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 Unaudited Consolidated Financial Statements and the notes thereto included in "Part I. Item 1. Financial Statements" of the Company. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q constitutes forward-looking information that involves risk and uncertainties. We also recommend you read Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . 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.
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. 20 -------------------------------------------------------------------------------- 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 has transitioned 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, we intend to achieve further premium growth with our expansion into new states.Positive Insurance Company was admitted intoTexas inNovember 2019 and is currently in the process of obtaining approval on premium rates before we can begin writing business there. We are also currently in the process of obtaining licenses to write business in the states ofCalifornia ,Florida andGeorgia .
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 that were 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 have seen premium decreases due to policy endorsements associated with doctors electing to work part time, take a leave of absence or retire. In addition, some of our insureds have elected to temporarily change their areas of practice and/or 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 went into effect onJune 30, 2020 and necessary reimbursements or credits against future payments have been applied. During the second quarter, we recorded approximately$160,000 in return premium adjustments, or reductions in direct premiums written, associated with these policy endorsements. 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, or post-payment due date. As a result of COVID-19, we have updated this policy and suspended cancellations of insurance contracts resulting from non-payment of premium and deferred payments untilJune 30, 2020 for invoices due afterApril 1, 2020 . The amount of premium payment deferrals is approximately$950,000 . Also, due to this change in policy, we recorded an allowance for uncollectible premium of approximately$150,000 atJune 30, 2020 based on the aging of outstanding premiums receivable. 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, although we have seen the number of new claims reported during the second quarter decline, it is unclear if this is from the closure of courts during this period of time or due to other factors. In general, our expectation is that the frequency of new claims reported regarding medical rendered 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).
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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
by Positive Insurance Company typically have a term of twelve months. Thus, for
example, for a policy that is written on July 1, 2020 , one-half of the premiums
would be earned in 2020 and the other half would be earned in 2021.
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. 22
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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.
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, were in a prolonged period of a soft
market cycle. However, we are seeing price increases with our policy renewals in
2020 and we believe the market is hardening. 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.
We reported net income of $358,063 for the second quarter of 2020, compared to a
net loss of $560,947 for the second quarter of 2019. The improvement for second
quarter in 2020 is due to better underwriting results and additional realized
investment gains. For the first six months, we had net losses of $764,640 in the
current year, compared to $469,158 in prior year. The year-to-date results
reflect realized investment losses in 2020, compared to gains in 2019, mainly
due to fluctuations in the unrealized position on our equity securities, which
was largely offset by improved underwriting results in 2020.
For the second quarter, operating losses were $30,570 in 2020, compared to
$698,105 in 2019. For the first six months, we had operating income of $398,620
in the current year, compared to an operating loss of $1,279,121 last year. The
increases in our operating results for both periods, compared to prior year,
largely reflect improvement in our underwriting profitability.
Total revenues were $5,840,208 in the second quarter of 2020, compared to
$6,267,859 for the same period last year. Total revenues were $9,326,794 for the
first six months of 2020, compared to $13,238,973 for the first half of
2019. The decline in revenues during the first six months of 2020, compared to
the first six months in 2019, primarily reflects unrealized losses on equity
securities recognized in current year in contrast to unrealized gains recorded
in prior year. The decreases for both the second quarter and first six months of
2020, compared to the same periods in 2019, also reflect lower net premiums
earned.
