurricane unless notice is provided within three years of the event. In September 2020, the three-year period following Hurricane Irma expired. The Company continues to adjust and settle Hurricane Irma claims that were reported prior to the expiration of the three-year period.
The financial benefit generated by our claims adjusting affiliate from the management of claims, including claim fees ceded by our Insurance Entities to reinsurers, was $11.9 million for the year ended December 31, 2021, compared to $17.3 million during the year ended December 31, 2020, driven by the recoveries from reinsurers and internal claim services. The benefit was recorded in the consolidated financial statements as a reduction to losses and LAE.
For the year ended December 31, 2021, general and administrative expenses were $314.2 million, compared to $289.7 million during the same period in 2020, as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For the Years Ended December 31, | | Change |
| | 2021 | | 2020 | | $ | | % |
| | $ | | Ratio | | $ | | Ratio | | | | |
Premiums earned, net | | $ | 1,035,463 | | | | | $ | 923,563 | | | | | $ | 111,900 | | | 12.1 | % |
General and administrative expenses: | | | | | | | | | | | | |
Policy acquisition costs | | 226,167 | | | 21.8 | % | | 199,102 | | | 21.6 | % | | 27,065 | | | 13.6 | % |
Other operating costs | | 88,066 | | | 8.5 | % | | 90,627 | | | 9.8 | % | | (2,561) | | | (2.8) | % |
Total general and administrative expenses | | $ | 314,233 | | | 30.3 | % | | $ | 289,729 | | | 31.4 | % | | $ | 24,504 | | | 8.5 | % |
(1) Other operating costs includes $652 and $102 of interest expense for the years ended December 31, 2021 and 2020, respectively. |
General and administrative expenses increased by $24.5 million, which was the result of increases in policy acquisition costs of $27.1 million primarily due to commissions and premium taxes associated with increased premium, and a decrease in other operating costs of $2.6 million. The expense ratio as a percentage of premiums earned, net was 30.3% for the year ended December 31, 2021 compared to 31.4% for the year ended December 31, 2020.
•The increase in policy acquisition costs as a percentage of premiums earned, net during the year ended December 31, 2021 was a result of higher reinsurance costs reducing premiums earned, net in a greater proportion than the prior year. The commission rate paid to agents on the renewal of Florida policies was reduced 2 percentage points effective April 1, 2021, which will benefit future periods as the new rate structure applies prospectively.
•The decrease in other operating costs of $2.6 million reflects lower performance compensation, lower share-based compensation, lower marketing and distribution costs, and lower costs associated with employee medical benefits. The other operating cost ratio for the year ended December 31, 2021 was 8.5% compared to 9.8% in the year ended December 31, 2020. This reduction, which was partially offset by higher reinsurance costs, reflects several factors including economies of scale as we continue to grow premium, efficiencies gained from leveraging technology and spending discipline.
As a result of the above, the combined ratio for the year ended December 31, 2021 was 105.6% compared to 113.5% for the same period in 2020. The decrease reflects improved underwriting results when compared to the same period of 2020. The reduction was the result of decreases in both the loss and LAE ratio and expense ratio as described above.
Income tax expense increased by $2.9 million to $8.0 million, or 56.2%, for the year ended December 31, 2021, when compared to income tax expense of $5.1 million for the year ended December 31, 2020. Our effective tax rate increased to 28.2% for the year ended December 31, 2021, as compared to 21.2% for the year ended December 31, 2020. Benefiting the 2020 effective tax rate was a non-recurring liability adjustment of 9.7 points of the effective tax rate. Benefiting 2021 effective tax rate was a non-recurring one-year Florida state income tax reduction which benefited the effective tax rate by 1.4 points when compared to 2020. Significant recurring items which impacted the effective tax rate in 2021 were a lower level of disallowed or non-deductible compensation of 2.1 points of the effective tax rate compared to 6.2 points of the effective tax rate in 2020 and a higher impact from excess tax shortfalls from stock-based compensation of 2.3 points of the effective tax in 2021 when compared to 0.4 points in 2020. See “Part II—Item 8—Note 12 (Income Taxes)” for an a table of items impacting the effective tax rate and an explanation of the change in our effective tax rates.
Other comprehensive loss, net of taxes for the year ended December 31, 2021 was $18.9 million compared to other comprehensive loss of $17.6 million for the same period in 2020, reflecting after-tax changes in fair value of available-for-sale debt securities held in our investment portfolio and reclassifications out of accumulated other comprehensive income for available-for-sale debt securities sold. See “Part II—Item 8—Note 14 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income (loss), net of taxes for these periods.
YEAR ENDED DECEMBER 31, 2020 COMPARED TO YEAR ENDED DECEMBER 31, 2019
A detailed discussion of our results of operations follows the table below (in thousands, except per share data).
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Years Ended December 31, | | Change |
| | 2020 | | 2019 | | $ | | % |
PREMIUMS EARNED AND OTHER REVENUES | | | | | | | | |
Direct premiums written | | $ | 1,517,479 | | | $ | 1,292,721 | | | $ | 224,758 | | | 17.4 | % |
Change in unearned premium | | (121,856) | | | (59,600) | | | (62,256) | | | 104.5 | % |
Direct premium earned | | 1,395,623 | | | 1,233,121 | | | 162,502 | | | 13.2 | % |
Ceded premium earned | | (472,060) | | | (390,619) | | | (81,441) | | | 20.8 | % |
Premiums earned, net | | 923,563 | | | 842,502 | | | 81,061 | | | 9.6 | % |
Net investment income | | 20,393 | | | 30,743 | | | (10,350) | | | (33.7) | % |
Net realized gains (losses) on investments | | 63,352 | | | (12,715) | | | 76,067 | | | NM |
Net change in unrealized gains (losses) of equity securities | | 25 | | | 23,188 | | | (23,163) | | | (99.9) | % |
Commission revenue | | 33,163 | | | 26,101 | | | 7,062 | | | 27.1 | % |
Policy fees | | 23,773 | | | 21,560 | | | 2,213 | | | 10.3 | % |
Other revenue | | 8,501 | | | 7,972 | | | 529 | | | 6.6 | % |
Total premiums earned and other revenues | | 1,072,770 | | | 939,351 | | | 133,419 | | | 14.2 | % |
OPERATING COSTS AND EXPENSES | | | | | | | | |
Losses and loss adjustment expenses | | 758,810 | | | 603,406 | | | 155,404 | | | 25.8 | % |
General and administrative expenses | | 289,729 | | | 272,428 | | | 17,301 | | | 6.4 | % |
Total operating costs and expenses | | 1,048,539 | | | 875,834 | | | 172,705 | | | 19.7 | % |
INCOME BEFORE INCOME TAXES | | 24,231 | | | 63,517 | | | (39,286) | | | (61.9) | % |
Income tax expense | | 5,126 | | | 17,003 | | | (11,877) | | | (69.9) | % |
NET INCOME | | $ | 19,105 | | | $ | 46,514 | | | $ | (27,409) | | | (58.9) | % |
Other comprehensive income (loss), net of taxes | | (17,618) | | | 28,374 | | | (45,992) | | | NM |
COMPREHENSIVE INCOME | | $ | 1,487 | | | $ | 74,888 | | | $ | (73,401) | | | (98.0) | % |
DILUTED EARNINGS PER SHARE DATA: | | | | | | | | |
Diluted earnings per common share | | $ | 0.60 | | | $ | 1.36 | | | $ | (0.76) | | | (55.9) | % |
Weighted average diluted common shares outstanding | | 31,972 | | | 34,233 | | | (2,261) | | | (6.6) | % |
Net income was $19.1 million for the year ended December 31, 2020, compared to net income of $46.5 million for the same period in 2019.
Diluted EPS for the year ended December 31, 2020 was $0.60 compared to $1.36 in 2019, a decrease of $0.76, or 55.9%. Weighted average diluted common shares outstanding for the year ended December 31, 2020 were lower by 6.6% to 32.0 million shares from 34.2 million shares for the same period of the prior year. Benefiting the year ended December 31, 2020 were increases in premiums earned, net, realized gains on investments, commission revenue, policy fees and other revenue, offset by a decrease in net investment income, a lower level of unrealized gains in the fair value of our equity securities in 2020 and increased total operating costs and expenses. Direct premium earned and premiums earned, net were up 13.2% and 9.6%, respectively, due to growth of policies in almost all states in which we are licensed and writing during the past 12 months and rate increases implemented during 2020, offset by higher costs for reinsurance flowing through to premiums earned, net. Increases in losses and LAE were the result of several factors including (1) increased estimated core losses and LAE for the current year compared to prior year, (2) premium growth and change in mix between Florida and other states and (3) increased adverse weather events. The increase was partially offset by a reduced level of prior years’ reserve development in 2020.
