PPHI Positive Physicans Holdings Inc

Notes to Unaudited Consolidated Financial Statements

Positive Physicians Holdings, Inc. (the “Company”) is a newly formed Pennsylvania business corporation incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania 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 the Company’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies and were merged together to form Positive Physicians Insurance Company (“Positive Insurance Company”), a wholly-owned subsidiary of the Company. The Company’s initial public offering and its acquisition of Positive Insurance Company were completed on March 27, 2019. Prior to that time, the Company had minimal assets and liabilities and had not engaged in any operations. References to Positive Insurance Company financial information in this Quarterly Report is to the financial information of PPIX, PCA, and PIPE on a consolidated basis. When used in this Quarterly Report, “we” and “our” mean PPIX, PCA, and PIPE prior to March 27, 2019, and Positive Insurance Company thereafter.

Positive Insurance Company

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Delaware, Maryland, Michigan, New Jersey, Ohio, Pennsylvania, and South Carolina. Diversus Management, Inc. (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement. Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement effective as of March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based on a percentage of Positive Insurance Company’s gross written premiums, less return premiums. Diversus Management may also earn quarterly performance management fees based on Positive 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 by Positive Insurance Company and for all sales commissions paid to producers.

Products and Services

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 in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina and Michigan. 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.

The Company accounts for its medical professional liability insurance business as a single reporting segment line of business.

Option Agreement

Upon completion of the conversions of PPIX, PCA, and PIPE and the securities offering, on March 27, 2019 the Company and Diversus entered into an option agreement whereby either party has the option to cause Diversus to merge with and become a wholly owned subsidiary of the Company.  Under the terms of the agreement, the option may be exercised by either the Company or Diversus at any time (1) during the period beginning 2 years after completion of the conversions of the exchanges and ending 54 months after the completion of the conversions, or (2) if earlier than 2 years after the completion of the conversions, then such date that the majority stockholder of the Company no longer has the right to appoint a majority of the board of directors of the Company.  In connection with any merger, the common stock shareholders of Diversus will receive either cash, common stock shares of the Company, or some combination thereof for their shares of Diversus’ common stock.  In regards to the preferred stock shares of Diversus, they will either be paid out in cash or converted into common stock shares of Diversus as if such preferred stock shares were converted into Diversus’ common stock shares immediately prior to the effective date of the merger.

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The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three months and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

Our consolidated financial statements include our accounts and those of our wholly owned subsidiary.  We have eliminated all inter-company accounts and transactions in consolidation.  

The Company was formed on May 1, 2018 and the financial statements of the Company for the period from May 1, 2018 through December 31, 2018 have been audited.  The accompanying unaudited financial statements for 2018 have been prepared on a combined basis and reflect our historical financial information and results of operations of PPIX, PCA, and PIPE as if the conversions and merger took place as of January 1, 2018.  Prior to the completion of the initial public offering, the Company, PPIX, PCA, and PIPE were under the common control of Diversus.  Additionally, prior to March 27, 2019, the Company did not engage in substantive precombination activities, and accordingly, is not considered the acquirer of the net assets of Positive Insurance Company.  The acquirer of these net assets is the majority stockholder of the Company.  Accordingly, the accompanying unaudited financial statements do not reflect any adjustments to fair value as might have been determined had the Company accounted for the acquisition of Positive Insurance Company’s net assets as a business combination.  The 2018 unaudited financial information is not necessarily indicative of the results of operations that would have been achieved if the conversions and merger had taken place at the beginning of 2018.

We recommend you read the interim consolidated financial statements we include in this Form 10-Q Report in conjunction with the financial statements and the notes to our financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2018.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and notes. Actual results could differ from these estimates and such differences could be material.  The Company’s principal estimates include the liability for losses and loss adjustment expenses, deferred acquisition costs, other-than-temporary impairments of investments, and valuation of deferred tax assets.

