KINSALE CAPITAL GROUP, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes included elsewhere in this Annual Report. The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" that could cause actual results to differ materially from those expressed in, or implied by, those forward-looking statements. See "Forward-Looking Statements."
Year ended
For a comparison of years endedDecember 31, 2020 andDecember 2019 , see "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our annual report on Form 10-K for the fiscal year endedDecember 31, 2020 , which was filed with theSEC onFebruary 25, 2021 .
Overview
Founded in 2009, we are an established and growing specialty insurance company. We focus exclusively on the E&S market in theU.S. , where we use our underwriting expertise to write coverages for hard-to-place small business risks and personal lines risks. We market and sell these insurance products in all 50 states, theDistrict of Columbia , theCommonwealth of Puerto Rico and theU.S. Virgin Islands primarily through a network of independent insurance brokers. We have an experienced and cohesive management team, that has an average of over 25 years of relevant experience. Many of our employees and members of our management team have also worked together for decades at other E&S insurance companies. We have one reportable segment, ourExcess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2021, the percentage breakdown of our gross written premiums was 85.1% casualty and 14.9% property. Our commercial lines offerings include small business, excess casualty, construction, commercial property, allied health, product liability, life sciences, general casualty, professional liability, management liability, energy, environmental, entertainment, health care, inland marine, public entity, and commercial insurance. We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 3.5% of our gross written premiums in 2021. Our goal is to deliver long-term value for our stockholders by growing our business and generating attractive returns. We seek to accomplish this by generating consistent and attractive underwriting profits while managing our capital prudently. We believe that we have built a company that is entrepreneurial and highly efficient, using our proprietary technology platform and leveraging the expertise of our highly experienced employees in our daily operations. We believe our systems and technology are at the digital forefront of the insurance industry, allowing us to quickly collect and analyze data, thereby improving our ability to manage our business and reducing response times for our customers. We believe that we have differentiated ourselves from our competitors by effectively leveraging technology, vigilantly controlling expenses and maintaining control over our underwriting and claims management.
COVID-19
We have been closely monitoring the impact of the COVID-19 pandemic and related
economic effects on all aspects of our business, including its impact on premium
volume, losses and the fair value of our investment portfolio.
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To date, we have not seen a significant decrease in the growth rate of our gross written premiums since the beginning of the COVID-19 pandemic and the related pressure in certain sectors of theU.S. economy. Over the past few years, including the time period preceding COVID-19, the E&S segment of the P&C market has been experiencing rapid growth due to dislocation in the overall property and casualty market. With respect to reported claims, we do not write lines of business with heightened exposure to COVID-19 related claims. Specifically, we do not write event cancellation, mortgage insurance, trade credit or surety, workers' compensation or reinsurance business. Lines of business written by us that could be subject to COVID-19 related claims include general liability, management liability, healthcare-related professional liability and commercial property. In each case, policy terms and conditions would be expected to preclude coverage for virus-related claims. Although we cannot definitively determine the ultimate impact of COVID-19 and related economic conditions at this time, we have not currently experienced any material adverse effect on our loss ratios due to COVID-19 related claims. With respect to our investment portfolio, we seek to hold a high-quality, diversified portfolio of investments. During the first quarter of 2020, we experienced a significant decline in the fair value of our investment portfolio due to disruption in the global financial markets associated with COVID-19. Subsequent to the first quarter of 2020, the fair values of our investment portfolio rebounded sharply, gaining back all of the decline in fair value. However, during economic downturns, certain investments may default or become impaired due to deterioration in the financial condition or due to deterioration in the financial condition of an insurer that guarantees an issuer's payments on such investments. Given the conservative nature of our investment portfolio, we do not expect a material adverse impact on the value of our investment portfolio or a long-term negative impact on our financial condition, results of operations or cash flows due to COVID-19. Components of Our Results of Operations Gross written premiums Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
•New business submissions;
•Conversion of new business submissions into policies;
•Renewals of existing policies; and
•Average size and premium rate of bound policies.
We earn insurance premiums on a pro rata basis over the term of the policy. Our
insurance policies generally have a term of one year. Net earned premiums
represent the earned portion of our gross written premiums, less that portion of
our gross written premiums that is ceded to third-party reinsurers under our
reinsurance agreements.
Ceded written premiums
Ceded written premiums are the amount of gross written premiums ceded to
reinsurers. We enter into reinsurance contracts to limit our exposure to
potential large losses. Ceded written premiums are earned over the reinsurance
contract period in proportion to the period of risk covered. The volume of our
ceded written premiums is impacted by the level of our gross written premiums
and any decision we make to increase or decrease retention levels.
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Losses and loss adjustment expenses
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
•Frequency of claims associated with the particular types of insurance contracts that we write;
•Trends in the average size of losses incurred on a particular type of business;
•Mix of business written by us;
•Changes in the legal or regulatory environment related to the business we write;
•Trends in legal defense costs;
•Wage inflation; and
•Inflation in medical costs.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
Underwriting, acquisition and insurance expenses
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs also include deferred underwriting expenses that are directly related to the successful acquisition of policies. The amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the policy life. Other underwriting expenses represent the general and administrative expenses of our insurance business such as employment costs, telecommunication and technology costs, and legal and auditing fees.
Net investment income
Net investment income is an important component of our results of operations. We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed-maturity securities, and may also include cash equivalents, equity securities and short-term investments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value), the size of our investment portfolio is mainly a function of our invested equity capital combined with premiums we receive from our insureds less payments on policyholder claims.
Change in fair value of equity securities
Change in fair value of equity securities represents the increase or decrease in the fair value of equity securities held during the period.
Net realized investment gains
Net realized investment gains are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost.
Income tax expense
Currently, substantially all of our income tax expense is comprised of federal
income taxes. Our insurance subsidiary,
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to date. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Key metrics
We discuss certain key metrics, described below, which we believe provide useful information about our business and the operational factors underlying our financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as net income, excluding net investment income, net change in the fair value of equity securities, net realized investment gains and losses, other income, other expenses and income tax expense. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. Net operating earnings is a non-GAAP financial measure. We define net operating earnings as net income excluding the net change in the fair value of equity securities, after taxes, and net realized investment gains and losses, after taxes. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Loss ratio, expressed as a percentage, is the ratio of losses and loss adjustment expenses to earned premiums, net of the effects of reinsurance.
