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. 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.
Impact of Stockholder Support and Contingent Sale Agreement
On May 5, 2020, the Board of Directors (the “Board”) of Protective Insurance Corporation formed a special committee of independent directors (the “Special Committee”) to evaluate a Stockholder Support and Contingent Sale Agreement (the “Contingent Sale Agreement”) entered into by and among certain prospective third party purchasers (the “Offering Parties”), certain of Protective’s shareholders and the other parties thereto. We received notice of the Contingent Sale Agreement on April 23, 2020, the date of filing of amendments to Schedule 13Ds relating to our Class A Common Stock, Subject to the satisfaction of certain conditions under the Contingent Sale Agreement, the Offering Parties may commence a tender offer to purchase all of the outstanding shares of Protective’s Class A Common Stock at a price per share of $18.30 per share (equal to 85% of our first quarter 2020 book value per share as reported by us on May 5, 2020).
In June 2020, Protective announced that the Board determined that the transactions contemplated by the Contingent Sale Agreement are not in the best interests of Protective and our stakeholders. As part of this evaluation, the Board determined that it would also recommend against the potential tender offer contemplated by the Contingent Sale Agreement if it were commenced, and that if the transactions contemplated by the Contingent Sale Agreement were consummated, it expects to take the necessary actions to redeem all or certain of the Class A shares of Protective purchased by the Offering Parties pursuant to Protective’s Code of By-laws. Protective also announced that the Special Committee of the Board is exploring, with the assistance of its independent financial and legal advisors, strategic alternatives that may be available to Protective. There can be no assurance that the Special Committee or Board will determine that a strategic alternative is in the best interest of the Company and its stakeholders, or that a transaction will be entered into or, if entered into, the timing, terms or conditions thereof.
During the second quarter of 2020, we incurred $1.7 million ($1.3 million, net of tax) of expenses in conjunction with the Board’s review of the Contingent Sale Agreement and the activities of the Special Committee.
Expected Credit Losses Standard (CECL) Adoption
On January 1, 2020, we adopted the provisions of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU 2016-13. ASU 2016-13 introduced a current expected credit loss ("CECL") model for measuring expected credit losses for certain types of financial instruments held at the reporting date requiring significant judgment in application based on historical experience, current conditions and reasonable supportable forecasts, but is not prescriptive about certain aspects of estimating expected losses. We adopted the guidance using a modified retrospective approach as of January 1, 2020 and recognized a cumulative effect adjustment of $15.5 million ($12.3 million net of tax), to the opening balance of retained earnings. The adjustment was primarily related to estimating credit losses on our accounts receivable balances, reinsurance recoverable balances and commercial mortgage loans at the date of adoption. We did not record any significant additional impact to the statement of operations in the first six months of 2020.
The updated guidance in ASU 2016-13 also amended the previous other-than-temporary impairment ("OTTI") model for available-for-sale fixed income securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. We adopted the guidance related to available-for-sale fixed income securities on January 1, 2020 using a prospective transition approach for available-for-sale fixed income securities that were purchased with credit deterioration or had recognized an OTTI write-down prior to the effective date. The effect of the prospective transition approach was to maintain the same amortized cost basis before and after the effective date. For those securities we intended to sell as of June 30, 2020, we recorded a write down to earnings of $0.4 million and $0.5 million during the three and six months ended June 30, 2020. We reviewed our remaining fixed income securities in an unrealized loss position as of June 30, 2020 and determined that the losses were primarily the result of non-credit factors, such as the increase in market volatility due to the recent disruption in global financial markets as a result of the novel coronavirus COVID-19 ("COVID-19") pandemic and responses to it. We currently do not intend to sell nor do we expect to be required to sell these securities before recovery of their amortized cost. Based on the above factors, we did not record any allowance for credit losses under the new guidance related to our available-for-sale securities under the new guidance in the first six months of 2020.