Cash and Cash Equivalents

The Company considers cash and cash equivalents to be cash on hand and depository bank accounts with original maturities of three months or less, are readily convertible to known amounts of cash, and present insignificant risk of changes in value due to changing interest rates.

Investments

Investments in fixed maturity securities are classified as available-for-sale and are stated at fair value. Unrealized holding gains and losses, net of related tax effects, on available-for-sale fixed maturity securities are recorded directly to accumulated other comprehensive income (loss).  Investments in equity securities are stated at fair value and unrealized holding gains and losses are credited or charged to net income (loss) as incurred.  

We have ownership interests in limited partnership equity hedge funds.  The partnership interests are measured at fair value using the funds’ net asset values as a practical expedient.  Unrealized holding gains and losses on partnership interests are credited or charged to net income (loss) as incurred.  There are no unfunded commitments related to these investments.  The funds’ investment strategies are short/long-term equities in financial institutions and global opportunities, long-term equity securities, and fixed maturity and equity securities in global opportunities.

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Realized gains and losses on sales of equity and fixed maturity securities are recognized into income based upon the specific identification method.  Interest and dividends are recognized as earned.  Short-term investments are considered to be short-term, highly liquid investments that are less than one year in term to the dates of maturity at the purchase dates, and they present insignificant risk of changes in value due to changing interest rates.

The Company regularly evaluates all of its investments based on current economic conditions, credit loss experience, and other specific developments.  If there is a decline in a security’s net realizable value that is other than temporary, it is considered as a realized loss and the cost basis in the security is reduced to its estimated fair value.

Other-than-temporary-impairments (“OTTI”) of fixed maturity securities are separated into credit and noncredit-related amounts when there are credit-related losses associated with the impaired fixed maturity security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  The amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors is recorded in other comprehensive income (loss).  A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, computed using original yield as the discount rate, to the amortized cost basis of the security.  The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the "credit loss."  

Deferred Acquisition Costs

Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off.

Prepaid Management Fee

Prepaid management fee consisting of costs incurred by the Positive Insurance Company to execute a new management agreement with Diversus Management is being amortized on a straight-line basis over the   seven-year useful life of the agreement.

Liability for Losses and Loss Adjustment Expenses

Liability for losses and loss adjustment expenses include an amount determined from individual case estimates and loss reports and an amount, based on prior experience, actuarial assumptions and management judgments for losses incurred but not reported. Such liabilities are necessarily based on assumptions and estimates, and while management believes the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates for establishing the resulting liabilities are continually reviewed.  Estimating the ultimate cost of future losses and loss adjustment expenses is an uncertain and complex process.  This estimation process is based upon the assumption that past developments are an appropriate indicator of future events and involves a variety of actuarial techniques that analyze experience, trends, and other relevant factors.  The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedure, as well external factors, such as economic trends and changes in the concepts of legal liability and damage awards.  Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.  Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary.  Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends. We offer extended reporting coverage at no additional charge in the event of disability, death or retirement after a policyholder reaches the age of 55 and has been a mature-claims policyholder with the Company for at least one year.  An extended reporting endorsement policy reserve is required to assure that premiums are not earned prematurely.  This reserve is actuarially determined and the balance is included in unearned premiums in the consolidated balance sheets.

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Reinsura nce

We cede insurance risk to other insurance companies. This arrangement allows us to minimize the net loss potential arising from large risks. Reinsurance contracts do not relieve us of our obligation to its policyholders. Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract.

Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments, non-U.S. government bonds, premiums receivable, and balances recoverable from reinsurers.  Non-U.S. government bonds are diversified, and no one investment accounts for greater than 5% of our invested assets. Cash and cash equivalents are deposited with financial institutions with balances that fluctuate in excess of federally insured limits. If the financial institutions were not to honor their contractual liability to us, we could incur losses.  We are of the opinion that there is low risk because of the financial strength of the respective financial institutions.  We are also subject to concentrations of credit risk through short-term money market investments. The credit risk related to short-term money market investments is minimized by our investing in money market funds or repurchase agreements, both secured by U.S. government securities.  