Expense ratio, expressed as a percentage, is the ratio of underwriting, acquisition and insurance expenses to net earned premiums.
Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
Return on equity is net income as a percentage of average beginning and ending total stockholders' equity during the period.
Operating return on equity is a non-GAAP financial measure. We define operating return on equity as net operating earnings expressed as a percentage of average beginning and ending stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Net retention ratio is the ratio of net written premiums to gross written premiums.
Gross investment return is investment income from fixed-maturity and equity securities, before any deductions for fees and expenses, expressed as a percentage of the average beginning and ending book values of those investments during the period.
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Results of Operations
Year ended
The following table summarizes our results of operations for the years endedDecember 31, 2021 and 2020: Year Ended December 31, ($ in thousands) 2021 2020 Change % Change Gross written premiums$ 764,373 $ 552,814 $ 211,559 38.3 % Ceded written premiums (104,164) (74,595) (29,569) 39.6 % Net written premiums$ 660,209 $ 478,219 $ 181,990 38.1 % Net earned premiums$ 582,879 $ 412,754 $ 170,125 41.2 % Losses and loss adjustment expenses 324,415 263,802 60,613 23.0 % Underwriting, acquisition and insurance expenses 124,900 94,296 30,604 32.5 % Underwriting income (1) 133,564 54,656 78,908 144.4 % Other expenses, net (1,451) (741) (710) NM Net investment income 31,048 26,110 4,938 18.9 % Change in fair value of equity securities 22,812 16,855 5,957 NM Net realized investment gains 2,828 3,533 (705) NM Income before taxes 188,801 100,413 88,388 88.0 % Income tax expense 36,142 11,994 24,148 201.3 % Net income$ 152,659 $ 88,419 $ 64,240 72.7 % Net operating earnings (2)$ 132,404 $ 72,313 $ 60,091 83.1 % Loss ratio 55.7 % 63.9 % Expense ratio 21.4 % 22.8 % Combined ratio 77.1 % 86.7 % Return on equity 23.9 % 18.0 % Operating return on equity (2) 20.8 % 14.7
%
NM - Percentage change is not meaningful
(1) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. (2) Net operating earnings and operating return on equity are non-GAAP financial measures. Net operating earnings is defined as net income excluding the net change in the fair value of equity securities, after taxes, and net realized investment gains and losses, after taxes. Operating return on equity is defined as net operating earnings expressed as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings. Net income was$152.7 million for the year endedDecember 31, 2021 compared to$88.4 million for the year endedDecember 31, 2020 , an increase of$64.2 million , or 72.7%. The increase in net income in 2021 over 2020 was primarily due to higher underwriting income reflecting favorable E&S market conditions, which resulted in higher 42
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rates on bound accounts and strong growth in broker submissions. In addition, higher net favorable development of loss reserves from prior accident years, lower catastrophe activity and a higher total return on our investment portfolio, both in terms of an increase in the fair value of equity securities and investment income, contributed to the strong results for the year. Our underwriting income was$133.6 million for the year endedDecember 31, 2021 compared to$54.7 million for the year endedDecember 31, 2020 , an increase of$78.9 million , or 144.4%. The increase in our underwriting income was largely due to premium growth and continued rate increases from a strong underwriting environment, higher net favorable development of loss reserves from prior accident years and lower catastrophe activity. The corresponding combined ratios were 77.1% for the year endedDecember 31, 2021 compared to 86.7% for the year endedDecember 31, 2020 . Premiums Gross written premiums were$764.4 million for the year endedDecember 31, 2021 compared to$552.8 million for the year endedDecember 31, 2020 , an increase of$211.6 million , or 38.3%. The increase in gross written premiums for the year endedDecember 31, 2021 over the prior year was due to higher submission activity from brokers and higher rates on bound accounts, resulting from favorable market conditions. The average premium per policy written by us was$10,400 in 2021 compared to$9,100 in 2020. Excluding our personal lines insurance, which has relatively low premiums per policy written, the average premium per policy written was$12,900 in 2021 compared to$11,800 in 2020. The increase in the average premium per policy written was due to changes in the mix of business and higher rates on bound accounts during 2021 compared to the prior year. Gross written premiums increased across substantially all of our lines of business for the year endedDecember 31, 2020 and were most notable in the following lines of business:
•Excess Casualty, which represented approximately 14.3% of our gross written
premiums in 2021, increased by
•Small Business, which represented approximately 14.7% of our gross written
premiums in 2021, increased by
•Commercial Property, which represented approximately 10.3% of our gross written
premiums in 2021, increased by
•Allied Health, which represented approximately 7.7% of our gross written
premiums in 2021, increased by
•Products Liability, which represented approximately 7.2% of our gross written
premiums in 2021, increased by
Net written premiums increased by$182.0 million , or 38.1%, to$660.2 million for the year endedDecember 31, 2021 from$478.2 million for the year endedDecember 31, 2020 . The increase in net written premiums was largely due to higher gross written premiums for the year endedDecember 31, 2021 . Our net retention ratio was 86.4% for the year endedDecember 31, 2021 compared to 86.5% for the year endedDecember 31, 2020 . The decrease in the net retention ratio was primarily due to change in the mix of business. Net earned premiums were$582.9 million for the year endedDecember 31, 2021 compared to$412.8 million for the year endedDecember 31, 2020 , an increase of$170.1 million , or 41.2%. As previously discussed, the increase was due to growth in gross written premiums in 2021 compared to 2020. 43
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Loss ratio
Our loss ratio was 55.7% for the year endedDecember 31, 2021 compared to 63.9% for the year endedDecember 31, 2020 . The decrease in the loss ratio for the year endedDecember 31, 2021 was due primarily to lower catastrophe activity, higher favorable development on loss reserves from prior accident years and slightly lower loss selections for the current accident year. The loss selections in the current accident year were slightly lower relative to the prior year due to favorable market conditions and continued rate increases that exceeded loss cost trends. During the year endedDecember 31, 2021 , net catastrophe losses incurred in the current accident year were primarily attributable to Hurricane Ida and winter storms inTexas . During the year endedDecember 31, 2020 , net catastrophe losses incurred were primarily due to Hurricanes Laura and Sally and theCalifornia wildfires. During the year endedDecember 31, 2021 , prior accident years developed favorably by$32.0 million , of which$33.7 million was attributable to the 2020 accident year and was related to a lower-than-expected level of reported losses. Although we did not have any significant direct COVID-19 exposure, the related disruption in the court system and the general economy created additional uncertainty in estimating loss reserves in 2020. As a result, 2020 accident year actuarial assumptions were adjusted in 2020 to increase IBNR to account for this additional uncertainty. Our current outlook is more favorable than in the prior year and, based on observed trends, we reevaluated and adjusted certain assumptions for accident year 2020 in 2021 to reflect the favorable experience. In addition,$3.8 million of favorable development was attributable to accident year 2019 due to reported losses emerging at lower levels than expected. This favorable development was offset in part by adverse development, mostly attributable to the 2016 and 2018 accident years due to modest adjustments in actuarial assumptions. During the year endedDecember 31, 2020 , loss reserves for prior accident years developed favorably by$13.3 million , of which$12.3 million was attributable to accident years 2019 and 2018, primarily due to reported losses emerging at lower levels than expected.
