POSITIVE PHYSICIANS HOLDINGS, INC. The following discussion is intended to provide a more comprehensive review ofPositive Physicians Holdings, Inc. ("PPHI") and its wholly owned subsidiary's (collectively referred to as the "Company," which also may be referred to as "we" or "us") operating results and financial condition than can be obtained from reading the Financial Statements alone. The discussion should be read in conjunction with the audited Consolidated and Combined Financial Statements and the notes thereto included in "Item 8. Financial Statements and Supplementary Data" of the Company. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K constitutes forward-looking information that involves risk and uncertainties. Please see "Forward-Looking Statements" in Part I for more information. OVERVIEWPositive Physicians Holdings, Inc. is aPennsylvania domiciled holding company, which was incorporated onMay 1, 2018 for the purpose of acquiring threePennsylvania based reciprocal insurance exchanges:Positive Physicians Insurance Exchange ("PPIX"),Professional Casualty Association ("PCA"), and Physicians' Insurance Program Exchange ("PIPE"). In connection with the completion of PPHI's initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies. As part of the conversions, onMarch 27, 2019 , PPIX merged with and intoPPIX Conversion Corp. , PCA merged with and intoPCA Conversion Corp. , and PIPE merged with and intoPIPE Conversion Corp. Accordingly, PPIX, PCA, and PIPE no longer exist. Immediately thereafter,PCA Conversion Corp. andPIPE Conversion Corp. merged with and intoPPIX Conversion Corp. , which then changed its name toPositive Physicians Insurance Company ("Positive Insurance Company ") and became our single insurance company subsidiary and successor to PPIX, PCA, and PIPE. PPHI had minimal assets and liabilities and had not engaged in any operations prior toMarch 27, 2019 .Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing inPennsylvania ,New Jersey ,Ohio ,Delaware ,Maryland ,South Carolina , andMichigan .Diversus Management, LLC ("Diversus Management") manages and administers essentially all of the operations ofPositive Insurance Company under the terms of a management agreement. Diversus Management is a wholly owned subsidiary ofDiversus, Inc. ("Diversus"). Pursuant to the terms of the agreement, effectiveMarch 27, 2019 , Diversus Management provides such administrative services toPositive Insurance Company in exchange for fees based upon a percentage ofPositive Insurance Company's gross written premiums, less return premiums. Diversus Management may also earn quarterly performance management fees based onPositive Insurance Company's combined ratio and net earned premiums.Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued byPositive Insurance Company and for all sales commissions paid to producers.Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers. Medical professional liability insurance ("MPLI") protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services. We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage inPennsylvania ,New Jersey ,Ohio ,Delaware ,Maryland ,South Carolina , andMichigan . Our policies include coverage for the cost of defending claims. Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage. We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires. Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported. Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.
Overview of PPIX
PPIX was an unincorporated exchange organized onApril 20, 2004 and was licensed by theCommonwealth of Pennsylvania as a reciprocal insurance exchange. PPIX provided medical professional liability insurance consisting of claims-made, tail, claims made plus, and occurrence policies to its subscribers (policyholders). OnOctober 9, 2018 ,Positive Physicians Captive Insurance Company ("PPCIC"), a sponsored captive insurance company, was incorporated in theState of New Jersey and became a wholly owned subsidiary of PPIX. PPCIC was licensed under the New Jersey Captive Insurance Act onOctober 16, 2018 . PPCIC has one protected unincorporated cell,Keystone Captive Group ("Keystone"). Keystone is owned by an insured ofPositive Insurance Company . PPIX marketed its medical professional liability insurance policies directly to physicians and through independent producers to doctors and allied healthcare professionals who practice inPennsylvania ,Delaware ,Maryland ,New Jersey , andOhio . 16
-------------------------------------------------------------------------------- PPIX was managed bySpecialty Insurance Services, LLC ("SIS"), aPennsylvania limited liability company, pursuant to the terms of an Attorney-In-Fact Agreement between the exchange and SIS. SIS provided underwriting and administrative services to PPIX based on a percentage not to exceed 25% of gross written premiums, less return premiums. As the attorney-in-fact, SIS had the power to direct the activities of PPIX that most significantly impact PPIX's economic performance.Diversus acquired 100% of the ownership interests of SIS onJanuary 1, 2017 . Overview ofPCA PCA was an unincorporated, reciprocal insurance association organized onApril 16, 2003 and formed for the purpose of insuring its subscribers against loss due to the imposition of legal liability. PCA provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders). PCA marketed its medical professional liability insurance policies through independent producers, primarily to doctors and allied healthcare providers who practice inPennsylvania . InNovember 2015 , PCA was granted a license to write insurance inMichigan and began writing policies inMichigan in the fourth quarter of 2015. PCA was managed byProfessional Third Party, LP ("PTP"), aPennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the association and PTP. PTP provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PCA, and paid certain expenses on behalf of PCA in exchange for 25% of gross written premium. As the attorney-in-fact, PTP had the power to direct the activities of PCA that most significantly impact PCA's economic performance.Diversus acquired 100% of the ownership interests of PTP onJune 4, 2014 . Overview of PIPE PIPE was an unincorporated exchange organized onMarch 14, 2005 and was licensed by theCommonwealth of Pennsylvania as a reciprocal insurance exchange. PIPE provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).
PIPE marketed its medical professional liability insurance policies through
independent producers to doctors and allied healthcare professionals who
practice primarily in
PIPE was managed byPhysicians' Insurance Program Management Company ("PIPE Management"), aPennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the exchange and PIPE Management. PIPE Management provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PIPE, and paid certain expenses on behalf of PIPE in exchange for 25% of gross written premium. As the attorney-in-fact, PIPE Management had the power to direct the activities of PIPE that most significantly impact PIPE's economic performance.Diversus acquired 100% of the ownership interests of PIPE Management onNovember 23, 2015 .
SIS, PTP, and PIPE Management merged with and into Diversus Management in
connection with the conversions on
Marketplace Conditions and Trends
The MPLI industry is affected by recurring industry cycles known as "hard" and "soft" markets. A soft market is characterized by intense competition, resulting in lower pricing in order to compete for business. A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing. From approximately 2001 until approximately 2007, the Pennsylvania MPLI market experienced a hard market cycle. This resulted in the creation of several alternative MPLI providers, such as PPIX, PCA, and PIPE. The MPLI market began to experience a soft market cycle around the second quarter of 2008, due primarily to the large rate increases taken over the previous six years. The soft market continued and was facilitated by the restructuring of the healthcare industry, partially as a result of the Affordable Care Act. This resulted in significant price competition, as the number of medical professionals practicing independent of hospitals or large professional groups began to decline. According to a study prepared by theNational Association of Insurance Commissioners , MPLI direct premiums written declined by 24.0% on a national basis from 2006 to 2018 and declined by 14.6% inPennsylvania and 33.0% inNew Jersey during this same time period. This resulted in lower direct premiums written and lower operating profits for many MPLI carriers. 17 -------------------------------------------------------------------------------- The soft market cycle troughed in 2012, and since then, national loss payouts, on average, have steadily increased through 2019. As a result, underwriting criteria in the MPLI industry has started to become more stringent, with opportunities for improved pricing, and we believe the market cycle is currently transitioning to a hard market. AtPositive Insurance Company , beginning inApril 2020 our renewal book of business has begun to experience price increases of 2.5% through reduced credits, a development which we expect to continue and extend through our policy renewals in 2020. We are also seeing rate increases take place by other carriers in many of the states in which we write business. In addition to pricing increases, in what we perceive to be the beginnings of a hard market, we intend to achieve further premium growth with our expansion into new states.Positive Insurance Company is currently in the process of obtaining licenses to write business in the states ofCalifornia andFlorida and was recently admitted intoTexas inNovember 2019 .
