UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
Form 10-Q

☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2019

OR

☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission file number: 0-5534


PROTECTIVE INSURANCE CORPORATION
(Exact name of registrant as specified in its charter)

INDIANA
 
35-0160330
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
     
111 Congressional Boulevard, Carmel, Indiana
 
46032
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code:  (317) 636-9800

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:
   
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A Common Stock, No Par Value
PTVCA
The Nasdaq Stock Market LLC
Class B Common Stock, No Par Value
PTVCB
The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    ✓        No ____

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   ✓     No ____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ____   Accelerated filer   ✓       Non-accelerated filer ____  Smaller reporting company ____                 Emerging growth company ____

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ____

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ____  No    ✓_

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of August 6, 2019:

Common Stock, No Par Value:
Class A (voting)
 
2,612,288
 
 
Class B (non-voting)
 
11,779,483
 
     
14,391,771
 

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(in thousands, except share data)

   
June 30
2019
   
December 31
2018
 
Assets
           
Investments:
           
Fixed income securities
 
$
737,148
   
$
592,645
 
Equity securities
   
74,555
     
66,422
 
Limited partnerships
   
35,535
     
55,044
 
Commercial mortgage loans
   
8,884
     
6,672
 
Short-term and other
   
1,000
     
1,000
 
     
857,122
     
721,783
 
                 
Cash and cash equivalents
   
80,772
     
163,996
 
Restricted cash and cash equivalents
   
16,333
     
6,815
 
Accounts receivable
   
111,573
     
102,972
 
Reinsurance recoverable
   
410,445
     
392,436
 
Other assets
   
87,425
     
88,426
 
Current federal income taxes recoverable
   
4,599
     
7,441
 
Deferred federal income taxes
   
2,757
     
6,262
 
   
$
1,571,026
   
$
1,490,131
 
                 
Liabilities and shareholders' equity
               
Reserves for losses and loss expenses
 
$
933,463
   
$
865,339
 
Reserves for unearned premiums
   
79,429
     
71,625
 
Reinsurance payable
   
59,313
     
66,632
 
Short-term borrowings
   
20,000
     
20,000
 
Accounts payable and other liabilities
   
111,405
     
110,453
 
     
1,203,610
     
1,134,049
 
Shareholders' equity:
               
Common stock-no par value:
               
Class A voting -- authorized 3,000,000 shares; outstanding -- 2019 - 2,612,446; 2018 - 2,615,339
   
112
     
112
 
Class B non-voting -- authorized 20,000,000 shares; outstanding -- 2019 - 11,932,076; 2018 - 12,253,922
   
509
     
522
 
Additional paid-in capital
   
54,065
     
54,720
 
Accumulated other comprehensive income (loss)
   
8,217
     
(7,347
)
Retained earnings
   
304,513
     
308,075
 
     
367,416
     
356,082
 
   
$
1,571,026
   
$
1,490,131
 

See notes to condensed consolidated financial statements.

- 2 -

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
(in thousands, except per share data)

   
Three Months Ended
June 30
   
Six Months Ended
June 30
 
   
2019
   
2018
   
2019
   
2018
 
Revenues
                       
Net premiums earned
 
$
115,631
   
$
111,940
   
$
225,644
   
$
217,402
 
Net investment income
   
6,500
     
5,796
     
12,732
     
10,432
 
Commissions and other income
   
1,978
     
2,263
     
4,043
     
4,076
 
Net realized gains on investments, excluding impairment losses
   
713
     
915
     
673
     
1,290
 
Other-than-temporary impairment losses on investments
   
(86
)
   
–
     
(346
)
   
–
 
Net unrealized gains (losses) on equity securities and limited partnership investments
   
2,262
     
(4,350
)
   
8,589
     
(9,258
)
Net realized and unrealized gains (losses) on investments
   
2,889
     
(3,435
)
   
8,916
     
(7,968
)
     
126,998
     
116,564
     
251,335
     
223,942
 
                                 
Expenses
                               
Losses and loss expenses incurred
   
90,433
     
77,488
     
177,555
     
149,787
 
Other operating expenses
   
34,615
     
36,019
     
68,316
     
70,784
 
     
125,048
     
113,507
     
245,871
     
220,571
 
Income before federal income tax expense
   
1,950
     
3,057
     
5,464
     
3,371
 
Federal income tax expense
   
415
     
570
     
1,181
     
554
 
Net income
 
$
1,535
   
$
2,487
   
$
4,283
   
$
2,817
 
                                 
Per share data:
                               
Basic and diluted earnings
 
$
.11
   
$
.17
   
$
.28
   
$
.19
 
                                 
Dividends paid to shareholders
 
$
.10
   
$
.28
   
$
.20
   
$
.56
 
                                 
Reconciliation of shares outstanding:
                               
Average shares outstanding - basic
   
14,616
     
15,014
     
14,731
     
15,012
 
Dilutive effect of share equivalents
   
63
     
9
     
60
     
9
 
Average shares outstanding - diluted
   
14,679
     
15,023
     
14,791
     
15,021
 

See notes to condensed consolidated financial statements.

- 3 -

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
(in thousands)

   
Three Months Ended
June 30
   
Six Months Ended
June 30
 
   
2019
   
2018
   
2019
   
2018
 
Net income
 
$
1,535
   
$
2,487
   
$
4,283
   
$
2,817
 
                                 
Other comprehensive income (loss), net of tax:
                               
   Unrealized net gains (losses) on fixed income securities
   
6,517
     
(2,026
)
   
14,973
     
(5,147
)
                                 
Foreign currency translation adjustments
   
284
     
(188
)
   
591
     
(411
)
                                 
Other comprehensive income (loss)
   
6,801
     
(2,214
)
   
15,564
     
(5,558
)
                                 
Comprehensive income (loss)
 
$
8,336
   
$
273
   
$
19,847
   
$
(2,741
)

See notes to condensed consolidated financial statements.

- 4 -

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Statements of Shareholders' Equity
(in thousands)

 
 
Common Stock
   
Additional
   
Accumulated Other
             
 
 
Class A
   
Class B
   
Paid-in
   
Comprehensive
   
Retained
   
Total
 
Description
 
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Income (Loss)
   
Earnings
   
Equity
 
Balance at December 31, 2018
   
2,615
   
$
112
     
12,254
   
$
522
   
$
54,720
   
$
(7,347
)
 
$
308,075
   
$
356,082
 
Net income
   
–
     
–
     
–
     
–
     
–
     
–
     
4,283
     
4,283
 
Foreign currency translation adjustment, net of tax
   
–
     
–
     
–
     
–
     
–
     
591
     
–
     
591
 
Change in unrealized gain (loss) on investments, net of tax
   
–
     
–
     
–
     
–
     
–
     
14,973
     
–
     
14,973
 
Common stock dividends
   
–
     
–
     
–
     
–
     
–
     
–
     
(2,987
)
   
(2,987
)
Repurchase of common stock
   
(3
)
   
–
     
(371
)
   
(15
)
   
(1,614
)
   
–
     
(4,858
)
   
(6,487
)
Restricted stock grants
   
–
     
–
     
49
     
2
     
959
     
––
     
–
     
961
 
Balance at June 30, 2019
   
2,612
   
$
112
     
11,932
   
$
509
   
$
54,065
   
$
8,217
   
$
304,513
   
$
367,416
 


 
 
Common Stock
   
Additional
   
Accumulated Other
             
 
 
Class A
   
Class B
   
Paid-in
   
Comprehensive
   
Retained
   
Total
 
Description
 
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Income
   
Earnings
   
Equity
 
Balance at March 31, 2019
   
2,615
   
$
112
     
12,249
   
$
522
   
$
55,049
   
$
1,416
   
$
308,971
   
$
366,070
 
Net income
   
–
     
–
     
–
     
–
     
–
     
–
     
1,535
     
1,535
 
Foreign currency translation adjustment, net of tax
   
–
     
–
     
–
     
–
     
–
     
284
     
–
     
284
 
Change in unrealized gain (loss) on investments, net of tax
   
–
     
–
     
–
     
–
     
–
     
6,517
     
–
     
6,517
 
Common stock dividends
   
–
     
–
     
–
     
–
     
–
     
–
     
(1,494
)
   
(1,494
)
Repurchase of common stock
   
(3
)
   
–
     
(346
)
   
(15
)
   
(1,506
)
   
–
     
(4,499
)
   
(6,020
)
Restricted stock grants
   
–
     
–
     
29
     
2
     
522
     
–
     
–
     
524
 
Balance at June 30, 2019
   
2,612
   
$
112
     
11,932
   
$
509
   
$
54,065
   
$
8,217
   
$
304,513
   
$
367,416
 


See notes to condensed consolidated financial statements.