On an inception-to-date basis as of
The following table summarizes the effect of the factors indicated above on the
loss ratios for the years ended
Year Ended December 31,
2021 2020
Losses and Loss Losses and Loss
Adjustment % of Earned Adjustment % of Earned($ in thousands) Expenses Premiums Expenses Premiums Loss ratio: Current accident year$ 347,761 59.7 %$ 253,948 61.5 % Current accident year - catastrophe losses 8,640 1.5 % 23,192 5.6 % Effect of prior year development (31,986) (5.5) % (13,338) (3.2) % Total$ 324,415 55.7 %$ 263,802 63.9 % 44
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Expense ratio
The following table summarizes the components of the expense ratio for the years
ended
Year Ended December 31,
2021 2020
% of Earned Underwriting % of Earned
($ in thousands) Underwriting Expenses Premiums Expenses Premiums
Commissions incurred:
Direct $ 98,847 16.9 % $ 69,922 16.9 %
Ceding (25,702) (4.4) % (16,145) (3.9) %
Net commissions incurred 73,145 12.5 % 53,777 13.0 %
Other underwriting expenses 51,755 8.9 % 40,519 9.8 %
Underwriting, acquisition, and
insurance expenses $ 124,900 21.4 % $ 94,296 22.8 %
The expense ratio was 21.4% for the year ended December 31, 2021 compared to
22.8% for the year ended December 31, 2020 . The decrease in the expense ratio
was due to lower other underwriting expenses and lower net commissions incurred
as a percentage of earned premiums. The decrease in the other underwriting
expense ratio was primarily due to higher net earned premiums, without a
proportional increase in the amount of other underwriting expenses, as a result
of management's focus on controlling costs. The decrease in the net commissions
incurred ratio was mostly due to higher ceding commissions resulting from growth
in the excess casualty and personal insurance lines of business and a change in
the mix of business. Direct commissions paid as a percent of gross written
premiums was 14.6% for the years ended December 31, 2021 and 2020.
Investing results
Our net investment income increased by 18.9% to$31.0 million for the year endedDecember 31, 2021 from$26.1 million for the year endedDecember 31, 2020 , primarily due to growth in our investment portfolio balance generated from the investment of positive cash flow sinceDecember 31, 2021 . The following table summarizes the components of net investment income and net unrealized and realized investment gains for the years endedDecember 31, 2021 and 2020: Year Ended December 31, ($ in thousands) 2021 2020 Change Interest from fixed-maturity securities$ 29,155 $ 24,111 $ 5,044 Dividends on equity securities 3,962 3,512 450 Other 12 262 (250) Gross investment income 33,129 27,885 5,244 Investment expenses (2,081) (1,775) (306) Net investment income 31,048 26,110 4,938 Change in the fair value of equity securities 22,812 16,855 5,957 Net realized investment gains 2,828 3,533 (705) Net unrealized and realized investment gains 25,640 20,388 5,252 Total$ 56,688 $ 46,498 $ 10,190 45
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The weighted average duration of our fixed-maturity portfolio, including cash equivalents, was 4.3 years atDecember 31, 2021 and 2020. Our fixed-maturity investment portfolio, excluding cash equivalents and unrealized gains and losses, had a gross investment return of 2.5% as ofDecember 31, 2021 , compared to 2.9% as ofDecember 31, 2020 and the decrease was due to a lower interest rate environment.
During the year ended
During the year endedDecember 31, 2020 , the change in fair value of equity securities of$16.9 million was comprised of unrealized gains related to ETF securities of$16.4 million and non-redeemable preferred stock of$0.5 million . The change in the fair value of our ETFs was reflective of the gains in the broader stock markets during the period. During the first quarter of 2020, the fair values our ETFs declined by$13.1 million , driven by the disruption in the financial markets associated with the COVID-19 pandemic. The fair value of these funds rebounded sharply during the second quarter of 2020, gaining back a substantial portion of the decline in value, and fair values continued to increase during the latter half of 2020 on an improving outlook. We perform quarterly reviews of all available-for-sale securities within our investment portfolio to determine whether the decline in a security's fair value is deemed to be a credit loss. Management concluded that there were no credit losses from available-for-sale investments for the year endedDecember 31, 2021 or 2020. Income tax expense Our effective tax rate was approximately 19.1% for the year endedDecember 31, 2021 compared to 11.9% for the year endedDecember 31, 2020 . The effective tax rate was lower than the federal statutory rate of 21% primarily due to the tax benefits from stock-based compensation and tax-exempt investment income. The effective tax rate was higher for the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 as a result of fewer stock options exercised in 2021 relative to the prior year.
Return on equity
Our return on equity was 23.9% for the year endedDecember 31, 2021 compared to 18.0% for the year endedDecember 31, 2020 . Operating return on equity was 20.8% for 2021, an increase from 14.7% for 2020. The increase in the operating return on equity was attributable primarily to growth in the business from continuing favorable market conditions and rate increases, lower catastrophe activity and higher net favorable development of loss reserves from prior accident years.