Effects of COVID-19
Our operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughoutthe United States . These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force. Our management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on our operations and financial position and developing operational and financial plans to address those matters. As a result of the COVID-19 pandemic, we anticipate that premiums will decrease due to policy endorsements associated with doctors electing to work part time, take a leave of absence or retire. In addition, our insureds may elect to temporarily change specialties. For example, a doctor may choose to drop from orthopedic surgery to office-only status due to the lack of elective surgeries. We have received notification for such requests from our policyholders which will go into effect onJune 30, 2020 . In terms of collections, prior to the pandemic, our policy was to cancel any insurance policies for which premiums had not been received within 60 days subsequent to policy effective date, with notice of intent to cancel sent to the insured after 30 days post-inception date. As a result of COVID-19, we have updated this policy and suspended cancellations of insurance contracts resulting from non-payment of premium untilJune 30, 2020 for invoices due afterApril 1, 2020 . ThroughMay 11, 2020 , the amount of premium payment deferrals is about$817,000 . Dependent upon the extent to which our policyholders' own businesses have been impacted by the pandemic, our collection of premiums against current in-force policies could be significantly impacted. With respect to claims, our policyholder base mainly consists of physicians, their corporations and medical groups. During the COVID-19 pandemic, on-site visits to doctors have declined and been replaced by an increase in telehealth/virtual office visits. Since the COVID-19 pandemic resulted in government-issued work from home orders, we have seen the number of new claims reported begin to decrease. In general, our expectation is that the frequency of new claims reported during this time period will decrease. As to actual claims relating to COVID-19 exposures, we anticipate that the number of claims will be minimal. Unless some unforeseen fact pattern is established, we expect that the difficulty of establishing the source of a COVID-19 exposure, as well as the heroic efforts of healthcare providers, will serve to make such claims unattractive to both patients and their counsel. We do not anticipate our loss and LAE ratios to be impacted. However, this view could change in the future depending on the duration of the pandemic and if the lower frequency of new claims reported becomes a trend.
Principal Revenue and Expense Items
Net premiums earned
Gross premiums written is equal to direct and assumed premiums before the effect of ceded reinsurance. Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written).
Premiums earned are the earned portion of net premiums written. Gross premiums written include all premiums recorded by an insurance company during a specified policy period. Insurance premiums on MPLI policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies. At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and recognized as revenue in subsequent periods over the remaining term of the policy. The policies written byPositive Insurance Company typically have a term of twelve months. Thus, for example, for a policy that is written onJuly 1, 2019 , one-half of the premiums would be earned in 2019 and the other half would be earned in 2020. 18 --------------------------------------------------------------------------------
Net investment income and net realized and unrealized gains (losses) from investments
We invest our surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expenses) in cash, cash equivalents, short-term investments, and equity and debt securities. Investment income includes interest and dividends earned. We recognize realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognize realized losses when investment securities are written down as a result of other-than-temporary-impairment or sold for an amount less than their cost or amortized cost, as applicable. Realized gains and losses on sales of fixed maturity and equity securities and other investments and unrealized holding gains and losses on equity securities and other investments are included in realized investment gains (losses), net. Our portfolio of investment securities is managed by our outside investment manager, who has discretion to buy and sell securities in accordance with the investment policy approved byPositive Insurance Company's Board of Directors.
Losses and loss adjustment expenses
Losses and loss adjustment expenses ("LAE") represent the largest expense item
and include: (1) claim payments made, (2) estimates for future claim payments
and changes in those estimates for prior periods, and (3) costs associated with
investigating, defending and adjusting claims, including legal fees.
Other underwriting expenses
Expenses incurred to underwrite risks include policy acquisition costs and underwriting and administrative expenses. Policy acquisition costs consist of commission expenses, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business. These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies. Underwriting and administrative expenses consist of salaries, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately, and payments to bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data. Income taxes We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.
Key Financial Measures
We evaluate our insurance operations by monitoring certain key measures of growth and profitability. Some of these measurements are "non-GAAP" financial measurements underSecurities and Exchange Commission rules and regulations. We utilize certain non-GAAP financial performance measures that are widely used in the property and casualty insurance industry and that we believe are valuable in managing our business and for comparison to our peers. These financial performance measures are the loss and LAE ratio, expense ratio, combined ratio, underwriting income (loss), and operating income (loss). We measure growth by monitoring changes in gross premiums written and net premiums written, and measure underwriting profitability by examining losses and LAE, underwriting expenses and combined ratios. We also measure profitability by examining underwriting income (loss) and operating income (loss).
Loss and LAE ratio
The loss and LAE ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned.Positive Insurance Company measures the loss and LAE ratio on a policy year and calendar year loss basis to measure underwriting profitability. A policy year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that year. A calendar year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior policy years as a percentage of premiums earned during that year. 19
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Expense ratio
The expense ratio is the ratio (expressed as a percentage) of other underwriting expenses (attributable to insurance operations) to premiums earned, and measures our operational efficiency in producing, underwriting and administering the Company's insurance business.
Combined ratio
The combined ratio is a measure of property and casualty underwriting performance. The combined ratio computed on a GAAP basis is equal to the sum of losses and loss adjustment expenses and other underwriting expenses, all divided by net premiums earned. If the combined ratio is below 100%, we are making an underwriting profit. If our combined ratio is at or above 100%, we are not profitable without investment income and may not be profitable if investment income is insufficient. Underwriting income (loss)
Underwriting income (loss) measures the pre-tax profitability of insurance operations. It is derived by subtracting losses and loss adjustment expenses and other underwriting expenses from earned premiums.
Operating income (loss)
Operating income (loss) measures the profitability of business operations. We
define it as GAAP net income (loss) excluding net realized investment gains and
losses, net of tax. Net realized investment activity is excluded because net
realized investment gains and losses are unpredictable and not necessarily
indicative of current operating fundamentals or future performance of the
business operations. Operating income is a non-GAAP measure which is important
for an understanding of our overall results of operations. However, it does not
replace net income (loss) as the GAAP measure of our consolidated results of
operations, nor should it be viewed as a substitute for measures determined in
accordance with GAAP.
