PROSIGHT GLOBAL, INC. This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Certain restatements have been made to historical information to give effect to the IPO merger, in whichProSight Global Holdings Limited merged with and into the Company, and related transactions. See Note 1 - Background in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those discussed in the section titled "Risk factors" included under Part I, Item 1A and elsewhere in this Annual Report on this Form 10-K. See "Special Note Regarding Forward-Looking Statements." This section of this Annual Report on Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Annual Report on Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 .
References to the "Company," "ProSight," "we," "us," and "our" are to
Special Note Regarding Forward-Looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of Operations includes certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" in this Annual Report. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. Forward-looking statements include statements relating to future developments in our business or expectations for our future financial performance and any statement not involving a historical fact. Forward-looking statements use words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "should," "seek," and other words and terms of similar meaning. Forward-looking statements in this Annual Report include, but are not limited to, statements about:
? our strategies to continue our growth trajectory, expand our distribution
network and maintain underwriting profitability;
the impact of coronavirus disease 2019 ("COVID-19") and related economic
? conditions and governmental actions, including the Company's assessment of the
vulnerability of certain categories of investments to the economic disruptions
associated with COVID-19;
? future growth in existing niches or by entering into new niches;
? our loss expectations and expectation to decrease our loss ratio;
? our expectations with respect to the ultimate financial obligations to the
buyers of our
? statements we make relating to the proposed merger.
Forward-looking statements are subject to known and unknown risks and
uncertainties, many of which may be beyond our control. We caution you that
forward-looking statements are not guarantees of future performance or outcomes
and that actual performance and outcomes may differ materially from those made
in or suggested by the forward-looking
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statements contained in this Annual Report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market in which we operate, are consistent with the forward-looking statements contained in this Annual Report, those results or developments may not be indicative of results or developments in subsequent periods. New factors emerge from time to time that may cause our business not to develop as we expect, and it is not possible for us to predict all of them. Factors that could cause actual results and outcomes to differ from those reflected in forward-looking statements include:
risks relating to our ability to obtain regulatory approvals of the proposed
? merger, including the timing, terms and conditions of any such approvals, which
could affect our ability to complete the proposed merger;
the occurrence of any event, change or other circumstances that could give rise
? to the termination of the Merger Agreement, including a termination of the
Merger Agreement under circumstances that could require us to pay a termination
fee;
? the risk that the parties to the proposed merger may not be able to satisfy the
conditions of the proposed merger in a timely manner or at all;
? risks related to disruption of management time from ongoing business operations
due to the proposed merger;
risk that the proposed merger could have an adverse effect on our ability to
? retain and hire key personnel and maintain relationships with our customers,
agents or business counterparties, and on our operating results and businesses
generally;
? the outcome of any potential legal proceedings that may be instituted against
us;
? the performance of and our relationship with third-party agents and vendors we
rely upon to distribute certain business on our behalf;
the adequacy of our loss reserves, including as a result of changes in the
? legal, regulatory, and economic environments in which the Company operates or
the impacts of COVID-19;
the direct and indirect impacts of COVID-19 and related risks such as
? governmental responses and economic contraction, including on the Company's
investments and business operations, its distribution or other key partners and
its customers;
the effects of uncertain emerging claim and coverage issues on the Company's
business, and court decisions or legislative or regulatory changes that take
place after the Company issues its policies, including those taken in response
? to COVID-19 (such as effectively expanding workers' compensation coverage by
instituting presumptions of compensability of claims for certain types of
workers or requiring insurers to cover business interruption claims
irrespective of terms, exclusions or other conditions included in the policies
that would otherwise preclude coverage);
? the effectiveness of our risk management policies and procedures;
? potential technology breaches or failure of our or our business partners'
systems;
? adverse changes in the economy which could lower the demand for our insurance
products;
? our ability to effectively start up or integrate new product opportunities;
? cyclical changes in the insurance industry;
? the effects of natural and man-made catastrophic events;
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? our ability to adequately assess risks and estimate losses;
? the availability and affordability of reinsurance;
? changes in interest rates, government monetary policies, general economic
conditions, liquidity and overall market conditions;
? changes in the business, financial condition or results of operations of the
entities in which we invest;
? increased costs as a result of operating as a public company, and time our
management will be required to devote to new compliance initiatives;
? our ability to protect intellectual property rights;
? the impact of government regulation, including the impact of restrictions on
our business activities under the
? our status as an emerging growth company;
? the absence of a previous public market for shares of our common stock; and
? potential conflicts of interests with our principal stockholders.