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The major components of consolidated revenues and pre-tax income (loss) for the
three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Revenues:
Net premiums earned $ 4,699,722 $ 5,327,994 $ 9,384,432 $ 10,819,201
Net investment income 648,546 766,247 1,414,843 1,394,503
Realized investment gains (losses), net 491,940 173,618 (1,472,481 ) 1,025,269
Total revenues 5,840,208 6,267,859 9,326,794 13,238,973
Expenses:
Losses and loss adjustment expenses 3,195,811 4,267,440 6,381,414 7,589,116
Other underwriting expenses 2,352,947 2,785,060 4,691,851 6,285,437
Interest expense 1,260 413 1,855 1,779
Total expenses 5,550,018 7,052,913 11,075,120 13,876,332
Income (loss) before income taxes 290,190 (785,054 ) (1,748,326 ) (637,359 )
Income tax benefit (67,873 ) (224,107 ) (983,686 ) (168,201 )
Net income (loss) $ 358,063 $ (560,947 ) $ (764,640 ) $ (469,158 )
Underwriting loss (1) $ (223,400 ) $ (1,159,770 ) $ (502,598 ) $ (2,290,214 )
Operating income (loss) $ (30,570 ) $ (698,105
)
(1) Underwriting loss excludes holding company expenses of
for the three months ended
Premiums Written and Premiums Earned
The comparative changes in premiums written and premiums earned for the three
months ended
Three Months Ended
June 30,
2020 2019 % Change
Premiums written:
Direct $ 3,515,340 $ 3,783,325 -7.1 %
Ceded 2,176,966 648,254 235.8 %
Premiums written, net of reinsurance
-57.3 %
Premiums earned:
Direct $ 5,164,623 $ 6,075,535 -15.0 %
Ceded 464,901 747,541 -37.8 %
Premiums earned, net of reinsurance
-11.8 %
The comparative changes in premiums written and premiums earned for the six
months ended
Six Months Ended
June 30,
2020 2019 % Change
Premiums written:
Direct $ 11,233,852 $ 11,980,842 -6.2 %
Ceded 2,423,445 2,600,731 -6.8 %
Premiums written, net of reinsurance
-6.1 % Premiums earned: Direct$ 11,066,071 $ 12,428,915 -11.0 % Ceded 1,681,639 1,609,714 4.5 %
Premiums earned, net of reinsurance
-13.3 %
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The decline in direct premiums written during the first six months of 2020, compared to the same period in 2019, is primarily due to the non-renewal of prior year policies which did not satisfy our underwriting criteria. In addition, the decreases in both second quarter and first six months of 2020 were impacted by return premium adjustments associated with policy endorsements related to the COVID-19 pandemic.
Ceded premiums written significantly increased during the second quarter of 2020, compared to the second quarter last year, as our ceded premiums are written based on direct premiums earned during the term of our reinsurance agreement. In 2020, our reinsurance agreement renewed onApril 1st , whereas in 2019, our reinsurance contract renewed onMarch 27th . As a result, the amount of direct premiums subject to our calculation of ceded premiums written was much greater during the second quarter of 2020. The decrease in ceded premiums written during the first six months of 2020, compared to the same period in 2019, correlates with the decline in direct premiums written.
Net Investment Income
The following table sets forth our average cash and invested assets and investment income for the reported periods:
Six Months Ended
June 30,
2020 2019
Average cash and invested assets $ 125,279,381 $ 112,326,218
Net investment income 1,414,843
1,394,503
Annualized return on average cash and invested assets 2.26 % 2.48 % Net investment income for the first six months of 2020 was$1,414,843 , compared to$1,394,503 for the first six months of 2019. The average monthly net investment income increased modestly from$232,000 during the first six months last year to$236,000 during the same period this year. 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 onMarch 27, 2019 , partially offset by lower investment yields in the current year.
Realized Investment Gains (Losses), Net
Net realized investment gains (losses) for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Total gain (loss) on sales of
investments $ 254,802 $ (144,998 ) $ 49,364 $ (179,944 )
Unrealized gain (loss) on equity 237,138 318,616
securities and other investments (1,521,845 ) 1,205,213
Total net realized investment gains
(losses) $ 491,940 $ 173,618 $ (1,472,481 ) $ 1,025,269
The unrealized loss on equity securities during the first six months of 2020
primarily reflects the market volatility associated with the COVID-19
pandemic. During the second quarter, we sold the majority of these equity
holdings for a modest net realized gain following a partial recovery in
corresponding fair values. Our fixed maturity 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:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Loss and LAE ratio 68.0 % 80.1 % 68.0 % 70.1 %
Expense ratio (1) 36.8 % 41.7 % 37.4 % 51.0 %
Combined ratio 104.8 % 121.8 % 105.4 % 121.1 %
(1) Expense ratio excludes holding company expenses of
the three months ended
for the six months ended June 30, 2020 and 2019, respectively.