- 5 -

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Statements of Shareholders' Equity
(in thousands)

 
 
Common Stock
   
Additional
   
Accumulated Other
             
 
 
Class A
   
Class B
   
Paid-in
   
Comprehensive
   
Retained
   
Total
 
Description
 
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Income (Loss)
   
Earnings
   
Equity
 
Balance at December 31, 2017
   
2,623
   
$
112
     
12,424
   
$
530
   
$
55,078
   
$
46,391
   
$
316,700
   
$
418,811
 
Cumulative effect of adoption of ASU 2016-01, net of tax (Note 1)
   
–
     
–
     
–
     
–
     
–
     
(46,157
)
   
46,157
     
–
 
Cumulative effect of adoption of ASU 2018-02 (Note 1)
   
–
     
–
     
–
     
–
     
–
     
117
     
(117
)
   
–
 
Net income
   
–
     
–
     
–
     
–
     
–
     
–
     
2,817
     
2,817
 
Foreign currency translation adjustment, net of tax
   
–
     
–
     
–
     
–
     
–
     
(411
)
   
–
     
(411
)
Change in unrealized gain (loss) on investments, net of tax
   
–
     
–
     
–
     
–
     
–
     
(5,147
)
   
–
     
(5,147
)
Common stock dividends
   
–
     
–
     
–
     
–
     
–
     
–
     
(8,456
)
   
(8,456
)
Repurchase of common stock
   
–
     
–
     
(54
)
   
(2
)
   
(234
)
   
–
     
(1,044
)
   
(1,280
)
Restricted stock grants
   
–
     
–
     
10
     
–
     
901
     
–
     
–
     
901
 
Balance at June 30, 2018
   
2,623
   
$
112
     
12,380
   
$
528
   
$
55,745
   
$
(5,207
)
 
$
356,057
   
$
407,235
 


 
 
Common Stock
   
Additional
   
Accumulated Other
             
 
 
Class A
   
Class B
   
Paid-in
   
Comprehensive
   
Retained
   
Total
 
Description
 
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Loss
   
Earnings
   
Equity
 
Balance at March 31, 2018
   
2,623
   
$
112
     
12,418
   
$
530
   
$
55,511
   
$
(2,993
)
 
$
358,651
   
$
411,811
 
Net income
   
–
     
–
     
–
     
–
     
–
     
–
     
2,487
     
2,487
 
Foreign currency translation adjustment, net of tax
   
–
     
–
     
–
     
–
     
–
     
(188
)
   
–
     
(188
)
Change in unrealized gain (loss) on investments, net of tax
   
–
     
–
     
–
     
–
     
–
     
(2,026
)
   
–
     
(2,026
)
Common stock dividends
   
–
     
–
     
–
     
–
     
–
     
–
     
(4,227
)
   
(4,227
)
Repurchase of common stock
   
–
     
–
     
(43
)
   
(2
)
   
(188
)
   
–
     
(854
)
   
(1,044
)
Restricted stock grants
   
–
     
–
     
5
     
–
     
422
     
–
     
–
     
422
 
Balance at June 30, 2018
   
2,623
   
$
112
     
12,380
   
$
528
   
$
55,745
   
$
(5,207
)
 
$
356,057
   
$
407,235
 


See notes to condensed consolidated financial statements.

- 6 -

Protective Insurance Corporation and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)

   
Six Months Ended
June 30
 
   
2019
   
2018
 
Operating activities
           
Net income
 
$
4,283
   
$
2,817
 
Adjustments to reconcile net income to net cash provided by operating activities
   
34,113
     
21,857
 
Net cash provided by operating activities
   
38,396
     
24,674
 
                 
Investing activities
               
Purchases of fixed income and equity securities
   
(245,099
)
   
(215,226
)
Purchases of limited partnership interests
   
–
     
(450
)
Distributions from limited partnerships
   
20,231
     
369
 
Proceeds from maturities
   
38,917
     
37,590
 
Proceeds from sales of fixed income securities
   
71,839
     
102,408
 
Proceeds from sales of equity securities
   
14,449
     
87,557
 
Purchase of insurance company-owned life insurance
   
–
     
(10,000
)
Purchase of commercial mortgage loans
   
(2,213
)
   
–
 
Purchases of property and equipment
   
(1,346
)
   
(2,691
)
Proceeds from disposals of property and equipment
   
3
     
8
 
Net cash used in investing activities
   
(103,219
)
   
(435
)
                 
Financing activities
               
Dividends paid to shareholders
   
(2,987
)
   
(8,456
)
Repurchase of common shares
   
(6,487
)
   
(1,280
)
Net cash used in financing activities
   
(9,474
)
   
(9,736
)
                 
Effect of foreign exchange rates on cash and cash equivalents
   
591
     
(411
)
                 
Increase (decrease) in cash, cash equivalents and restricted cash and cash equivalents
   
(73,706
)
   
14,092
 
Cash, cash equivalents and restricted cash and cash equivalents at beginning of period
   
170,811
     
68,713
 
Cash, cash equivalents and restricted cash and cash equivalents at end of period
 
$
97,105
   
$
82,805
 

See notes to condensed consolidated financial statements.

- 7 -

Notes to Unaudited Condensed Consolidated Financial Statements
(All dollar amounts presented in these notes are in thousands, except share and per share data)

(1)  Summary of Significant Accounting Policies:

Description of Business:  Protective Insurance Corporation (the "Company"), based in Carmel, Indiana, 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.  In addition, the Company offers workers' compensation coverage for a variety of operations outside the transportation industry.  The Company operates 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 “Insurance Subsidiaries,” as used throughout this document, refers to Protective Insurance Company, Protective Specialty Insurance Company, Sagamore Insurance Company and B&L Insurance, Ltd.

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included.  Interim financial statements should be read in conjunction with the Company's annual audited financial statements and other disclosures included in the Company's most recent Annual Report on Form 10-K.  Operating results for interim periods are not necessarily indicative of results that may be expected for the year ending December 31, 2019 or any other future period.

Investments : Carrying amounts for fixed income securities represent fair value and are based on quoted market prices, where available, or broker/dealer quotes for specific securities where quoted market prices are not available.  Equity securities are carried at quoted market prices (fair value).  Commercial mortgage loans are carried primarily at amortized cost along with a valuation allowance for losses when necessary. These investments represent interests in commercial mortgage loans originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. There was no valuation allowance on the Company's commercial mortgage loans as of June 30, 2019.

The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to record its proportionate share of the limited partnership's net income.  To the extent the limited partnerships include both realized and unrealized investment gains or losses in the determination of net income or loss, then the Company would also recognize, through its condensed consolidated statements of operations, its proportionate share of the investee's unrealized, as well as realized, investment gains or losses within net unrealized gains (losses) on equity securities and limited partnership investments.

Short-term and other investments are carried at cost, which approximates their fair values.

Fixed income securities are considered to be available-for-sale. The related unrealized net gains or losses (net of applicable tax effects) on fixed income securities are reflected directly in shareholders' equity. Included within available-for-sale fixed income securities are convertible debt securities.  A portion of the changes in the fair values of convertible debt securities is reflected as a component of net realized gains on investments, excluding impairment losses within the condensed consolidated statements of operations.  Realized gains and losses on disposals of fixed income securities are recorded on the trade date.  Realized gains and losses on fixed income securities are determined by the specific identification of the cost of investments sold and are included in net realized gains on investments, excluding impairment losses.

Effective January 1, 2018, the Company adopted new accounting guidance that requires equity securities to be recorded at fair value, with unrealized net gains or losses reflected as a component of net unrealized gains (losses) on equity securities and limited partnership investments within the condensed consolidated statements of operations.  Realized gains and losses on disposals of equity securities are recorded on the trade date and included in net realized gains on investments, excluding impairment losses.  Prior to adoption of the new accounting guidance, unrealized gains and losses related to equity securities were reflected directly in shareholders’ equity unless a decline in value was determined to be other-than-temporary, in which case the loss was charged to income.

In accordance with the Financial Accounting Standards Board's ("FASB") other-than-temporary impairment guidance, if a fixed income security is in an unrealized loss position and the Company has the intent to sell the fixed income security, or it is more likely than not that the Company will have to sell the fixed income security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to other-than-temporary impairment losses on investments in the condensed consolidated statements of operations.   For impaired fixed income securities that the Company does not intend to sell or in cases where it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in other-than-temporary impairment losses on investments in the condensed consolidated statements of operations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity.

- 8 -
The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed income security.  The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the appropriate effective interest rate.

Recognition of Revenue and Costs:  Premiums are earned over the period for which insurance protection is provided.  A reserve for unearned premiums, computed by the daily pro-rata method, is established to reflect amounts applicable to subsequent accounting periods.  Commissions to unaffiliated companies and premium taxes applicable to unearned premiums are deferred and expensed as the related premiums are earned.  The Company does not defer acquisition costs that are not directly variable with the production of premiums.  If it is determined that expected losses and deferred expenses will likely exceed the related unearned premiums, the asset representing deferred policy acquisition costs is reduced and an expense is charged against current operations to reflect any such premium deficiency.  In the event that the expected premium deficiency exceeds deferred policy acquisition costs, an additional liability would be recorded with a corresponding expense to current operations for the amount of the excess premium deficiency.  Anticipated investment income is considered in determining recoverability of deferred acquisition costs.  The Company had no material contract assets, contract liabilities, or deferred contract costs recorded on its condensed consolidated balance sheet at June 30, 2019.

Recently Adopted Accounting Pronouncements:   In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 changed the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income.  Previously, the Company's equity securities were classified as available-for-sale and changes in fair value were recognized in accumulated other comprehensive income (loss) as a component of shareholders' equity.  The Company adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective approach and recorded a cumulative-effect adjustment to reclassify unrealized gains on equity securities of $71,012 ($46,157, net of tax) from other comprehensive income (loss) to retained earnings within the consolidated balance sheet as of December 31, 2018.  Going forward, unrealized gains or losses on equity securities will be recognized in the consolidated statements of operations within net unrealized gains (losses) on equity securities and limited partnership investments.

