ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Protective Insurance Corporation is a property-casualty insurer specializing in marketing and underwriting property, liability and workers' compensation coverage for trucking and public transportation fleets, as well
as coverage for trucking industry independent contractors. Additionally, we offer workers' compensation coverage for a variety of operations outside the transportation industry. We operate as one reportable property and casualty insurance segment,
offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.
The term “Protective,” as used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), refers to Protective Insurance Corporation, the parent company. The
terms the “Company,” “we,” “us” and “our,” as used throughout this MD&A, refer to Protective and all of its subsidiaries, unless the context clearly indicates otherwise. The term “Insurance Subsidiaries,” as used throughout this MD&A, refers
to Protective Insurance Company, Protective Specialty Insurance Company, Sagamore Insurance Company and B&L Insurance, Ltd.
Liquidity and Capital Resources
The primary sources of our liquidity are (1) funds generated from insurance operations, including net investment income, (2) proceeds from the sale of investments, and (3) proceeds from maturing investments.
We generally experience positive cash flow from operations. Premiums are collected on insurance policies in advance of the disbursement of funds for payment of claims. Operating costs of our property/casualty
Insurance Subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, average less than one-third of net premiums earned on a consolidated basis, and the remaining amount is available for investment for
varying periods of time depending on the type of insurance coverage provided and the timing of the claim payments. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, become negative
as loss settlements on claim reserves established in prior years exceed current revenues. Our cash flow relating to premiums is significantly affected by reinsurance programs in effect, whereby we cede both premium and risk to other insurance and
reinsurance companies. These programs vary significantly among products, and certain contracts call for reinsurance payment patterns, which do not coincide with the collection of premiums by us from our insureds.
On August 31, 2017, our Board of Directors authorized the reinstatement of our share repurchase program for up to 2,464,209 shares of our Class A or Class B Common Stock. On August 6, 2019, our Board of Directors
reaffirmed our share repurchase program, but also provided that the aggregate dollar amount of shares of our common stock that may be repurchased under the share repurchase program between August 6, 2019 and August 6, 2020 may not exceed $25.0
million, including a limit of up to $6.25 million per quarter. The repurchases may be made in the open market or through privately negotiated transactions, from time-to-time, and in accordance with applicable laws, rules and regulations. On
September 23, 2019, we entered into a stock repurchase plan for the purpose of repurchasing up to $0.6 million of shares of our common stock, at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Securities
Exchange Act of 1934, as amended (the "Rule 10b5-1 Plan"). The Rule 10b5-1 Plan was established pursuant to, and as part of, our share repurchase program and permits shares to be repurchased in accordance with pre-determined criteria when repurchases
would otherwise be prohibited, such as during self-imposed blackout periods, or under insider trading laws. The Rule 10b5-1 Plan expires on November 7, 2019. The share repurchase program may be amended, suspended or discontinued at any time and does
not commit us to repurchase any shares of our common stock. We have funded, and intend to continue to fund, the share repurchase program from cash on hand. The actual number and value of the shares to be purchased will depend on the performance of
our stock price, market volume and other market conditions. During the nine months ended September 30, 2019, we paid $10.3 million to repurchase 6,520 shares of Class A and 595,326 shares of Class B Common Stock under the share repurchase program.
For several years, our investment philosophy has emphasized the purchase of short-term bonds with high quality and liquidity. Our fixed income investment portfolio continues to emphasize shorter-duration instruments.
If there was a hypothetical increase in interest rates of 100 basis points, the price of our fixed income portfolio, including cash, at September 30, 2019 would be expected to decrease by approximately 2.6%. The credit quality of our fixed income securities remains high with a weighted average rating of AA-, including cash. The average contractual life of our fixed income and short-term investment portfolio was 6.7 years at
September 30, 2019 and 5.5 years at December 31, 2018. The average duration of our fixed income portfolio remains shorter than the average duration of our liabilities. We also remain an active participant in the equity securities market, using
capital in excess of amounts considered necessary to fund our current operations. The long-term horizon for our equity investments allows us to invest in positions that primarily focus on ultimate value, and not short-term market fluctuation.
Investments made by our domestic property/casualty Insurance Subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners (the "NAIC"), which are designed to provide protection for both policyholders and
shareholders.