No one insured accounted for over 20% of premiums receivable as of June 30, 2019 and December 31, 2018 or gross written premium for the three months and six months ended June 30, 2019 and 2018.  We have reinsurance contracts with various reinsurers all of whom have A.M. Best ratings of A or better.  

Revenue Recognition

Premiums are earned on a daily pro rata basis over the terms of the insurance policies.  Unearned premium reserves are established to cover the unexpired portion of the policies in force less amounts ceded to reinsurers.  For consideration received for policies with effective dates subsequent to the reporting period, the Company records an advance premium liability in lieu of written premium.

Comprehensive Income

Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale fixed maturity securities and unrealized losses related to factors other than credit on fixed maturity securities, are reported as a separate component in the equity section in the accompanying consolidated balance sheets. Such items, along with net income (loss), are components of comprehensive income (loss), and are reflected in the accompanying consolidated statements of comprehensive income (loss).  Reclassifications of realized gains and losses on sales of investments out of accumulated other comprehensive income (loss) are recorded in net investment income in the accompanying consolidated statements of operations.

Income Taxes

The Company accounts for income taxes under the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized.  In making such determination, we consider all available positive and negative evidence, including future reversal of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.

Prior to March 27, 2019, PPIX, PCA, and PIPE filed separate federal income tax returns.  The Company did not recognize any interest and penalties in the accompanying consolidated statement of operations for the three months and six months ended June 30, 2019 and the combined statement of operations for the three months and six months ended June 30, 2018.  PPIX, PCA, and PIPE remain subject to examination by the Internal Revenue Service for tax years 2015 through 2017.

Reclassification

The consolidated balance sheet of the Company as of March 31, 2019 inadvertently presented common stock at no par value per share.  The consolidated balance sheet of the Company as of June 30, 2019 presents common stock at a par value of $0.01 per share.  The misstatement in the balance sheet as of March 31, 2019 resulted in a reclassification of $33,580,925 from common stock to additional paid-in capital as of June 30, 2019.

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As an emerging growth company, we have elected to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.  The following discussion includes effective dates for both public business entities and emerging growth companies, as well as whether specific guidance may be adopted early.

Recently Adopted Accounting Pronouncements

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) ASU 2016-01 for the year ended December 31, 2018.  The amendments in this ASU require among other things that equity investments to be measured at fair value (excluding those equity securities measured at fair value using net asset value as a practical expedient) with changes in fair value recognized in net income, simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, require an entity to present separately in other comprehensive income the portion of the total change in the fair value of the liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the consolidated financial statements, and clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.  With the adoption of ASU 2016-01, a cumulative effect of unrealized holding gains and losses on previously classified available-for-sale equity securities included in accumulated other comprehensive income at January 1, 2018 are to be reclassified to retained earnings.  At January 1, 2018, unrealized holding gains in equity securities, net of tax effect, of $1,387,895 were reclassified from accumulated other comprehensive income to retained earnings for the year ended December 31, 2018.

Recently Issued Accounting Pronouncements

New accounting rules and disclosure requirements can impact the results and the comparability of the Company’s consolidated financial statements. The following recently issued accounting pronouncements are relevant to the Company’s consolidated financial statements:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.   The amendments in this Update require a new topic to be added (Topic 326) to the Accounting Standards Codification ("ASC") and removes the thresholds that entities apply to measure credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities.  Under current GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred.  The guidance under ASU 2016-13 will remove all current recognition thresholds and will require entities under the new current expected credit loss ("CECL") model to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that an entity expects to collect over the instrument's contractual life.   The new CECL model is based upon expected losses rather than incurred losses.  Additionally, the credit loss recognition guidance for available-for-sale securities is amended and will require that credit losses on such debt securities should be recognized as an allowance for credit losses rather than a direct write-down of amortized cost balance.  The ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years.   In July 2019, the FASB decided to add a project to its technical agenda to propose staggered effective dates for certain accounting standards, including ASU 2016-13.  The FASB has proposed an approach that ASU 2016-13 will be effective for Public Business Entities that are SEC filers, excluding smaller reporting companies such as the Company, for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years.  For all other entities, including smaller reporting companies like the Company, ASU 2016-13 will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.   For all entities, early adoption will continue to be permitted; that is, early adoption is allowed for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (that is, effective January 1, 2019, for calendar-year-end companies).  The FASB is currently in the process of drafting a proposed ASU for this project to be voted upon by FASB members after a 30-day comment period.  The Company is currently a smaller reporting company, and if this proposal is approved and becomes effective, the Company’s expected adoption date for ASU 2016-13 would change from fiscal years beginning after December 15, 2019 to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. At this time, we are evaluating the potential impact of ASU 2016-13 in the Company’s consolidated financial statements.