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-------------------------------------------------------------------------------- The decrease in the loss and LAE ratios for the second quarter and first six months of 2020, compared to the same periods in 2019, primarily reflects a lower loss and LAE estimate for the current policy year. 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, decreased to$2,352,947 for the second quarter of 2020, compared to$2,785,060 for the second quarter of 2019, and decreased to$4,691,851 during the first six months of 2020, compared to$6,285,437 for the same period in 2019.Positive Insurance Company pays a management fee to Diversus Management which is equal to a percentage of premiums written. This percentage was reduced from 25% to 12%, effectiveMarch 27, 2019 .Positive Insurance Company also incurred$371,000 in initial public offering and conversion costs during the first half of 2019, mainly in the first quarter, which are included in other underwriting expenses. These expense reductions during the first six months of 2020 were partially offset by the amortization of the prepaid management fee which was not incurred in the first quarter last year.
The decrease in other underwriting expenses on a quarter-to-date basis is primarily due to a lower amortization of deferred acquisition costs in the current year, which reflects the prior year reduction in the management fee percentage noted above.
Income Tax Expense (Benefit)
The provision for income taxes for the three and six months endedJune 30, 2020 resulted in income tax benefits of$67,873 and$983,686 , respectively, compared to income tax benefits of$224,107 and$168,201 for the same periods in 2019. The Company's effective tax rate for both years was 21%. 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 have a material effect on our deferred income taxes. The most significant effect on our deferred income taxes is due to changes in the federal net operating loss ("NOL") carryback provisions which 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%). As a result of this legislation, during the first six months of 2020, we significantly reduced our NOL balance by$2,969,550 , or$623,606 tax-effected, and recorded additional federal income tax refunds of$1,205,964 , which resulted in an income tax benefit of$582,358 . Loss Reserves
The following tables provide case and incurred-but-not-reported reserves of
As ofJune 30, 2020 Case IBNR Total Reserves Reserves Reserves Medical professional liability$ 34,648,805 $ 21,437,061 $ 56,085,866 Total net reserves 34,648,805 21,437,061 56,085,866 Reinsurance recoverables on unpaid claims 2,498,603 4,925,855 7,424,458 Gross reserves$ 37,147,408 $ 26,362,916 $ 63,510,324 As ofDecember 31, 2019 Case IBNR Total Reserves Reserves Reserves Medical professional liability$ 30,126,567 $ 25,966,273 $ 56,092,840 Total net reserves 30,126,567 25,966,273 56,092,840 Reinsurance recoverables on unpaid claims 1,894,670 5,620,465 7,515,135 Gross reserves$ 32,021,237 $ 31,586,738 $ 63,607,975 The estimation ofPositive Insurance Company's reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the independent 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. 26 -------------------------------------------------------------------------------- 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 maintain 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 the six months ended
Six Months Ended
June 30,
2020 2019
Cash flows used in operating activities $ (1,251,338 ) $ (14,367,325 )
Cash flows provided by investing activities 3,163,016 1,286,084
Cash flows (used in) provided by financing activities (32,168 ) 33,543,464 Net increase in cash and cash equivalents
$ 1,879,510 $ 20,462,223 Cash flows from operating activities improved during the first six months of 2020, compared to prior year, primarily attributable to the payment of the$10,000,000 prepaid management fee toDiversus in 2019. Cash flows from investing activities increased in the first six months of 2020, compared to prior year, mainly due to additional sales of equity securities in the current year. The decrease in cash flows from financing activities in 2020 reflects proceeds of$33,574,401 received from the initial public offering stock issuance 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. AtJune 30, 2020 , we had$15,824,903 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. AtJune 30, 2020 ,Positive Insurance Company had statutory surplus of$39,027,224 . 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 . 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. 27 --------------------------------------------------------------------------------
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.
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.
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 of June 30, 2020 , the
average duration of our fixed maturity security investments that support the
insurance reserves was approximately was 2.7 years, while the duration of our
insurance reserves was slightly lower, reflecting 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
$3,622,658 at June 30, 2020 .