We discuss many of these risks in greater detail under the section titled Item 1A. "Risk Factors" of this Annual Report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Annual Report by these cautionary statements. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. Merger Agreement
OnJanuary 15, 2021 , we announced that we had entered into an agreement and plan of merger (the "Merger Agreement") withPedal Parent Inc. , aDelaware corporation ("Parent"), owned by affiliates ofTowerBrook Capital Partners L.P. andFurther Global Capital Management , andPedal Merger Sub, Inc. , pursuant to which, subject to the terms and conditions of the Merger Agreement,Pedal Merger Sub, Inc. would merge with and into the Company (the "proposed merger"), with the Company surviving as a wholly owned subsidiary of Parent. For a further discussion of the proposed merger, see Item 1. "Business" and Note 22. "Subsequent Events" to our consolidated financial statements on this Annual Report.
Overview
We are an entrepreneurial specialty insurance company that since our founding in 2009 has built products, services and solutions with the goal of significantly improving the experience and value proposition for our customers. We write property and casualty insurance with a focus on underwriting specialty risks by partnering with a select number of distributors, often on an exclusive basis. We currently write insurance coverage in eight customer segments across a broad range of specialty lines of business. Our customer segments currently include:Media and Entertainment , Real Estate, Professional Services, Transportation, Construction, Consumer Services, Marine and Energy, and Sports. Within each customer segment, we have multiple niches which represent similar groups of customers. We believe having deep expertise in these niches across our organization is critical and therefore, we have aligned various functional areas at the niche level, including underwriting, operations and claims. We focus on small and medium-sized customers, a market segment which we believe has been, and will continue to be, less affected by intense competitive dynamics of the broader property and casualty insurance industry. Over time, the composition of business within our customer segments evolves as we identify certain niches that present opportunities to develop distinct customer solutions with attractive profit potential and others 62 Table of Contents
that were at one time attractive but may become less so. We are focused on delivering consistent underwriting profitability with low volatility of underwriting results. We market and distribute our insurance product offerings in all 50 states on both an admitted and non-admitted basis.
Initial Public Offering
OnJuly 29, 2019 , the Company completed its initial public offering ("IPO") with the sale of 7,857,145 shares of the Company's common stock, including the issuance and sale by the Company of 4,285,715 shares of the Company's common stock and the sale byProSight Parallel Investment LLC andProSight Investment LLC ("PI") (collectively, the "GS Investors ") andProSight TPG, L.P. , TPG PS 1, L.P., TPG PS 2, L.P., TPG PS 3, L.P. and TPG PS 4, L.P. (collectively the "TPG Investors " and together with theGS Investors , the "Principal Stockholders") of 3,571,430 shares of the Company's common stock. Shares of the Company's common stock were initially offered to the public by the underwriters in the IPO at a per-share price of$14.00 . The Company did not receive any of the proceeds from the sale of the shares of the Company's common stock sold by the Principal Stockholders in the IPO. Following the IPO, theGS Investors held approximately 40.9% of the Company's outstanding common stock and theTPG Investors held approximately 39.4% of the Company's outstanding common stock. OnAugust 15, 2019 the Principal Stockholders completed the sale of 1,178,570 shares of the Company's common stock at a price of$14.00 per share less the underwriting discount pursuant to the underwriters' exercise of their over-allotment option granted in connection with the IPO. The Company did not receive any of the proceeds from the sale of the shares of common stock of the Company sold by the Principal Stockholders in this offering. Following this offering, theGS Investors held approximately 39.5% of the Company's outstanding common stock and theTPG Investors held approximately 38.0% of the Company's outstanding common stock. The offer and sale of all shares sold in the IPO, including those sold in connection with the underwriters' exercise of their over-allotment option, were registered pursuant to a registration statement filed on Form S-1, which theSecurities and Exchange Commission ("SEC") declared effective onJuly 24, 2019 . After deducting underwriting discounts and commissions and estimated offering expenses (including expenses related to the offering pursuant to the underwriters' exercise of their overallotment option), the net proceeds to the Company from the IPO were approximately$50.8 million .