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We use fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Fixed maturity available-for-sale securities and equity securities are recorded at fair value on a recurring basis. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

Under ASC Topic 820, we base fair values of assets on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our  or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of the consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

We obtain one price for each security primarily from a third-party pricing service (“pricing service”), which generally uses quoted prices or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds. Because we are responsible for the determination of fair value, we perform analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value.

In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest-level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

Amortized cost/cost, gross unrealized gains, gross unrealized losses, and fair value of fixed maturity and equity securities by major security type for the results at June 30, 2019 and December 31, 2018 are as follows:

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At June 30, 2019 and December 31, 2018, contractual maturities of investments in bond securities are as follows:

Realized gains and losses are determined using the specific identification method. During the three months and six months ended June 30, 2019 and 2018, proceeds from maturity and sales and gross realized gains and losses on securities are:

The components of net investment income for the three months and six months ended June 30, 2019 and 2018 are as follows:

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The fair value and unrealized losses of our securities that were temporarily impaired as of June 3 0 , 2019 and December 31, 2018 are as follows:

Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates, which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions.

We evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. We found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed. Our fixed maturity portfolio is managed by our investment committee in concert with an outside investment manager for investment grade bond investments. By agreement, the investment manager cannot sell any security without the consent of our investment committee if such sale will result in a net realized loss.

We monitor our investment portfolio and review securities that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. When assessing whether the amortized cost basis of the security will be recovered, we compare the present value of the cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as the “credit loss.” If there is a credit loss, the impairment is considered to be other-than-temporary. If we identify that an other-than-temporary impairment loss has occurred, we then determine whether we intend to sell the security, or if it is more likely than not that we will be required to sell the security prior to recovering the amortized cost basis less any current-period credit losses. If we determine that we do not intend to sell, and it is not more likely than not that we will be required to sell the security, the amount of the impairment loss related to the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of tax. If we determine that we intend to sell the security, or that it is more likely than not that we will be required to sell the security prior to recovering its amortized cost basis less any current-period credit losses, the full amount of the other-than-temporary impairment will be recognized in earnings.

For the three months and six months ended June 30, 2019 and 2018, we determined that none of our securities were other-than-temporarily impaired. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

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The table below presents the level within the fair value hierarchy generally utilized by us to estimate the fair value of assets disclosed on a recurring basis at June 3 0 , 2019:

The table below presents the level within the fair value hierarchy generally utilized by us to estimate the fair value of assets disclosed on a recurring basis at December 31, 2018:

At June 30, 2019 and December 31, 2018, we had ownership interests in limited partnerships. Our partnership interests are measured at fair value using the partnerships’ net asset values as a practical expedient. At June 30, 2019, the fair value and cost basis of these investments were $4,244,663 and $3,550,000, respectively. At December 31, 2018, the fair value and cost basis of these investments were $4,051,399 and $3,547,687, respectively.