The following table shows the fair value and amortized cost/cost of our available-for-sale fixed maturity and equity securities:
June 30, 2020 December 31, 2019
Amortized Amortized
Fair Value Cost/Cost Fair Value Cost/Cost
U.S. government $ 11,547,057 $ 11,359,661 $ 10,751,562 $ 10,689,829
States, territories, and possessions 1,148,378 1,088,928 1,143,023 1,096,638
Subdivisions of states, territories, and
possessions 12,778,686 12,290,490 12,822,865 12,440,863
Industrial and miscellaneous 76,043,585 72,558,805 71,030,592 69,445,114
Total fixed maturity securities 101,517,706 97,297,884 95,748,042 93,672,444
Equity securities 260,915 628,256 7,756,966 6,602,462
$ 101,778,621 $ 97,926,140 $ 103,505,008 $ 100,274,906
The fair value of our investment portfolio increased during the second quarter
of 2020, primarily due to unrealized appreciation in our fixed maturity
securities, mainly corporate bonds, which resulted from declining interest
rates. We also sold the majority of our equity securities during the second
quarter for a modest net realized gain in order to de-risk our consolidated
balance sheet. The total net unrealized gain on our investment portfolio at June
30, 2020 was $3,852,481 , or nearly 4% of the amortized cost or cost basis,
compared to an overall net unrealized gain of $3,230,102 at December 31, 2019 .
Year-to-date movements in the unrealized gain (loss) position of our fixed maturity and equity securities are as follows:
June 30, 2020 December 31, 2019 YTD Change
Fixed maturity securities:
Unrealized gains $ 4,446,149 $ 2,127,857 $ 2,318,292
Unrealized losses (226,327 ) (52,259 ) (174,068 )
Net fixed maturity securities unrealized gains 4,219,822 2,075,598 2,144,224
Equity securities:
Unrealized gains - 1,493,581 (1,493,581 )
Unrealized losses (367,341 ) (339,077 ) (28,264 )
Net equity securities unrealized (losses) gains (367,341 ) 1,154,504 (1,521,845 )
Net unrealized gain $ 3,852,481 $ 3,230,102 $ 622,379
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-------------------------------------------------------------------------------- For our fixed maturity securities that were temporarily impaired atJune 30, 2020 andDecember 31, 2019 , the length of time that such securities were in an unrealized loss position, as measured by their month-end fair value, are as follows: Less than 12 months 12 months or longer Total Fair Unrealized Fair Unrealized Fair Unrealized Description of securities Value Losses Value Losses Value LossesJune 30, 2020 : U.S. government$ 3,670,584 $ 945 $ 444,584 $ 17,156 $ 4,115,168 $ 18,101 States, territories, and possessions - - - - - - Subdivisions of states, territories, and possessions - - 68,379 6,946 68,379 6,946 Industrial and miscellaneous 4,947,932 201,280 - - 4,947,932 201,280 Total fixed maturity securities$ 8,618,516 $ 202,225 $ 512,963 $ 24,102 $ 9,131,479 $ 226,327 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 $ 30,263 $ 6,689,593 $ 38,490 States, territories, and possessions - - - - - - Subdivisions of states, territories, and possessions - - 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
AtJune 30, 2020 , we had gross unrealized losses on fixed maturity securities of$226,327 , compared to gross unrealized losses on fixed maturity securities of$52,259 atDecember 31, 2019 . The increase in gross unrealized losses during the first six months of 2020 was attributable to increases in interest rates, mainly associated with our holdings in certain corporate bonds. We have not observed any evidence which would lead us to believe that the entire amortized cost basis will not be recovered. 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
Refer to Note 4 to the Unaudited Consolidated Financial Statements for information regarding recent accounting guidance.
Critical Accounting Policies
As ofJune 30, 2020 , there were no material changes to our critical accounting estimates. For a full discussion of our critical accounting estimates, refer to Item 7 in our 2019 Form 10-K. 29
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report may contain forward-looking statements as defined in the Private
Securities Litigation Reform Act of 1995 with respect to the Company's business,
financial condition and results of operations and the plans and objectives of
its management. Forward-looking statements can generally be identified by use of
forward-looking terminology such as "may," "will," "plan," "expect," "intend,"
"anticipate," and "believe." These forward-looking statements may include
estimates, assumptions or projections and are based on currently available
financial, industry, competitive and economic data and our current operating
plans. All forward-looking statements are subject to risks and uncertainties,
including risks regarding the effects and duration of the COVID-19 pandemic,
that could cause actual results to differ materially from those expressed or
implied by the forward-looking statements.