Direct premiums written increased by $224.8 million, or 17.4%, for the year ended December 31, 2020, driven by growth within our Florida business of $184.6 million, or 17.3%, and growth in our other states business of $40.1 million, or 17.7%, as compared to the same period of the prior year. Rate increases in Florida and in certain other states along with slightly improved retention also contributed to the premium growth. Premium in force increased in every state in which we are writing at December 31, 2020 compared to December 31, 2019. We implemented new guidelines during the year ended December 31, 2020 on new business to address emerging loss trends that have since slowed the rate of growth in Florida in certain territories during December 31, 2020. We actively wrote policies in 19 states during 2020 compared to 18 in 2019. In addition, we are authorized to do business in Tennessee and Wisconsin and are proceeding with product filings in those states. During the second quarter of 2020 the Company withdrew its application to write business in Connecticut. Policies in force, premium in force and total insured value all increased as of December 31, 2020 when compared to December 31, 2019.
Direct premium earned increased by $162.5 million, or 13.2%, for the year ended December 31, 2020, reflecting the earning of premiums written over the past 12 months and changes in rates and policies in force during that time.
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events and other covered events. Ceded premium represents amounts paid to reinsurers for this protection. Ceded premium earned increased $81.4 million, or 20.8%, for the year ended December 31, 2020 as compared to the same period of the prior year. The increase in reinsurance costs reflects both an increase in costs associated with the increase in exposures we insure, reinstatement premiums emerging during the year and increased pricing when compared to the expired reinsurance program. Reinsurance costs, as a percentage of direct premium earned, increased from 31.7% in 2019 to 33.8% in 2020. During the fourth quarter of 2020 the Company recorded additional ceded written premiums of $18.5 million representing reinstatement premiums on Hurricane Sally losses of which $7.7 million was unearned at December 31, 2020. Reinsurance costs associated with each year’s reinsurance program are earned over the June 1st to May 31st twelve-month coverage period. See the discussion above for the Insurance Entities’ 2020-2021 reinsurance program and “Part II—Item 8— Note 4 (Reinsurance).”
Premiums earned, net of ceded premium earned, grew by 9.6%, or $81.1 million, to $923.6 million for the year ended December 31, 2020, reflecting an increase in direct premium earned offset by increased costs for reinsurance.
Net investment income was $20.4 million for the year ended December 31, 2020, compared to $30.7 million for the same period in 2019, a decrease of $10.4 million, or 33.7%. The decrease is driven by lower trends in market yields. During 2020, the Company sold most securities in an unrealized gain position to recognize market value appreciation. The total amount of securities sold was $1.1 billion. As a result, the Company reinvested its portfolio into similar securities yielding current market rates, which in many cases is a reduction from the book yields of the portfolio prior to the sale and reinvestment. The book yield of the available-for-sale debt securities was 3.08% at December 31, 2019 compared to 1.16% at December 31, 2020, a reduction of 62.3%. Total invested assets were $919.9 million as of December 31, 2020 compared to $914.6 million as of December 31, 2019. Cash and cash equivalents were $167.2 million at December 31, 2020 compared to $182.1 million at December 31, 2019, a decrease of 8.2%. Cash and cash equivalents are invested short term until needed to settle loss and LAE payments, reinsurance premium payments and operating cash needs or until they are deployed by our investment advisors.
Yields from cash and cash equivalents, short-term investments and the available-for-sale debt portfolio are dependent on future market forces, monetary policy and interest rate policy from the Federal Reserve. The Federal Reserve has broadly been lowering and maintaining lower interest rates, which has impacted the effective yields on new available-for-sale portfolio and overnight cash purchases and short-term investments. The overall trend has been lower interest rates on new purchases of securities over the past year and lower returns on cash and cash equivalents and short-term investments. As discussed below, due to the significant sale of securities during the third quarter of 2020, it is expected that future portfolio returns will reflect lower book yields based on current market conditions.
We sell investments from our investment portfolio from time to time to meet our investment objectives or take advantage of market opportunities. During the year ended December 31, 2020, sales of available-for-sale debt securities resulted in net realized gain of $56.9 million and sales of equity securities resulted in net realized gain of $6.5 million, in total generating net realized gain of $63.4 million. We took the opportunity to monetize an increase in fair value of these securities to enhance surplus for UPCIC. The proceeds from the sale of available-for-sale debt securities are in the process of reinvestment. During the year ended December 31, 2019, sales of equity securities resulted in net realized losses of $14.4 million, sales of available-for-sale debt securities resulted in net realized gains of $0.5 million and the sale of an investment real estate property resulted in a realized gain of $1.2 million, in total generating net realized loss of $12.7 million. See “Part II—Item 8—Note 3 (Investments).”
There was a nominal favorable net unrealized gain in equity securities during the year ended December 31, 2020 compared to a $23.2 million favorable net unrealized gain during the year ended December 31, 2019. Unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held and the reversal of unrealized gains or losses for securities sold during the period. See “Part II—Item 8—Note 3 (Investments).”
During 2020, the COVID-19 pandemic disrupted the financial markets. In the first quarter of 2020, our investment portfolio was negatively impacted, but has since substantially recovered. We took advantage of the recovery with the realization of gains on our available-for-sale debt securities discussed above. We believe the adverse impact to our investment portfolio was minimized during this COVID-19-induced market dislocation as a result of our conservative investment strategy’s focus on capital preservation and adequate liquidity to pay claims. We believe the high credit rating and shorter duration foundation of our portfolio and portfolio diversification will help us weather these difficult market conditions, thereby limiting the impact of future economic financial market downturns on the portfolio. Recent market yields have been lower when compared to prior years and we expect that trend to continue, negatively impacting future investment returns on our portfolio. We will continue to monitor the impact of COVID-19 on our portfolio. Significant uncertainties and emerging risks still exist regarding the potential long-term impact of COVID-19 on the credit markets and our investment portfolio.
Commission revenue is comprised principally of brokerage commissions we earn from third-party reinsurers (excluding the FHCF) on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1st to May 31st of the following year. For the year ended December 31, 2020, commission revenue was $33.2 million, compared to $26.1 million for the year ended December 31, 2019. The increase in commission revenue of $7.1 million, or 27.1%, for the year ended December 31, 2020 was primarily due to increased commissions from third-party
reinsurers earned on increased reinsurance premiums due to growth in our exposures, as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year.
Policy fees for the year ended December 31, 2020 were $23.8 million compared to $21.6 million for the same period in 2019. The increase of $2.2 million, or 10.3%, was the result of an increase in the total number of new and renewal policies written during the year ended December 31, 2020 compared to the same period in 2019.
Other revenue, representing revenue from policy installment fees, premium financing and other miscellaneous income, was $8.5 million for the year ended December 31, 2020 compared to $8.0 million for the same period in 2019.
The following table presents losses and LAE incurred on a direct, ceded and net basis expressed in dollars and as a percent of the respective amounts of earned premium. These amounts are further categorized as 1) core losses, 2) weather events for the current accident year and 3) prior years’ reserve development (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | For The Year Ended December 31, 2020 |
| | Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | | $ | 1,395,623 | | | | | $ | 472,060 | | | | | $ | 923,563 | | | |
Losses and loss adjustment expenses: | | | | | | | | | | | | |
Core losses | | $ | 538,826 | | | 38.6 | % | | $ | 316 | | | 0.1 | % | | $ | 538,510 | | | 58.3 | % |
Weather events* | | 256,917 | | | 18.4 | % | | 94,954 | | | 20.1 | % | | 161,963 | | | 17.6 | % |
Prior years’ reserve development | | 284,315 | | | 20.4 | % | | 225,978 | | | 47.9 | % | | 58,337 | | | 6.3 | % |
Total losses and loss adjustment expenses | | $ | 1,080,058 | | | 77.4 | % | | $ | 321,248 | | | 68.1 | % | | $ | 758,810 | | | 82.2 | % |
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| | For The Year Ended December 31, 2019 |
| | Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | | $ | 1,233,121 | | | | | $ | 390,619 | | | | | $ | 842,502 | | | |
Losses and loss adjustment expenses: | | | | | | | | | | | | |
Core losses | | $ | 476,739 | | | 38.7 | % | | $ | 51 | | | — | % | | $ | 476,688 | | | 56.6 | % |
Weather events* | | 45,562 | | | 3.7 | % | | 6,912 | | | 1.8 | % | | 38,650 | | | 4.6 | % |
Prior years’ reserve development | | 562,303 | | | 45.6 | % | | 474,235 | | | 121.4 | % | | 88,068 | | | 10.4 | % |
Total losses and loss adjustment expenses | | $ | 1,084,604 | | | 88.0 | % | | $ | 481,198 | | | 123.2 | % | | $ | 603,406 | | | 71.6 | % |
*Includes only current weather events beyond those expected.