Critical Accounting Policies
General
The preparation of financial statements in accordance with GAAP requires both
the use of estimates and judgment relative to the application of appropriate
accounting policies. We are required to make estimates and assumptions in
certain circumstances that affect amounts reported in our financial statements
and related footnotes. We evaluate these estimates and assumptions on an
on-going basis based on historical developments, market conditions, industry
trends and other information that we believe to be reasonable under the
circumstances. There can be no assurance that actual results will conform to our
estimates and assumptions and that reported results of operations will not be
materially adversely affected by the need to make accounting adjustments to
reflect changes in these estimates and assumptions from time to time. We believe
the following policies are the most sensitive to estimates and judgments:
• losses and loss adjustment expenses;
• the valuation of our investment portfolio and assessment of
other-than-temporary impairments ("OTTI");
• deferred acquisition costs;
• reinsurance recoverable; and
• valuation of deferred tax assets.
We believe our accounting policies for these items are of critical importance to
our consolidated financial statements. The following discussion provides more
information regarding the estimates and assumptions required to arrive at these
amounts.
Losses and Loss Adjustment Expenses
We maintain reserves for the payment of claims (indemnity losses) and expenses
related to adjusting those claims (loss adjustment expenses). The loss reserves
consist of case reserves, which are reserves for claims that have been reported
to us, and reserves for claims that have been incurred but have not yet been
reported and for the future development of case reserves.
When a claim is reported to us, our claims personnel establish a case reserve
for the estimated amount of the ultimate payment to the extent it can be
determined or estimated. The amount of the loss reserve for the reported claim
is based primarily upon a claim-by-claim evaluation of coverage, liability, and
injury severity, and any other information considered pertinent to estimating
the
20
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exposure presented by the claim. Each claim is contested or settled individually
based upon its merits, and some claims may take years to resolve, especially if
legal action is involved. Case reserves are reviewed on a regular basis and are
updated as new information becomes available.
In addition to case reserves, we maintain reserve estimates for those that have
been incurred but not reported ("IBNR"). These reserves include estimates for
the future development of case reserves and claims in which case reserves have
not yet been established. Some claims may not be reported for several years. As
a result, the liability for unpaid losses and LAE reserves includes significant
estimates for IBNR.
We utilize an independent actuary to assist with the estimation of our losses
and LAE reserves on a quarterly basis. Our independent actuary prepares
estimates of the ultimate liability for unpaid losses and LAE based on
established actuarial methods described below. We review these estimates and
supplement the actuarial analysis with information not fully incorporated into
the actuarially based estimate, such as changes in the external business
environment and changes in internal company processes and strategy. We may
adjust the actuarial estimates based on this supplemental information in order
to arrive at the amount recorded in the financial statements.
We accrue liabilities for unpaid losses and LAE based upon estimates of the ultimate amount payable. We project our estimate of ultimate losses and LAE by using the following actuarial methodologies:
• Actual versus Expected Model - The Actual versus Expected Model utilizes
the actuarial point ultimate loss and defense containment cost ("DCC")
estimates as of the prior reserve review which are adjusted based on the
difference between actual and expected loss development between the prior
reserve review and the current evaluation to arrive at an updated
actuarial point ultimate loss and DCC estimate. The method is dependent on
the loss development factors used to determine the expected losses.
• Bornhuetter-Ferguson Method (Paid and Incurred) - The Bornhuetter-Ferguson
Method is a blended method that explicitly takes into account both actual
loss development to date and expected future loss emergence. This method
is applied on both a paid loss development basis and an incurred lossdevelopment basis. This method uses the selected loss development patterns
from each of the two loss development methods to calculate the expected
percentage of loss unpaid or unreported, as applicable. The expected
future loss component of the method is calculated by multiplying earned
premium for the given exposure period by a selected a priori
(i.e. deductive) loss ratio. The resulting dollars are then multiplied by
the expected percentage of unpaid (or unreported) loss described above.
This provides an estimate of future paid (or reported) losses that is then
added to actual paid (or incurred) loss data to produce estimated ultimate
loss.
• Expected Loss Ratio Method - The Expected Loss Ratio Method utilizes some
measure of anticipated losses and does not consider actual losses. An
expected loss ratio, a ratio of anticipated losses relative to some
measure of exposure, is applied to that measure of exposure to determine
estimated ultimate losses for each year. This method provides stability
over time because the ultimate loss estimates do not change unless the
exposure measure changes. This is offset by a lack of responsiveness to
actual loss experience.
• Frequency/Severity Method - The Frequency/Severity Method estimates
ultimate losses by estimating a frequency and a severity component. For
each year, the actuary estimates ultimate claim counts and an ultimate
average severity. The actuary then multiplies these two estimates
together. The method is useful when the claim count development pattern is
more stable than the loss development pattern.
• Incurred Loss Development Method - The Incurred Loss Development Method
utilizes historical incurred loss (the sum of cumulative historical loss
payments plus outstanding case reserves) patterns to estimate future
losses. This method is often preferred over the paid method as it includes
the additional information provided by the aggregation of individual case
reserves. The resulting loss development factors (LDFs) tend to be lower
and more stable than those of the paid development method. However, theincurred development method may be affected by changes in case reserving
practices and any unusually large individual claims. The actuaries produce
and review several indications of ultimate loss using this method based on
various LDF selections.
We estimate IBNR reserves by first deriving an actuarially based estimate of the
ultimate cost of total losses and loss adjustment expenses incurred as of the
financial statement date. We then reduce the estimated ultimate losses and LAE
by loss and LAE payments and case reserves carried as of the financial statement
date. The actuarially determined estimate is based upon indications from one of
the above actuarial methodologies or uses a weighted average of these
results. The specific method used to estimate the ultimate losses will vary
depending on the judgment of the actuary as to what is the most appropriate
method for the MPLI business. Finally, we consider other factors that impact
reserves that are not fully incorporated in the actuarially based estimate, such
as changes in the external business environment and changes in internal company
processes and strategy.
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The process of estimating loss reserves involves a high degree of judgment and
is subject to a number of variables. These variables can be affected by both
internal and external events, such as changes in claims handling procedures,
inflation, legal trends, and legislative changes, among others. The impact of
many of these items on ultimate costs for claims and claim adjustment expenses
is difficult to estimate. Loss reserve estimation is affected by the volume of
claims, the potential severity of individual claims, the determination of
occurrence date for a claim, and reporting lags (the time between the occurrence
of the policyholder event and when it is actually reported to the insurer).
Informed judgment is applied throughout the process, including the application
of various individual experiences and expertise to multiple sets of data and
analyses. We continually refine our loss reserve estimates in a regular ongoing
process as historical loss experience develops and additional claims are
reported and settled. We consider all significant facts and circumstances known
at the time loss reserves are established.
Due to the inherent uncertainty underlying loss reserve estimates, final
resolution of the estimated liability for losses and loss adjustment expense
reserves may be higher or lower than the related loss reserves at the reporting
date. Therefore, actual paid losses, as claims are settled in the future, may be
materially higher or lower in amount than current loss reserves. We reflect
adjustments to loss reserves in the results of operations in the period the
estimates are changed.