The following table summarizes the components of deferred acquisition costs for the three months and six months ended June 30, 2019 and 2018:

Effective as of March 27, 2019, Positive Insurance Company entered into a new policy reinsurance agreement.  Under the new agreement, we retain a portion of our exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by us are reinsured with other insurance companies principally to:

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Under Pennsylvania law, each insured must maintain MPLI of at least $1,000,000 for each claim and $3,000,000 of annual aggregate coverage. We provide primary insurance coverage up to $500,000 per claim and $1,500,000 of annual aggregate coverage. The Pennsylvania Medical Care Availability and Reduction of Error ( “ MCARE ” ) Fund provides coverage for any losses above $500,00 0 per claim up to $1,000,000. In cases where coverage under the Pennsylvania MCARE Fund does not apply, the primary insurance provides coverage up to $1,000,000 per claim and $3,000,000 of annual aggregate coverage. We retain the first $300,000 on all poli ces and reinsurance covers the excess up to $1,000,000 that is not covered by the Pennsylvania MCARE Fund, and cede to reinsurers claims in excess of $1,000,000.       

Other states in which we write insurance require doctors to maintain certain minimum coverage and provide a fund that provides coverage for losses above a certain amount, but many states do not prescribe insurance requirements for doctors.

We offer primary coverage up to $1,000,000 for each claim and $3,000,000 of annual aggregate coverage in Delaware, Maryland, Michigan, Ohio, New Jersey, and South Carolina. We retain the first $300,000 on all polices, and reinsurance covers the excess up to $1,000,000. If an insured in New Jersey requests, additional coverage of $1,000,000, each claim, each insured, each policy can be provided and is fully ceded to the reinsurer up to a maximum aggregate liability of $2,000,000 to the reinsurer per the term of the reinsurance agreement.  In South Carolina and Michigan, the policy limits are $200,000, each claim, each insured, and we retain the first $100,000 and the reinsurer covers the next $100,000.  

We also purchase additional reinsurance coverage for clash, loss in excess of policy limits and extra contractual obligation claims.

Our premiums under the new reinsurance agreement is based on a percentage of our earned premiums during the term of the agreement.  The agreement terminates on April 1, 2020.

Reinsurance does not legally discharge the insurance company issuing the policy from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the company issuing the policy to the extent of the coverage ceded. A primary factor in the selection of reinsurers from whom we purchase reinsurance is their financial strength. Our reinsurance arrangements are generally renegotiated annually. The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition. Our reinsurance providers, the majority of whom are longstanding partners that understand our business, are all carefully selected with the help of our reinsurance broker. We monitor the solvency of reinsurers through regular review of their financial statements and, if available, their A.M. Best ratings. Hanover Re, our current reinsurance partner, has at least an “A” rating from A.M. Best. According to A.M. Best, companies with a rating of “A” or better “have an excellent ability to meet their ongoing obligations to policyholders.”

We generally do not assume risks from other insurance companies. However, we are required by statute to participate in certain residual market pools. This participation requires us to assume business for exposures that are not insured in the voluntary marketplace. We participate in these residual markets pro rata on a market share basis, and as of June 30, 2019, our participation was not material.

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The effect of reinsurance on premiums written, amounts earned, and l osses incurred for the three months and six months ended June 3 0 , 2019 and 2018 is as follows:

The following tables provide a reconciliation of our beginning and ending unpaid losses and loss adjustment expense reserve balances for the six months ended June 30, 2019 and 2018.

The liability for losses and loss adjustment expenses at June 30, 2019 and 2018 were $67,491,760 and $69,415,921, respectively. For the six months ended June 30, 2019 and 2018, $9,246,084 and $7,849,105, respectively, has been paid for incurred claims attributable to insured events of prior years. Original estimates are increased or decreased, as additional information becomes known regarding individual claims. During the six months ended June 30, 2018, we experienced an unfavorable development of $1,735,552 primarily related to significant reserve strengthening in the 2014 and 2015 years for both claims-made and occurrence policies.  These increases are due to greater amount of incurred expenses than was originally estimated.  During the six months ended June 30, 2019, we experienced an unfavorable development of $183,428 in reserve strengthening from prior years while leaving most of the incurred related to the 2019 year based upon year to date actuarial estimates.     