See “Part II—Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for change in liability for unpaid losses and LAE.
Management evaluates losses and LAE in three areas, as described below and represented in the tables above, each of which have different drivers which impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were $758.8 million resulting in a 82.2% net loss and LAE ratio for the year ended December 31, 2020. This compares to $603.4 million resulting in a 71.6% net loss and LAE ratio for the year ended December 31, 2019.
The factors impacting losses and LAE are as follows:
Core losses
Our core losses consist of all losses and LAE, except weather events beyond those expected and prior years’ reserve development. We establish core loss reserves by applying a direct loss percentage (loss pick) to direct premium earned. The loss pick is set by management each year with input coming out of the annual study performed by our independent third-party
actuary. Our loss pick before the claims management benefits described below, which we increased in 2019 as a result of higher loss trends in Florida, was increased slightly (0.9 loss ratio points) in 2020.
The core losses and loss ratios in the above table benefit from favorable claim management adjustment benefits derived from certain ceded claim fees or other benefits, which are described below, reducing core losses. Core losses for the year, after favorable claim management adjusting benefits for the year ended 2020 were 38.6% of direct premium earned compared to 38.7% for the same period in 2019. Although the core loss ratio only slightly changed year over year, core loss and LAE has increased and reserves increased resulting from higher premium volume and the impact of primary rate increases approved in 2020.
Weather events beyond those expected
During the year ended December 31, 2020, there were a significant number of storms including Hurricane Sally compared to prior years which in the aggregate exceeded core loss ratio expectations. The number of adverse weather events and resulting claims during the fourth quarter exceeded weather event claims reported during the first three quarters. Reported losses from Hurricane Sally significantly benefited from our catastrophe reinsurance protection. Our reinsurance program reduced our direct estimate of Hurricane Sally ultimate losses of $133.4 million to $43.0 million on a net basis after estimated reinsurance recoveries. Other weather events resulting in losses with only limited benefit from our catastrophe reinsurance protection included Hurricanes Isaias, Eta, Delta and Zeta and other unnamed storms tracked by an industry numerically assigned identifier. These weather events totaled direct losses of $123.5 million and $119.0 million net after reinsurance. In 2020 the Company experienced the highest level of unnamed weather events when compared to the previous three years.
During the year ended December 31, 2019, weather events totaled $45.6 million direct and $38.7 million net, principally for Hurricane Dorian and other weather events beyond those expected.
Prior years’ reserve development
Management identifies two drivers which influence amounts recorded as prior years’ reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes in prior estimates of direct and net ultimate losses on hurricanes. During the year ended December 31, 2020, prior years’ reserve development totaled $284.3 million of direct losses and $58.3 million of net losses after the benefit of reinsurance.
Prior years’ reserve development, excluding hurricanes described above, was $42.1 million direct and $40.2 million net of reinsurance for the year ended December 31, 2020. This development largely resulted from increased prior-year non-hurricane companion claims in the run up to the expiration of limitations period for Hurricane Irma claims, the emergence of claims associated with AOB litigated claims, and an increase in reopened claims. In 2019, the Florida legislature enacted legislation intended to reduce abuses with claims involving AOB. Prior the effective date of the new law, the Company experienced an increase in claims reported by vendors seeking to pursue their claims under the prior law. In many instances, these claims have since further developed into litigated claims during 2020. Also, Hurricane Irma made landfall in 2017. In accordance with Florida law, the deadline for filing Hurricane Irma claims expired three years later in September 2020. As a result, in 2020 the Company experienced adverse development due to non-hurricane companion claims reported with new Hurricane Irma claims reported as the deadline approached. In 2020, claims associated with these issues continued to adversely develop, Florida’s one-way attorneys’ fee statute and overall negative legal environment have led to increased litigation and higher losses and LAE.
For the year ended December 31, 2020, development of direct and net losses on previously reported hurricanes was $242.2 million direct and $18.1 million net after the benefit of reinsurance. This was principally driven by continued adverse development of previous estimated losses and LAE on Hurricanes Irma, Michael, Florence and Matthew. Net development for the year ended December 31, 2020 principally resulted from an increase in our previously estimated losses and LAE on Hurricane Irma for claims which are not eligible for recovery from the FHCF.
As noted above, Florida law bars new, supplemental or reopened claim for loss caused by the peril of windstorm or hurricane unless notice is provided within three years of the event. In September 2020, the three-year period following Hurricane Irma expired. The Company continues to adjust and settle Hurricane Irma claims that were reported prior to the expiration of the three-year period.
For the year ended December 31, 2019, direct prior years’ reserve development of $562.3 million was principally due to increased ultimate direct losses and LAE for Hurricane Irma, which were fully ceded, while net prior years’ reserve development of $88.1 million was principally due to a change in the allocation of estimated reinsurance recoveries on Hurricane Michael losses from our Non-Florida reinsurance coverage to the All States reinsurance coverage. The Non-Florida reinsurance coverage has a lower retention and the change in the allocation of reinsurance recoveries to the All States reinsurance coverage resulted in higher retained losses.
The net loss and LAE ratio for the year ended December 31, 2020 was 82.2% compared to 71.6% for the prior year. The increase of 10.6% loss ratio points was a result of: (1) increase in weather (13.0% loss ratio points); and (2) an increase in estimated core losses and LAE ratio for the current year (1.7% loss ratio points) principally the result of higher reinsurance costs. The increase was partially offset by a lower level of prior years’ reserve development on prior years’ losses and LAE reserves (4.1% loss ratio points).
The Company continues to experience increased costs for losses and LAE in the Florida market where an industry has developed around the solicitation, filing and litigation of personal residential claims, resulting in a pattern of continued increased year over year levels of represented claims, inflation of purported claim amounts, and increased demands for attorneys’ fee. Active solicitation of personal residential claims in Florida by policyholder representatives, remediation companies and repair companies has led to an increase in the frequency and severity of personal residential claims in Florida exceeding historical levels and levels seen in other jurisdictions. A Florida statute providing a one-way right of attorneys’ fees against insurers, coupled with other adverse statutes and judicial rulings, have further produced a legal environment in Florida that encourages litigation, in many cases without regard to the underlying circumstances of the claims.
The market trends in losses and LAE led us to file in February 2020 for an overall 12.4% rate increase in Florida, which was approved effective May 18, 2020 for new business and July 7, 2020 for renewals. In addition we filed and received approval on December 31, 2020 to further increase our rates in Florida by an additional 7.0% in response to higher reinsurance costs associated with the reinsurance program we put into effect June 1, 2020. This rate change was effective December 31, 2020 for new business and March 1, 2021 for renewal business. In addition, we implemented changes to certain new business underwriting guidelines, reduced new business writings in certain Florida counties and developed and implemented specialized claims and litigation management efforts to address market trends which we believe are driving up claim costs. Nonetheless, the deterioration of the Florida residential insurance market, fostered by the proliferation of represented and litigated claims, thus far has outpaced the benefits of these initiatives.
The financial benefit from the management of claims ceded, including claim fees ceded to reinsurers, was $17.3 million for the year ended December 31, 2020, compared to $3.2 million during the year ended December 31, 2019, driven primarily by the recoveries from reinsurers in excess of costs and the financial impact of internal claim services on the expected core loss ratio. The benefit was recorded in the consolidated financial statements as a reduction to losses and LAE.