COVID-19 Impacts
Beginning in March 2020 and continuing through the date of this Quarterly Report on Form 10-Q, the global pandemic associated with COVID-19 and related economic conditions have impacted the global economy and our results of operations. For the three and six months ended June 30, 2020, net premiums earned within our commercial automobile products, specifically public transportation, were negatively impacted due to a reduction in miles driven, which are the basis for premiums we receive, as well as an overall reduction in public transportation units insured. However, losses and loss expenses incurred during those same periods reflected favorable impacts within all commercial automobile products as a result of declines in accident frequency due to lower traffic density. In addition to these impacts on our underwriting loss, as defined below, we incurred net realized and unrealized gains on investments of $10.6 million during the three months ended June 30, 2020, reflecting an improvement in the global financial markets during the quarter; however, we incurred net realized and unrealized losses on investments of $17.1 million for the six months ended June 30, 2020 due to investment losses of $27.8 million during the three months ended March 31, 2020 as a result of the significant decline in the global financial markets experienced in that quarter due to the COVID-19 pandemic. These gains and losses were primarily driven by the impact of changes in the fair value of our equity investments as a result of the recent fluctuations in the global financial markets driven primarily by the COVID-19 pandemic. Additionally, insurance departments throughout the country have issued bulletins and regulations urging or requiring insurers to extend grace periods for the payment of policy premiums and to refrain from canceling or non-renewing policies for the non-payment of policy premiums for policyholders adversely affected by COVID-19; however, we have not seen a material decrease or slowdown in premium collection to date. We have also taken additional steps, including a temporary freeze on hiring in most areas of the company and reductions to discretionary spending in response to COVID-19. We expect this impact will persist for the remainder of 2020 and beyond, but the degree of the impact will depend on the extent and duration of the challenging economic circumstances. For further discussion regarding the potential impacts of COVID-19 and related economic conditions on us, see Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q and of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020.
Liquidity and Capital Resources
Our liquidity and capital resources were not materially impacted by COVID-19 and related economic conditions during the first six months of 2020. For further discussion regarding the potential future impacts of COVID-19 and related economic conditions, see "Part II, Item 1A, "Risk Factors" of this Quarterly Report on Form 10-Q.
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 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 and added a limit of no more than $6.25 million in repurchases 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. 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 six months ended June 30, 2020, we paid $1.8 million to repurchase 126,764 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. If there was a hypothetical increase in interest rates of 100 basis points, the price of our fixed income portfolio, including cash, at June 30, 2020 would be expected to fall by approximately 2.4%. 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 7.0 years and 6.9 years at June 30, 2020 and December 31, 2019. 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 markets, 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 where ultimate value, and not short-term market fluctuation, is the primary focus. 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 from operations was $11.7 million during the six months ended June 30, 2020 compared to $38.4 million for the six months ended June 30, 2019. The decrease in operating cash flows during the six months ended June 30, 2020 reflected lower premium volume and higher claim payments when compared to the same period of 2019. Net cash from operations for the six months ended June 30, 2019 benefited from the impact of growth in premiums and the timing of related claims payments. Additionally, for the six months ended June 30, 2020, loss reserve increases were lower when compared to the same period in 2019 due to lower premium writings and an increase in losses paid.
Net cash provided by investing activities was $22.2 million for the six months ended June 30, 2020 compared to cash used in investing activities of $103.2 million for the six months ended June 30, 2019. The $125.4 million change was primarily due to a decrease in the investment of cash and cash equivalent investments into fixed income securities and an increase in net proceeds from maturities and sales of fixed income and equity securities, partially offset by $5.6 million less in limited partnership distributions, during the six months ended June 30, 2020 when compared to the same period in 2019.
Net cash used in financing activities for the six months ended June 30, 2020 consisted of regular cash dividend payments to shareholders of $2.9 million ($0.20 per share) and $1.8 million to repurchase shares of our Class B Common Stock. Financing activities for the six months ended June 30, 2019 consisted of regular cash dividend payments to shareholders of $3.0 million ($0.20 per share) and $6.5 million to repurchase shares of our Class A and B Common Stock.