In February 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842), or ASU 2016-02. ASU 2016-02 superseded the prior lease guidance in Accounting Standards Codification ("ASC") Topic 840, Leases.  Under the new guidance, lessees are required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis.  Concurrently, lessees are required to recognize a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term.  The guidance provides for a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements.  In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, or ASU 2018-11, which provided adopters an additional transition method by allowing entities to initially apply ASU 2016-02, and subsequent related standards, at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.   The Company adopted the new guidance on January 1, 2019 utilizing the transition method allowed per ASU 2018-11, and accordingly, comparative period financial information was not adjusted for the effects of the new guidance. No cumulative-effect adjustment was required to the opening balance of retained earnings on the adoption date. The Company's adoption of the new standard did not have any impact on the Company's condensed consolidated statements of operations or cash flows; however, the impact of adopting the new guidance resulted in a right-of-use asset and a lease liability being recorded on the condensed consolidated balance sheet as of June 30, 2019 of approximately $300, which are included within other assets and accounts payable and other liabilities. 

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). This ASU allows for the option to reclassify, from accumulated other comprehensive income (loss) to retained earnings, stranded tax effects resulting from the newly enacted federal corporate income tax rate in the U.S. Tax Cuts and Jobs Act of 2017 (the "U.S. Tax Act"), which was enacted on December 22, 2017. The legislation included a reduction to the corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. The amount of the reclassification was the difference between the historical corporate income tax rate and the newly enacted 21 percent corporate income tax rate. The Company adopted the new guidance in the first quarter of 2018 and recorded a cumulative-effect adjustment to reclassify the tax effects on fixed income investments of $117 from other comprehensive income (loss) to retained earnings within the consolidated balance sheet as of December 31, 2018.

In July 2018, the FASB issued ASU No. 2018-09, Codification Improvements. This update provides clarification, corrects errors in and makes minor improvements to various ASC topics. Many of the amendments in this update have transition guidance with effective dates for annual periods beginning after December 15, 2018, and some amendments in this update do not require transition guidance and were effective upon issuance of this update. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.


- 9 -

Recently Issued Accounting Pronouncements:  In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, or ASU 2018-13. This update removes the disclosure requirements for the amounts of and the reasons for transfers between Level 1 and Level 2 and disclosure of the policy for timing of transfers between levels. This update also removes disclosure requirements for the valuation processes for Level 3 fair value measurements. Additionally, this update adds disclosure requirements for the changes in unrealized gains and losses for recurring Level 3 fair value measurements and quantitative information for certain unobservable inputs in Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019. The Company is currently evaluating the effects the adoption of ASU 2018-13 will have on its consolidated financial statements.

In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief. In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. In November 2018, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. These updates provide an option to irrevocably elect to measure certain individual financial assets at fair value instead of amortized cost and provide additional clarification and implementation guidance on certain aspects of the previously issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU 2016-13, and have the same effective date and transition requirements as ASU 2016-13. ASU 2016-13 introduces a current expected credit loss model for measuring expected credit losses for certain types of financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. ASU 2016-13 replaces the current incurred loss model for measuring expected credit losses, requires expected losses on available-for-sale debt securities to be recognized through an allowance for credit losses rather than as reductions in the amortized cost of the securities, and provides for additional disclosure requirements. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the effects the adoption of ASU 2016-13 will have on its consolidated financial statements.

- 10 -
(2)  Investments:

The following is a summary of available-for-sale securities at June 30, 2019 and December 31, 2018:

   
Fair
Value
   
Cost or
Amortized Cost
   
Gross
Unrealized Gains
   
Gross
Unrealized Losses
   
Net Unrealized
Gains (Losses)
 
June 30, 2019
                             
Fixed income securities
                             
Agency collateralized mortgage obligations
 
$
15,730
   
$
15,384
   
$
352
   
$
(6
)
 
$
346
 
Agency mortgage-backed securities
   
41,031
     
39,609
     
1,438
     
(16
)
   
1,422
 
Asset-backed securities
   
94,880
     
94,847
     
539
     
(506
)
   
33
 
Bank loans
   
16,074
     
16,279
     
60
     
(265
)
   
(205
)
Certificates of deposit
   
2,835
     
2,835
     
–
     
–
     
–
 
Collateralized mortgage obligations
   
6,165
     
5,686
     
549
     
(70
)
   
479
 
Corporate securities
   
256,318
     
251,977
     
5,185
     
(844
)
   
4,341
 
Mortgage-backed securities
   
42,506
     
41,706
     
946
     
(146
)
   
800
 
Municipal obligations
   
32,834
     
32,177
     
688
     
(31
)
   
657
 
Non-U.S. government obligations
   
31,378
     
31,064
     
326
     
(12
)
   
314
 
U.S. government obligations
   
197,397
     
194,489
     
3,092
     
(184
)
   
2,908
 
Total fixed income securities
 
$
737,148
   
$
726,053
   
$
13,175
   
$
(2,080
)
 
$
11,095
 

   
Fair
Value
   
Cost or
Amortized Cost
   
Gross
Unrealized Gains
   
Gross
Unrealized Losses
   
Net Unrealized
Gains (Losses)
 
December 31, 2018
                             
Fixed income securities
                             
Agency collateralized mortgage obligations
 
$
10,687
   
$
10,636
   
$
145
   
$
(94
)
 
$
51
 
Agency mortgage-backed securities
   
37,385
     
37,168
     
371
     
(154
)
   
217
 
Asset-backed securities
   
64,422
     
66,241
     
14
     
(1,833
)
   
(1,819
)
Bank loans
   
9,750
     
10,208
     
27
     
(485
)
   
(458
)
Certificates of deposit
   
2,835
     
2,835
     
–
     
–
     
–
 
Collateralized mortgage obligations
   
5,423
     
5,095
     
376
     
(48
)
   
328
 
Corporate securities
   
190,450
     
196,925
     
127
     
(6,602
)
   
(6,475
)
Mortgage-backed securities
   
38,540
     
38,586
     
377
     
(423
)
   
(46
)
Municipal obligations
   
29,155
     
29,102
     
239
     
(186
)
   
53
 
Non-U.S. government obligations
   
25,180
     
25,339
     
6
     
(165
)
   
(159
)
U.S. government obligations
   
178,818
     
178,369
     
1,252
     
(803
)
   
449
 
Total fixed income securities
 
$
592,645
   
$
600,504
   
$
2,934
   
$
(10,793
)
 
$
(7,859
)

The following table summarizes, for available-for-sale fixed income securities in an unrealized loss position at June 30, 2019 and  December 31, 2018, the aggregate fair value and gross unrealized loss categorized by the duration individual securities have been continuously in an unrealized loss position.

   
June 30, 2019
   
December 31, 2018
 
   
Number of
Securities
   
Fair
Value
   
Gross
Unrealized Loss
   
Number of
Securities
   
Fair
Value
   
Gross
Unrealized Loss
 
Fixed income securities:
                                   
12 months or less
   
81
   
$
76,363
   
$
(1,166
)
   
275
   
$
282,646
   
$
(7,296
)
Greater than 12 months
   
149
     
95,614
     
(914
)
   
217
     
131,001
     
(3,497
)
Total fixed income securities
   
230
   
$
171,977
   
$
(2,080
)
   
492
   
$
413,647
   
$
(10,793
)
                                                 


- 11 -

The fair value and the cost or amortized costs of fixed income investments at June 30, 2019, organized by contractual maturity, are shown below.  Actual maturities may ultimately differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.

   
Fair
Value
   
Cost or
Amortized Cost
 
One year or less
 
$
99,531
   
$
99,574
 
Excess of one year to five years
   
342,358
     
336,988
 
Excess of five years to ten years
   
89,596
     
87,051
 
Excess of ten years
   
11,517
     
10,894
 
Contractual maturities
   
543,002
     
534,507
 
Asset-backed securities
   
194,146
     
191,546
 
Total
 
$
737,148
   
$
726,053
 

Following is a summary of the components of net realized and unrealized gains (losses) on investments for the periods presented in the accompanying condensed consolidated statements of operations.

   
Three Months Ended
June 30
   
Six Months Ended
June 30
 
   
2019
   
2018
   
2019
   
2018
 
Gross gains on available-for-sale fixed income securities sold during the period
 
$
4,132
   
$
3,691
   
$
7,303
   
$
6,134
 
Gross losses on available-for-sale fixed income securities sold during the period
   
(3,154
)
   
(3,088
)
   
(6,681
)
   
(5,796
)
                                 
Other-than-temporary impairments
   
(86
)
   
–
     
(346
)
   
–
 
                                 
Change in value of limited partnership investments
   
314
     
(2,842
)
   
722
     
(5,445
)
                                 
Gains (losses) on equity securities:
                               
Realized gains (losses) on equity securities sold during the period
   
(265
)
   
312
     
51
     
953
 
Unrealized gains (losses) on equity securities held at the end of the period
   
1,948
     
(1,508
)
   
7,867
     
(3,814
)
Realized and unrealized gains (losses) on equity securities during the period
   
1,683
     
(1,196
)
   
7,918
     
(2,861
)
                                 
Net realized and unrealized gains (losses) on investments
 
$
2,889
   
$
(3,435
)
 
$
8,916
   
$
(7,968
)

Shareholders' equity at June 30, 2019 included approximately $25,071, net of federal income tax expense, of reported earnings that remain undistributed by limited partnerships.


(3)  Reinsurance:

The following table summarizes the Company's transactions with reinsurers for the 2019 and 2018 comparative periods.