General and administrative expenses were $289.7 million for the year ended December 31, 2020, compared to $272.4 million during the same period in 2019 as detailed below (dollars in thousands):
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| | For The Years Ended December 31, | | Change |
| | 2020 | | 2019 | | $ | | % |
| | $ | | Ratio | | $ | | Ratio | | | | |
Premiums earned, net | | $ | 923,563 | | | | | $ | 842,502 | | | | | $ | 81,061 | | | 9.6 | % |
General and administrative expenses: | | | | | | | | | | | | |
Policy acquisition costs | | 199,102 | | | 21.6 | % | | 177,530 | | | 21.1 | % | | 21,572 | | | 12.2 | % |
Other operating costs (1) | | 90,627 | | | 9.8 | % | | 94,898 | | | 11.2 | % | | (4,271) | | | (4.5) | % |
Total general and administrative expenses | | $ | 289,729 | | | 31.4 | % | | $ | 272,428 | | | 32.3 | % | | $ | 17,301 | | | 6.4 | % |
(1)Other operating costs includes $102 and $248 of interest expense for the years ended December 31, 2020 and 2019, respectively. |
General and administrative expenses increased by $17.3 million, which was the result of increases in policy acquisition costs of $21.6 million due to commissions associated with increased premium volume offset by a decrease in other operating costs of $4.3 million. The expense ratio as a percentage of premiums earned, net decreased from 32.3% for the year ended December 31, 2019 to 31.4% for the same period in 2020. Our increase in policy acquisition costs continued to be driven by increased premium volume and continued geographic expansion into states that typically have higher commission rates as compared to Florida. Other operating costs ratio for the year ended December 31, 2020 was 9.8% compared to 11.2% for the year ended December 31, 2019, reflecting lower share-based compensation and performance bonuses in 2020 and economies of scale as other operating costs did not increase at the same rate as premiums earned, net. In addition, due to the COVID-19 pandemic, travel and auto expenses along with meal and entertainment were lower in 2020 when compared to the prior year.
Income tax expense decreased by $11.9 million, or 69.9%, for the year ended December 31, 2020, primarily as a result of a 61.9% reduction in income before income taxes, when compared with the year ended December 31, 2019. Our estimated tax rate (“ETR”) decreased to 21.2% for the year ended December 31, 2020, as compared to 26.8% for the year ended December 31, 2019. The ETR decreased as a result of a higher ratio of permanent items relative to the amount of income before taxes, principally non-deductible compensation, and a higher level of discrete tax benefits.
Other comprehensive loss, net of taxes for the year ended December 31, 2020 was $17.6 million, compared to other comprehensive income of $28.4 million for the same period in 2019, reflecting reclassifications out of cumulative other comprehensive income for available-for-sale debt securities sold and after-tax changes in fair value of available-for-sale debt securities held in our investment portfolio. See “Part II—Item 8—Note 11 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income for these periods.
ANALYSIS OF FINANCIAL CONDITION AS OF DECEMBER 31, 2021 COMPARED TO DECEMBER 31, 2020
We believe that cash flows generated from operations will be sufficient to meet our working capital requirements for at least the next twelve months. We invest amounts considered to be in excess of current working capital requirements.
The following table summarizes, by type, the carrying values of investments as of the dates presented (in thousands):
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| | As of December 31, |
Type of Investment | | 2021 | | 2020 |
Available-for-sale debt securities | | $ | 1,040,455 | | | $ | 819,861 | |
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Equity securities | | 47,334 | | | 84,887 | |
Investment real estate, net | | 5,891 | | | 15,176 | |
Total | | $ | 1,093,680 | | | $ | 919,924 | |
See “Part II—Item 8—Consolidated Statements of Cash Flows” and “Item 8—Note 3 (Investments)” for explanations on changes in investments. Investment real estate, net was reduced by $9.3 million during 2021 as a result of the sale of two investment real estate properties, one which was classified as assets held for sale earlier in 2021 . The gain on the sale of these two investment properties was $2.7 million.
Restricted cash and cash equivalents decreased by $10.1 million to $2.6 million as of December 31, 2021 as a result of the release of collateral held by a reinsurance captive arrangement between affiliates that was terminated effective December 1, 2021, pursuant to the terms of the agreement. In connection with the termination of the agreement, the affiliates agreed to release funds held in trust due to UPCIC and the balance to the participant of the separate account (UVE) in December 2021. See “Part II—Item 8—Note 18 (Variable Interest Entities)” for more information.
Prepaid reinsurance premiums represent the portion of unearned ceded written premium that will be earned pro-rata over the coverage period of our reinsurance program, which runs from June 1st to May 31st of the following year. The increase of $25.3 million to $241.0 million as of December 31, 2021 was primarily due to additional ceded written premium and the reinsurance costs relating to our 2021-2022 catastrophe reinsurance program beginning June 1, 2021, less amortization of ceded written premium for the reinsurance costs earned since the beginning of the program.
Reinsurance recoverable represents the estimated amount of paid and unpaid losses, LAE and other expenses that are expected to be recovered from reinsurers. The increase of $25.2 million to $185.6 million as of December 31, 2021 was primarily due to the increased estimate of amounts recoverable from reinsurers relating to settled claims from hurricanes and covered by our reinsurance contracts.
Premiums receivable, net represents amounts receivable from policyholders. The decrease in premiums receivable, net of $2.0 million to $64.9 million as of December 31, 2021 relates to consumer payment behavior of our business.
Deferred policy acquisition costs (“DPAC”) decreased by $1.8 million to $108.8 million as of December 31, 2021, which is consistent with the underlying premium growth and changes to the Company’s commission structure. See “Part II—Item 8—Note 5 (Insurance Operations)” for a roll-forward in the balance of our DPAC.
Income taxes recoverable represents the difference between estimated tax obligations and tax payments made to taxing authorities. As of December 31, 2021, the balance recoverable was $16.9 million, representing amounts due from taxing authorities at that date, compared to a balance recoverable of $30.6 million as of December 31, 2020. Income taxes recoverable as of December 31, 2021 will either be refunded or applied to future periods to offset future federal and state income tax obligations.
Deferred income taxes represent the estimated tax asset or tax liability caused by temporary differences between the tax return basis of certain assets and liabilities and amounts recorded in the financial statements. During the year ended December 31, 2021, the deferred income tax asset, net increased by $10.0 million to $16.3 million. Deferred income taxes reverse in future years as the temporary differences between book and tax reverse.
Other assets increased by $7.2 million to $22.0 million as of December 31, 2021, primarily driven from increases in receivable due from brokers relating to securities sold from our investment portfolio which settled after December 31, 2021.
See “Part II—Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a roll-forward in the balance of our unpaid losses and LAE. Unpaid losses and LAE increased by $23.8 million to $346.2 million as of December 31, 2021. The increase in unpaid losses and LAE was principally due to increases in the core loss ratio, increases in the estimated amounts to settle claims from previous hurricane and storm events, the impact of inflation on estimated claims settlements and increased litigation costs. Unpaid losses and LAE are net of estimated subrogation recoveries of $119 million as of December 31, 2021 compared to $71 million as of December 31, 2020.
Unearned premiums represent the portion of direct premiums written that will be earned pro-rata in the future. The increase of $74.6 million to $857.8 million as of December 31, 2021 reflects the increase in written premiums of our business.
Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $4.1 million from December 31, 2020 to $53.7 million as of December 31, 2021 reflects customer payment behavior.
We exclude net negative cash balances, if any, from cash and cash equivalents that we have with any single financial institution based on aggregating the book balance of all accounts at the institution which have the right of offset. If the aggregation results in a net negative book balance, that balance is reclassified from cash and cash equivalents in our Consolidated Balance Sheet to book overdraft. These amounts represent outstanding checks or drafts not yet presented to the financial institution in excess of amounts on deposit at the financial institutions. We maintain a short-term cash investment strategy sweep to maximize investment returns on cash balances. Book overdraft totaled $26.8 million as of December 31, 2021, compared to $59.4 million as of December 31, 2020. The decrease of $32.6 million is the result of higher cash balances available for offset as of December 31, 2021 compared to December 31, 2020.
Reinsurance payable, net, represents the unpaid reinsurance premium installments owed to reinsurers, unpaid reinstatement premiums due to reinsurers and cash advances received from reinsurers, if any. On June 1st of each year, we renew our core catastrophe reinsurance program and record the estimated annual cost of our reinsurance program. These estimated annual costs are increased or decreased during the year based on premium adjustments or as a result of new placements during the year. The annual cost initially increases reinsurance payable, which is then reduced as installment payments are made over the policy period of the reinsurance, which typically runs from June 1st to May 31st. The balance increased by $178.4 million to $188.7 million as of December 31, 2021 as a result of an acceleration of payments in December 2020 for amounts typically paid in January and April of the following year relating to the 2020-2021 reinsurance program. There was no similar acceleration of payment made for the year ended December 31, 2021 relating to the 2021-2022 reinsurance program.
Other liabilities and accrued expenses decreased by $25.0 million to $27.3 million as of December 31, 2021, primarily driven by decreases in the collection of advanced reinsurance commission of $14.0 million and payable for unsettled security purchases of $8.8 million. Advance reinsurance commission represents the early collection of reinsurance commissions as a result of the Company settling its reinsurance obligations before the contractual due date. Payables for securities purchased represents payables relating to available-for-sale debt securities purchases which settled after December 31, 2020. There were payables for securities purchased totaling $8.8 million as of December 31, 2020. There were no payables for securities purchased as of December 31, 2021.