Our assets at June 30, 2020 included $94.0 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 $96.5 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 or our premiums are further restricted due to market conditions, including related to the impact of COVID-19, we believe 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 June 30, 2020. At June 30, 2020, the effective interest rate was 1.29% 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 June 30, 2020. These covenants require us to have a minimum U.S. generally accepted accounting principles ("GAAP") net worth and a maximum consolidated debt to equity ratio of 0.35.
Annualized net premiums written by our Insurance Subsidiaries for the second quarter of 2020 equaled approximately 117% 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 June 30, 2020. 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 June 30, 2020, $56.9 million may be transferred by dividend or loan to Protective during the remainder of 2020 without approval by, or prior notification to, regulatory authorities. An additional $150.3 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 $18.3 million at June 30, 2020.
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 or loss of our insurance operations and is derived by subtracting net realized and unrealized gains (losses) on investments and net investment income from income (loss) before federal income tax expense (benefit). For the three and six months ended June 30, 2020, we also excluded corporate charges incurred in conjunction with the Board's review of the Contingent Sale Agreement and activities of the Special Committee discussed above from the calculation of underwriting income (loss). We believe the exclusion of these corporate charges more accurately reflects our operational results. 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 (loss) 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. For the three and six months ended June 30, 2020, we also excluded the corporate charges discussed above from other operating expenses when calculating our expense ratio and our combined ratio, as these ratios are intended to depict our underlying business performance and ongoing operating trends. We also believe the exclusion of these charges improves the comparability of our expense and combined ratio with our ratios in prior years. 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.
1 Represents the corporate charges incurred in conjunction with the Board's review of the Contingent Sale Agreement and activities of the Special Committee discussed above.
Results of Operations
Comparison of Second Quarter 2020 to Second Quarter 2019 (in thousands)
Gross premiums written during the second quarter of 2020 decreased $31.7 million (21.5%), while net premiums earned decreased $17.9 million (15.5%), as compared to the second quarter of 2019. The lower net premiums earned in the second quarter of 2020 were primarily the result of declines in premiums within our commercial automobile products, specifically public transportation, as a result of COVID-19 due to a reduction in miles driven, which are the basis for premiums we receive, as well as an overall reduction in public transportation units insured. Additionally, we had reduced premiums associated with lower retention rates as we continue to take actions to improve profitability, including rate increases and non-renewal of certain risks. These decreases were partially offset by rate increases and new business policies sold. 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 22.7% of gross premiums written for the second quarter of 2020 compared to 21.4% in the second quarter of 2019. The increase in the percentage of premiums ceded was primarily due to an increase in facultative reinsurance placements during the quarter as a percentage of our direct premiums written for public transportation.
Losses and loss expenses incurred during the second quarter of 2020 decreased $22.2 million (24.6%) compared to the second quarter of 2019, resulting in a loss ratio of 69.8% during the second quarter of 2020 compared to a loss ratio of 78.2% during the second quarter of 2019. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The lower losses and loss expenses and lower loss ratio in the second quarter of 2020 reflected results of our underwriting actions, including non-renewal of unprofitable business as well as significant rate increases in commercial automobile. Additionally, losses and loss expenses incurred reflected favorable impacts from COVID-19 within all commercial automobile products as a result of declines in accident frequency due to lower traffic density.
Net investment income for the second quarter of 2020 decreased 1.9% to $6.4 million compared to $6.5 million for the second quarter of 2019. The decrease reflected lower interest rates earned on cash and cash equivalent balances in the current period, partially offset by an increase in average funds invested compared to the second quarter of 2019.