   
2019
   
2018
 
Three months ended June 30:
           
Premiums ceded to reinsurers
 
$
32,425
   
$
28,800
 
Losses and loss expenses ceded to reinsurers
   
28,859
     
21,975
 
Commissions from reinsurers
   
8,176
     
6,443
 
                 
Six months ended June 30:
               
Premiums ceded to reinsurers
 
$
62,598
   
$
61,241
 
Losses and loss expenses ceded to reinsurers
   
59,648
     
48,636
 
Commissions from reinsurers
   
15,410
     
14,323
 
                 

- 12 -
(4)  Loss and Loss Expense Reserves:

Activity in the reserves for losses and loss expenses for the six months ended June 30, 2019 and 2018 is summarized as follows.  All amounts are shown net of reinsurance, unless otherwise indicated.

   
Six Months Ended
 
   
June 30
 
   
2019
   
2018
 
Reserves, gross of reinsurance recoverable, at the beginning of the year
 
$
865,339
   
$
680,274
 
Reinsurance recoverable on unpaid losses at the beginning of the year
   
375,935
     
308,143
 
Reserves at the beginning of the year
   
489,404
     
372,131
 
                 
Provision for losses and loss expenses:
               
Claims occurring during the current period
   
179,211
     
151,462
 
Claims occurring during prior periods
   
(1,656
)
   
(1,675
)
Total incurred
   
177,555
     
149,787
 
                 
Loss and loss expense payments:
               
Claims occurring during the current period
   
30,573
     
28,903
 
Claims occurring during prior periods
   
92,822
     
88,965
 
Total paid
   
123,395
     
117,868
 
Reserves at the end of the period
   
543,564
     
404,050
 
                 
Reinsurance recoverable on unpaid losses at the end of the period
   
389,899
     
312,231
 
Reserves, gross of reinsurance recoverable, at the end of the period
 
$
933,463
   
$
716,281
 

The table above shows a reserve savings of $1,656 that developed during the six months ended June 30, 2019 in the settlement of claims occurring on or before December 31, 2018.  Losses incurred from claims occurring during prior years reflect the development from prior accident years, composed of individual claim savings and deficiencies which, in the aggregate, have resulted from the settlement of claims at amounts higher or lower than previously reserved and from changes in estimates of losses incurred but not reported.

The $1,656 prior accident year savings that developed during the six months ended June 30, 2019 was primarily due to favorable loss development in workers' compensation and independent contractor coverages.  This savings compares to a savings of $1,675 for the six months ended June 30, 2018, which was also related to favorable loss development from workers' compensation and independent contractor coverages.


(5)  Segment Information:

The Company has one reportable business segment in its operations: Property and Casualty Insurance.  The property and casualty insurance segment provides multiple lines of insurance coverage primarily to commercial automobile companies, as well as to independent contractors who contract with commercial automobile companies.  In addition, the Company provides workers' compensation coverage for a variety of operations outside the transportation industry.

The following table summarizes segment revenues for the three and six months ended June 30, 2019 and 2018:

   
Three Months Ended
June 30
   
Six Months Ended
June 30
 
   
2019
   
2018
   
2019
   
2018
 
Revenues:
                       
Net premiums earned
 
$
115,631
   
$
111,940
   
$
225,644
   
$
217,402
 
Net investment income
   
6,500
     
5,796
     
12,732
     
10,432
 
Net realized and unrealized gains (losses) on investments
   
2,889
     
(3,435
)
   
8,916
     
(7,968
)
Commissions and other income
   
1,978
     
2,263
     
4,043
     
4,076
 
Total revenues
 
$
126,998
   
$
116,564
   
$
251,335
   
$
223,942
 

- 13 -
(6)  Debt:

On August 9, 2018, the Company entered into a credit agreement providing a revolving credit facility with a $40,000 limit, with the option for up to an additional $35,000 in incremental loans at the discretion of the lenders.  This credit agreement 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 the Company's option.  Outstanding drawings on this revolving credit facility were $20,000 as of June 30, 2019.  At June 30, 2019, the effective interest rate was 3.50% and the Company had $20,000 remaining under the revolving credit facility.  The current outstanding borrowings were used to repay the Company's previous line of credit.  The Company's revolving credit facility has two financial covenants, each of which were met as of June 30, 2019.  These covenants require the Company to have a minimum U.S. generally accepted accounting principles net worth and a maximum consolidated leverage ratio of 0.35 to 1.00.


(7)  Taxes:

The effective federal tax rate on consolidated income for the three months ended June 30, 2019 was 21.3% compared to 18.6% for the three months ended June 30, 2018.  The effective federal tax rate on consolidated income for the six months ended June 30, 2019 was 21.6% compared to 16.4% for the six months ended June 30, 2018.  The effective federal income tax rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.  For the three and six months ended June 30, 2019, the Company had lower tax-exempt income when compared to the same periods in 2018, primarily due to the reduction of tax exempt municipal securities within the Company's investment portfolio in the current year as well as a decrease in dividend income, which provides a deduction for taxes, related to the reallocation of equity securities to fixed income securities within the Company’s investment portfolio throughout 2018.

As of June 30, 2019, the Company's calendar years 2017, 2016 and 2015 r emain subject to examination by the Internal Revenue Service.

- 14 -
(8)  Fair Value:

Assets and liabilities recorded at fair value in the condensed consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The following tables summarize fair value measurements by level for assets measured at fair value on a recurring basis:

As of June 30, 2019:

Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Fixed income securities:
                       
Agency collateralized mortgage obligations
 
$
15,730
   
$
–
   
$
15,730
   
$
–
 
Agency mortgage-backed securities
   
41,031
     
–
     
41,031
     
–
 
Asset-backed securities
   
94,880
     
–
     
94,880
     
–
 
Bank loans
   
16,074
     
–
     
16,074
     
–
 
Certificates of deposit
   
2,835
     
2,835
     
–
     
–
 
Collateralized mortgage obligations
   
6,165
     
–
     
6,165
     
–
 
Corporate securities
   
251,394
     
–
     
251,394
     
–
 
Options embedded in convertible securities
   
4,924
     
–
     
4,924
     
–
 
Mortgage-backed securities
   
42,506
     
–
     
42,506
     
–
 
Municipal obligations
   
32,834
     
–
     
32,834
     
–
 
Non-U.S. government obligations
   
31,378
     
–
     
31,378
     
–
 
U.S. government obligations
   
197,397
     
–
     
197,397
     
–
 
Total fixed income securities
   
737,148
     
2,835
     
734,313
     
–
 
Equity securities:
                               
Consumer
   
17,125
     
17,125
     
–
     
–
 
Energy
   
3,340
     
3,340
     
–
     
–
 
Financial
   
29,117
     
29,117
     
–
     
–
 
Industrial
   
4,176
     
4,176
     
–
     
–
 
Technology
   
2,414
     
2,414
     
–
     
–
 
Funds (e.g. mutual funds, closed end funds, ETFs)
   
9,796
     
9,796
     
–
     
–
 
Other
   
8,587
     
8,587
     
–
     
–
 
Total equity securities
   
74,555
     
74,555
     
–
     
–
 
Short-term
   
1,000
     
1,000
     
–
     
–
 
Cash equivalents
   
76,967
     
–
     
76,967
     
–
 
Total
 
$
889,670
   
$
78,390
   
$
811,280
   
$
–
 

- 15 -
As of December 31, 2018:

Description
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Fixed income securities:
                       
Agency collateralized mortgage obligations
 
$
10,687
   
$
–
   
$
10,687
   
$
–
 
Agency mortgage-backed securities
   
37,385
     
–
     
37,385
     
–
 
Asset-backed securities
   
64,422
     
–
     
64,422
     
–
 
Bank loans
   
9,750
     
–
     
9,750
     
–
 
Certificates of deposit
   
2,835
     
2,835
     
–
     
–
 
Collateralized mortgage obligations
   
5,423
     
–
     
5,423
     
–
 
Corporate securities
   
186,651
     
–
     
186,651
     
–
 
Options embedded in convertible securities
   
3,799
     
–
     
3,799
     
–
 
Mortgage-backed securities
   
38,540
     
–
     
38,540
     
–
 
Municipal obligations
   
29,155
     
–
     
29,155
     
–
 
Non-U.S. government obligations
   
25,180
     
–
     
25,180
     
–
 
U.S. government obligations
   
178,818
     
–
     
178,818
     
–
 
Total fixed income securities
   
592,645
     
2,835
     
589,810
     
–
 
Equity securities:
                               
Consumer
   
17,945
     
17,945
     
–
     
–
 
Energy
   
3,179
     
3,179
     
–
     
–
 
Financial
   
25,253
     
25,253
     
–
     
–
 
Industrial
   
6,920
     
6,920
     
–
     
–
 
Technology
   
2,303
     
2,303
     
–
     
–
 
Funds (e.g. mutual funds, closed end funds, ETFs)
   
5,489
     
5,489
     
–
     
–
 
Other
   
5,333
     
5,333
     
–
     
–
 
Total equity securities
   
66,422
     
66,422
     
–
     
–
 
Short-term
   
1,000
     
1,000
     
–
     
–
 
Cash equivalents
   
156,855
     
–
     
156,855
     
–
 
Total
 
$
816,922
   
$
70,257
   
$
746,665
   
$
–
 

Level inputs, as defined by the FASB guidance, are as follows:

Level Input:
 
Input Definition:
     
Level 1
 
Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
     
Level 2
 
Inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with market data at the measurement date.
     