Capital resources, net increased by $75.7 million during the year ended December 31, 2021, reflecting a net increase in total stockholders’ equity and long-term debt. The decrease in stockholders’ equity was principally the result of our benefits coming from our 2021 net income and share-based compensation offset by declines in the after-tax changes in the fair value of available-for-sale debt securities, treasury shares purchases and dividends to shareholders. Available-for-sale debt securities in the portfolio experienced net unrealized losses of $24.6 million (before tax) in 2021, which caused the net unrealized gain position of $4.4 million at December 31, 2020 to decrease to a net unrealized loss position of $20.2 million at December 31, 2021. Current market outlooks, signaling further Federal Reserve tightening, could have a negative impact on the valuation of available-for-sale debt securities. See “Part II—Item 8—Consolidated Statements of Stockholders’ Equity” and “Item 8—Note 8 (Stockholders’ Equity)” for an explanation of changes in treasury shares. The increase in long-term debt of $95.2 million was primarily the result of cash proceeds from the Notes, net of debt issuance costs of $96.7 million offset by principal payments on long-term debt of $1.5 million during 2021. See “—Liquidity and Capital Resources” for more information.
Additional paid-in-capital increased by $4.8 million primarily from share-based compensation expense of $5.8 million for the year ended December 31, 2021. This was offset by the common stock value acquired and cancelled through tax withholdings on the intrinsic value of performance units and restricted stock units vested for share-based payment transactions of $1.1 million for the year ended December 31, 2021.
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short- and long-term obligations. Funds generated from operations have been sufficient and we expect them to be sufficient to meet our current and long term liquidity requirements. See discussion below regarding the COVID-19 pandemic’s impact. Also see the discussion above under “Overview—Trends—Impact of the COVID-19 Pandemic” regarding our response to the COVID-19 pandemic, the financial impact to us, our general outlook and plans to monitor the economic consequences of the COVID-19 pandemic.
The balance of cash and cash equivalents, excluding restricted cash, as of December 31, 2021 was $250.5 million, compared to $167.2 million at December 31, 2020. See “Part II—Item 8—Consolidated Statements of Cash Flows” for a reconciliation of the balance of cash and cash equivalents between December 31, 2021 and 2020. The increase in cash and cash equivalents was driven by cash flows generated from operating and financing activities in excess of cash flows used in investing activities. Our cash investment strategy at times includes cash investments where the right of offset against other bank accounts does not exist. A book overdraft occurs when aggregating the book balance of all accounts at a financial institution for accounts which have the right of offset, and if the aggregation results in a net negative book balance, that balance is reclassified from cash and cash equivalents in our Consolidated Balance Sheet to book overdraft. Cash and cash equivalents balances are available to settle
book overdrafts, and to pay reinsurance premiums, expenses and claims. Reinsurance premiums are paid in installments during the reinsurance policy period, which runs from June 1st to May 31st of the following year. The FHCF reimbursement premiums are paid in three installments on August 1st, October 1st and December 1st, and third-party reinsurance premiums are generally paid in four installments on July 1st, October 1st, January 1st and April 1st, resulting in significant payments at those times. See “Part II—Item 8—Note 15 (Commitments and Contingencies)” and “—Material Cash Requirements” for more information.
During 2020, there was one significant hurricane, Hurricane Sally, in which estimated losses benefited from UPCIC’s reinsurance program. The Company’s reinsurance program provides sufficient liquidity in the form of cash advances for paid losses ceded to the reinsurers. During 2021, the Company routinely collected amounts ceded to reinsurers and, as in the past did not have to use funds in the Company’s investment portfolio. See “Results of Operations” for more information.
The balance of restricted cash and cash equivalents as of December 31, 2021 and 2020 represents cash equivalents on deposit with certain regulatory agencies in the various states in which our Insurance Entities do business. Restricted cash and cash equivalents also includes collateral held by a reinsurance captive arrangement with one of the Insurance Entities reported as a VIE in the condensed consolidated financial statements. The amount of collateral held was $10.1 million as of December 31, 2020. See “Part II—Item 8—Note 18 (Variable Interest Entities)” for more information.
Liquidity is required at the holding company for us to cover the payment of general operating expenses and contingencies, dividends to shareholders (if and when authorized and declared by our Board of Directors), payment for the possible repurchase of our common stock (if and when authorized by our Board of Directors), payment of our tax obligations, capital contributions to subsidiaries, if needed, and interest and principal payments on outstanding debt obligations of the holding company. See “Part II—Item 8—Note 5 (Insurance Operations).” The declaration and payment of future dividends to our shareholders, and any future repurchases of our common stock, will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, debt covenants and any regulatory constraints. New regulations or changes to existing regulations imposed on the Company and its affiliates may also impact the amount and timing of future dividend payments to the parent. Principal sources of liquidity for the holding company include dividends paid by our service entities generated from income earned on fees paid by the Insurance Entities to affiliated companies for general agency, inspections and claims adjusting services. Dividends are also paid from income earned from brokerage commissions earned on reinsurance contracts placed by BARC and policy fees. We also maintain high quality investments in our portfolio as a source of liquidity along with ongoing interest and dividend income from those investments. As discussed in “Item 8—Note 5 (Insurance Operations),” there are limitations on the dividends the Insurance Entities may pay to their immediate parent company, Protection Solutions, Inc. (“PSI”, formerly known as Universal Insurance Holding Company of Florida).
The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the FLOIR is subject to restrictions as referenced below and in “Item 8—Note 5 (Insurance Operations).” Dividends from the Insurance Entities can only be paid from accumulated unassigned funds derived from net operating profits and net realized capital gains. Subject to such accumulated unassigned funds, the maximum dividend that may be paid by the Insurance Entities to PSI without prior approval (an “ordinary dividend”) is further limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the years ended December 31, 2021 and 2020 the Insurance Entities did not pay dividends to PSI.
On November 23, 2021, we entered into Note Purchase Agreements with certain institutional accredited investors and qualified institutional buyers pursuant to which we issued and sold $100 million of 5.625% Senior Unsecured Notes due 2026 and we intend to use the net proceeds for general corporate purposes, including growth capital. If necessary, the Company also has amounts available under our unsecured revolving loan as discussed in “Part II—Item 8—Note 7 (Long-term debt).”
Liquidity for the Insurance Entities is primarily required to cover payments for reinsurance premiums, claims payments including potential payments of catastrophe losses (offset by recovery of any reimbursement amounts under our reinsurance agreements), fees paid to affiliates for managing general agency services, inspections and claims adjusting services, agent commissions, premium and income taxes, regulatory assessments, general operating expenses, and interest and principal payments on debt obligations. The principal source of liquidity for the Insurance Entities consists of the revenue generated from the collection of premiums earned, net, interest and dividend income from the investment portfolio, the collection of reinsurance recoverable and financing fees.
Our insurance operations provide liquidity as premiums are generally received months or even years before potential losses are paid under the policies written. In the event of catastrophic events, many of our reinsurance agreements provide for “cash advance” whereby reinsurers advance or prepay amounts to us, thereby providing liquidity, which we utilize in the claim settlement process. In addition, the Insurance Entities maintain substantial investments in highly liquid, marketable securities, which would generate funds upon sale. The average credit rating on our available-for-sale securities was A+ as of December 31, 2021 and December 31, 2020. Credit ratings are a measure of collection risk on invested assets. Credit ratings are provided by third party nationally recognized rating agencies and are periodically updated. Management establishes guidelines for minimum credit rating and overall credit rating for all investments. The duration of our available-for-sale securities was 4.4 years as of December 31, 2021 compared to 4.0 years at December 31, 2020. Duration is a measure of a bond’s sensitivity to interest rate changes and is used by management to limit the potential impact of longer-term investments.
The Insurance Entities are responsible for losses related to catastrophic events in excess of coverage provided by the Insurance Entities’ reinsurance programs and retentions before our reinsurance protection commences. Also, the Insurance Entities are responsible for all other losses that otherwise may not be covered by the reinsurance programs and any amounts arising in the
event of a reinsurer default. Losses or a default by reinsurers may have a material adverse effect on either of the Insurance Entities or on our business, financial condition, results of operations and liquidity.