Liquidity and Capital Resources
Sources and uses of funds
We are organized as aDelaware holding company with our operations primarily conducted by our wholly-owned insurance subsidiary,Kinsale Insurance , which is domiciled inArkansas . Accordingly, Kinsale may receive cash through (1) loans from banks, (2) issuance of equity and debt securities, (3) corporate service fees from our insurance subsidiary, (4) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions and (5) dividends from our insurance subsidiary. We may use the proceeds from these sources to contribute funds toKinsale Insurance in order to support premium growth, reduce our reliance on reinsurance, pay dividends and taxes and for other business purposes. 46
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We receive corporate service fees fromKinsale Insurance to reimburse us for most of the operating expenses that we incur. Reimbursement of expenses through corporate service fees is based on the actual costs that we expect to incur with no mark-up above our expected costs. We file a consolidated federal income tax return with our subsidiaries, and under our corporate tax allocation agreement, each participant is charged or refunded taxes according to the amount that the participant would have paid or received had it filed on a separate return basis with the Internal Revenue Service. State insurance laws restrict the ability ofKinsale Insurance to declare stockholder dividends without prior regulatory approval. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. The maximum dividend distributionKinsale Insurance may make absent the approval or non-disapproval of the insurance regulatory authority inArkansas is limited byArkansas law to the greater of (1) 10% of policyholder surplus as ofDecember 31 of the previous year, or (2) net income, not including realized capital gains, for the previous calendar year. TheArkansas statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. The maximum amount of dividendsKinsale Insurance can pay us during 2022 without regulatory approval is$114.0 million . Insurance regulators have broad powers to ensure that statutory surplus remains at adequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. In the future, state insurance regulatory authorities that have jurisdiction over the payment of dividends byKinsale Insurance may adopt statutory provisions more restrictive than those currently in effect.Kinsale Insurance paid$8.0 million of dividends to us during 2021. See also "Risk Factors - Risks Related to Our Business and Our Industry - Because we are a holding company and substantially all of our operations are conducted by our insurance subsidiary, our ability to pay dividends depends on our ability to obtain cash dividends or other permitted payments from our insurance subsidiary."
As of
Management believes there is sufficient liquidity available at the holding company and in its insurance subsidiary,Kinsale Insurance , as well as in its other operating subsidiaries, to meet its operating cash needs and obligations for the next 12 months. Credit agreement OnMay 28, 2019 , we entered into a Credit Agreement that provided us with a$50 million Credit Facility (the "Credit Facility") and an uncommitted accordion feature that permits the Company to increase the commitments by an additional$30 million . The Credit Facility has a maturity ofMay 28, 2024 . Borrowings under the Credit Facility were used to fund the construction of our new headquarters but may also be used for working capital and general corporate purposes. As ofDecember 31, 2021 , there was$42.7 million outstanding under the Credit Facility, net of debt issuance costs. Loans under the Credit Facility may be subject to varying rates of interest depending on whether the loan is a Eurodollar loan or an alternate base rate (ABR) loan, at the Company's election. Eurodollar loans bear an interest rate per annum equal to adjusted LIBOR for the applicable interest period plus a margin of 1.75%. ABR loans bear an interest rate per annum equal to the higher of the prime rate, the New York Federal Reserve Board Rate or the one-month adjusted LIBOR, plus the applicable margin of 0.75% or 1.75%, depending on which interest option was applicable for the particular ABR loan. The Credit Agreement also contains representations and warranties and affirmative and negative covenants customary for financings of this type, as well as customary events of default. As ofDecember 31, 2021 , the Company was in compliance with all of its financial covenants under the Credit Facility. 47
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InJuly 2017 , theU.K. Financial Conduct Authority announced that, after the end of 2021, it would no longer persuade or compel contributing banks to make rate submissions to theICE Benchmark Administration (together with any successor to the ICE Benchmark Administrator, the "IBA") for purposes of the IBA setting theLondon interbank offered rate. OnMarch 5, 2021 the IBA announced that it will 1) cease the publication of the one-week and two-month USD LIBOR afterDecember 31, 2021 , and 2) cease the publication of all other tenors of USD LIBOR afterJune 30, 2023 , including the three-month USD LIBOR rate. The Credit Agreement provides procedures for determining a replacement or alternative base rate in the event that LIBOR is discontinued. However, there can be no assurances as to whether such replacement or alternative base rate will be more or less favorable than LIBOR. The Company has been monitoring the developments with respect to the phasing out of LIBOR and will work with its lenders to seek to ensure the transition away from LIBOR will have minimal impact on its financial condition.