Our independent actuary determined a range of reasonable reserve estimates shown
in the tables below, which reflect the uncertainty inherent in the loss reserve
process. This range does not represent the range of all possible outcomes. We
believe that the actuarially determined ranges represent reasonably likely
changes in the loss and LAE estimates, however, actual results could differ
significantly from these estimates. The range was determined after a review of
the output generated by the various actuarial methods utilized. Our actuary
reviewed the variance around the select loss reserve estimates for each of the
actuarial methods and selected reasonable low and high estimates based on their
knowledge and judgment. In addition, when selecting these low and high
estimates, the actuary considered:
• Historical industry development experience in MPLI;
• Historical company development experience;
• Changes in the company's internal claims processing policies and
procedures; and
• Trends and risks in claim costs, such as risk that medical cost inflation
could increase.
Our actuary is required to exercise a considerable degree of judgment in the evaluation of all of these and other factors in the analysis of losses and loss adjustment expenses, and related range of anticipated losses. Because of the level of uncertainty impacting the estimation process, it is reasonably possible that different actuaries would arrive at different conclusions. The method of determining the reserve range has not changed and the reserve range generated by the actuary is consistent with the observed development of our loss reserves over the last few years. The width of the range in reserves arises primarily because specific losses may not be known and reported for some time and the ultimate losses and LAE paid and incurred with respect to known losses may be larger or smaller than currently estimated. The ultimate frequency or severity of the claims can be very different than the assumptions used in the estimation of our ultimate reserves for these exposures.
Specifically, the following factors could impact the frequency and severity of claims and, therefore, the ultimate amount of losses and loss adjustment expenses paid:
• The rate of increase in medical costs that underlie insured risks; and
• Impact of changes in laws or regulations.
The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts less than originally estimated or a reduction in the estimate for unpaid losses and loss adjustment expense (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts greater than originally estimated or an increase in the estimate for unpaid losses and loss adjustment expense (unfavorable development).Positive Insurance Company uses a combination of the Actual versus Expected Method, Bornhuetter-Ferguson Method, Expected Loss Ratio Method, Frequency/Severity Method, and the Incurred Loss Development Method in order to estimate its liability for losses and LAE. Following the conversions and merger which were completed onMarch 27, 2019 , the Company changed its approach by aggregating its data, previously under PPIX, PCA, and PIPE, and performing a single loss reserve analysis, as opposed to three separate loss reserve analyses. The Company used combined development patterns based on PPIX, PCA, and PIPE experience for claims-made development factors, but derived occurrence development factors strictly based on former PPIX 22 -------------------------------------------------------------------------------- experience. Tail policy development factors were derived from the occurrence factors. Management does not believe that the effects of these changes had a material impact on the Company's estimates. The year-end loss reserve analysis also assumes that the Company will no longer utilizeAndrews Outsource Solutions LLC to provide claims processing and risk management services following 2020, a measure which is expected to reduce the amount of LAE incurred in subsequent periods. If this action is not taken, then the Company's reserves for loss adjustment expenses would increase as a result. There were no other significant changes in the methodologies and assumptions used to develop the liabilities for losses and LAE during the year endedDecember 31, 2019 .
The following tables provide case and IBNR reserves for losses and LAE at
AtDecember 31, 2019 Case IBNR Total December 31, 2019 Reserves Reserves Reserves
Medical professional liability $ 30,127 $ 25,966
Total net reserves 30,127 25,966 56,093
Reinsurance recoverable on unpaid claims 1,895 5,620
7,515
Gross reserves $ 32,022 $ 31,586 $ 63,608
At December 31, 2018
Case IBNR Total
December 31, 2018 Reserves Reserves Reserves
Medical professional liability $ 30,741 $ 29,701
Total net reserves 30,741 29,701 60,442
Reinsurance recoverable on unpaid claims 1,614 6,336
7,950
Gross reserves $ 32,355 $ 36,037 $ 68,392 At
The components of our (favorable) unfavorable development of reserves for losses
and LAE for prior accident years by accident year were as follows (dollars in
thousand):
Accident Year 2019 2018
2009 and prior $ (185 ) $ 455
2010 (158 ) (755 )
2011 (151 ) (988 )
2012 956 (152 )
2013 (148 ) 575
2014 135 (25 )
2015 (1,056 ) (121 )
2016 647 2,515
2017 (1,279 ) 2,554
2018 1,375 -
Total net (favorable) unfavorable development $ 136 $ 4,058
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-------------------------------------------------------------------------------- In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.
During 2018, we experienced unfavorable development primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.
As discussed earlier, the estimation ofPositive Insurance Company's losses and LAE reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given policy year. Recent
Variabilities of the Liability for
Unpaid Losses and Loss Adjustment Expenses, Net of Reinsurance Recoverables Dollars in thousands
2015 2016 2017 2018 2019
As originally estimated $ 70,514 $
63,288
60,874 65,035 67,771 65,147 56,093
Net cumulative redundancy (deficiency) 9,640 (1,747 ) (6,725 ) (4,705 ) -
% redundancy (deficiency) 13.7 % -2.8 % -11.0 % -7.8 % -%
At December 31, 2019 , our carried reserves for losses and loss adjustment
expenses, net of reinsurance, reflect an estimate of loss and LAE reserves that
is approximately the point estimate of our actuaries' range of loss reserves. If
the liability for losses and loss adjustment expenses were recorded at the high
end of the actuarially determined range, then the liability for losses and loss
adjustment expenses would increase, which would result in a higher net loss and
lower equity. If the liability for losses and loss adjustment expenses were
recorded at the low end of the actuarially determined range, then the liability
for losses and loss adjustment expenses would be reduced with a corresponding
increase in net income and equity.