Capital Resources
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. The following table provides our stockholders’ equity, total long-term debt, total capital resources, debt-to-total capital ratio and debt-to-equity ratio for the periods presented (dollars in thousands):
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| | As of December 31, |
| | 2021 | | 2020 |
Stockholders’ equity | | $ | 429,702 | | | $ | 449,262 | |
Total long-term debt | | 103,676 | | | 8,456 | |
Total capital resources | | $ | 533,378 | | | $ | 457,718 | |
| | | | |
Debt-to-total capital ratio | | 19.4 | % | | 1.8 | % |
Debt-to-equity ratio | | 24.1 | % | | 1.9 | % |
The debt-to-total capital ratio is total long-term debt divided by total capital resources, whereas the debt-to-equity ratio is total long-term debt divided by stockholders’ equity. These ratios help management measure the amount of financing leverage in place in relation to equity and future leverage capacity.
The Insurance Entities are required annually to comply with the NAIC RBC requirements. RBC requirements prescribe a method of measuring the amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. NAIC’s RBC requirements are used by regulators to determine appropriate regulatory actions relating to insurers who show signs of weak or deteriorating condition. As of December 31, 2021, based on calculations using the appropriate NAIC RBC formula, the Insurance Entities reported respective total adjusted capital in excess of the requirements. Failure by the Insurance Entities to maintain the required level of statutory capital and surplus could result in the suspension of their authority to write new or renewal business, other regulatory actions, or ultimately, in the revocation of their certificate of authority by the FLOIR.
In 2006, UPCIC entered into a $25.0 million surplus note with the State Board of Administration of Florida (the “SBA”) under Florida’s Insurance Capital Build-Up Incentive Program (the “ICBUI”). The surplus note has a twenty-year term, with quarterly payments of interest based on the 10-year Constant Maturity Treasury Index. As of December 31, 2021, UPCIC’s net written premium to surplus ratio and gross written premium to surplus ratio were in excess of the required minimums and, therefore, UPCIC is not subject to increases in interest rates. See “Part II—Item 8—Note 7 (Long-term debt)” for additional details. At December 31, 2021, UPCIC was in compliance with the terms of the surplus note and with each of the loan’s covenants as implemented by rules promulgated by the SBA. Total adjusted capital surplus, which includes the surplus note, was in excess of regulatory requirements for both UPCIC and APPCIC.
As discussed in “Part II—Item 8—Note 7 (Long-term debt),” we entered into a credit agreement and related revolving loan with JPMorgan Chase Bank, N.A. in August 2021 which makes available an unsecured revolving credit facility with an aggregate commitment not to exceed $35.0 million. Borrowings under the Revolving Loan mature 364 days after the date of the loan. The Revolving Loan contains customary financial covenants. As of December 31, 2021, the Company was in compliance with all applicable covenants, including financial covenants. We had not drawn any amounts under the Revolving Loan as of December 31, 2021.
In November 2021, we completed a private placement offering through which we issued and sold $100 million of 5.625% Senior Unsecured Notes due 2026 (the “Notes”) to certain institutional accredited investors and qualified institutional buyers. The Notes mature on November 26, 2026, at which time the entire $100.0 million of principal is due and payable. At any time on or after November 23, 2023, the Company may redeem all or part of the Notes. See “Part II—Item 8—Note 7 (Long-term debt)” for additional details. As of December 31, 2021, we were in compliance with all applicable covenants, including financial covenants.
We will also continue to evaluate opportunities to access the debt capital markets to raise additional capital. We anticipate any proceeds would be used for general corporate purposes, including investing in the capital and surplus of the Insurance Entities.
In addition to the liquidity generally provided from operations, we maintain a conservative, well-diversified investment portfolio, predominantly comprised of fixed income securities with an average credit rating of A+, that focuses on capital preservation and providing an adequate source of liquidity for potential claim payments and other cash needs. The portfolio’s secondary investment objective is to provide a total rate of return with emphasis on investment income. Historically, we have consistently generated funds from operations, allowing our cash and invested assets to grow. We have not had to liquidate investment holdings to fund either operations or financing activities.
Impact of COVID-19 Pandemic
Towards the latter part of 2020 there had been a significant recovery in the fair value of invested assets since the low point on or about March 23, 2020 and in the third and fourth quarters of 2020, the Company sold many of its securities in an unrealized gain position to take advantage of the recovery in asset values. The proceeds from the sales of available-for-sale debt securities in the third and fourth quarters of 2020 have been fully reinvested. The sales took advantage of increased market prices occurring on our available-for-sale debt investment portfolio. As a result of the sales and reinvestment of available-for-sale debt securities, it is expected that future portfolio investment income will lower, as reinvestment rates reflect market rates which are below the book yields of the securities sold.
The impact of the COVID-19 pandemic on the credit markets remains a key risk as the world continues to navigate its consequences and the efforts taken by governments to accelerate and stimulate a financial recovery. We remain in regular contact with our advisors to monitor the credit quality of the issuers of the securities in our portfolio and discuss appropriate responses to credit downgrades or changes in companies’ credit outlook. We believe these measures, when combined with the inherent liquidity generated by our business model and in our investment portfolio, will allow us to continue to meet our short- and long-term obligations.
Looking Forward
We continue to monitor a range of financial metrics related to our business. Although we have not yet experienced material adverse impacts on our business or liquidity, conditions are subject to change depending on the extent of the economic downturn, and the pace and extent of an economic recovery. Significant uncertainties exist with the potential long-term impact of the COVID-19 pandemic, including unforeseen newly emerging risks that could affect us. We will continue to monitor the broader economic impacts of the COVID-19 pandemic and its impact on our operations and financial condition including liquidity and capital resources.
Common Stock Repurchases
We may repurchase shares from time to time at our discretion, based on ongoing assessments of our capital needs, the market price of our common stock and general market conditions. We will fund the share repurchase program with cash from operations.
In total, during the year ended December 31, 2021, we repurchased an aggregate of 116,886 shares of our common stock in the open market at an aggregate purchase price of $1.6 million. Also see “Part II—Item 5—Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities—Registrant Purchases of Equity Securities” for share repurchase activity during 2021 and the three months ended December 31, 2021.
Cash Dividends
The following table summarizes the dividends declared and paid by the Company during the year ended December 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Dividend | | Shareholders | | Dividend | | Cash Dividend |
2021 | | Declared Date | | Record Date | | Payable Date | | Per Share Amount |
First Quarter | | March 1, 2021 | | March 11, 2021 | | March 18, 2021 | | $ | 0.16 | |
Second Quarter | | April 22, 2021 | | May 14, 2021 | | May 21, 2021 | | $ | 0.16 | |
Third Quarter | | July 19, 2021 | | August 2, 2021 | | August 9, 2021 | | $ | 0.16 | |
Fourth Quarter | | November 15, 2021 | | December 10, 2021 | | December 17, 2021 | | $ | 0.29 | |
Reinsurance Recoverable
The following table provides total unpaid loss and LAE, net of related reinsurance recoverable for the dates presented (in thousands):
| | | | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2021 | | 2020 |
Unpaid loss and LAE, net | | $ | 83,468 | | | $ | 75,471 | |
IBNR loss and LAE, net | | 146,888 | | | 127,472 | |
Total unpaid loss and LAE, net | | $ | 230,356 | | | $ | 202,943 | |
| | | | |
Reinsurance recoverable on unpaid loss and LAE | | $ | 6,560 | | | $ | 18,957 | |
Reinsurance recoverable on IBNR loss and LAE | | 109,300 | | | 100,565 | |
Total reinsurance recoverable on unpaid loss and LAE | | $ | 115,860 | | | $ | 119,522 | |
Statutory Loss Ratios
Underwriting results of insurance companies are frequently measured by their combined ratios, which is the sum of the loss and expense ratios described in the following paragraph. However, investment income, federal income taxes and other non-underwriting income or expense are not reflected in the combined ratio. The profitability of property and casualty insurance companies depends on income from underwriting, investment and service operations. Underwriting results are considered profitable when the combined ratio is under 100% and unprofitable when the combined ratio is over 100%.
The following table provides the statutory loss ratios, expense ratios and combined ratios for the periods indicated for the Insurance Entities:
| | | | | | | | | | | | | | |
| | Years Ended December 31, |
| | 2021 | | 2020 |
Loss and LAE Ratio (1) | | | | |
UPCIC | | 77 | % | | 84 | % |
APPCIC | | 62 | % | | 34 | % |
Expense Ratio (1) | | | | |
UPCIC | | 35 | % | | 36 | % |
APPCIC | | (17) | % | | 50 | % |
Combined Ratio (1) | | | | |
UPCIC | | 112 | % | | 120 | % |
APPCIC | | 45 | % | | 84 | % |
(1)The ratios are net of ceded premiums and losses and LAE, including premiums ceded to our catastrophe reinsurers which comprise a significant cost, and losses and LAE ceded to reinsurers. The expense ratio includes management fees and commissions, which are based on market rates, paid to an affiliate of the Insurance Entities in the amount of $135.2 million and $118.1 million for UPCIC for the years ended December 31, 2021 and 2020, respectively, and $0.9 million for each of the years ended December 31, 2021 and 2020 for APPCIC. The management fees and commissions paid to the affiliate are eliminated in consolidation.