Shelf registration
InAugust 2019 , we filed a universal shelf registration statement with theSEC that expires in 2022. We can use this shelf registration to issue an unspecified amount of debt securities, common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements. OnAugust 7, 2020 , we completed an underwritten public offering and sold and issued 310,500 shares of our common stock at a price of$190 per share. After deducting underwriting discounts and commissions, we received net proceeds of$56.7 million , which was used for general corporate purposes, including to fund organic growth. Cash flows Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends. We also use cash to pay commissions to brokers, as well as to pay for ongoing operating expenses such as salaries, consulting services and taxes. As described under "-Reinsurance" below, we use reinsurance to manage the risk that we take on our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the years ended
Year Ended December 31,
2021 2020
(in thousands)
Cash and cash equivalents provided by (used in):
Operating activities $ 407,042 $ 279,974
Investing activities (351,955) (379,433)
Financing activities (11,140) 76,144
Change in cash and cash equivalents $ 43,947 $ (23,315)
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We have historically generated positive operating cash flows. The increase in cash provided by operating activities in 2021 compared to 2020 was due primarily to growth in business and the timing of claim payments and reinsurance recoverable balances. Cash flows from operations were used to fund investing activities and to pay dividends to our stockholders. For the year endedDecember 31, 2021 , net cash used in investing activities of$352.0 million reflected growth in our business operations. For the year endedDecember 31, 2021 , funds from operations were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of$633.6 million , and to a lesser extent, municipal bonds of$14.4 million and sovereigns of$6.9 million . During 2021, we received proceeds of$113.0 million from sales of fixed-maturity securities, largely corporate bonds in order to take advantage of favorable valuations. In addition, we received proceeds of$216.1 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year endedDecember 31, 2021 , purchases of ETFs and non-redeemable preferred stock were$2.1 million and$22.7 million , respectively. Net cash used in investing activities included purchases of property and equipment of$5.9 million . For the year endedDecember 31, 2020 , net cash used in investing activities of$379.4 million reflected growth in our business operations and proceeds from our equity offering inAugust 2020 of$56.7 million . For the year endedDecember 31, 2020 , these funds were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of$474.8 million , and to a lesser extent, municipal bonds of$54.8 million andU.S. Treasuries of$1.1 million . During 2020, we received proceeds of$119.7 million from sales of fixed-maturity securities, largely corporate bonds in order to take advantage of favorable valuations. In addition, we received proceeds of$93.8 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year endedDecember 31, 2020 , purchases of ETFs and non-redeemable preferred stock were$27.2 million and$9.6 million , respectively. Net cash used in investing activities included net purchases of property and equipment of$27.8 million , primarily related to the construction of our corporate headquarters. For the year endedDecember 31, 2021 , net cash used in financing activities was$11.1 million and reflected dividends of$0.44 per common share, or$10.0 million in the aggregate. Proceeds received from our equity compensation plans were$1.0 million , offset by payroll taxes withheld and remitted on restricted stock awards of$2.1 million for the year endedDecember 31, 2021 . For the year endedDecember 31, 2020 , net cash provided by financing activities was$76.1 million and reflected the proceeds from our equity offering of$56.7 million , previously discussed, and the drawdown of$25.7 million on our Credit Facility, which was used to fund construction of our headquarter facilities. During the year endedDecember 31, 2020 , we paid dividends of$0.36 per common share, or$8.1 million in the aggregate. Proceeds received from our equity compensation plans were$3.6 million , offset by payroll taxes withheld and remitted on restricted stock awards of$1.8 million for the year endedDecember 31, 2020 .
Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large
losses as well as to provide additional capacity for growth. Our reinsurance is
primarily contracted under quota-share reinsurance treaties and excess of loss
treaties. In quota-share reinsurance, the reinsurer agrees to assume a specified
percentage of the ceding company's losses arising out of a defined class of
business in exchange for a corresponding percentage of premiums, net of a ceding
commission. In excess of loss reinsurance, the reinsurer agrees to assume all or
a portion of the ceding company's losses, in excess of a specified amount. In
excess of loss reinsurance, the premium payable to the reinsurer is negotiated
by the parties based on their assessment of the amount of risk being ceded to
the reinsurer because the reinsurer does not share proportionately in the ceding
company's losses.
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For the year endedDecember 31, 2021 , property insurance represented 14.9% of our gross written premiums. When we write property insurance, we buy reinsurance to significantly mitigate our risk. We use sophisticated computer models to analyze the risk of severe losses from weather-related events and earthquakes. We measure exposure to these catastrophe losses in terms of PML, which is an estimate of what level of loss we would expect to experience in a windstorm or earthquake event occurring once in every 100 or 250 years. We manage this PML by purchasing catastrophe reinsurance coverage. EffectiveJune 1, 2021 , we purchased catastrophe reinsurance coverage of$60.0 million per event in excess of our$15.0 million per event retention. Our property catastrophe reinsurance includes a reinstatement provision which requires us to pay reinstatement premiums after a loss has occurred in order to preserve coverage. Including the reinstatement provision, the maximum aggregate loss recovery limit is$120 million and is in addition to the per-occurrence coverage provided by our treaty coverages. Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to us, and therefore, we established an allowance for credit risk based on historical analysis of credit losses for highly rated companies in the insurance industry. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. As ofDecember 31, 2021 ,Kinsale Insurance has only contracted with reinsurers withA.M. Best financial strength ratings of "A" (Excellent) or better. AtDecember 31, 2021 , the net reinsurance receivable, defined as the sum of paid and unpaid reinsurance recoverables, ceded unearned premiums less reinsurance payables, from five reinsurers represented 74.1% of the total balance. AtDecember 31, 2021 , we recorded an allowance for credit losses of$0.4 million related to our reinsurance balances.
Ratings
Kinsale Insurance has a financial strength rating of "A" (Excellent) fromA.M. Best .A.M. Best assigns ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A" (Excellent) is the third highest rating issued byA.M. Best . The "A" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. See also "Risk Factors - Risks Related to Our Business and Our Industry - A decline in our financial strength rating may adversely affect the amount of business we write." The financial strength ratings assigned byA.M. Best have an impact on the ability of the insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that the insurance companies receive. The "A" (Excellent) rating obtained byKinsale Insurance is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
Contractual obligations and commitments
Reserves for losses and loss adjustment expenses
Reserves for losses and loss adjustment expenses represent our best estimate of
the ultimate cost of settling reported and unreported claims and related
expenses. The estimation of loss and loss expense reserves is based on various
complex and subjective judgments. Actual losses and settlement expenses paid may
deviate, perhaps substantially, from the reserve estimates reflected in our
consolidated financial statements. Similarly, the timing for payment of our
estimated losses is not fixed and is not determinable on an individual or
aggregate basis due to the uncertainty inherent in the process of estimating
such payments.
See Note 7 of the notes to the consolidated financial statements and "-Critical
Accounting Estimates" for a discussion of estimates and assumptions related to
the reserves for unpaid losses and loss adjustment expenses.
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Reinsurance balances recoverable on reserves for losses and loss adjustment expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. The method for determining reinsurance recoverables for unpaid losses and loss adjustment expenses involves reviewing actuarial estimates of gross unpaid losses and loss adjustment expenses to determine the Company's ability to cede unpaid losses and loss adjustment expenses under the Company's existing reinsurance contracts.
See Note 8 to the consolidated financial statements and "-Critical Accounting Estimates" for a discussion of reinsurance recoverables.
Credit facility
As of
See Note 11 to the consolidated financial statements for further details regarding our Credit Facility.