Our Business
We currently write insurance coverage in eight customer segments across a broad range of specialty lines of business. Our customer segments currently include:Media and Entertainment , Real Estate, Professional Services, Transportation, Construction, Consumer Services, Marine and Energy and Sports. Within each customer segment, we have multiple niches which represent similar groups of customers. For a description of niches served in each of these customer segments, see "Business - Our Customer Segments and Niches." We believe having deep expertise in these niches across our organization is critical and therefore, we have aligned various functional areas at the niche level, including underwriting, operations and claims. We focus on small- and medium-sized customers, a market segment which we believe has been, and will continue to be, less affected by intense competitive dynamics of the broader property and casualty insurance industry. Over time, the composition of business within our customer segments evolves as we identify certain niches that present opportunities to develop distinct customer solutions with attractive profit potential and others that were at one time attractive but may become less so. The tables below set forth the gross written premiums ("GWP"), gross written commission ratios, and gross loss and allocated loss adjustment expense ("ALAE") ratios by customer segment for the years endedDecember 31, 2020 , 2019, and 2018. We have one reportable segment,Specialty Insurance . "Other" includes GWP from: (i) primary and excess workers' compensation coverage for exited Self-Insured Groups; (ii) niches exited prior to 2018, many with a concentration in commercial auto; (iii) participation in industry pools; and (iv) emerging new business. 63 Table of Contents GWP Years Ended December 31 ($ in millions) % Change % Change Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Construction$ 110.0 $ 117.9 $ 101.9 (6.7) % 15.7 % Consumer Services 123.0 133.7 107.1 (8.0) 24.8 Marine and Energy 110.2 94.7 83.1 16.4 14.0 Media and Entertainment 88.8 124.9 119.9 (28.9) 4.2 Professional Services 130.9 119.3 110.5 9.7 8.0 Real Estate 159.2 167.6 132.7 (5.0) 26.3 Sports 23.3 30.1 23.6 (22.6) 27.5 Transportation 64.6 112.2 92.2 (42.4) 21.7
Customer segments subtotal 810.0 900.4 771.0
(10.0) 16.8
Other 7.1 67.6 124.1 (89.5) (45.5)
Total $ 817.1 $ 968.0 $ 895.1 (15.6) % 8.1 %
Gross Written Commission Ratio
Years Ended December 31
% Change % Change
Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018
Construction 20.2 % 20.3 % 20.7 % (0.1) % (0.4) %
Consumer Services 21.5 18.1 17.1 3.4 1.0
Marine and Energy 19.7 18.5 17.9 1.2 0.6Media and Entertainment 17.4 16.9 16.6 0.5
0.3
Professional Services 23.2 22.9 23.0 0.3 (0.1)
Real Estate 20.6 21.2 21.1 (0.6) 0.1
Sports 22.7 23.0 22.7 (0.3) 0.3
Transportation 13.5 14.1 14.5 (0.6) (0.4)
All customer segments 20.1 19.1 19.0 1.0 0.1
Other 17.8 16.6 18.1 1.2 (1.5)
Total 20.1 % 18.9 % 18.9 % 1.2 % - %
Gross Loss and ALAE Ratio, excluding Unallocated Loss Adjustment Expense
("ULAE") Ratio
Years Ended December 31
% Change % Change
Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018
Construction 58.9 % 58.0 % 56.1 % 0.9 % 1.9 %
Consumer Services 77.0 65.5 58.0 11.5 7.5
Marine and Energy 57.4 52.0 32.4 5.4 19.6
Media and Entertainment 38.4 45.8 54.8 (7.4) (9.0)
Professional Services 58.0 47.5 37.6 10.5 9.9
Real Estate 104.1 65.2 60.6 38.9 4.6
Sports 55.1 39.0 61.7 16.1 (22.7)
Transportation 57.3 69.0 62.9 (11.7) 6.1
All customer segments 67.3 57.2 52.6 10.1 4.6
Other (351.6) 87.9 59.8 (439.5) 28.1
Total 64.9 % 60.4 % 53.6 % 4.5 % 6.8 %
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Components of Our Results of Operations
Gross written and earned premiums
GWP are the amounts received or to be received for insurance policies written by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our GWP in any given period is generally influenced by:
? Expansion or retraction of business within existing niches;
? Entrance into new customer segments or niches;
? Exit from customer segments or niches;
? Average size and premium rate of newly issued and renewed policies; and
? The amount of policy endorsements, audit premiums, and cancellations.
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 GWP, less that portion of our GWP that is earned and ceded to third-party reinsurers under our reinsurance agreements.
Ceded written and earned premiums
Ceded written premiums are the amount of GWP ceded to reinsurers. We actively use ceded reinsurance across our book of business to reduce our overall risk position and to protect our capital. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered and the underlying policies. The volume of our ceded written premiums is impacted by the level of our GWP and any decision we make to increase or decrease retention levels.
Net investment income
We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of debt securities, and may also include cash and cash equivalents, short-term investments, and alternative 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, such as changes in interest rates and credit spreads), the size of our investment portfolio is mainly a function of our invested equity capital along with premiums we receive from our insureds less payments on policyholder claims and operating expenses.
Realized investment gains and losses
Realized investment gains and losses are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost, as well as any change in current expected credit loss allowance for available-for-sale fixed maturity securities recognized in earnings.
Losses and Loss Adjustment Expenses ("LAE")
Losses and LAE are a function of the amount and type of insurance contracts we
write, the loss experience associated with the underlying coverage, and the
expenses incurred in the handling of the losses. In general, our losses and LAE
are affected by:
? Frequency of claims associated with the particular types of insurance contracts
that we write;
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? 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 LAE are based on an actuarial analysis of the paid and estimated outstanding losses, including losses incurred during the period and changes in estimates from prior periods. Losses and LAE may be paid out over a number 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 distribution partners and ceding commissions we receive on business ceded under certain reinsurance contracts, as well as taxes we pay to the states in which we write business, generally based on premium volume. Policy acquisition costs that are directly related to the successful acquisition of those policies are deferred. 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 including employment costs, telecommunication and technology costs, the costs of our leases, and legal
and auditing fees. Income tax expense
Substantially all of our income tax expense relates toU.S. federal income taxes. Our insurance companies are generally not subject to income taxes in the states in which they operate; however, our non-insurance subsidiaries are subject to state income taxes. 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 provide useful information about our business and the operational factors underlying our financial performance.
Net income is the amount of profit or loss remaining after deducting all incurred expenses, including income taxes, from the total earned revenues for an accounting period.
Underwriting (loss) income is calculated by subtracting losses and LAE and underwriting, acquisition and insurance expenses from net earned premiums.
Adjusted operating income is net income excluding net realized investment gains and losses, impairment of goodwill and expenses relating to various transactions that we consider to be unique and non-recurring in nature (net of estimated tax impact).