Net realized and unrealized gains on investments of $10.6 million during the second quarter of 2020 were primarily driven by $15.7 million in unrealized gains on equity securities during the period as a result of the improvement in the global financial markets following sharp declines related to COVID-19 during the first quarter of 2020. These gains were partially offset by $4.1 million in net realized losses on sales of securities, excluding impairment losses, a $0.6 million decrease in the value of our limited partnership investments and impairments on our fixed income securities of $0.4 million recognized during the period. Comparative second quarter 2019 net realized and unrealized gains on investments of $2.9 million were primarily driven by $2.0 million in unrealized gains on equity securities, net realized gains on sales of securities, excluding impairment losses, of $0.7 million and a $0.3 million increase in the value of our limited partnership investments, partially offset by impairments on our fixed income securities of $0.1 million recognized during the period. 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 second quarter of 2020 decreased $0.4 million, or 1.2%, to $34.2 million compared to the second quarter of 2019. The decrease was driven primarily by lower commission expenses as a result of the mix of premium written during the second quarter of 2020, partially offset by $1.7 million of corporate charges paid during the second quarter of 2020 to third party advisors of a special committee of the board of directors in connection with the special committee's review of the Contingent Sale Agreement, as well as other strategic alternatives as discussed above. The expense ratio was 33.0% during the second quarter of 2020, or 31.3% excluding the corporate charges discussed above, compared to 28.2% for the second quarter of 2019. The increase in the expense ratio was primarily related to the decrease in net premiums earned during the period.
Federal income tax expense was $2.8 million for the second quarter of 2020 compared to $0.4 million for the second quarter of 2019. The effective tax rate on consolidated income for the second quarter of 2020 was 20.0% compared to 21.3% in the second quarter of 2019. The difference in the effective federal income tax rate from the normal statutory rate was primarily related to the effects 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 $9.8 million to $11.4 million during the second quarter of 2020 compared to net income of $1.5 million during the second quarter of 2019.
Comparison of Six Months Ended June 30, 2020 to Six Months Ended June 30, 2019 (in thousands)
Gross premiums written during the six months ended June 30, 2020 decreased $46.6 million (15.7%), while net premiums earned decreased $18.3 million (8.1%), as compared to the same period in 2019. The lower net premiums earned in 2020 were primarily the result of declines in premiums within our commercial automobile products, specifically public transportation, as a result of COVID-19 due to a reduction in miles driven, which are the basis for premiums we receive, as well as an overall reduction in public transportation units insured. Additionally, we had reduced premiums associated with lower retention rates as we continue to take actions to improve profitability, including rate increases and non-renewal of certain risks. These decreases were partially offset by rate increases and new business policies sold. 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 20.4% of gross premiums written for the six months ended June 30, 2020 compared to 22.0% for the same period of 2019. The decrease in premiums ceded was primarily due to a mix shift toward more commercial automobile business (specifically Independent Contractor lines that carry no reinsurance coverage) and less workers' compensation business.
Losses and loss expenses incurred during the six months ended June 30, 2020 decreased $27.5 million (15.5%) compared to the same period of 2019, resulting in a loss ratio of 72.3% during the period. This compares to a loss ratio of 78.7% during the same period of 2019. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The lower losses and loss expenses and lower loss ratio for the six months ended June 30, 2020 reflected results of our underwriting actions, including non-renewal of unprofitable business as well as significant rate increases in commercial automobile. Additionally, losses and loss expenses incurred reflected favorable impacts from COVID-19 within all commercial automobile products as a result of declines in accident frequency due to lower traffic density.
Net investment income for the six months ended June 30, 2020 increased 6.9% to $13.6 million compared to $12.7 million for the same period of 2019. 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, partially offset by lower interest rates earned on cash and cash equivalent balances in the current period.