Investments
Our investment portfolio is invested primarily in publicly traded, investment grade, fixed maturity securities with an average credit quality of A as rated by nationally recognized credit rating agencies. The portfolio is externally managed by independent, professional investment managers and is broadly diversified across sectors and issuers. Exposures are aggregated, monitored, and actively managed by our Investment Committee. We also have an investment policy statement which requires managers to maintain highly diversified exposures to individual issuers and closely monitor compliance with portfolio guidelines. Our investment portfolio also includes equity securities. We have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claims payments. The fair values of these investments are subject to fluctuation in interest rates. If we decide or are required in the future to sell securities in a rising interest rate environment, then we would expect to incur losses from such sales. As ofDecember 31, 2019 , the average duration of our fixed maturity security investments that support the insurance reserves was approximately 3.1 years and the duration of our insurance reserves was about 2.6 years. The difference in the duration of our investments and our insurance reserves reflects our decision to maintain longer asset duration in order to enhance overall yield, while maintaining a high overall credit quality. We estimate that a 100 basis points (bps) increase in interest rates would reduce the valuation of our fixed maturity portfolio by$3,416,769 atDecember 31, 2019 . 24
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Our investments at
2019 2018
Percentage Percentage
Fair Value of Total Fair Value of Total
Fixed maturity securities
available-for-sale:
U.S. government $ 10,751,562 10.3 % $ 12,737,756 13.1 %
States, territories, and possessions 1,143,023 1.1 % 1,125,479 1.2 %
Subdivisions of states, territories,
and possessions 12,822,865 12.2 % 13,292,064 13.7 %
Industrial and miscellaneous 71,030,592 67.9 % 58,051,370 59.9 %
Total fixed maturity securities 95,748,042 91.5 % 85,206,669 87.9 %
Equity securities 7,756,966 7.4 % 7,267,094 7.5 %
Other investments - 0.0 % 4,051,399 4.2 %
Short-term investments 1,169,472 1.1 % 373,949 0.4 %
Total investments $ 104,674,480 100.0 % $ 96,899,111 100.0 %
Our investment portfolio is comprised of mostly investment grade fixed maturity
securities and equity securities, all of which are publicly traded. We believe
the portfolio is sufficiently diversified because it does not contain any
significant concentrations in single issuers other than U.S. government
obligations. Our largest exposure to a single corporate issuer is $1,743,740 , or
less than 2% of total invested assets. In addition, we do not have a significant
concentration of our investments in any single industry segment other than
finance companies, which comprised approximately 22% of invested assets at
December 31, 2019 . Included in this industry segment are diverse financial
institutions, including banks (11%) and financial service (9%) and insurance
(2%) companies, with no single issuer exceeding 2% of the total investment
portfolio. During the first quarter of 2020, we reduced our exposure to this
industry segment by about 3%. All of our investments as of December 31, 2019 are
dollar denominated.
At
2019
Percentage
Fair Value of Total
U.S. government and AAA $ 13,975,988 14.6 %
AA 14,637,137 15.3 %
A 35,937,635 37.5 %
BBB 30,358,520 31.7 %
Below investment grade 838,762 0.9 %
Total $ 95,748,042 100.0 %
Ratings as assigned by Standard and Poor's. Such ratings are generally assigned
at the time of the issuance of the securities, subject to revision on the basis
of ongoing evaluations.
At December 31, 2019 , all but 17 of the publicly traded securities in our fixed
maturity portfolio were of investment grade credit quality. The 17 below
investment grade securities had an aggregate fair value of $838,762 and a net
unrealized loss of $(3,761) .
Investments in fixed maturity securities are classified as available-for-sale
and are stated at fair value. Unrealized holding gains and losses, net of
related tax effects, on available-for-sale fixed maturity securities are
recorded directly to accumulated other comprehensive income (loss). Investments
in equity securities are stated at fair value and unrealized holding gains and
losses are credited or charged to net income (loss) as incurred. During 2019 and
2018, we had ownership interests in limited partnership equity hedge funds which
were sold in 2019. The partnership interests were measured at fair value using
the funds' net asset values as a practical expedient. Unrealized holding gains
and losses on partnership interests were credited or charged to net income
(loss) as incurred. Realized gains and losses on sales of equity and fixed
maturity securities as well as other investments are recognized into income
based upon the specific identification method. Interest and dividends are
recognized as earned. We regularly evaluate all of our investments based on
current economic conditions, credit loss experience, and other specific
developments. If there is a decline in a security's net realizable value that is
other than temporary, it is considered as a realized loss and the cost basis in
the security is reduced to its estimated fair value.
25
--------------------------------------------------------------------------------The following table shows the fair value and amortized cost/cost of our available-for-sale fixed maturity securities:
December 31, 2019 December 31, 2018
Amortized Amortized
Fair Value Cost/Cost Fair Value Cost/Cost
U.S. government $ 10,751,562 $ 10,689,829 $ 12,737,756 $ 12,859,101
States, territories, and possessions 1,143,023 1,096,638 1,125,479 1,111,879
Subdivisions of states, territories, and
possessions 12,822,865 12,440,863 13,292,064 13,230,690
Industrial and miscellaneous 71,030,592 69,445,114 58,051,370 59,561,984
Total fixed maturity securities
$ 85,206,669 $ 86,763,654 The fair value of these securities increased$10,541,373 during 2019, primarily due to the investing of net proceeds from the initial public offering stock issuance and unrealized appreciation driven by declining interest rates. The net unrealized gain on these securities atDecember 31, 2019 was$2,075,598 or more than 2% of the amortized cost or cost basis. The net unrealized gain included gross unrealized gains of$2,127,857 and gross unrealized losses of$52,259 .
For 2019, our investment portfolio experienced a gain in the net change in
unrealized gains/losses of
December 31,
2019 2018 Difference
Fixed maturity securities:
Unrealized gains $ 2,127,857 $ 221,846 $ 1,906,011
Unrealized losses (52,259 ) (1,778,831 ) 1,726,572
Net fixed maturity securities unrealized
gains (losses) 2,075,598 (1,556,985 ) 3,632,583
Equity securities:
Unrealized gains 1,493,581 524,526 969,055
Unrealized losses (339,077 ) (826,242 ) 487,165
Net equity securities unrealized gains
(losses) 1,154,504 (301,716 ) 1,456,220
Net unrealized gain (loss) $ 3,230,102 $ (1,858,701 ) $ 5,088,803 The fair value and unrealized losses of our securities that were temporarily
impaired at
Less than 12 months 12 months or longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of securities Value Losses Value Losses Value Losses
December 31, 2019 :
U.S. government $ 2,628,516 $ 8,227 $
4,061,077
- - 93,000 7,470 93,000 7,470
Industrial and miscellaneous 4,773,607 5,934 350,922 365 5,124,529 6,299
Total fixed maturity securities $ 7,402,123 $ 14,161 $ 4,504,999 $ 38,098 $ 11,907,122 $ 52,259
Less than 12 months 12 months or longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of securities Value Losses Value Losses Value Losses
December 31, 2018:
U.S. government $ 1,757,021 $ 5,521 $ 8,858,782 $ 203,178 $ 10,615,803 $ 208,699
States, territories, and
possessions 410,416 897 - - 410,416 897
Subdivisions of states,
territories, and possessions 3,138,650 11,729 1,993,170 32,862 5,131,820 44,591
Industrial and miscellaneous 28,187,416 563,317
25,787,215 961,327 53,974,631 1,524,644
Total fixed maturity securities
At
26
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Fair values of interest rate sensitive instruments may be affected by increases
and decreases in prevailing interest rates which generally translate,
respectively, into decreases and increases in fair values of fixed maturity
investments. The fair values of interest rate sensitive instruments also may be
affected by the credit worthiness of the issuer, prepayment options, relative
values of other investments, the liquidity of the instrument, and other general
market conditions.
We evaluated each security and took into account the severity and duration of
the impairment, the current rating on the bond, and the outlook for the issuer
according to independent analysts. We found that the declines in fair value are
most likely attributable to increases in interest rates, and there is no
evidence that the likelihood of not receiving all of the contractual cash flows
as expected has changed. Our fixed maturity portfolio is managed by our
investment committee in concert with an outside investment manager for
investment grade bond investments. By agreement, the investment manager cannot
sell any security without the consent of our investment committee if such sale
will result in a net realized loss.