Net cash flows from operations increased $1.9 million to $62.3 million during the nine months ended September 30, 2019 compared to $60.4 million for the nine months ended September 30, 2018. The increase in operating
cash flows was primarily related to higher premium volume as well as higher investment income during the nine months ended September 30, 2019 compared to the same period in 2018.
Net cash used in investing activities was $110.6 million for the nine months ended September 30, 2019 compared to cash provided by investing activities of $1.5 million for the nine months ended September 30, 2018. The
$112.1 million change was primarily due to the increased investment of cash and cash equivalent investments into fixed income securities during the 2019 period. We also received an additional $33.0 million from limited partnership investments, which
were reinvested into fixed income securities during the nine months ended September 30, 2019. During the nine months ended September 30, 2018, we reallocated a large portion of our equity portfolio to fixed income securities, however the total
amount invested was relatively stable. Additionally, during 2018, we purchased $10.0 million of company-owned life insurance, which did not recur in 2019.
Net cash used in financing activities for the nine months ended September 30, 2019 consisted of regular cash dividend payments to shareholders of $4.4 million ($0.30 per share) and $10.3 million to repurchase shares of
our Class A and B Common Stock. Financing activities for the nine months ended September 30, 2018 consisted of regular cash dividend payments to shareholders of $12.7 million ($0.84 per share) and $2.6 million to repurchase shares of our Class A and
B Common Stock.
Our assets at September 30, 2019 included $78.1 million of investments included within cash and cash equivalents on the condensed consolidated balance sheet that are readily convertible to cash without market penalty
and an additional $67.1 million of fixed income investments maturing in less than one year. We believe these liquid investments, plus the expected cash flow from premium collections, are sufficient to provide for projected claim payments and
operating cost demands. In the event competitive conditions produce inadequate premium rates and we choose to further restrict volume, the liquidity of our investment portfolio would permit us to continue to pay claims as settlements are reached
without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, our reinsurance program is structured to avoid significant cash outlays that accompany large losses.
We maintain a revolving credit facility with a $40.0 million limit, with the option for up to an additional $35.0 million in incremental loans at the discretion of the lenders, which has an expiration date of August 9,
2022. Interest on this revolving credit facility is referenced to the London Interbank Offered Rate and can be fixed for periods of up to one year at our option. Outstanding drawings on this revolving credit facility were $20.0 million as of
September 30, 2019. At September 30, 2019, the effective interest rate was 3.14% and we had $20.0 million remaining under the revolving credit facility. The current outstanding borrowings were used to repay our previous line of credit. Our
revolving credit facility has two financial covenants, each of which were met as of September 30, 2019. These covenants require us to have a minimum U.S. generally accepted accounting principles ("GAAP") net worth and a maximum consolidated leverage
ratio of 0.35 to 1.00.
Annualized net premiums written by our Insurance Subsidiaries for the third quarter of 2019 equaled approximately 122% of the combined statutory surplus of these subsidiaries. According to the NAIC, acceptable ranges
for the ratio of net premiums written to statutory surplus include results of up to 300%. This ratio is designed to measure our ability to absorb above-average losses and our financial strength.
Additionally, the statutory capital of each of our Insurance Subsidiaries substantially exceeded minimum risk-based capital requirements set by the NAIC as of September 30, 2019. As a result, we have the ability to increase our business
without seeking additional capital to meet regulatory guidelines.
Consolidated shareholders' equity is composed largely of GAAP shareholders' equity of our Insurance Subsidiaries. As such, there are statutory restrictions on the transfer of substantial portions of this equity to
Protective. At September 30, 2019, $37.1 million may be transferred by dividend or loan to Protective during the remainder of 2019 without approval by, or prior notification to, regulatory authorities. An additional $215.3 million of shareholders'
equity of our Insurance Subsidiaries could be advanced or loaned to Protective with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical. We believe these restrictions pose no
material liquidity concerns for us. We also believe the financial strength and stability of our Insurance Subsidiaries would permit access by Protective to short-term and long-term sources of credit when needed. Protective had cash and marketable
securities valued at $6.4 million at September 30, 2019.