Financial Condition
Stockholders' equity
AtDecember 31, 2021 , total stockholders' equity was$699.3 million and tangible stockholders' equity was$696.5 million , compared to total stockholders' equity of$576.2 million and tangible stockholders' equity of$573.4 million atDecember 31, 2020 . The increase in both total stockholders' equity and tangible stockholders' equity in 2021 compared to 2020 was primarily due to profits generated during the period and net activity related to stock-based compensation plans. These increases were offset in part by a decrease in net unrealized gains on available-for-sale investments, net of taxes, and dividends declared during 2021. Tangible stockholders' equity is a non-GAAP financial measure. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of stockholders' equity in accordance with GAAP to tangible stockholders' equity.
See Note 9 to the consolidated financial statements for further details regarding our stock-based compensation plans.
Dividend declarations
OnFebruary 11, 2021 , the Company's Board of Directors declared a cash dividend of$0.11 per share of common stock. This dividend was paid onMarch 12, 2021 to all stockholders of record onFebruary 26, 2021 . OnMay 4, 2021 , the Company's Board of Directors declared a cash dividend of$0.11 per share of common stock. This dividend was paid onJune 11, 2021 to all stockholders of record onMay 27, 2021 . OnAugust 11, 2021 , the Company's Board of Directors declared a cash dividend of$0.11 per share of common stock. This dividend was paid onSeptember 13, 2021 to all stockholders of record onAugust 31, 2021 . OnNovember 11, 2021 , the Company's Board of Directors declared a cash dividend of$0.11 per share of common stock. This dividend was paid onDecember 13, 2021 to all stockholders of record onNovember 29, 2021 . OnFebruary 14, 2022 , the Company's Board of Directors declared a cash dividend of$0.13 per share of common stock. This dividend is payable onMarch 14, 2022 to all stockholders of record onMarch 2, 2022 . 51
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Investment portfolio
AtDecember 31, 2021 , our cash and invested assets of$1.7 billion consisted of fixed-maturity securities, cash and cash equivalents and equity securities. AtDecember 31, 2021 , the majority of the investment portfolio was comprised of fixed-maturity securities of$1.4 billion that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on those securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. AtDecember 31, 2021 , we also held$172.6 million of equity securities, which were comprised of ETFs and non-redeemable preferred stock and$121.0 million of cash and cash equivalents. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 4.3 years and an average rating of "AA-" atDecember 31, 2021 . Our investment portfolio, excluding cash equivalents, had a gross investment return of 2.5% as ofDecember 31, 2021 , compared to 2.9% as ofDecember 31, 2020 .
At
December 31, 2021
Estimated Fair % of Total Fair
Amortized Cost Value Value
($ in thousands)
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
government agencies $ 6,936 $ 6,847 0.4 %
Obligations of states, municipalities and
political subdivisions 216,375 228,045 14.6 %
Corporate and other securities 450,594 458,487 29.3 %
Asset-backed securities 299,810 301,775 19.3 %
Residential mortgage-backed securities 340,804 337,685 21.6 %
Commercial mortgage-backed securities 57,000 59,227 3.8 %
Total fixed maturities 1,371,519 1,392,066 89.0 %
Equity securities:
Exchange traded funds 70,151 123,389 7.9 %
Nonredeemable preferred stock 48,744 49,222 3.1 %
Total equity securities 118,895 172,611 11.0 %
Total investments $ 1,490,414 $ 1,564,677 100.0 %
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The table below summarizes the credit quality of our fixed-maturity securities as ofDecember 31, 2021 , as rated byStandard & Poor's Financial Services, LLC ("Standard & Poor's") or equivalent designation: December
31, 2021
% of Total
($ in thousands)
AAA $ 375,579 27.0 %
AA 523,739 37.6 %
A 234,547 16.9 %
BBB 196,740 14.1 %
Below BBB 61,461 4.4 %
Total $ 1,392,066 100.0 %
The amortized cost and estimated fair value of our available-for-sale
investments in fixed-maturity securities summarized by contractual maturity as
of
December 31, 2021
Amortized Estimated Fair
Cost Value % of Fair Value
($ in thousands)
Due in one year or less $ 6,742 $ 6,822 0.5 %
Due after one year through five years 185,273 189,497 13.6 %
Due after five years through ten years 226,707 232,197 16.7 %
Due after ten years 255,183 264,863 19.0 %
Asset-backed securities 299,810 301,775 21.7 %
Residential mortgage-backed securities 340,804 337,685 24.3 %
Commercial mortgage-backed securities 57,000 59,227 4.2 %
Total fixed maturities $ 1,371,519 $ 1,392,066 100.0 %
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties, and the lenders may have the right to put the securities back to the
borrower.
Restricted investments
In order to conduct business in certain states, we are required to maintain
letters of credit or assets on deposit to support state-mandated insurance
regulatory requirements and to comply with certain third-party agreements.
Assets held on deposit or in trust accounts are primarily in the form of cash or
certain high-grade securities. The fair value of our restricted assets was $6.7
million and $6.9 million at December 31, 2021 and 2020, respectively.
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Reconciliation of Non-GAAP Financial Measures Reconciliation of underwriting income Underwriting income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting income is defined as net income excluding net investment income, the net change in the fair value of equity securities, net realized investment gains and losses, other income, other expenses and income tax expense. We use underwriting income as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define underwriting income differently.
Net income for the years ended
Year Ended December 31,
($ in thousands) 2021 2020
Net income $ 152,659 $ 88,419
Income tax expense 36,142 11,994
Income before taxes 188,801 100,413
Other expenses 1,663 1,375
Net investment income (31,048) (26,110)
Change in the fair value of equity securities (22,812) (16,855)
Net realized investment gains (2,828) (3,533)
Other income (212) (634)
Underwriting income $ 133,564 $ 54,656 Reconciliation of net operating earnings
Net operating earnings is defined as net income excluding the effects of the net
change in the fair value of equity securities, after taxes, and net realized
investment gains and losses, after taxes. Management believes the exclusion of
these items provides a more useful comparison of the Company's underlying
business performance from period to period. Net operating earnings and
percentages or calculations using net operating earnings (e.g., operating return
on equity) are non-GAAP financial measures. Net operating earnings should not be
viewed as a substitute for net income calculated in accordance with GAAP, and
other companies may define net operating earnings differently.