Ratings
The Insurance Entities’ financial strength is rated by a rating agency to measure the Insurance Entities’ ability to meet their financial obligations to its policyholders. The agency maintains a letter scale Financial Stability Rating® system ranging from “A” (A double prime) to “L” (licensed by state regulatory authorities).
In December 2021, Demotech, Inc. affirmed the Financial Stability Rating® of “A” for the Insurance Entities. According to Demotech, Inc., the assigned rating represents a company’s continued positive surplus related to policyholders, liquidity of invested assets, an acceptable level of financial leverage, reasonable loss and LAE reserves, and realistic pricing. The ratings of the Insurance Entities are subject to at least annual review by Demotech, Inc., and may be revised upward or downward or revoked at the sole discretion of Demotech, Inc. Financial Stability Ratings® are primarily directed towards policyholders, and are not evaluations directed toward the protection of investors in a company, including holders of a company’s common stock, and are not recommendations to buy, sell or hold securities. See “Part I—Item 1A—Risk Factors—Risks Relating to Our Business and Operations—A downgrade in our Financial Stability Rating® may have an adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition.”
The 5.625% Senior Unsecured Notes due 2026 were assigned a rating of “A” by Egan-Jones Ratings Company in October 2021. There are three notches in the rating categories assigned by Egan-Jones Ratings Company (e.g., A- A, and A+), except for AAA and those deep into speculative grade, i.e., CC, C, and D, which do not have notches. According to Egan-Jones Ratings Company, the assigned rating pertains solely to their view of current and prospective credit quality. Their rating does not address pricing, liquidity, or other risks associated with holding investments in the issuer (UVE). Their rating is dependent on numerous factors including the reliability, accuracy, and quality of the data used in determining the credit rating.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company, except for multi-year reinsurance contract commitments for future years that will be recorded at the commencement of the coverage period. See “Part II—Item 8—Note 15 (Commitments and Contingencies)” for more information.
Material Cash Requirements
The following table represents our material cash requirements for which cash flows are fixed or determinable as of December 31, 2021 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Total | | Next 12 months | | Beyond 12 months | | | | |
Reinsurance payable and multi-year commitments (1) | | $ | 493,306 | | | $ | 282,930 | | | $ | 210,376 | | | | | |
Unpaid losses and LAE, direct (2) | | 346,216 | | | 195,266 | | | 150,950 | | | | | |
Long-term debt (3) | | 135,381 | | | 7,195 | | | 128,186 | | | | | |
Total material cash requirements | | $ | 974,903 | | | $ | 485,391 | | | $ | 489,512 | | | | | |
(1)Amount represents the payment of reinsurance premiums payable under multi-year commitments. See “Part II—Item 8—Note 15 (Commitments and Contingencies).”
(2)There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the unpaid losses and LAE do not represent all the obligations that will arise under the contracts, but rather only the estimated liability incurred through December 31, 2021. Unpaid losses and LAE are net of estimated subrogation recoveries. In addition, these balances exclude amounts recoverable from our reinsurance program. See “Part II—Item 8—Note 4 (Reinsurance).”
(3)Long-term debt consists of a Surplus note and 5.625% Senior unsecured notes. See “Part II—Item 8—Note 7 (Long-term debt).”
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE.
Insurance premiums are established before we know the amount of loss and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate rates, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements.
Arrangements with Variable Interest Entities
We entered into a reinsurance captive arrangement with a VIE in the normal course of business, and consolidated the VIE since we are the primary beneficiary.
For a further discussion of our involvement with the VIE, see “Part II—Item 8—Note 2 (Summary of Significant Accounting Policies)” and “Item 8—Note 18 (Variable Interest Entities).”
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Use of Estimates
The preparation of financial statements in conformity with U.S. 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 periods.
Liability for Unpaid Losses and LAE
A liability, net of estimated subrogation, is established to provide for the estimated costs of paying losses and LAE under insurance policies the Insurance Entities have issued. Underwriting results are significantly influenced by an estimate of a liability for unpaid losses and LAE. The liability is an estimate of amounts necessary to settle all outstanding claims, including claims that have been incurred, but not yet reported as of the financial statement date. The process of estimating loss reserves requires significant judgment due to a number of variables, such as the type, severity and jurisdiction of loss, economic conditions including inflation, social attitudes, judicial decisions and legislative development and changes in claims handling procedures. These variables will inherently result in an ultimate liability that will differ from initial estimates. See “Part I—Item 1A—Risk Factors—Risks Relating to Our Business and Operations—Actual claims incurred have exceeded, and in the future may exceed, reserves established for claims, adversely affecting our operating results and financial condition.” We revise our reserve for unpaid losses as additional information becomes available, and reflect adjustments, if any, in our earnings in the periods in which we determine the adjustments are necessary. We estimate and accrue our right to subrogate reported or estimated claims against other parties. Subrogated claims are recorded at amounts estimated to be received from the subrogated parties, net of expenses and netted against unpaid losses and LAE.
See “Part II—Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a discussion of the Company’s basis and methodologies used to establish its liability for unpaid losses and LAE along with the following quantitative disclosures:
•Five-year accident year table on incurred claim and allocated claim adjustment expenses, net of reinsurance including columns of:
◦IBNR—Total of Incurred-but-not-reported liabilities plus expected development (redundancy) on reported claims by accident year, and
◦Claim counts—cumulative number of reported claims by accident year.
•Five-year accident year table on cumulative paid claims and allocated claim adjustment expenses, net of reinsurance,
•Reconciliation of net incurred and paid claims development tables to the liability for unpaid losses and LAE in the consolidated balance sheet,
•Duration—a table of the average historical claims duration for the past five years, and
•Reconciliation of the change in liability for unpaid losses and LAE presented in the consolidated financial statements.
We utilize independent actuaries to help establish liabilities for unpaid losses, anticipated loss recoveries and LAE. We do not discount the liability for unpaid losses and LAE for financial statement purposes. In establishing the liability for unpaid losses and LAE, actuarial judgment is relied upon in order to make appropriate assumptions to estimate a best estimate of ultimate losses. There are inherent uncertainties associated with this estimation process, especially when a company is undergoing changes in its claims settlement practices, when a company has limited experience in a certain area or when behaviors of policyholders are influenced by external factors and/or market dynamics. As an example, a dramatic change occurred during calendar year 2015 when we realigned our adjusting teams as well as launched our Fast Track initiative, reducing settlement costs and strengthening case reserve adequacy for claims reported during the year. These changes have had a meaningful influence on development pattern selections applied to 2013 through 2017 accident year claims in the reserving estimates for each of the methods described in “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses).” More recently, since 2016 there has been a significant increase in efforts to pursue subrogation against third parties responsible for property damage losses to our insureds. As a result, anticipated subrogation recoveries are reviewed and estimated on a stand-alone basis in the Company’s reserve analysis. Market dynamics in Florida include the use of assignments of benefits (“AOB”) and the resulting increase in litigation against the Company. As a result of the use of AOBs, as well as the continued overall increase in represented claims and claims-related abuses in Florida, we have increased our estimates of ultimate losses for the most recent and prior accident years.
Factors Affecting Reserve Estimates
Reserve estimates are developed based on the processes and historical development trends discussed in “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. These estimates are considered in conjunction with known facts and interpretations of circumstances and factors including our experience with similar cases, actual claims paid, differing 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. When these types of changes are experienced, actuarial judgment is applied in the determination and selection of development factors in order to better reflect new trends or expectations. For example, if a change in law is expected to have a significant impact on the development of claim severity, actuarial judgment is applied to determine appropriate development factors that will most accurately reflect the expected impact on that specific estimate. This example appropriately describes the reserving methodology selection for use in estimating sinkhole liabilities after the passing of legislation, as noted in “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. Another example would be when a change in economic conditions is expected to affect the cost of repairs to property; actuarial judgment is applied to
determine appropriate development factors to use in the reserve estimate that will most accurately reflect the expected impacts on severity development.