We believe investors’ understanding of our performance is enhanced by our disclosure of underwriting income (loss), which is a measure that is not calculated in accordance with GAAP. Underwriting income (loss)
represents the pre-tax profitability of our insurance operations and is derived by subtracting net realized and unrealized gains (losses) on investments and net investment income from income before federal income tax expense (benefit). We use
underwriting income (loss) as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations, our underlying business performance
and our ongoing operating trends. Underwriting income (loss) should not be viewed as a substitute for income before federal income tax expense (benefit) calculated in accordance with GAAP, and other companies may define underwriting income (loss)
differently.
The ratio of consolidated other operating expenses, less commissions and other income, to net premiums earned, or our expense ratio, and the ratio of losses and loss expenses incurred, plus other operating expenses,
less commissions and other income, to net premiums earned, or our combined ratio, are measures of our profitability that we believe increase the period-to-period comparability of our operational results. Our management uses these ratios to evaluate
performance, allocate resources and forecast future operating periods. While expense ratios and combined ratios are widely used within our industry, our use of such ratios may not be directly comparable to similarly titled measures reported by other
companies.
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30
|
|
|
September 30
|
|
(dollars in thousands)
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
Income (loss) before federal income tax expense (benefit)
|
|
$
|
(1,019
|
)
|
|
$
|
(15,569
|
)
|
|
$
|
4,445
|
|
|
$
|
(12,199
|
)
|
Less: Net realized and unrealized gains (losses) on investments
|
|
|
125
|
|
|
|
2,373
|
|
|
|
9,041
|
|
|
|
(5,595
|
)
|
Less: Net investment income
|
|
|
6,703
|
|
|
|
5,578
|
|
|
|
19,434
|
|
|
|
16,010
|
|
Underwriting loss
|
|
$
|
(7,847
|
)
|
|
$
|
(23,520
|
)
|
|
$
|
(24,030
|
)
|
|
$
|
(22,614
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred
|
|
$
|
84,781
|
|
|
$
|
94,540
|
|
|
$
|
262,336
|
|
|
$
|
244,327
|
|
Net premiums earned
|
|
|
110,288
|
|
|
|
96,807
|
|
|
|
335,931
|
|
|
|
314,209
|
|
Loss ratio
|
|
|
76.9
|
%
|
|
|
97.7
|
%
|
|
|
78.1
|
%
|
|
|
77.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other operating expenses
|
|
$
|
36,070
|
|
|
$
|
29,200
|
|
|
$
|
104,386
|
|
|
$
|
99,984
|
|
Less: Commissions and other income
|
|
|
2,716
|
|
|
|
3,413
|
|
|
|
6,761
|
|
|
|
7,488
|
|
Other operating expenses, less commissions and other income
|
|
|
33,354
|
|
|
|
25,787
|
|
|
|
97,625
|
|
|
|
92,496
|
|
Net premiums earned
|
|
|
110,288
|
|
|
|
96,807
|
|
|
|
335,931
|
|
|
|
314,209
|
|
Expense ratio
|
|
|
30.2
|
%
|
|
|
26.6
|
%
|
|
|
29.1
|
%
|
|
|
29.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined ratio
|
|
|
107.1
|
%
|
|
|
124.3
|
%
|
|
|
107.2
|
%
|
|
|
107.2
|
%
|
Results of Operations
Comparison of Third Quarter 2019 to Third Quarter 2018 (in thousands)
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
|
% Change
|
|
Gross premiums written
|
|
$
|
137,145
|
|
|
$
|
138,699
|
|
|
$
|
(1,554
|
)
|
|
|
(1.1
|
)%
|
Ceded premiums written
|
|
|
(27,853
|
)
|
|
|
(41,685
|
)
|
|
|
13,832
|
|
|
|
(33.2
|
)%
|
Net premiums written
|
|
$
|
109,292
|
|
|
$
|
97,014
|
|
|
$
|
12,278
|
|
|
|
12.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
110,288
|
|
|
$
|
96,807
|
|
|
$
|
13,481
|
|
|
|
13.9
|
%
|
Net investment income
|
|
|
6,703
|
|
|
|
5,578
|
|
|
|
1,125
|
|
|
|
20.2
|
%
|
Commissions and other income
|
|
|
2,716
|
|
|
|
3,413
|
|
|
|
(697
|
)
|
|
|
(20.4
|
)%
|
Net realized and unrealized gains on investments
|
|
|
125
|
|
|
|
2,373
|
|
|
|
(2,248
|
)
|
|
|
94.7
|
%
|
Total revenue
|
|
|
119,832
|
|
|
|
108,171
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred
|
|
|
84,781
|
|
|
|
94,540
|
|
|
|
(9,759
|
)
|
|
|
(10.3
|
)%
|
Other operating expenses
|
|
|
36,070
|
|
|
|
29,200
|
|
|
|
6,870
|
|
|
|
23.5
|
%
|
Total expenses
|
|
|
120,851
|
|
|
|
123,740
|
|
|
|
|
|
|
|
|
|
Loss before federal income tax benefit
|
|
|
(1,019
|
)
|
|
|
(15,569
|
)
|
|
|
14,550
|
|
|
|
|
|
Federal income tax benefit
|
|
|
(312
|
)
|
|
|
(3,244
|
)
|
|
|
2,932
|
|
|
|
|
|
Net loss
|
|
$
|
(707
|
)
|
|
$
|
(12,325
|
)
|
|
$
|