The effect of the COVID-19 pandemic on our operations could have a material
adverse effect on our business, financial condition, results of operations, or
cash flows. The World Health Organization has declared the outbreak of COVID-19,
which began in December 2019 , a pandemic and the U.S. federal government has
declared it a national emergency. Our business and operations could be
materially and adversely affected by the effects of COVID-19. The global spread
of COVID-19 has already created significant volatility, uncertainty and economic
disruption in the markets in which we operate. Governments, public institutions,
and other organizations in countries and localities where cases of COVID-19 have
been detected are taking certain emergency measures to mitigate its spread,
including implementing travel restrictions and closing factories, schools,
public buildings, and businesses. While the full impact of this outbreak is not
yet known, we are closely monitoring the spread of COVID-19 and continually
assessing its potential effects on our business.
As a result of the restrictions put in place to address COVID-19 and the related
economic downturn, the Company has experienced business disruptions including,
but not limited to, office closures and difficulties in maintaining operational
continuance during remote operations required by illness, social quarantining,
and work from home orders that were in force. The extent to which our results
continue to be affected by COVID-19 will largely depend on future developments
which cannot be accurately predicted, including the duration and scope of the
pandemic, governmental and business responses to the pandemic and the impact on
the global economy. While these factors are uncertain, the COVID-19 pandemic or
the perception of its effects could continue to have a material adverse effect
on our business, financial condition, results of operations, or cash flows.
Other factors that could cause actual results to differ materially from those in the forward-looking statements, include, but are not limited to:
• the potential impact of fraud, operational errors, system malfunctions, or
cybersecurity incidents;
• financial market conditions, including, but not limited to, changes in
interest rates and the stock markets causing a reduction of investment
income or investment gains and reduction in the value of our investment
portfolio;
• future economic conditions in the market in which we compete that are less
favorable than expected;
• the effect of legislative, judicial, economic, demographic, and regulatory
events in the jurisdictions where we do business;
• our ability to successfully implement steps to optimize the business
portfolio, ensure capital efficiency, and enhance investment returns;
• the risks associated with the management of capital on behalf of investors;
• our ability to enter new markets successfully and capitalize on growth
opportunities either through acquisitions or the expansion of our producer
network;
• the success with which our brokers sell our products and our ability to
collect payments from our insureds;
• heightened competition, including specifically the intensification of
price competition, the entry of new competitors and the development of new
products by new or existing competitors, resulting in a reduction in the
demand for our products;
• our concentration in medical professional liability insurance, which makes
us particularly susceptible to adverse changes in that industry segment;
• changes in general economic conditions, including inflation, unemployment,
interest rates and other factors;
• estimates and adequacy of loss reserves and trends in loss and loss
adjustment expenses;
• changes in the coverage terms required by state laws, including higher
limits;
• our inability to obtain regulatory approval of, or to implement, premium
rate increases;
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• inadequacy of premiums we charge to compensate us for our losses incurred;
• the effectiveness of our risk management loss limitation methods;
• our ability to obtain reinsurance coverage at reasonable prices or on
terms that adequately protect us and to collect amounts that we believe we
are entitled to under such reinsurance;
• our ability to attract and retain qualified management personnel;
• dependence upon our relationship with
management fee under our agreement with them;
• the potential impact on our reported net income (loss) that could result
from the adoption of future accounting standards issued by the Financial
Accounting Standards Board or other standard-setting bodies;
• unanticipated changes in industry trends and ratings assigned by
nationally recognized rating organizations;
• statutory requirements that limit our ability to receive dividends from
our insurance subsidiary;
• the impact of future results on the recoverability of our deferred tax asset;
• adverse litigation or arbitration results; and
• adverse changes in applicable laws, regulations or rules governing
insurance holding companies and insurance companies, including tax or
accounting matters, limitations on premium levels, increases in minimum
capital and reserves, other financial viability requirements, and changes
that affect the cost of, or demand for, our products.
You should not place undue reliance on any forward-looking statements that we
make. All forward-looking statements made in this Form 10-Q reflect our views on
the date of this report. Forward-looking statements are not generally required
to be publicly revised as circumstances change and we do not intend to update
the forward-looking statements in this Form 10-Q to reflect circumstances after
the date of this report or to reflect the occurrence of unanticipated events.
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