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Net income for the years ended
Year Ended December 31,
($ in thousands) 2021 2020
Net income $ 152,659 $ 88,419
Adjustments:
Change in the fair value of equity securities,
before taxes (22,812) (16,855)
Income tax expense (1) 4,791 3,540
Change in the fair value of equity securities,
after taxes (18,021) (13,315)
Net realized investment gains, before taxes (2,828) (3,533)
Income tax expense (1) 594 742
Net realized investment gains, after taxes (2,234) (2,791)
Net operating earnings $ 132,404 $ 72,313
Operating return on equity:
Average equity (2) $ 637,787 $ 491,059
Return on equity (3) 23.9 % 18.0 %
Operating return on equity (4) 20.8 % 14.7 %
(1) Income taxes on adjustments to reconcile net income to net operating earnings use an effective tax rate of 21%.
(2) Computed by adding the total stockholders' equity as of the date indicated to the prior year-end total and dividing by two.
(3) Return on equity is net income expressed as a percentage of average beginning and ending stockholders' equity during the period.
(4) Operating return on equity is net operating earnings expressed as a percentage of average beginning and ending stockholders' equity during the period.
Reconciliation of tangible stockholders' equity
Tangible stockholders' equity is a non-GAAP financial measure. We define tangible stockholders' equity as stockholders' equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders' equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders' equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at
December 31,
($ in thousands) 2021 2020
Stockholders' equity $ 699,335 $ 576,238
Less: Intangible assets, net of deferred taxes 2,795 2,795
Tangible stockholders' equity $ 696,540 $ 573,443
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Critical Accounting Estimates
We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities, if any. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the "Notes to Consolidated Financial Statements" included in this Annual Report on Form 10-K.
Reserves for unpaid losses and loss adjustment expenses
The reserves for unpaid losses and loss adjustment expenses are the largest and
most complex estimate in our consolidated balance sheet. The reserves for unpaid
losses and loss adjustment expenses represent our estimated ultimate cost of all
unreported and reported but unpaid insured claims and the cost to adjust these
losses that have occurred as of or before the consolidated balance sheet date.
As a relatively new company, our historical loss experience is limited. We
estimate the reserves using individual case-basis valuations of reported claims
and statistical analyses. Those estimates are based on our historical
information, industry information and our estimates of future trends in variable
factors such as loss severity, loss frequency and other factors such as
inflation. We regularly review our estimates and adjust them as necessary as
experience develops or as new information becomes known to us. Such adjustments
are included in current operations. Additionally, during the loss settlement
period, it often becomes necessary to refine and adjust the estimates of
liability on a claim either upward or downward. Even after such adjustments,
ultimate liability may exceed or be less than the revised estimates.
Accordingly, the ultimate settlement of losses and the related loss adjustment
expenses may vary significantly from the estimate included in our consolidated
financial statements.
We categorize our reserves for unpaid losses and loss adjustment expenses into
two types: case reserves and reserves for incurred but not reported losses
("IBNR"). Our gross reserves for losses and loss adjustment expenses at
December 31, 2021 were $881.3 million , and of this amount, 84.8% related to
IBNR. Our reserves for losses and loss adjustment expenses, net of reinsurance,
at December 31, 2021 were $763.8 million , and of this amount, 85.9% related to
IBNR. A 5% change in net IBNR reserves would equate to a $32.8 million change in
the reserve for losses and loss adjustment expenses at such date, as well as a
$25.9 million change in net income, a 3.7% change in both stockholders' equity
and tangible stockholders' equity, in each case at or for the year ended
December 31, 2021 .
The following tables summarize our reserves for unpaid losses and loss
adjustment expenses, on a gross basis and net of reinsurance, at December 31,
2021 and 2020:
December 31, 2021
Gross % of Total Net % of Total
($ in thousands)
Case reserves $ 133,748 15.2 % $ 107,340 14.1 %
IBNR 747,596 84.8 % 656,443 85.9 %
Total $ 881,344 100.0 % $ 763,783 100.0 %
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December 31, 2020
Gross % of Total Net % of Total
($ in thousands)
Case reserves $ 100,628 15.8 % $ 83,638 15.1 %
IBNR 535,385 84.2 % 468,645 84.9 %
Total $ 636,013 100.0 % $ 552,283 100.0 %
Case reserves are established for individual claims that have been reported to
us. We are notified of losses by our insureds or their brokers. Based on the
information provided, we establish case reserves by estimating the ultimate
losses from the claim, including defense costs associated with the ultimate
settlement of the claim. Our claims department personnel use their knowledge of
the specific claim along with advice from internal and external experts,
including underwriters and legal counsel, to estimate the expected ultimate
losses. During the life cycle of a particular claim, as more information becomes
available, we may revise our estimate of the ultimate value of the claim either
upward or downward. The amount of the individual claim reserve is based on the
most recent information available.
Methodology
IBNR reserves are determined using actuarial methods to estimate losses that
have occurred but have not yet been reported to us. We principally use the
incurred Bornhuetter-Ferguson actuarial method ("BF method") to arrive at our
loss reserve estimates for each line of business. This method estimates the
reserves based on our initial expected loss ratio and expected reporting
patterns for losses. Because we have a limited number of years of loss
experience compared to the period over which we expect losses to be reported, we
use industry and peer-group data, in addition to our own data, as a basis for
selecting our expected reporting patterns. Since the incurred BF method does not
directly use reported losses in the estimation of IBNR, it is less sensitive to
our level of reported losses than other actuarial methods. This method avoids
some of the distortions that could result from a large loss development factor
being applied to a small base of reported losses to calculate ultimate losses.
However, this method will react more slowly than some other loss development
methods if reported loss experience deviates significantly from our expected
losses.
Our Reserve Committee consists of our Chief Actuary and other select members of
senior management. The Reserve Committee meets quarterly to review the actuarial
recommendations made by the Chief Actuary. In establishing the actuarial
recommendation for the reserves for losses and loss adjustment expenses, our
actuary estimates an initial expected ultimate loss ratio for our statutory
lines of business by accident year. Input from our underwriting and claims
departments, including premium pricing assumptions and historical experience, is
considered by our actuary in estimating the initial expected loss ratios. During
each quarter, the Reserve Committee reviews the emergence of actual losses
relative to expectations by line of business to assess whether the assumptions
used in the reserving process continue to form a reasonable basis for the
projection of liabilities for those product lines. Our reserving methodology
uses a loss reserving model that calculates a point estimate for our ultimate
losses. Although we believe that our assumptions and methodology are reasonable,
our ultimate payments may vary, potentially materially, from the estimates we
have made.