Changes in homeowners current year claim severity are generally influenced by inflation in the cost of building materials, the cost of construction and property repair services, the cost of replacing home furnishings and other contents, the types of claims that qualify for coverage, the presence of third party representation, such as legal or repair contractors (which serve to inflate claim expenses) and other economic and environmental factors. We employ various loss management programs to mitigate the effects of these factors.
Key assumptions that may materially affect the estimate of the reserve for loss and LAE relate to the effects of emerging claim and coverage issues. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverages may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent, lengthening the time to final settlement, or by increasing the number or size of claims. Key assumptions that are premised on future emergence that are inconsistent with historical loss reserve development patterns include but are not limited to:
•Adverse changes in loss cost trends, including inflationary pressures in home repair costs;
•Judicial expansion of policy coverage and the impact of new theories of liability; and
•Plaintiffs targeting property and casualty insurers in purported class action litigation related to claims-handling and other practices.
As loss experience for the current year develops for each type of loss, the reserves for loss and LAE are monitored relative to initial assumptions until they are judged to have sufficient statistical credibility. From that point in time and forward, reserves are re-estimated using statistical actuarial processes to reflect the impact loss trends have on development factors incorporated into the actuarial estimation processes.
Causes of Reserve Estimate Uncertainty
Since reserves are estimates of the unpaid portions of claims and claims expenses that have occurred, the establishment of appropriate reserves, including reserves for catastrophes, requires regular reevaluation and refinement of estimates to determine ultimate loss and LAE estimates.
At each reporting date, the highest degree of uncertainty in reserve estimates arises from claims remaining to be settled for the current accident year and the most recent preceding accident year, and claims that have occurred but have not been reported. The estimate for the current accident year contains the greatest degree of uncertainty because it contains the greatest proportion of losses that have not been reported or settled but must be estimated as of the current reporting date. During the first year after the end of an accident year, a large portion of the total losses for that accident year are settled. When accident year losses paid through the end of the first year following the initial accident year are incorporated into updated actuarial estimates, the trends inherent in the settlement of claims emerge more clearly. Consequently, this is the point in time at which the largest re-estimates of losses for an accident year can occur. After the second year, the losses paid for the accident year typically relate to claims that are more difficult to settle, such as those involving litigation.
Reserves for Catastrophe Losses
Loss and LAE reserves also include reserves for catastrophe losses. Catastrophe losses are an inherent risk of the property-casualty insurance industry that have contributed, and will continue to contribute, to potentially material year-to-year fluctuations in results of operations and financial position. A catastrophe is an event that produces significant insured losses before reinsurance and involves multiple first party policyholders, or an event that produces a number of claims in excess of a preset, per-event threshold of average claims in a specific area, occurring within a certain amount of time following the event. Catastrophes are commonly caused by various natural events including high winds, tornadoes, wildfires, winter storms, tropical storms and hurricanes.
The estimation of claims and claims expense reserves for catastrophes also comprises estimates of losses from reported and unreported claims, primarily for damage to property. In general, estimates for catastrophe reserves are based on claim adjuster inspections and the application of historical loss development factors as described previously and in “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements. However, depending on the nature of the catastrophe, as noted above, the estimation process can be further complicated. For example, for hurricanes, complications could include the inability of insureds to be able to promptly report losses, limitations placed on claims adjusting staff affecting their ability to inspect losses, determining whether losses are covered by our homeowners policy (generally for damage caused by wind or wind driven rain) or specifically excluded coverage caused by flood, estimating additional living expenses or assessing the impact of demand surge and exposure to mold damage. The effects of numerous other considerations, include the timing of a catastrophe in relation to other events, such as at or near the end of a financial reporting period, which can affect the availability of information needed to estimate reserves for that reporting period. In these situations, practices are adapted to accommodate these circumstances in order to determine a best estimate of losses from a catastrophe.
Key Actuarial Assumptions That Affect the Loss and LAE Estimate
The aggregation of estimates for reported losses and IBNR forms the reserve liability recorded in the Consolidated Balance Sheets.
At any given point in time, the recorded loss and LAE reserves represent our best estimate of the ultimate settlement and administration cost of insured claims incurred and unpaid. Since the process of estimating loss and LAE reserves requires significant judgment due to a number of variables, such as fluctuations in inflation, judicial decisions, legislative changes and changes in claims handling procedures, ultimate liability may exceed or be less than these estimates. Reserves for losses and LAE are revised as additional information becomes available, and adjustments, if any, are reflected in earnings in the periods in which they are determined.
In selecting development factors and averages described in “Item 8—Note 17 (Liability for Unpaid Losses and Loss Adjustment Expenses)” to the consolidated financial statements, due consideration is given to how the historical experience patterns change from one year to the next over the course of several consecutive years of recent history. Predictions surrounding these patterns drive the estimates that are produced by each method, and are based on statistical techniques that follow standard actuarial practices.
In compliance with annual statutory reporting requirements, our appointed independent actuary provides a Statement of Actuarial Opinion (“SAO”) indicating that carried loss and LAE reserves recorded at each annual balance sheet date make a reasonable provision for all of the Insurance Entities’ unpaid loss and LAE obligations under the terms of contracts and agreements with our policyholders. Recorded reserves are compared to the indicated range provided in the actuary’s report accompanying the SAO. At December 31, 2021, the recorded amount for net loss and LAE falls within the range determined by the Company’s appointed independent actuary.
Potential Reserve Estimate Variability
The methods employed by actuaries include a range of estimated unpaid losses, each reflecting a level of uncertainty. Projections of loss and LAE liabilities are subject to potentially large variability in the estimation process since the ultimate disposition of claims incurred prior to the financial statement date, whether reported or not, is subject to the outcome of events that have not yet occurred. Examples of these events include jury decisions, court interpretations, legislative changes, public attitudes and social/economic conditions such as inflation. Any estimate of future costs is subject to the inherent limitation on one’s ability to predict the aggregate course of future events. It should therefore be expected that the actual emergence of losses and LAE will vary, perhaps materially, from any estimate.
In selecting the range of reasonable estimates, the range of indications produced by the various methods is evaluated, the relative strengths and weaknesses of each method are considered, and from those inputs a range of estimates can be selected. For reasons cited above, this range of estimated ultimate losses is typically smaller for older, more mature accident periods and greater for more recent, less mature accident periods. The greatest level of uncertainty is associated with the most recent accident years, and particularly years during which catastrophe events occurred.
The inherent uncertainty associated with our loss and LAE liability is magnified due to our concentration of property business in catastrophe-exposed and litigious states, primarily Florida. In 2018, for example, loss and expense payments for Hurricane Irma claims exceeded initial liability estimates that were established at year-end 2017, which was shortly after the event occurred. This unexpected development was partially due to the influence of plaintiff attorneys in the claim filing process; both at initial contact prior to coverage validation or damage assessment, and after claims were settled and closed which resulted in a large number of claims being reopened during the year. In 2019, UPCIC continued to experience unanticipated unfavorable development on losses from claims being reopened and new claims being opened due to public adjusters encouraging policyholders to file new claims. Due to the relatively low frequency and inherent uncertainty of catastrophe events, the parameters utilized in loss estimation methodologies are updated whenever new information emerges.
The following table summarizes the effect on net loss and LAE reserves and net income, net of tax in the event of reasonably likely changes in the severity of claims considered in establishing loss and LAE reserves. The range of reasonably likely changes in the severity of our claims was established based on a review of changes in loss year development and applied loss and LAE reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios (dollars in thousands):
| | | | | | | | | | | | | | |
Year ended December 31, 2021 |
| | | | Percent Change in |
Change in Reserves | | Reserves | | Net Income |
-20.0% | | $ | 276,973 | | | 244 | % |
-15.0% | | 294,284 | | | 183 | % |
-10.0% | | 311,594 | | | 122 | % |
-5.0% | | 328,905 | | | 61 | % |
Base | | 346,216 | | | — | |
5.0% | | 363,527 | | | (61) | % |
10.0% | | 380,838 | | | (122) | % |
15.0% | | 398,148 | | | (183) | % |
20.0% | | 415,459 | | | (244) | % |
Adequacy of Reserve Estimates
We believe our net loss and LAE reserves are appropriately established based on available methodology, facts, technology, laws and regulations. We calculate and record a single best reserve estimate, in conformance with generally accepted actuarial standards, for reported and unreported losses and LAE losses and as a result we believe no other estimate is better than our recorded amount.
Due to the uncertainties involved, the ultimate cost of losses and LAE may vary materially from recorded amounts, which are based on our best estimates. The liability for unpaid losses and LAE at December 31, 2021 is $346.2 million.
Recent Accounting Pronouncements Not Yet Adopted
None