Net realized and unrealized losses on investments of $17.1 million during the six months ended June 30, 2020 were primarily driven by $8.9 million in net realized losses on sales of securities, excluding impairment losses, $6.5 million in unrealized losses on equity securities, which were largely attributable to disruptions in the global financial markets related to COVID-19, and a $1.3 million decrease in the value of our limited partnership investments. Comparative six months ended June 30, 2019 net realized and unrealized gains on investments of $8.9 million were primarily driven by $7.9 million in unrealized gains on equity securities during the period, a $0.7 million increase in the value of our limited partnership investments and net realized gains on sales of securities, excluding impairment losses, of $0.6 million, partially offset by impairments on our fixed income securities of $0.3 million recognized during the period. 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 six months ended June 30, 2020 were flat at $68.3 million compared to the same period of 2019. The $1.7 million of corporate charges paid in the second quarter of 2020 to third party advisors of a special committee of the board of directors were offset by lower salary and benefit expense and commission expense. The expense ratio was 31.2% during the six months ended June 30, 2020, or 30.4% excluding the corporate charges discussed above, compared to 28.5% for the same period of 2019. The increase in the expense ratio was primarily related to the decrease in net premiums earned during the period.
Federal income tax benefit was $0.1 million for the six months ended June 30, 2020 compared to federal income tax expense of $1.2 million for the same period of 2019. The effective tax rate on consolidated loss for the six months ended June 30, 2020 was a 1.3% tax benefit compared to a 21.6% tax expense on consolidated income in the same period of 2019. The pre-tax loss for the six months ended June 30, 2020 makes these interim period effective tax rates less comparable year-over-year. The difference in the effective federal income tax rate from the normal statutory rate was primarily related to the recording of a valuation allowance in the current period on our deferred tax assets, in addition to the effects of tax-exempt investment income and the dividends received deduction. In assessing the valuation of deferred tax assets, we considered whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income or availability to carryback the losses to taxable income during the period in which those temporary differences become deductible. We considered several factors when analyzing the need for a valuation allowance, including our current three year cumulative loss through June 30, 2020, the increase in deferred tax assets due to the adoption of CECL at January 1, 2020 discussed above, the change in unrealized gains and losses and the loss of a high taxable income year from the carryback period. The three year cumulative loss limits our ability to use projected income beyond 2020 in the analysis. Based on this analysis, we concluded that a valuation allowance was necessary for our deferred tax assets not supported by either carryback availability or future reversals of existing taxable temporary differences. Our valuation allowance was $2.4 million as of June 30, 2020, of which $2.2 million was recorded in the condensed consolidated statement of operations for the six months ended June 30, 2020 and the balance was recorded in shareholders' equity within accumulated other comprehensive income as of June 30, 2020. This represented a $2.5 million reduction to the valuation allowance of $4.9 million recorded for the three months ended March 31, 2020. 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 decreased $15.1 million to a loss of $10.8 million during the six months ended June 30, 2020 compared to net income of $4.3 million during the same period of 2019.
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 unlimited aggregate stop-loss provision. Currently each of these treaty years is reserved at or above the attachment level of these treaties. For every $100 of additional loss, we are only responsible for our $25 retention.
Commercial automobile products covered by our reinsurance treaty from July 2019 through June 2020 are also subject to an unlimited 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 the combination of (1) a decreased need for stop-loss reinsurance protection resulting from a significant decrease in our commercial automobile subject limits profile, (2) a higher cost for this cover and (3) our confidence in profitability improvements given the limit reductions and rate increases 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, 2019, in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, in Part II, Item 1A of this Quarterly Report on Form 10-Q and in 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:
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 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, and in Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. 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
A summary of our significant accounting policies that we consider to be the most dependent on the application of estimates and assumptions can be found in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2019. Changes in 2020 to our significant accounting policies, which are dependent upon estimates and assumptions, include the adoption of new accounting guidance for the recognition of credit losses. For discussion of the new guidance and the related changes to our accounting policy, see "Accounting Policies" within Note 1 - Summary of Significant Accounting Policies in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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 June 30, 2020, amounts due from reinsurers on paid and unpaid losses were estimated to total approximately $405 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.