In addition, we retain an independent actuary annually to review our reserve
levels. The independent actuary is not involved in the establishment and
recording of our loss reserve. The actuarial consulting firm prepares its own
estimate of our reserves for loss and loss adjustment expenses, and we compare
their estimate to the reserves for losses and loss adjustment expenses reviewed
and approved by the Reserve Committee in order to gain additional comfort on the
adequacy of those reserves.
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While we believe that loss reserves atDecember 31, 2021 are adequate, new information, events, or circumstances may result in ultimate losses that are materially greater or less than our estimates. As previously noted, there are many factors that may cause reserves to increase or decrease, particularly those related to catastrophe losses and long-tailed lines of business.
Key assumptions
Expected loss ratios are a key assumption in estimates of ultimate losses for business at an early stage of development. A higher expected loss ratio results in a higher ultimate loss estimate, and vice versa. Assumed loss development patterns are another significant assumption in estimating loss reserves. Accelerating a loss development pattern results in lower ultimate losses, as the estimated proportion of losses already incurred would be higher. The uncertainty in estimating the loss development patterns is generally greater for a company with a relatively limited operating history, therefore, we rely on industry benchmarks to a certain extent when establishing loss reserve estimates. Each of the impacts described below is estimated individually, without consideration for any correlation among key indicators or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for our reserves in total. For any one reserving line of business, the estimated variation in reserves due to changes in key indicators is a reasonable estimate of possible variation that may occur in the future. The variation discussed is not meant to be a worst-case scenario and, therefore, it is possible that future variation may be greater than the amounts shown below.
The impact of reasonably likely changes in the two key assumptions used to
estimate net loss reserves at
Development Pattern Expected Loss Ratio
Property 10% lower Unchanged 10% higher
($ in millions)
2 months slower $ 7.6 $ 10.5 $ 13.4
Unchanged (1.7) - 1.7
2 months faster (5.8) (4.7) (3.6)
Casualty Occurrence 5% lower Unchanged 5% higher
6 months slower $ 22.9 $ 62.4 $ 101.9
Unchanged (35.0) - 35.0
6 months faster (90.4) (59.6) (28.9)
Casualty Claims-Made 5% lower Unchanged 5% higher
6 months slower $ 14.6 $ 30.0 $ 45.3
Unchanged (12.7) - 12.7
6 months faster (38.0) (27.7) (17.4)
Reserve development
The amount by which estimated losses differ from those originally reported for a
period is known as "development." Development is unfavorable when the losses
ultimately settle for more than the amount reserved or subsequent estimates
indicate a basis for reserve increases on unresolved claims. Development is
favorable when losses ultimately settle for less than the amount reserved or
subsequent estimates indicate a basis for reducing loss reserves
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on unresolved claims. We reflect favorable or unfavorable development of loss reserves in the results of operations in the period the estimates are changed. Refer to Note 7 to the consolidated financial statements for discussion on our reserve development for the years endedDecember 31, 2021 and 2020.
Fair value measurements
Like other accounting estimates, fair value measurements may be based on subjective information and generally involve uncertainty and judgment. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Fair value hierarchy disclosures are based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. The three levels of the fair value hierarchy are described below:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3). The use of valuation methodologies may require a significant amount of judgment. During periods of financial market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable. We review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities. Fair values of our investment portfolio are estimated using unadjusted prices obtained by our investment accounting vendor from nationally recognized third-party pricing services, where available. For securities where we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from our investment accounting vendor. We perform several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements atDecember 31, 2021 , including (1) obtaining and reviewing the internal control report from our investment accounting vendor that obtain fair values from third party pricing services, (2) discussing with our investment accounting vendor their process for reviewing and validating pricing obtained from outside pricing services and (3) reviewing the security pricing received from our investment accounting vendor and monitoring changes in unrealized gains and losses at the individual security level. Investment securities are subject to fluctuations in fair value due to changes in issuer-specific circumstances, such as credit rating, and changes in industry-specific circumstances, such as movements in credit spreads based on the market's perception of industry risks. In addition, fixed maturities are subject to fluctuations in fair value due to changes in interest rates. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. 59
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Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large losses and to provide additional capacity for growth. Reinsurance refers to an arrangement in which a company called a reinsurer agrees in a contract (often referred to as a treaty) to assume specified risks written by an insurance company (known as a ceding company) by paying the insurance company all or a portion of the insurance company's losses arising under specified classes of insurance policies in return for a share in premiums. Reinsurance recoverables recorded on insurance losses ceded under reinsurance contracts are subject to judgments and uncertainties similar to those involved in estimating gross loss reserves. In addition to these uncertainties, our reinsurance recoverables may prove uncollectible if the reinsurers are unable or unwilling to perform under the reinsurance contracts. In establishing our reinsurance allowance for credit losses, we evaluate the financial condition of our reinsurers and monitor concentration of credit risk arising from our exposure to individual reinsurers. To determine if an allowance is necessary, we consider, among other factors, published financial information, reports from rating agencies, payment history, collateral held and our legal right to offset balances recoverable against balances we may owe. Our reinsurance allowance for credit losses is subject to uncertainty and volatility due to the time lag involved in collecting amounts recoverable from reinsurers. Over the period of time that losses occur, reinsurers are billed and amounts are ultimately collected, economic conditions, as well as the operational and financial performance of particular reinsurers may change and these changes may affect the reinsurers' willingness and ability to meet their contractual obligations to us. It is difficult to fully evaluate the impact of major catastrophic events on the financial stability of reinsurers, as well as the access to capital that reinsurers may have when such events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear the collection risk if any reinsurer fails to meet its obligations under the reinsurance contracts. We target reinsurers withA.M. Best financial strength ratings of "A" (Excellent) or better. Based on our evaluation of the factors discussed above, the allowance for credit losses related to reinsurance balances was$0.4 million atDecember 31, 2021 .
Recent Accounting Pronouncements
Refer to Note 1 - "Summary of significant accounting policies" of the Notes to Consolidated Financial Statements for further discussion.
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