We monitor our investment portfolio and review securities that have experienced
a decline in fair value below cost to evaluate whether the decline is other than
temporary. When assessing whether the amortized cost basis of the security will
be recovered, we compare the present value of the cash flows likely to be
collected, based on an evaluation of all available information relevant to the
collectability of the security, to the amortized cost basis of the security. The
shortfall of the present value of the cash flows expected to be collected in
relation to the amortized cost basis is referred to as the "credit loss." If
there is a credit loss, the impairment is considered to be other-than-temporary.
If we identify that an other-than-temporary impairment loss has occurred, we
then determine whether we intend to sell the security, or if it is more likely
than not that we will be required to sell the security prior to recovering the
amortized cost basis less any current-period credit losses. If we determine that
we do not intend to sell, and it is not more likely than not that we will be
required to sell the security, the amount of the impairment loss related to the
credit loss will be recorded in earnings, and the remaining portion of the
other-than-temporary impairment loss will be recognized in other comprehensive
income (loss), net of tax. If we determine that we intend to sell the security,
or that it is more likely than not that we will be required to sell the security
prior to recovering its amortized cost basis less any current-period credit
losses, the full amount of the other-than-temporary impairment will be
recognized in earnings.
For 2019 and 2018, we determined that none of our securities were
other-than-temporarily impaired. Adverse investment market conditions, or poor
operating results of underlying investments, could result in impairment charges
in the future.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain
assets to determine fair value disclosures. Fixed maturity available-for-sale
securities and equity securities are recorded at fair value on a recurring
basis. FASB ASC Topic 820 "Fair Value Measurements and Disclosures" ("ASC Topic
820"), establishes a fair value hierarchy that prioritizes the inputs to
valuation methods used to measure fair value. The three levels of the fair value
hierarchy under ASC Topic 820 are as follows:
Level 1: Quoted (unadjusted) prices for identical assets in active markets.
Level 2: Quoted prices for similar assets in active markets, quoted prices for
identical or similar assets in nonactive markets (fewtransactions,
limited information, noncurrent prices, high variability over time,
etc., inputs other than quoted prices that are observable for the
asset (interest rates, yield curves, volatilities, default rates,
etc., and inputs that are derived principally from orcorroborated by
other observable market data)).
Level 3: Unobservable inputs that cannot be corroborated by observable market
data.
Under ASC Topic 820, we base fair values of assets on the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. It is our
policy to maximize the use of observable inputs and minimize the use of
unobservable inputs when developing fair value measurements, in accordance with
the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for
assets where there exists limited or no observable market data and, therefore,
are based primarily upon our or other third-party's estimates, are often
calculated based on the characteristics of the asset, the economic and
competitive environment and other such factors. Management uses its best
judgment in estimating the fair value of financial instruments; however, there
are inherent weaknesses in any estimation technique. Therefore, for
substantially all financial instruments, the fair value estimates herein are not
necessarily indicative of the amounts we could have realized in a sales
transaction on the dates indicated. The estimated fair value amounts have been
measured as of their respective period end and have not been re-evaluated or
updated for purposes of the consolidated and combined financial statements
subsequent to those respective dates. As such, the estimated fair values of
these financial instruments subsequent to the respective reporting dates may be
different than the amounts reported at each period-end. Additionally, changes in
the underlying assumptions used, including discount rates and estimates of
future cash flows, could significantly affect the results of current or future
valuations.
27
--------------------------------------------------------------------------------
We obtain one price for each security primarily from a third-party pricing
service ("pricing service"), which generally uses quoted prices or other
observable inputs for the determination of fair value. The pricing service
normally derives the security prices through recently reported trades for
identical or similar securities, making adjustments through the reporting date
based upon available observable market information. For securities not actively
traded, the pricing service may use quoted market prices of comparable
instruments or discounted cash flow analyses, incorporating inputs that are
currently observable in the markets for similar securities. Inputs that are
often used in the valuation methodologies include, but are not limited to,
non-binding broker quotes, benchmark yields, credit spreads, default rates, and
prepayment speeds.
In instances in which the inputs used to measure fair value fall into different
levels of the fair value hierarchy, the fair value measurement has been
determined based on the lowest-level input that is significant to the fair value
measurement in its entirety. Our assessment of the significance of a particular
item to the fair value measurement in its entirety requires judgment, including
the consideration of inputs specific to the asset or liability.
The table below presents the level within the fair value hierarchy generally
utilized to estimate the fair value of assets disclosed on a recurring basis at
December 31, 2019 and 2018:
December 31, 2019 Total Level 1 Level 2 Level 3
Fixed maturity securities $ 95,748,042 $ - $ 95,748,042 $ -
Equity securities 7,756,966 7,756,966 - -
$ 103,505,008 $ 7,756,966 $ 95,748,042 $ -
December 31, 2018 Total Level 1 Level 2 Level 3
Fixed maturity securities $ 85,206,669 $ - $ 85,206,669 $ -
Equity securities 7,267,094 7,267,094 - -
$ 92,473,763 $ 7,267,094 $ 85,206,669 $ -
Investment Portfolio Update
Our investment portfolio has experienced significant fluctuations in fair value as a result of the market volatility due to the COVID-19 pandemic. The following tables reflect the changes in our investment portfolio sinceDecember 31, 2019 . Gross Amortized Unrealized Cost/Cost Gains, Net Fair ValueMay 8, 2020 U.S. government$ 9,172,746 $ 190,297 $ 9,363,043 States, territories, and possessions 1,091,178 47,775 1,138,953 Subdivisions of states, territories, and possessions 12,313,961 358,989 12,672,950 Industrial and miscellaneous 68,391,118
1,727,660 70,118,778
Total fixed maturity securities 90,969,003 2,324,721 93,293,724
Equity securities 6,446,067 (66,457 ) 6,379,610
Short-term investments 2,231,703 (9 ) 2,231,694
Total investments 99,646,773 2,258,255 101,905,028
Cash and cash equivalents 19,924,270 - 19,924,270
$ 119,571,043 $ 2,258,255 $ 121,829,298
28
--------------------------------------------------------------------------------
Gross
Amortized Unrealized
Cost/Cost Gains, Net Fair Value
December 31, 2019
U.S. government $ 10,689,829 $ 61,733 $ 10,751,562
States, territories, and possessions 1,096,638 46,385 1,143,023
Subdivisions of states, territories, and
possessions 12,440,863 382,002 12,822,865
Industrial and miscellaneous 69,445,114 1,585,478 71,030,592
Total fixed maturity securities 93,672,444 2,075,598 95,748,042
Equity securities 6,602,462 1,154,504 7,756,966
Short-term investments 1,169,472 - 1,169,472
Total investments 101,444,378 3,230,102 104,674,480
Cash and cash equivalents 20,988,081 - 20,988,081
$ 122,432,459 $ 3,230,102 $ 125,662,561
Deferred Acquisition Costs
Certain direct acquisition costs consisting of commissions, premium taxes and
certain other direct underwriting expenses that vary with and are primarily
related to the successful production of business are deferred and amortized over
the effective period of the related insurance policies as the underlying policy
premiums are earned. The method followed in computing deferred acquisition costs
limits the amount of deferred costs to their estimated realizable value, which
gives effect to the premium to be earned, related investment income, losses and
loss adjustment expenses, and certain other costs expected to be incurred as the
premium is earned. Future changes in estimates, the most significant of which is
expected losses and loss adjustment expenses, may require adjustments to
deferred acquisition costs. If the estimation of net realizable value indicates
that the deferred acquisition costs are not recoverable, they would be written
off.