11,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums written during the third quarter of 2019 decreased $1.6 million (1.1%), while net premiums earned increased $13.5 million (13.9%), as compared to the third quarter of 2018. The higher net premiums
earned in the third quarter of 2019 were primarily the result of lower premiums ceded in the current quarter when compared to the same period in 2018, as discussed below. The difference in the percentage change for premiums written compared to earned
was reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.
Premiums ceded to reinsurers on our insurance business averaged 20.3% of gross premiums written for the third quarter of 2019 compared to 30.1% in the third quarter of 2018. The decrease in premiums ceded was
primarily due to our reserve strengthening during the third quarter of 2018 that resulted in ceding an additional $13.8 million in premium from prior treaty years related to the variable premium adjustment provisions in our historical reinsurance
treaties, which did not recur in 2019. This was partially offset by higher gross premiums written in our workers' compensation coverages, which carry a higher reinsurance ceding rate, in the third quarter of 2019 compared to the third quarter of
2018.
Losses and loss expenses incurred during the third quarter of 2019 decreased $9.8 million (10.3%) compared to the third quarter of 2018, resulting in a loss ratio of 76.9% during the third quarter of 2019 compared to a
loss ratio of 97.7% during the third quarter of 2018. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The higher losses and loss expenses and higher loss ratio in the third quarter of 2018
reflected reserve strengthening of $16.4 million related to unfavorable prior accident year loss development in commercial automobile coverages as a result of increased claim severity due to a more challenging litigation environment and an increase
in the time to settle claims. The third quarter of 2019 loss ratio reflected an increase in losses driven by severe commercial automobile claims, including continued emergence of severity as well as $0.1 million of adverse prior accident year
development.
Net investment income for the third quarter of 2019 increased 20.2% to $6.7 million compared to $5.6 million for the third quarter of 2018. The increase reflected an increase in average funds invested resulting from
positive cash flow, as well as the continued reallocation from equity investments in limited partnerships and cash and cash equivalent investments into short-duration, high-quality bonds.
Net realized and unrealized gains on investments of $0.1 million during the third quarter of 2019 were primarily driven by net realized gains on sales of securities, excluding impairment losses, of $1.2 million and a
$0.3 million increase in the value of our limited partnership investments, partially offset by $1.3 million in unrealized losses on equity securities during the period and other-than-temporary impairments on our fixed income securities of $0.1
million recognized during the period. Comparative third quarter 2018 net realized and unrealized losses on investments of $2.4 million were primarily driven by $3.0 million in unrealized gains on equity securities and net realized gains on sales of
fixed income and equity securities, excluding impairment losses, of $0.5 million during the period, partially offset by a $1.1 million decrease in the value of our limited partnership investments. Realized investment gains and losses result from
decisions regarding overall portfolio realignment as well as the sale of individual securities, including the change in the aggregate value of limited partnerships and, as such, should not be expected to be consistent from period to period.
Other operating expenses for the third quarter of 2019 increased $6.9 million, or 23.5%, to $36.1 million compared to the third quarter of 2018. The increase was driven primarily by higher salary and benefit expenses
and higher commission expenses as a result of the mix of premium written during the third quarter of 2019. Additionally, other operating expenses for the third quarter of 2019 included charges of $1.6 million related to severance and new hire costs
as well as bad debt expense, which we do not expect to recur. The expense ratio was 30.2% during the third quarter of 2019 compared to 26.6% for the third quarter of 2018. The increase in the expense ratio was primarily related to the higher salary
and benefit expenses and higher commission expenses noted above.