Level 3
 
Unobservable inputs that reflect management's best estimate of what market participants would use in pricing the asset or liability at the measurement date.

The Company did not have any Level 3 assets at June 30, 2019 or December 31, 2018.  Level 3 assets, when present, are valued using various unobservable inputs including extrapolated data, proprietary models and indicative quotes. 

Quoted market prices are obtained whenever possible.  Where quoted market prices are not available, fair values are estimated using broker/dealer quotes for specific securities.  These techniques are significantly affected by the Company's assumptions, including discount rates and estimates of future cash flows.  Potential taxes and other transaction costs have not been considered in estimating fair values.

Transfers between levels, if any, are recorded as of the beginning of the reporting period.  There were no significant transfers of assets between Level 1 and Level 2 during the six months ended June 30, 2019 and 2018.

In addition to the preceding disclosures on assets recorded at fair value in the condensed consolidated balance sheets, FASB guidance also requires the disclosure of fair values for certain other financial instruments for which it is practicable to estimate fair value, whether or not such values are recognized in the condensed consolidated balance sheets.

Non-financial instruments such as real estate, property and equipment, other assets, deferred income taxes and intangible assets, and certain financial instruments such as policy reserve liabilities are excluded from the fair value disclosures.  Therefore, the fair value amounts cannot be aggregated to determine the underlying economic value of the Company.  The following methods, assumptions and inputs were used to estimate the fair value of each class of financial instrument:

- 16 -
Limited partnerships: The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to carry the investment at its proportionate share of the limited partnership's equity.   The underlying assets of the Company's investments in limited partnerships are carried primarily at fair value; therefore, the Company's carrying value of limited partnerships approximates fair value.  As these investments are not actively traded and the corresponding inputs are based on data provided by the investees, they are classified as Level 3.

Commercial mortgage loans:  Commercial mortgage loans are carried primarily at amortized cost along with a valuation allowance for losses when necessary. These investments represent interests in commercial mortgage loans originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans.  The fair value of the Company’s investment in these commercial mortgage loans is based on expected future cash flows discounted at the current interest rate for origination of similar quality loans, adjusted for specific loan risk.  These investments are classified as Level 3.

Short-term borrowings: The fair value of the Company's short-term borrowings is based on quoted market prices for the same or similar debt, or, if no quoted market prices are available, on the current market interest rates available to the Company for debt of similar terms and remaining maturities.

A summary of the carrying value and fair value by level of financial instruments not recorded at fair value on the Company's condensed consolidated balance sheets at June 30, 2019 and December 31, 2018 is as follows:

   
Carrying
   
Fair Value
 
   
Value
   
Level 1
   
Level 2
   
Level 3
   
Total
 
June 30, 2019
                             
Assets:  
                             
Limited partnerships
 
$
35,535
   
$
–
   
$
–
   
$
35,535
   
$
35,535
 
Commercial mortgage loans
   
8,884
     
–
     
–
     
8,884
     
8,884
 
Liabilities:  
                                       
Short-term borrowings
   
20,000
     
–
     
20,000
     
–
     
20,000
 
                                         
December 31, 2018
                                       
Assets:  
                                       
Limited partnerships
 
$
55,044
   
$
–
   
$
–
   
$
55,044
   
$
55,044
 
Commercial mortgage loans
   
6,672
     
–
     
–
     
6,672
     
6,672
 
Liabilities:  
                                       
Short-term borrowings
   
20,000
     
–
     
20,000
     
–
     
20,000
 


(9)  Stock-Based Compensation:

The Company issues shares of restricted Class B Common Stock to the Company's outside directors as their annual retainer compensation.  The shares are distributed to the outside directors on the vesting date, which, with the exception of pro-rated annual retainers granted to outside directors, is one year following the date of grant.  On May 17, 2019, the Company granted shares of restricted Class B Common Stock in connection with the election of a new outside director, reflecting such director’s pro-rated annual retainer compensation, which shares will vest and be distributed on May 7, 2020.  Additionally, effective May 22, 2019, John D. Nichols, Jr. ceased serving as the Company's Interim Chief Executive Officer and principal executive officer, but continued to serve as Chairman of the Company's Board of Directors.  On May 22, 2019, the Company granted shares of restricted Class B Common Stock to Mr. Nichols in connection with this transition, reflecting his pro-rated annual retainer compensation, which shares will also vest and be distributed on May 7, 2020.  The table below provides detail of the restricted stock issuances to directors for 2018 and 2019:

Grant Date
 
Number of
Shares Issued
 
Vesting Date
Service Period
 
Grant Date Fair
Value Per Share
 
5/9/2017
   
18,183
 
5/9/2018
7/1/2017 - 6/30/2018
 
$
24.20
 
                     
8/31/2017
   
1,257
 
5/9/2018
8/31/2017 - 6/30/2018
 
$
21.90
 
                     
2/9/2018
   
408
 
5/9/2018
2/9/2018 - 6/30/2018
 
$
24.20
 
                     
5/8/2018
   
19,085
 
5/8/2019
7/1/2018 - 6/30/2019
 
$
23.05
 
                     
5/7/2019
   
29,536
 
5/7/2020
7/1/2019 - 6/30/2020
 
$
16.25
 
                     
5/17/2019
   
3,591
 
5/7/2020
7/1/2019 - 6/30/2020
 
$
16.25
 
                     
5/22/2019
   
3,541
 
5/7/2020
7/1/2019 - 6/30/2020
 
$
16.25
 

- 17 -
Compensation expense related to the above stock grants is recognized over the period in which the directors render services.

In May 2017, the Company's Compensation Committee granted equity-based awards pursuant to the Company's Long-Term Incentive Plan (the "Long-Term Incentive Plan"), which was approved by the Company's shareholders at the 2017 Annual Meeting of Shareholders.  Certain participants under the Long-Term Incentive Plan were granted Value Creation Incentive Plan awards (the "2017 VCIP Awards").  The 2017 VCIP Awards are performance-based equity awards that will be earned based on the Company's cumulative operating income over a three-year performance period from January 1, 2017 through December 31, 2019 relative to a cumulative operating income goal for the period set by the Compensation Committee in March 2017.  For the purpose of the 2017 VCIP Awards, cumulative operating income is equal to income before taxes excluding net realized gains (losses) on investments.  Any 2017 VCIP Awards that are earned will be paid in unrestricted shares of the Company's Class B Common Stock at the end of the three-year performance period, but no later than March 15, 2020.  No shares are eligible to be issued under the 2017 VCIP Awards as of June 30, 2019.

In March 2018, the Company's Compensation Committee granted equity-based awards pursuant to the Long-Term Incentive Plan.  Certain participants under the Long-Term Incentive Plan were granted equity awards (the "2018 LTIP Awards"), with the number of shares of Class B Common Stock earned pursuant to such awards determined by applying a performance matrix consisting of a measurement of the combined results of the Company's 2018 growth in gross premiums earned and the Company's 2018 combined ratio.  The combined ratio is calculated as a ratio of (A) losses and loss expenses incurred, plus other operating expenses, less commission and other income to (B) net premiums earned.   No 2018 LTIP Awards were earned based on the Company's performance in 2018, and therefore no shares were issued pursuant to the 2018 LTIP Awards.  I n addition to the 2018 LTIP Awards, in March 2018 the Company's Compensation Committee also granted Value Creation Incentive Plan awards (the "2018 VCIP Awards") to certain participants under the Long-Term Incentive Plan.  The 2018 VCIP Awards are performance-based equity awards that will be earned based on the Company's cumulative operating income, as defined above, over a three-year performance period from January 1, 2018 through December 31, 2020 relative to a cumulative operating income goal for the period set by the Compensation Committee in March 2018.  Any 2018 VCIP Awards that are earned will be paid in unrestricted shares of the Company's Class B Common Stock at the end of the three-year performance period, but no later than March 15, 2021.  No shares are eligible to be issued under the 2018 VCIP Awards as of June 30, 2019.

On November 13, 2018, the Company entered into an employment agreement with its Interim Chief Executive Officer, John D. Nichols, Jr.  Pursuant to the terms of this employment agreement, on November 13, 2018, Mr. Nichols was granted 85,000 restricted shares of the Company's Class B Common Stock (the "Nichols Stock Grant"), of which 42,500 shares will vest as of October 17, 2019; 21,250 shares will vest as of October 17, 2020, and 21,250 shares will vest as of October 17, 2021.  The Company recorded $559 of expense during the six months ended June 30, 2019 related to the Nichols Stock Grant.


In March 2019, the Company's Compensation Committee granted equity-based awards pursuant to the Long-Term Incentive Plan.  Certain participants under the Long-Term Incentive Plan were granted equity awards (the "2019 LTIP Awards"), with the number of shares of Class B Common Stock earned pursuant to such awards determined by applying a performance matrix consisting of a corporate performance component as well as a personal performance component.  The corporate performance component of the 2019 LTIP Awards will be determined based on the Company's achievement of 2019 underwriting income compared to the plan target.  The Company's underwriting income will be calculated as income (loss) before federal income tax expense (benefit), less net realized gains (losses) on investments, less net unrealized gains (losses) on equity securities and limited partnerships, less net investment income.  The personal performance component of the 2019 LTIP Awards will be determined based on the achievement of personal goals that align with departmental and corporate objectives for 2019.  Any 2019 LTIP Awards earned will be paid in shares of restricted Class B Common Stock in early 2020.  One-third of such shares will vest annually over the three-year period beginning one year from the date of issue.  The Company recorded $51 of expense during the six months ended June 30, 2019 related to the 2019 LTIP Awards.