Reinsurance Recoverable
We cede reinsurance risk to other insurance companies. This arrangement allows
us to reduce the net loss potential arising from large risks. Reinsurance
contracts do not relieve us of our obligation to our policyholders. Reinsurance
premiums, losses, and loss adjustment expenses are accounted for on a basis
consistent with those used in accounting for the original policies issued and
the terms of the reinsurance contract.
Our reinsurance recoverable balance at December 31, 2019 was $7,850,409 , which
we anticipate will be fully collectible. Although the contractual obligation of
individual reinsurers to pay their reinsurance obligations is determinable from
specific contract provisions, the collectability of such amounts requires
estimation by management. Many years may pass between the occurrence of a claim,
when it is reported to us and when we ultimately settle and pay the claim. As a
result, it can be several years before a reinsurer has to actually remit amounts
to us. Over this period of time, economic conditions and operational performance
of a particular reinsurer may impact their ability to meet these obligations and
while they may still acknowledge their contractual obligation to do so, they may
not have the financial resources to fully meet their obligation to us. If this
occurs, we may have to write down a reinsurance recoverable to its then
determined net realizable value and reflect that write-down in earnings in the
period such determination is made. We attempt to limit any such exposure to
uncollectible reinsurance recoverable by assessing the creditworthiness of our
reinsurers. In addition, we require collateral, such as assets held in trust or
letters of credit, for certain reinsurance recoverable balances. However, if our
future estimate of uncollectible recoverable exceeds our current expectations,
we may need to record an allowance for uncollectible reinsurance
recoverable. This allowance would result in a charge to earnings in the period
recorded. Accordingly, any related charge could have a material adverse effect
on our financial condition, results of operations and liquidity.
At
Income Taxes
We use the asset and liability method of accounting for income taxes. Deferred
income taxes arise from the recognition of temporary differences between
financial statement carrying amounts and the tax bases of its assets and
liabilities. The effect of a change in tax rates is recognized in the period of
the enactment date.
29
-------------------------------------------------------------------------------- AtDecember 31, 2019 , we had a net deferred tax asset of$891,584 , resulting from$2,362,499 of gross deferred tax assets reduced by$1,470,915 of deferred tax liabilities. In establishing the appropriate value of this asset, management must make judgments about our ability to utilize the net tax benefit from the reversal of temporary differences and the utilization of operating loss carryforwards that will begin to expire in 2038. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets.
CARES Act
OnMarch 27, 2020 ,President Trump signed the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") into law. The CARES Act includes certain income tax-related law changes that we believe will have a material effect on our deferred income taxes in 2020. The most significant effect on our deferred income taxes is expected to be due to changes in the Federal net operating loss ("NOL") carryback provisions which will allow us to carryback NOLs originating in 2018 and 2019 to prior tax years with corporate income tax rates of 34% (as opposed to forward to future tax years with corporate income tax rates of 21%). We estimate that this change will result in additional Federal income tax refunds of approximately$1.1 million during 2020 and will reduce our NOL by about$3.1 million , or about$650,000 tax-effected.
Results of Operations
Our results of operations are influenced by factors affecting the MPLI industry, in general. The operating results of the United States MPLI industry are subject to significant variations due to competition, changes in regulation, rising medical expenses, judicial trends, fluctuations in interest rates, and other changes in the investment environment. Our premium levels and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the MPLI industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle which makes it difficult to attract and retain properly priced MPLI business. As previously discussed, the markets in which we operate, and the national MPLI markets, have been in a prolonged period of a soft market cycle. However, we have started to see price increases with our policy renewals in 2020 and we believe the market is beginning to harden. Therefore, it is generally likely that insurers will be able to increase their rates or profit margins, as market conditions continue to improve. A hard market typically has a positive effect on premium growth, which can include absolute increases in premiums written. In 2019, we had a net loss of$(238,951) , compared to a net loss of$(5,371,516) in 2018. We also reported operating losses of$(1,269,329) and$(4,160,239) in 2019 and 2018, respectively. Total revenues for 2019 were$27,965,606 , compared to$24,623,479 for 2018. The increase in revenues for 2019, compared to prior year, primarily reflects unrealized gains on equity securities recognized in 2019 in contrast to unrealized losses recorded in 2018. To a lesser extent, the increase in revenues also reflects realized gains on sales of other investments in 2019 and higher net investment income reported in current year. Net premiums earned increased modestly in 2019, compared to 2018. 30 -------------------------------------------------------------------------------- The major components of consolidated revenues and pre-tax loss for 2019 and major components of combined revenues and pre-tax loss for 2018 are as follows: Year Ended December 31, 2019 2018 Revenues: Net premiums earned$ 23,700,963 $ 23,587,834 Net investment income 2,960,367 2,568,907
Realized investment gains (losses), net 1,304,276 (1,533,262 )
Total revenues 27,965,606 24,623,479
Expenses:
Losses and loss adjustment expenses 15,574,609 19,583,218
Other underwriting expenses 12,619,517 12,340,647
Interest expense 3,445 6,458
Total expenses 28,197,571 31,930,323
Loss before income taxes (231,965 ) (7,306,844 )
Income tax expense (benefit) 6,986 (1,935,328 )
Net loss $ (238,951 ) $ (5,371,516 ) Premiums Written and Premiums Earned
The comparative changes in premiums written and premiums earned for 2019 and
2018 are reflected in the table below. The increases in direct and net premiums
written are primarily due to new business written during 2019, while premiums
earned remained relatively consistent year-over-year.
Year Ended
December 31,
2019 2018 % Difference
Premiums written:
Direct $ 26,717,701 $ 25,323,049 5.5 %
Ceded 4,044,207 3,700,189 9.3 %
Premiums written, net of reinsurance
4.9 % Premiums earned: Direct$ 27,137,204 $ 27,435,509 -1.1 % Ceded 3,436,241 3,847,675 -10.7 %
Premiums earned, net of reinsurance
0.5 % Net Investment Income
The following table sets forth our average cash and invested assets and investment income for 2019 and 2018:
Year Ended
December 31,
2019 2018
Average cash and invested assets $ 113,232,646 $ 105,921,752
Net investment income 2,960,367 2,568,907
Return on average cash and invested assets 2.61 % 2.43 % Net investment income for 2019 was$2,960,367 , compared to$2,568,907 for 2018. The average monthly net investment income increased from$214,000 during 2018 to$247,000 during 2019.
The increase in net investment income primarily reflects the increase in our cash and invested asset positions, due to proceeds from the initial public offering stock issuance in 2019.