Federal income tax benefit was $0.3 million for the third quarter of 2019 compared to $3.2 million for the third quarter of 2018. The effective tax rate for the third quarter of 2019 was a 30.6% tax benefit compared
to a 20.8% tax benefit in the third quarter of 2018. The lower pre-tax loss for the three months ended September 30, 2019 made these interim period effective tax rates less comparable. The effective federal income tax rate in the current year
differed from the normal statutory rate primarily as a result of tax-exempt investment income and the dividends received deduction. The effective tax rate can fluctuate throughout the year because estimates used in the quarterly tax provision are
updated as more information becomes available throughout the year.
As a result of the factors mentioned above, net loss improved $11.6 million to a loss of $0.7 million during the third quarter of 2019 compared to a net loss of $12.3 million during the third quarter of 2018.
Comparison of Nine Months Ended September 30, 2019 to Nine Months Ended September 30, 2018 (in thousands)
|
|
2019
|
|
|
2018
|
|
|
Change
|
|
|
% Change
|
|
Gross premiums written
|
|
$
|
433,191
|
|
|
$
|
429,792
|
|
|
$
|
3,399
|
|
|
|
0.8
|
%
|
Ceded premiums written
|
|
|
(92,882
|
)
|
|
|
(105,090
|
)
|
|
|
12,208
|
|
|
|
(11.6
|
)%
|
Net premiums written
|
|
$
|
340,309
|
|
|
$
|
324,702
|
|
|
$
|
15,607
|
|
|
|
4.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned
|
|
$
|
335,931
|
|
|
$
|
314,209
|
|
|
$
|
21,722
|
|
|
|
6.9
|
%
|
Net investment income
|
|
|
19,434
|
|
|
|
16,010
|
|
|
|
3,424
|
|
|
|
21.4
|
%
|
Commissions and other income
|
|
|
6,761
|
|
|
|
7,488
|
|
|
|
(727
|
)
|
|
|
(9.7
|
)%
|
Net realized and unrealized gains (losses) on investments
|
|
|
9,041
|
|
|
|
(5,595
|
)
|
|
|
14,636
|
|
|
|
261.6
|
%
|
Total revenue
|
|
|
371,167
|
|
|
|
332,112
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred
|
|
|
262,336
|
|
|
|
244,327
|
|
|
|
18,009
|
|
|
|
7.4
|
%
|
Other operating expenses
|
|
|
104,386
|
|
|
|
99,984
|
|
|
|
4,402
|
|
|
|
4.4
|
%
|
Total expenses
|
|
|
366,722
|
|
|
|
344,311
|
|
|
|
|
|
|
|
|
|
Income (loss) before federal income tax expense (benefit)
|
|
|
4,445
|
|
|
|
(12,199
|
)
|
|
|
16,644
|
|
|
|
|
|
Federal income tax expense (benefit)
|
|
|
869
|
|
|
|
(2,691
|
)
|
|
|
3,560
|
|
|
|
|
|
Net income (loss)
|
|
$
|
3,576
|
|
|
$
|
(9,508
|
)
|
|
$
|
13,084
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross premiums written during the nine months ended September 30, 2019 increased $3.4 million (0.8%), while net premiums earned increased $21.7 million (6.9%), as compared to the same period in 2018. The higher net
premiums earned in the nine months ended September 30, 2019 were primarily the result of lower premiums ceded in the current period when compared to the same period in 2018, as discussed below. The difference in the percentage change for premiums
written compared to earned was reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.
Premiums ceded to reinsurers on our insurance business averaged 21.4% of gross premiums written for the nine months ended September 30, 2019 compared to 24.5% for the same period of 2018. The decrease in premiums
ceded was primarily due to our reserve strengthening during the nine months ended September 30, 2018 that resulted in ceding an additional $16.4 million in premium from prior treaty years related to the variable premium adjustment provisions in our
historical reinsurance treaties, compared to the ceding of an additional $1.6 million in commercial automobile premium from prior treaty years related to the same adjustment provisions during the nine months ended September 30, 2019. Additionally,
during the nine months ended September 30, 2019, we had higher gross premiums written in workers' compensation coverages, which carry a higher reinsurance ceding rate.