On May 22, 2019, the Company entered into an employment agreement with its new Chief Executive Officer, Jeremy D. Edgecliffe-Johnson.  Pursuant to the terms of this employment agreement, on May 22, 2019, Mr. Edgecliffe-Johnson was granted 70,000 restricted shares of the Company's Class B Common Stock (the "Edgecliffe-Johnson Stock Grant"), of which 35,000 shares will vest as of June 1, 2022, 21,000 shares will vest as of June 1, 2023, and 14,000 shares will vest as of June 1, 2024.  The Company recorded $36 of expense during the six months ended June 30, 2019 related to the Edgecliffe-Johnson Stock Grant.


- 18 -
(10)  Litigation, Commitments and Contingencies:

In the ordinary, regular and routine course of their business, the Company and its Insurance Subsidiaries are frequently involved in various matters of litigation relating principally to claims for insurance coverage provided.  No currently pending matter is deemed by management to be material to the Company.

Personnel Staffing Group Litigation

In July 2019, Protective Insurance Company (“PIC”) was named as a defendant in a California action brought by former insured, Personnel Staffing Group d/b/a MVP Staffing (“PSG”) alleging breach of PIC’s workers’ compensation insurance policy and breach of the duties of good faith and fair dealing.  PIC provided workers’ compensation insurance to PSG from January 1, 2017 through June 30, 2018, which was subject to a $500 per claim deductible to be paid by PSG.  No specific damages were included in the complaint.   The Company intends to vigorously defend these claims; however, the ultimate outcome cannot be presently determined.

In August 2019, PIC filed its own lawsuit against PSG in Marion County, Indiana alleging breach of contract, breach of the parties collateral agreement, breach of the parties indemnity agreement, and seeking declaratory judgment regarding PSG’s ongoing obligation to fund its ongoing claims deductible obligations and adequately collateralize PIC’s current and ongoing claims exposure, pursuant to the parties agreements.  Pursuant to the terms of the workers’ compensation policies, PIC has a duty to adjust and pay claims arising under the policies as they develop regardless of whether PSG fulfills its deductible obligations.  Under its contractual obligations to PIC, PSG is required to maintain a “loss fund” for the payment of claims, the balance of which is to remain at or above $4,000; in addition, PSG is required to provide collateral in an amount equal to 110% of PIC’s current open case reserves on workers’ compensation claims arising under PSG’s policies.

As of June 30, 2019, PIC had approximately $20,000 in open case reserves within PSG’s $500 deductible, in addition to $1,800 in deductible receivables on claims arising under PSG’s workers’ compensation policies and had exhausted all collateral provided by PSG.  Continued claims development is anticipated to be consistent with similar lines of workers’ compensation as described in the Company’s 2018 Annual Report on Form 10-K and therefore, PSG’s ultimate obligations to PIC under the agreements is estimated to be approximately $40,000 as of June 30, 2019 (inclusive of the $20,000 in open case reserves and $1,800 in deductible receivable amounts noted above).  At June 30, 2019, the Company believes that it will fully collect all future amounts due from PSG relating to this contingency and therefore has not recorded a provision for any potential asset impairment.


(11)  Shareholders' Equity:

On August 31, 2017, the Company's Board of Directors authorized the reinstatement of its share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B Common Stock.  On August 7, 2018, the Company's Board of Directors reaffirmed its share repurchase program, but also provided that the aggregate dollar amount of shares of the Company's Common Stock that may be repurchased under the share repurchase program through August 8, 2019 may not exceed $25,000.  As of June 30, 2019, the Company has repurchased $9,293 under the share repurchase program.  Pursuant to this share repurchase program, the Company entered into a Rule 10b5-1 plan on June 21, 2019, which authorized the repurchase of up to $4,000 of the Company's outstanding Common Stock at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934.  The Rule 10b5-1 plan expires on August 8, 2019.  No duration has been placed on the Company's share repurchase program, and the Company reserves the right to amend, suspend or discontinue it at any time.  The share repurchase program does not commit the Company to repurchase any shares of its Common Stock.

During the six months ended June 30, 2019, the Company paid $6,487 to repurchase 2,893 shares of Class A and 371,188 shares of Class B Common Stock under the share repurchase program.

The following table illustrates changes in accumulated other comprehensive income (loss) by component for the six months ended June 30, 2019:

   
Foreign
Currency
   
Unrealized Holding Gains (Losses) on
Available-for-sale Securities
   
Total
 
Beginning balance at December 31, 2018
 
$
(1,139
)
 
$
(6,208
)
 
$
(7,347
)
                         
Other comprehensive income before reclassifications
   
591
     
14,758
     
15,349
 
Amounts reclassified from accumulated other comprehensive income (loss)
   
–
     
215
     
215
 
                         
Net current-period other comprehensive income
   
591
     
14,973
     
15,564
 
                         
Ending balance at June 30, 2019
 
$
(548
)
 
$
8,765
   
$
8,217
 


- 19 -
The following table illustrates changes in accumulated other comprehensive income (loss) by component for the six months ended June 30, 2018:

   
Foreign
Currency
   
Unrealized Holding Gains (Losses) on
Available-for-sale Securities
   
Total
 
Beginning balance at December 31, 2017
 
$
(309
)
 
$
46,700
   
$
46,391
 
                         
Cumulative effect of adoption of ASU 2016-01, net of tax
   
–
     
(46,157
)
   
(46,157
)
                         
Balance at January 1, 2018
   
(309
)
   
543
     
234
 
                         
Cumulative effect of adoption of ASU 2018-02
   
–
     
117
     
117
 
Other comprehensive loss before reclassifications
   
(411
)
   
(4,050
)
   
(4,461
)
Amounts reclassified from accumulated other comprehensive income (loss)
   
–
     
(1,097
)
   
(1,097
)
                         
Net current-period other comprehensive loss
   
(411
)
   
(5,147
)
   
(5,558
)
                         
Ending balance at June 30, 2018
 
$
(720
)
 
$
(4,487
)
 
$
(5,207
)


(12)  Related Parties:

At June 30, 2019, the Company was invested in one limited partnership, the New Vernon India Fund, with an aggregate estimated value of $17,489, that is managed by an organization in which one director of the Company is an executive officer and owner.  The Company's ownership interest in this limited partnership at June 30, 2019 was 4%.  For the six months ended June 30, 2019 and 2018, the Company recorded $125 and $275 of fees related to the management of this limited partnership investment.

The Company utilizes the services of an investment firm of which one director of the Company is a partial owner.  This investment firm manages equity securities and fixed income portfolios held by the Company with an aggregate market value of approximately $8,601 at June 30, 2019.  Total commissions and net fees earned by this investment firm and its affiliates on these portfolios were $12 and $54 for the six months ended June 30, 2019 and 2018.


( 13)  Subsequent Events:

In July 2019, the Company withdrew $11,127 from the Arbiter Partners LP, a limited partnership, which liquidated the Company's investment in this limited partnership.

On August 6, 2019, the Company's Board of Directors declared a regular quarterly dividend of $0.10 per share on the Company's Class A and Class B Common Stock.  The dividend per share will be payable September 3, 2019 to shareholders of record on August 20, 2019.

Pursuant to the Rule 10b5-1 plan entered into on June 21, 2019, the Company paid $2,565 to repurchase 158 shares of Class A and 152,593 shares of Class B Common Stock between July 1, 2019 and the date of this Quarterly Report on Form 10-Q.


- 20 -
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 7, 2018, 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 through August 8, 2019 may not exceed $25.0 million.  As of June 30, 2019 we have repurchased $9.3 million under the share repurchase program reaffirmed on August 7, 2018.  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 June 21, 2019, we entered into a stock repurchase plan for the purpose of repurchasing up to $4.0 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 August 8, 2019.  Pursuant to the Rule 10b5-1 plan, we paid $2.6 million to repurchase 158 shares of Class A and 152,593 shares of Class B Common Stock between July 1, 2019 and the date of this Quarterly Report on Form 10-Q.  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, 2019, we paid $6.5 million to repurchase 2,893 shares of Class A and 371,188 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 June 30, 2019 would be expected to fall by approximately 2.2%.  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 5.9 years at June 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 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.

- 21 -

Net cash flows from operations increased $13.7 million to $38.4 million during the six months ended June 30, 2019 compared to $24.7 million for the six months ended June 30, 2018.  The increase in operating cash flows was primarily related to higher premium volume and higher investment income during the six months ended June 30, 2019 compared to the same period in 2018.

Net cash used in investing activities was $103.2 million for the six months ended June 30, 2019 compared to $0.4 million for the six months ended June 30, 2018.  The $102.8 million increase in cash used in investing activities in the six months ended June 30, 2019 was primarily the result of a decrease in proceeds from sales of our equity and fixed income securities of $103.7 million compared to the six months ended June 30, 2018, when we reallocated our equity portfolio to fixed income securities.  We also had higher purchases of equity and fixed income securities of $29.9 million and an additional investment of $2.2 million in commercial mortgage loans in the first half of 2019, partially offset by $19.9 million of higher distributions received from limited partnerships during the first half of 2019 and a $1.3 million reduction in purchases of property and equipment. Additionally, the first half of 2018 included the purchase of $10.0 million of company-owned life insurance, which did not recur in the first half of 2019.