31
--------------------------------------------------------------------------------Realized Investment Gains (Losses), Net
Realized net investment gains (losses) for 2019 and 2018 are as follows:
Year Ended
December 31,
2019 2018
Total gain on sales of investments $ 351,768 $ 24,256
Unrealized gain (loss) on equity securities and other
investments 952,508
(1,557,518 )
Total net realized investment gains (losses)$ 1,304,276 $ (1,533,262 ) The total gain on sales of investments in 2019 includes a realized gain of$556,723 related to sales of our interests in limited partnership equity hedge funds. Our fixed maturity investments and equity investments are available-for-sale because we may, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies.
Losses and Loss Adjustment Expenses
The components of the GAAP combined ratios were as follows:
Year Ended
December 31,
2019 2018
Loss and LAE ratio 65.7 % 83.0 %
Expense ratio (1) 45.7 % 52.3 %
Combined ratio 111.4 % 135.3 %
(1) Expense ratio excludes holding company expenses of
The improved loss and LAE ratio for 2019 reflects lower adverse loss reserve development in prior accident years. During 2019, we recorded unfavorable prior year loss reserve development of$136,271 , compared to unfavorable prior year development of$4,057,821 in 2018. In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.
During 2018, we experienced unfavorable development primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.
The MPLI line of business is prone to variability in the loss reserving process due to the extended period of time during which claims can be made and the subsequent time required to settle those claims. Adjustments to our original estimates resulting from claims are not made until the period in which there is reasonable evidence that an adjustment to the reserve is appropriate.
Other Underwriting Expenses
Other underwriting expenses, including changes in deferred acquisition costs, were$12,619,517 for 2019, compared to$12,340,647 for 2018. The amount for 2019 includes expenses incurred by the holding company which did not exist in prior year.Positive Insurance Company pays a management fee to Diversus Management which is equal to a percentage of premiums written. This percentage was 25% in 2018 and was reduced to 12%, effectiveMarch 27, 2019 . The reduction in the management fee is largely offset by the increase due to holding company expenses in 2019.Positive Insurance Company also had$371,000 and$532,000 in initial public offering and conversion costs that were expensed during 2019 and 2018, respectively, and are included in other underwriting expenses.
We are required to participate in the
32
--------------------------------------------------------------------------------Income Tax Expense (Benefit)
The provision for income taxes for 2019 and 2018 resulted in an income tax
expense (benefit) of
Liquidity and Capital Resources
Liquidity is a measure of an entity's ability to secure sufficient cash to meet its contractual obligations and operating needs. Our insurance operations generate cash by writing policies and collecting premiums. The cash generated is used to pay losses and LAE as well as other underwriting expenses. Any excess cash is invested and earns investment income. We maintained investment and reinsurance programs that are intended to provide sufficient funds to meet our obligations without forced sales of investments. As such, our investment portfolio contains a high degree of liquidity, with relatively short-term and highly liquid assets, to ensure the availability of funds and to meet the demands of claim settlements and operating expenses. We also have an Investment Committee which meets regularly to discuss cash flow projections and our short-term cash needs as well as asset allocation within our investment portfolio. Furthermore, liquidity requirements are met primarily through operating cash flows and by maintaining a portfolio with maturities that reflect our estimates of future cash flow requirements. Our investment strategy includes setting guidelines for asset quality standards, allocating assets among investment types and issuers, and other relevant criteria for our portfolio. In addition, invested asset cash flows, which include both current interest income received and investment maturities, are structured to consider projected liability cash flows of loss reserve payouts that are based on actuarial models. Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets. Our invested assets are structured to emphasize current investment income while maintaining appropriate portfolio quality and diversity.
Cash flows for 2019 and 2018 were as follows:
Year Ended
December 31,
2019 2018
(Combined)
Cash flows used in operating activities $ (13,352,352 ) $ (6,765,867 )
Cash flows (used in) provided by investing activities (3,075,119 ) 2,533,156
Cash flows provided by (used in) financing activities 33,511,932
(59,895 )
Net increase (decrease) in cash and cash equivalents
Cash flows used in operating activities increased during 2019, compared to prior year, primarily attributable to the current year payment of the$10,000,000 prepaid management fee toDiversus . Cash flows from investing activities decreased in 2019, compared to 2018, mainly due to additional purchases of fixed maturity securities. The increase in cash flows from financing activities reflects the initial public offering stock issuance of$33,574,401 inMarch 2019 . At the holding company level, our primary sources of liquidity are dividends and tax payments received fromPositive Insurance Company and capital raising activities. We utilize cash to pay debt obligations, taxes to the federal government, and corporate expenses. AtDecember 31, 2019 , we had$16,843,126 of cash and short-term investments at our holding company which we believe, combined with our other capital sources, will continue to provide us with sufficient funds to meet our foreseeable ongoing expenses and other obligations. Our insurance subsidiary,Positive Insurance Company , is restricted by the insurance laws and regulations of theCommonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the holding company. In considering future dividend policy,Positive Insurance Company will consider, among other things, applicable regulatory constraints. AtDecember 31, 2019 ,Positive Insurance Company had statutory surplus of$39,415,264 . An order by thePennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by PPHI toInsurance Capital Group, LLC andEnstar Holdings (US) LLC , the two principal stockholders of PPHI, or any other shareholder without the prior approval of thePennsylvania Insurance Department , for a period of three years following the effective date of the conversions. Additionally, by the order of thePennsylvania Insurance Department ,Positive Insurance Company cannot pay a dividend to PPHI for a period of three years following the effective date of the conversions without the approval of thePennsylvania Insurance Department . 33 -------------------------------------------------------------------------------- Prior to its payment of any dividend,Positive Insurance Company will be required to provide notice of the dividend to thePennsylvania Insurance Department . This notice must be provided to thePennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend.The Pennsylvania Insurance Department has the power to limit or prohibit dividends ifPositive Insurance Company is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity. Upon completion of the offering onMarch 27, 2019 , the Company is a public company and is subject to the proxy solicitation, periodic reporting, insider trading and other requirements of the Exchange Act and to most of the provisions of the Sarbanes-Oxley Act of 2002. As a result, the Company anticipates incurring significant increases in expenses related to accounting and legal services that will be necessary to comply with such requirements. We estimate that the cost of initial compliance with the requirements of the Sarbanes-Oxley Act will be approximately$350,000 and that compliance with the ongoing requirements of the Exchange Act and the Sarbanes-Oxley Act will result in an increase of approximately$200,000 in annual operating expenses.
Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital reserves.
Other Matters
Comparison of SAP and GAAP Results
Results presented in accordance with GAAP vary in certain respects from results presented in accordance with statutory accounting practices prescribed or permitted by thePennsylvania Insurance Department (collectively "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety ofNational Association of Insurance Commissioners publications. Permitted SAP encompasses all accounting practices that are not prescribed. Our domestic insurance subsidiary uses SAP to prepare various financial reports for use by insurance regulators.
Recent Accounting Guidance
For a discussion of recent accounting guidance, see Note 4 to the Consolidated and Combined Financial Statements in "Item 8. Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
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