Losses and loss expenses incurred during the nine months ended September 30, 2019 increased $18.0 million (7.4%) compared to the same period of 2018, resulting in a loss ratio of 78.1% for the period. This compares
to a loss ratio of 77.8% during the same period of 2018. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The increased losses and loss expenses and the higher loss ratio in the nine months
ended September 30, 2019 reflected an increase in losses driven by severe commercial automobile claims, including continued emergence of severity. This loss development was partially offset by prior accident year net savings of $1.6 million that
developed during the nine months ended September 30, 2019, primarily due to favorable loss development in workers' compensation and independent contractor coverages. Including the impact of the additional $1.6 million ceded premium discussed above,
the total prior accident year impacts offset each other for the nine months ended September 30, 2019. Losses and loss expenses for the nine months ended September 30, 2018 reflected reserve strengthening of $14.7 million related to unfavorable prior
accident year loss development in commercial automobile coverages.
Net investment income for the nine months ended September 30, 2019 increased 21.4% to $19.4 million compared to $16.0 million in the same period of 2018. The increase reflected an increase in average funds invested
resulting from positive cash flow, as well as a reallocation from equity investments in limited partnerships and cash and cash equivalent investments into short-duration, high-quality bonds.
Net realized and unrealized gains on investments of $9.0 million during the nine months ended September 30, 2019 were primarily driven by $6.6 million in unrealized gains on equity securities during the period, net
realized gains on sales of securities, excluding impairment losses, of $1.9 million and a $1.0 million increase in the value of our limited partnership investments, partially offset by other-than-temporary impairments on our fixed income securities
of $0.4 million recognized during the period. In the comparative nine month period ended September 30, 2018, net realized and unrealized losses on investments of $5.6 million were driven by a $6.5 million decrease in the value of our limited
partnership investments and $0.8 million in unrealized losses on equity securities, excluding impairment losses, during the period, partially offset by net realized gains on sales of fixed income and equity securities of $1.7 million. Realized
investment gains and losses result from decisions regarding overall portfolio realignment as well as the sale of individual securities, including the change in the aggregate value of limited partnerships and, as such, should not be expected to be
consistent from period to period.
Other operating expenses for the nine months ended September 30, 2019 increased $4.4 million, or 4.4%, to $104.4 million compared to $100.0 million for the same period of 2018. The increase was driven primarily by
higher commission expenses as a result of the mix of premium written and higher salary and benefit expenses during the nine months ended September 30, 2019. The expense ratio was 29.1% during the nine months ended September 30, 2019 compared to
29.4% for the same period of 2018. The decrease in the expense ratio was primarily related to the leveraging effect of higher net premiums earned in the nine months ended September 30, 2019 compared to the same period of 2018.
Federal income tax expense was $0.9 million for the nine months ended September 30, 2019 compared to federal income tax benefit of $2.7 million for the same period of 2018. The effective tax rate for the nine months
ended September 30, 2019 was a 19.6% expense compared to a 22.1% benefit in the same period of 2018. The relatively low amount of pre-tax income for the nine months ended September 30, 2019 made these interim period effective tax rates less
comparable. The effective federal income tax rate in the current year differed from the normal statutory rate primarily as a result of tax-exempt investment income and the dividends received deduction. The effective tax rate can fluctuate
throughout the year because estimates used in the quarterly tax provision are updated as more information becomes available throughout the year.
As a result of the factors mentioned above, net income increased $13.1 million to $3.6 million during the nine months ended September 30, 2019 compared to net loss of $9.5 million during the same period of 2018.
Sensitivity Analysis
Management is aware of the potential for variation from the reserves established at any particular point in time. Savings or deficiencies could develop in future valuations of the currently established loss and loss
expense reserve estimates under a variety of reasonably possible scenarios. The majority of our reserves for losses and loss expenses, on a net of reinsurance basis, relate to our commercial automobile products. Perhaps the most significant example
of sensitivity to variation in the key assumptions is the loss ratio selection for our commercial automobile products for policies subject to certain major reinsurance treaties.