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Positive Insurance Company uses a combination of the Actual versus Expected Method, Bornhuetter-Ferguson Method, Expected Loss Ratio Method, Frequenc y/Severity Method, and the Loss Development Method in order to estimate its liability for losses and loss adjustment expenses. There were no significant changes in the methodologies and assumptions used to develop the liabilities for losses and loss adjust ment expenses for the six months ended June 3 0 , 2019 and 2018.

On December 12, 2014, PPIX entered into a loan agreement with a financial institution with proceeds totaling $300,000 to finance the development of a new policy system.  The loan is secured by the equipment purchased with the proceeds received.  The loan is being repaid on a monthly basis from January 2016 through December 2020 with interest calculated on the unpaid principal balance at a rate of 4%.   At June 30, 2019 and December 31, 2018, the balance of the note was $96,390 and $127,327, respectively.  At June 30, 2019 and December 31, 2018, PPIX was in compliance with all loan covenants.

Future maturities of the note for the succeeding years are as follows at June 30, 2019:

At June 30, 2019 and December 31, 2018, we had no unrecognized tax benefits, no accrued interest and penalties, and no significant uncertain tax positions.  No interest and penalties were recognized during the periods ended June 30, 2019 and December 31, 2018.

At June 30, 2019 and December 31, 2018, we have unused net operating loss carryforwards (“NOL”) of $5,869,644 and $3,865,253, respectively, which will begin to expire in tax years 2038 and 2039.  At June 30, 2019 and December 31, 2018, we have capital loss carryforwards of $344,510  and $164,566, respectively.  Of the NOLs as of June 30, 2019, $5,310,679 are subject to limitations under Section 382 of the Internal Revenue Code.  These NOLs are limited in the amount that can be utilized in any one year and may expire before they are realized.  At this time, we do not expect that any of the remaining NOL carryforwards will expire before utilized.  At June 30, 2019 and December 31, 2018, the Company had no other income tax related carryovers for net operating losses, alternative tax credits, or capital losses.  

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  Management considers the scheduled reversal of deferred tax liabilities (including the impact of carryback and carryforward periods), projected future taxable income, and tax planning strategies in making this assessment.  At June 30, 2019 and December 31, 2018, management determined that it is more likely than not that all of the deferred tax assets will be realized by the Company in future years.    Accordingly, the Company did not record a valuation allowance against its deferred tax assets at June 30, 2019 and December 31, 2018.

Positive Insurance Company is managed by Diversus Management.  Prior to March 27, 2019, Diversus Management, through former attorneys-in-fact of PPIX, PCA, and PIPE, earned management fees at 25% of gross written premiums of the exchanges.  Simultaneously with the acquisition of PPIX, PCA, and PIPE and the initial public offering on March 27, 2019, Positive Insurance Company and Diversus Management entered into a new management agreement effective as of March 27, 2019 whereby Diversus Management provides administrative services to Positive Insurance Company in exchange for fees based on a percentage of Positive Insurance Company’s gross written premium, less return premium. For the three months ended June 30, 2019, Diversus Management earned management fees at 12% of gross written premiums of Positive Insurance Company.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Management fees incurred by us for the three months ended June 30, 2019 and 2018 were $530,180 and $852,872, respectively, which is recorded in other underwriting expenses in the consolidated statements of operations.  Management fees incurred by us for the six months ended June 30, 2019 and 2018 were $2,579,559 and $2,989,967, respectively, which is recorded in other underwriting expenses in the consolidated statements of operations.   

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In connection with the execution of the new management agreement with Diversus Management, the Company incurred costs of $10,000,000 to execute the agreement; such costs are presented as “prepaid management fees” in the accompany consolidated balance sheet at June 30, 2019 is being amortized on a straight-line basis over a period of seven years.   For the three months and six months end ed June 30, 2019, amortization expense was $ 357,143 .