Net cash used in 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.  Financing activities for the six months ended June 30, 2018 consisted of regular cash dividend payments to shareholders of $8.5 million ($0.56 per share) and $1.3 million to repurchase shares of our Class B Common Stock.

Our assets at June 30, 2019 included $77.0 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 $99.5 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, 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, 2019.  At June 30, 2019, the effective interest rate was 3.50% 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, 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 second quarter of 2019 equaled approximately 124% of the combined statutory surplus of these subsidiaries, a level consistent with higher premiums written.  Premium writings of up to 100% and in some cases up to 200% of surplus are generally considered acceptable by regulatory authorities.  Further, the statutory capital of each of our Insurance Subsidiaries substantially exceeded minimum risk-based capital requirements set by the NAIC as of June 30, 2019.  Accordingly, we have the ability to significantly 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, 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 $216.2 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 $12.1 million at June 30, 2019.


- 22 -

Non-GAAP Measures

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
   
Six Months Ended
 
   
June 30
   
June 30
 
   
2019
   
2018
   
2019
   
2018
 
Income before federal income tax expense
 
$
1,950
   
$
3,057
   
$
5,464
   
$
3,371
 
Less: Net realized and unrealized gains (losses) on investments
   
2,889
     
(3,435
)
   
8,916
     
(7,968
)
Less: Net investment income
   
6,500
     
5,796
     
12,732
     
10,432
 
Underwriting income (loss)
 
$
(7,439
)
 
$
696
   
$
(16,184
)
 
$
907
 
                                 
                                 
Ratios
                               
Losses and loss expenses incurred
 
$
90,433
   
$
77,488
   
$
177,555
   
$
149,787
 
Net premiums earned
   
115,631
     
111,940
     
225,644
     
217,402
 
Loss ratio
   
78.2
%
   
69.2
%
   
78.7
%
   
68.9
%
                                 
Other operating expenses
 
$
34,615
   
$
36,019
   
$
68,316
   
$
70,784
 
Less: Commissions and other income
   
1,978
     
2,263
     
4,043
     
4,076
 
Other operating expenses, less commissions and other income
   
32,637
     
33,756
     
64,273
     
66,708
 
Net premiums earned
   
115,631
     
111,940
     
225,644
     
217,402
 
Expense ratio
   
28.2
%
   
30.2
%
   
28.5
%
   
30.7
%
                                 
Combined ratio
   
106.4
%
   
99.4
%
   
107.2
%
   
99.6
%


- 23 -

Results of Operations

Comparison of Second Quarter 2019 to Second Quarter 2018

   
2019
   
2018
   
Change
   
% Change
 
Gross premiums written
 
$
147,152
   
$
142,270
   
$
4,882
     
3.4
%
Ceded premiums written
   
(31,457
)
   
(28,016
)
   
(3,441
)
   
12.3
%
Net premiums written
 
$
115,695
   
$
114,254
   
$
1,441
     
1.3
%
                                 
Net premiums earned
 
$
115,631
   
$
111,940
   
$
3,691
     
3.3
%
Net investment income
   
6,500
     
5,796
     
704
     
12.1
%
Commissions and other income
   
1,978
     
2,263
     
(285
)
   
(12.6
)%
Net realized and unrealized gains (losses) on investments
   
2,889
     
(3,435
)
   
6,324
     
184.1
%
Total revenue
   
126,998
     
116,564
                 
Losses and loss expenses incurred
   
90,433
     
77,488
     
12,945
     
16.7
%
Other operating expenses
   
34,615
     
36,019
     
(1,404
)
   
(3.9
)%
Total expenses
   
125,048
     
113,507
                 
Income before federal income tax expense
   
1,950
     
3,057
     
(1,107
)
       
Federal income tax expense
   
415
     
570
     
(155
)
       
Net income
 
$
1,535
   
$
2,487
   
$
(952
)
       
                                 

Gross premiums written during the second quarter of 2019 increased $4.9 million (3.4%), while net premiums earned increased $3.7 million (3.3%), as compared to the second quarter of 2018.  The higher net premiums earned were the result of growth in workers' compensation business.

Premiums ceded to reinsurers on our insurance business averaged 21.4% of gross premiums written for the second quarter of 2019 compared to 19.7% in the second quarter of 2018.  The increase in premiums ceded reflected the differences in reinsurance ceding rates on the mix of our business in-force.  During the second quarter of 2019, we had higher gross premiums written in our workers' compensation coverages, which carry a higher reinsurance ceding rate.

Losses and loss expenses incurred during the second quarter of 2019 increased $12.9 million (16.7%) compared to the second quarter of 2018, resulting in a loss ratio of 78.2% during the second quarter of 2019 compared to a loss ratio of 69.2% during the second quarter 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 second quarter of 2019 reflected an increase in current accident year losses driven by severe commercial automobile claims, including continued emergence of severity.  This current accident year development was partially offset by prior accident year net savings of $0.6 million that developed during the three months ended June 30, 2019, primarily due to favorable loss development in workers' compensation and independent contractor coverages.

Net investment income for the second quarter of 2019 increased 12.1% to $6.5 million compared to $5.8 million for the second quarter of 2018. The increase reflected an increase in average funds invested resulting from positive cash flow, as well as a reallocation from equity investments held in limited partnerships into short-duration, high-quality bonds.  After-tax investment income increased by 10.6% to $5.2 million during the second quarter of 2019, compared to $4.7 million during the second quarter of 2018, reflecting the aforementioned increase in average funds invested and reallocation from limited partnerships to short-duration, high- quality bonds.

Net realized and unrealized gains on investments of $2.9 million during the second quarter of 2019 were primarily driven by $2.0 million in unrealized gains on equity securities during the period, 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 other-than-temporary impairments on our fixed income securities of $0.1 million recognized during the period.  Comparative second quarter 2018 net realized and unrealized losses on investments of $3.4 million were driven by a $2.8 million decrease in the value of our limited partnership investments and $1.5 million in unrealized losses on equity securities during the period, partially offset by net realized gains on sales of securities, excluding impairment losses, of $0.9 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 second quarter of 2019 decreased $1.4 million, or 3.9%, to $34.6 million compared to the second quarter of 2018.  The decrease was driven primarily by lower salary and benefit expense in addition to lower other operating expenses, partially offset by higher commission expenses as a result of the mix of premium written in the second quarter of 2019.  The ratio of consolidated other operating expenses, less commissions and other income, to net premiums earned (the “expense ratio”) was 28.2% during the second quarter of 2019 compared to 30.2% for the second quarter of 2018.  The decrease in the expense ratio was primarily related to the leveraging effect of higher net premiums earned in the second quarter of 2019 compared to the second quarter of 2018.

- 24 -
Federal income tax expense was $0.4 million for the second quarter of 2019 compared to federal income tax expense of $0.6 million for the second quarter of 2018.  The effective tax rate for the second quarter of 2019 was 21.3% compared to 18.6% in the second quarter of 2018.  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.  For the three months ended June 30, 2019, we had lower tax-exempt income when compared to the same period in 2018, primarily due to the reduction of tax exempt municipal securities within our investment portfolio in the current year as well as a decrease in dividend income, which provides a deduction for taxes, related to the reallocation of equity securities to fixed income securities within our investment portfolio throughout 2018.

As a result of the factors mentioned above, net income decreased $1.0 million to $1.5 million during the second quarter of 2019 compared to net income of $2.5 million during the second quarter of 2018.



Comparison of Six Months Ended June 30, 2019 to Six Months Ended June 30, 2018

   
2019
   
2018
   
Change
   
% Change
 
Gross premiums written
 
$
296,045
   
$
291,093
   
$
4,952
     
1.7
%
Ceded premiums written
   
(65,028
)
   
(63,405
)
   
(1,623
)
   
2.6
%
Net premiums written
 
$
231,017
   
$
227,688
   
$
3,329
     
1.5
%
                                 
Net premiums earned
 
$
225,644
   
$
217,402
   
$
8,242
     
3.8
%
Net investment income
   
12,732
     
10,432
     
2,300
     
22.0
%
Commissions and other income
   
4,043
     
4,076
     
(33
)
   
(0.8
)%
Net realized and unrealized gains (losses) on investments
   
8,916
     
(7,968
)
   
16,884
     
211.9
%
Total revenue
   
251,335
     
223,942
                 
Losses and loss expenses incurred
   
177,555
     
149,787
     
27,768
     
18.5
%
Other operating expenses
   
68,316
     
70,784
     
(2,468
)
   
(3.5
)%
Total expenses
   
245,871
     
220,571
                 
Income before federal income tax expense
   
5,464
     
3,371
     
2,093
         
Federal income tax expense
   
1,181
     
554
     
627
         
Net income
 
$
4,283
   
$
2,817
   
$
1,466
         
                                 

Gross premiums written during the six months ended June 30, 2019 increased $5.0 million (1.7%), while net premiums earned increased $8.2 million (3.8%), as compared to the same period in 2018.  The higher net premiums earned were the result of the changes in our reinsurance structure discussed below in addition to growth in workers' compensation business.  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 described below.