Commercial automobile products covered by our reinsurance treaties from July 2013 through June 2019 are subject to an aggregate stop-loss provision. Once this aggregate stop-loss level is reached, for every $100 of
additional loss, we are only responsible for our $25 retention. The following table illustrates the benefit of these reinsurance treaties, as the net financial loss to us of a further increase in ultimate losses for each of the six most recent
reinsurance treaty years (2013-2018) covering these commercial automobile products is only about 25% of the gross loss:
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5% Increase in
Ultimate Loss Ratio
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10% Increase in
Ultimate Loss Ratio
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Gross loss expense from further strengthening current reserve position
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$
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45.5
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$
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90.9
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Net financial loss
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|
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11.8
|
|
|
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23.1
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|
|
|
|
|
|
|
|
|
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$/share (after tax)
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$
|
0.64
|
|
|
$
|
1.25
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|
Commercial automobile products covered by our reinsurance treaty from July 2019 through June 2020 are also subject to an aggregate stop-loss provision. Once the aggregate stop-loss level is
reached, for every $100 of additional loss, we are responsible for our $65 retention. This increase in our retention compared to recent years reflects both: (1) our decision to buy less reinsurance due to a higher cost of reinsurance for the 2019
treaty year, and (2) our confidence in profitability improvements given rate increases we are receiving on our commercial automobile products.
Forward-Looking Information
The disclosures in this Form 10-Q contain "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements,
trend analyses and other information contained in this Form 10-Q relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "may," "target," "anticipate," "believe,"
"plan," "estimate," "expect," "intend," "project," and other similar expressions, constitute forward-looking statements.
Investors are cautioned that such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that could
cause actual results to differ materially from such forward-looking statements, many of which are difficult to predict and generally beyond our control. Investors are cautioned not to place undue reliance on these forward-looking statements that
speak only as of the date hereof. Investors are also urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the factors that affect our business, including "Risk Factors" set forth
in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and our reports filed with the U.S. Securities and Exchange Commission from time to time. Except to the extent otherwise required by federal
securities laws, we do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof.
Factors that could contribute to these differences include, among other things:
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general economic conditions, including weakness of the financial markets, prevailing interest rate levels and stock and credit market performance, which
may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value
of our investments;
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●
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our ability to obtain adequate premium rates and manage our operating strategies;
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●
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increasing competition in the sale of our insurance products and services resulting from the entrance of new competitors into, or the expansion of the
operations of existing competitors in, our markets and our ability to retain existing customers;
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●
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other changes in the markets for our insurance products;
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●
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the impact of technological advances, including those specific to the transportation industry;
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●
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changes in the legal or regulatory environment, which may affect the manner in which claims are adjusted or litigated, including loss and loss adjustment
expense;
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legal or regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and
services and capital requirements;
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●
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the impact of a downgrade in our financial strength rating;
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●
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technology or network security disruptions or breaches;
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●
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adequacy of insurance reserves;
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●
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availability of reinsurance and ability of reinsurers to pay their obligations;
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●
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our ability to attract and retain qualified employees;
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●
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tax law and accounting changes; and
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●
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legal actions brought against us.
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Some of the significant risks and uncertainties that could cause actual results to differ materially from our expectations and projections are described more fully in
Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. You should read that information in conjunction with this
"Management's Discussion and Analysis of Financial Condition and Results of Operations" and our unaudited condensed consolidated financial statements and related notes in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Critical Accounting Policies
There have been no changes in our critical accounting policies as disclosed in our Annual Report on Form 10-K filed for the year ended December 31, 2018.
Concentrations of Credit Risk
Our Insurance Subsidiaries cede portions of their gross premiums to numerous reinsurers under quota share and excess of loss treaties, as well as facultative
placements. These reinsurers assume commensurate portions of the risk of loss covered by the contracts. As losses are reported and reserved, portions of the gross losses attributable to reinsurers are established as receivable assets and losses
incurred are reduced. At September 30, 2019, amounts due from reinsurers on paid and unpaid losses were estimated to total approximately $396 million. Because of the large policy limits reinsured by us, the ultimate amount of incurred but not
reported losses and loss adjustment expenses attributable to reinsurers could vary significantly from this estimate; provided, however, absent the inability to collect from reinsurers, such variance would not result in changes in net claim losses
incurred by us.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.