Loss and LAE ratio, expressed as a percentage, is the ratio of losses and LAE, allocated and unallocated, to net earned premiums, net of the effects of reinsurance.
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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 and LAE ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
Adjusted loss and LAE ratio is the loss and LAE ratio excluding the effects of the WAQS (as defined below).
Adjusted expense ratio is the expense ratio excluding the effects of the WAQS.
Adjusted combined ratio is the combined ratio excluding the effects of the WAQS.
Return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
Adjusted operating return on equity is adjusted operating income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
Net retention ratio is the ratio of net written premiums to GWP.
Underwriting income, adjusted operating income, adjusted loss and LAE ratio,
adjusted expense ratio, adjusted combined ratio and adjusted operating return on
equity are non-generally accepted accounting principles ("GAAP") financial
measures. See "- Reconciliation of Non-GAAP Financial Measures" for a
reconciliation of net income in accordance with GAAP to underwriting income and
adjusted operating income. See "- Factors Affecting Our Results of
Operations - The WAQS" for additional detail on the impact of the WAQS on our
results of operations.
Factors Affecting Our Results of Operations
The WAQS
In connection with the divestment of ourU.K. business, New York Marine as reinsured entered into the whole account quota share reinsurance agreements (the "WAQS") with third party reinsurers to maintain reasonable underwriting leverage within New York Marine and its subsidiary insurance companies during a transition period following theU.K. divestment. The effective date of the WAQS wasApril 1, 2017 . The reinsurers' ceding participation is an aggregate 26.0%. A provisional ceding commission of 30.0% to 30.5% is received as a reduction in the amount of ceded premium. Subject to limits, these ceding commissions will vary in subsequent periods based on contractual ultimate loss ratios. During 2018 and following the transition of theU.S. business back to New York Marine, the WAQS were terminated. Previously ceded written and unearned premium, net of the ceding commission, was reversed. Loss reserves on premium earned prior to the cut-off termination remain ceded loss reserves. There were no ceded loss reserves under the WAQS as ofDecember 31, 2020 and$33.1 million as ofDecember 31, 2019 . Loss reserve development on the reserves ceded under the WAQS is included in continuing operations. The effect of the WAQS on our results of operations is primarily reflected in our ceded written premiums, losses and LAE, as well as our underwriting, acquisition and insurance expenses. For the year endedDecember 31, 2020 there was no impact of WAQS on underwriting results or ratios. 67
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The following tables summarize the effect of the WAQS on our underwriting (loss)
income for the years ended
Year Ended December 31, 2020 Year Ended December 31, 2019 Year Ended December 31, 2018
Including Effect of Excluding Including Effect of Excluding Including Effect of Excluding
($ in thousands) WAQS WAQS WAQS WAQS WAQS WAQS WAQS WAQS WAQS
GWP $ 817,090 $ - $ 817,090 $ 968,011 $ - $ 968,011 $ 895,112 $ - $ 895,112
Ceded written premiums (122,912) - (122,912) (115,871) 3 (115,874) (45,038) 58,857 (103,895)
Net written premiums $ 694,178 $ - $ 694,178 $ 852,140 $ 3 $ 852,137 $ 850,074 $ 58,857 $ 791,217
Net retention(1) 85.0 % - 85.0 % 88.0 % - 88.0 % 95.0 % - 88.4 %
Net earned premiums $ 737,755 $ - $ 737,755 $ 807,854 $ 3 $ 807,851 $ 730,785 $ (14,560) $ 745,345
Losses and LAE 472,671 - 472,671 501,025 4,746 496,279 434,830 (9,514) 444,344
Underwriting,
acquisition and
insurance expenses 272,844 - 272,844 290,457 (4,743) 295,200 271,547 (3,955) 275,502
Underwriting (loss)
income(2) $ (7,760) $ - $ (7,760) $ 16,372 $ - $ 16,372 $ 24,409 $ (1,091) $ 25,499
Loss and LAE ratio 64.1 % - % - 62.0 % - % - 59.5 % 65.3 % -
Expense ratio 37.0 % - % - 36.0 % - % - 37.2 % 27.2 % -
Combined ratio 101.1 % - % - 98.0 % - % - 96.7 % 92.5 % -
Adjusted loss and LAE
ratio(3) - - 64.1 % - - 61.4 % - - 59.6 %
Adjusted expense
ratio(3) - - 37.0 % - - 36.6 % - - 37.0 %
Adjusted combined
ratio(3) - - 101.1 % - - 98.0 % - - 96.6 %
(1) Net retention is a non-GAAP measure. We define net retention as the ratio of
net written premiums to GWP.