Premiums ceded to reinsurers on our insurance business averaged 22.0% of gross premiums written for the six months ended June 30, 2019 compared to 21.8% for the same period of 2018.  The increase for the 2019 period reflected the ceding of an additional $1.6 million in commercial automobile premium from prior treaty years related to variable premium adjustment provisions in our historical reinsurance treaties.  Additionally, during the first half of 2019, we had higher gross premiums written in workers' compensation coverages, which carry a higher reinsurance ceding rate.  These increases were offset by changes made to our reinsurance structure in the third quarter of 2017, when we lowered the quota share rate on our workers' compensation premiums to reflect growing profitability and confidence in this book of business.  We also restructured our commercial automobile reinsurance treaty, moving away from variable premium ceded rates (based on loss performance) to a flat ceding arrangement with no material changes to the economic risks taken for these products (i.e. ceded losses will decrease by a similar amount as ceded premiums).

Losses and loss expenses incurred during the six months ended June 30, 2019 increased $27.8 million (18.5%) compared to the same period of 2018, resulting in a loss ratio of 78.7% for the period.   This compares to a loss ratio of 68.9% 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 six months ended June 30, 2019 reflected an increase in current accident year losses driven by severe commercial automobile claims, including continued emergence of severity.  This current accident year development was partially offset by prior accident year net savings of $1.7 million that developed during the six months ended June 30, 2019, primarily due to favorable loss development in workers' compensation and independent contractor coverages.  Including the impact of additional ceded premium discussed above, the total prior accident year impacts were favorable by $0.1 million for the six months ended June 30, 2019.

Net investment income for the six months ended June 30, 2019 increased 22.0% to $12.7 million compared to $10.4 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 held in limited partnerships into short-duration, high-quality bonds.  After-tax investment income increased by 21.4% to $10.2 million during the six months ended June 30, 2019, compared to $8.4 million during the same period of 2018, reflecting the aforementioned increase in average funds invested and reallocation from limited partnerships to short-duration, high-quality bonds.

- 25 -
Net realized and unrealized gains on investments of $8.9 million during the six months ended June 30, 2019 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 other-than-temporary impairments on our fixed income securities of $0.3 million recognized during the period.  Comparative six months ended June 30, 2018 net realized and unrealized losses on investments of $8.0 million were driven by a $5.5 million decrease in the value of our limited partnership investments and $3.8 million in unrealized losses on equity securities, excluding impairment losses, during the period, partially offset by net realized gains on sales of securities of $1.3 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 six months ended June 30, 2019 decreased $2.5 million, or 3.5%, to $68.3 million compared to $70.8 million for the same period of 2018.  The decrease was driven primarily by lower salary and benefit expense in addition to lower other operating expenses, partially offset by higher commission expenses as a result of the mix of premium written in the six months ended June 30, 2019.  The expense ratio was 28.5% during the six months ended June 30, 2019 compared to 30.7% 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 six months ended June 30, 2019 compared to the same period of 2018.

Federal income tax expense was $1.2 million for the six months ended June 30, 2019 compared to $0.6 million for the same period of 2018.  The effective tax rate for the six months ended June 30, 2019 was 21.6% compared to 16.4% in the same period of 2018.  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.  For the six months ended June 30, 2019, we had lower tax-exempt income when compared to the same period in 2018, primarily due to the reduction of tax exempt municipal securities within our investment portfolio in the current year as well as a decrease in dividend income, which provides a deduction for taxes, related to the reallocation of equity securities to fixed income securities within our investment portfolio throughout 2018.

As a result of the factors mentioned above, net income increased $1.5 million to $4.3 million during the six months ended June 30, 2019 compared to net income of $2.8 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 responsible only 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:

   
5% Increase in
Ultimate Loss Ratio
   
10% Increase in
Ultimate Loss Ratio
 
Gross loss expense from further strengthening current reserve position
 
$
42.6
   
$
85.2
 
Net financial loss
   
10.7
     
21.3
 
                 
$/share (after tax)
 
$
0.57
   
$
1.14
 

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.

- 26 -
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:

●
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;

●
our ability to obtain adequate premium rates and manage our operating strategies;

●
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;

●
other changes in the markets for our insurance products;

●
the impact of technological advances, including those specific to the transportation industry;

●
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;

●
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;

●
the impact of a downgrade in our financial strength rating;

●
technology or network security disruptions or breaches;

●
adequacy of insurance reserves;

●
availability of reinsurance and ability of reinsurers to pay their obligations;

●
our ability to attract and retain qualified employees and to successfully complete our executive officer transition;

●
tax law and accounting changes; and

●
legal actions brought against us.

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.

- 27 -

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 June 30, 2019, amounts due from reinsurers on paid and unpaid losses were estimated to total approximately $390 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 the 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.

- 28 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Other than as set forth below, there have been no material changes in the Company's exposure to market risk since the disclosure in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.

Interest Rate Risk
We are exposed to interest rate risk on our fixed income investments. Given the anticipated duration of our liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, a 100 to 200 basis point increase in interest rates would not have a material impact on our ability to conduct daily operations or to meet our obligations and could result in significantly higher investment income in a relatively short period of time, as short-term investments and maturing bonds could be reinvested in higher yielding securities.

The table below summarizes our interest rate risk by illustrating the sensitivity of the fair value of our fixed income investments as of June 30, 2019 to selected hypothetical changes in interest rates (dollars in thousands).

   
Fair Value
   
Estimated Change
in Fair Value
 
200 basis point increase
 
$
702,383
   
$
(34,765
)
100 basis point increase
   
719,203
     
(17,945
)
Current fair value
   
737,148
     
–
 
100 basis point decrease
   
755,094
     
17,946
 
200 basis point decrease
   
771,913
     
34,765
 

Our selection of the range of values chosen to represent changes in interest rates should not be construed as our prediction of future market events, but rather as an illustration of the impact of such events should they occur.  Several other factors, including but not limited to the financial strength of the issuer, prepayment options, relative values of alternative investments, liquidity of the investment, currency fluctuations for non-U.S. debt holdings and other general market conditions, can impact the fair values of fixed income investments and, therefore, significant variations in market interest rates could produce quite different results from the hypothetical estimates presented above.


ITEM 4. CONTROLS AND PROCEDURES

The Company carried out an evaluation as of June 30, 2019 under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Rule 13a-15(e) adopted by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, or the "Exchange Act". Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded the disclosure controls and procedures were effective in ensuring that information required to be disclosed in reports that the Company files or submits under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms; and (b) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. The Company noted no change in its internal control over financial reporting that occurred during the period covered by this report that materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information required with respect to this item can be found in Note 10 - Litigation, Commitments and Contingencies of Notes to Unaudited Condensed Consolidated Financial Statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q and is incorporated by reference into this Part II, Item 1.


ITEM 1A. RISK FACTORS

In addition to the information set forth in this Quarterly Report on Form 10-Q and before deciding to invest in, or retain, shares of the Company's common stock, you should carefully review and consider the information contained in the Company's other reports and periodic filings that it makes with the Securities and Exchange Commission, including, without limitation, the information contained under the caption Part I, Item 1A "Risk Factors" in its Annual Report on Form 10-K for the year ended December 31, 2018. Those risk factors could materially affect the Company's business, financial condition and results of operations. There have been no material changes from the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.


ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

   
Total Number of
Shares Purchased
   
Average Price
Paid per Share
   
Total Number of
Shares Purchased
Under the Program (1)
   
Remaining Shares
Available to be Purchased
Under the Program (1)
 
April 1 – April 30
   
172,439
   
$
17.52
     
172,439
     
1,982,184
 
May 1 – May 31
   
86,082
     
16.60
     
86,082
     
1,896,102
 
June 1 – June 30
   
90,602
     
17.33
     
90,602
     
1,805,500
 
Total
   
349,123
             
349,123
         

(1)
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 7, 2018, 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 through August 8, 2019 may not exceed $25.0 million.  Pursuant to this share repurchase program, we entered into a Rule 10b5-1 plan on June 21, 2019, which authorizes the repurchase of up to $4.0 million of our outstanding common stock, at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Exchange Act. The Rule 10b5-1 plan expires on August 8, 2019.  No duration has been placed on our share repurchase program, and we reserve the right to amend, suspend or discontinue it at any time.   The share repurchase program 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.

- 30 -
ITEM 6. EXHIBITS

INDEX TO EXHIBITS

Exhibit No.
 
Description
 
Amended and Restated Articles of Incorporation of Protective Insurance Corporation, incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q filed August 8, 2018.
     
 
Code of By-Laws of Protective Insurance Corporation, as amended effective May 17, 2019.
     
 
Employment Agreement, effective as of May 22, 2019, by and between the Company and Jeremy D. Edgecliffe-Johnson, incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed May 22, 2019.
     
 
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
 
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
 
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101
 
The following materials from Protective Insurance Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, formatted in XBRL (eXtensible Business Reporting Language): (1) the Condensed Consolidated Balance Sheets, (2) the Condensed Consolidated Statements of Operations, (3) the Condensed Consolidated Statements of Comprehensive Income (Loss), (4) the Condensed Consolidated Statements of Shareholders' Equity, (5) the Condensed Consolidated Statements of Cash Flows, and (6) the Notes to Unaudited Condensed Consolidated Financial Statements.

- 31 -
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PROTECTIVE INSURANCE CORPORATION


Date August 7, 2019


By:
/s/ Jeremy D. Edgecliffe-Johnson
 
 
Jeremy D. Edgecliffe-Johnson
 
 
Chief Executive Officer
 



Date August 7, 2019

By:
/s/ William C. Vens
 
 
William C. Vens
 
 
Chief Financial Officer
 







                                                                                                                                                                                                                                           - 32 -


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