(2) Underwriting (loss) income is a non-GAAP financial measure. See
"Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net
income to underwriting (loss) income.
(3) Adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined
ratio are non-GAAP financial measures. We define adjusted loss and LAE ratio,
adjusted expense ratio and adjusted combined ratio as the corresponding ratio
excluding the effects of the WAQS. We use these adjusted ratios as internal
performance measures in the management of our operations because we believe
they give our management and other users of our financial information useful
insight into our results of operations and our underlying business
performance. Our adjusted loss and LAE ratio, adjusted expense ratio and
adjusted combined ratio should not be viewed as substitutes for our loss and
LAE ratio, expense ratio and combined ratio, respectively.
Our results of operations may be difficult to compare from year to year due to the origination and termination of the WAQS. While there was no impact of WAQS on underwriting results or ratios for the year endedDecember 31, 2020 , the impact of WAQS on prior periods is shown above. In light of the impact of the WAQS on our results of operations for prior periods, we internally evaluated our financial performance both including and excluding the effect of the WAQS.
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Results of Operations
Year Ended
Years Ended December 31 Change
($ in thousands) 2020 2019 $ Percent GWP$ 817,090 $ 968,011 $ (150,921) (15.6) % Ceded written premiums (122,912) (115,871) (7,041) 6.1 Net written premiums$ 694,178 $ 852,140
Net earned premiums$ 737,755 $ 807,854 $ (70,099) (8.7) % Net losses and LAE incurred 472,671 501,025 (28,354) (5.7) Underwriting, acquisition and insurance expenses 272,844 290,457 (17,613) (6.1) Underwriting (loss) income(1) (7,760) 16,372 (24,132) (147.4) Interest and other expenses, net 31,751 28,408 3,343 11.8 Net investment income 73,021 68,897 4,124 6.0 Realized investment gains, net 4,980 770
4,210 546.8
Income before taxes 38,490 57,631 (19,141) (33.2)
Income tax expense 10,740 12,137 (1,397) (11.5)Net income from continuing operations$ 27,750 $ 45,494 $ (17,744) (39.0) % Adjusted operating income(1)$ 40,328 $ 57,636
Adjusted operating return on equity(1) 6.9 % 12.4
% Return on equity 4.8 % 9.8 % Loss and LAE ratio: 64.1 % 62.0 % Loss and LAE ratio - excluding catastrophe(2) 61.6 % 61.6 % Loss and LAE ratio - catastrophe 2.5 % 0.4
% Expense ratio 37.0 % 36.0 % Combined ratio 101.1 % 98.0 %
Adjusted loss and LAE ratio(3) 64.1 % 61.4 % Adjusted loss and LAE ratio - excluding catastrophe(2) 61.6 % 61.0 % Adjusted loss and LAE ratio - catastrophe 2.5 % 0.4 % Adjusted expense ratio(3) 37.0 % 36.6 % Adjusted combined ratio(3) 101.1 % 98.0 %
(1) Underwriting (loss) income, adjusted operating income and adjusted operating
return on equity are non-GAAP financial measures. See "Reconciliation of
Non-GAAP Financial Measures" for reconciliations of net income in accordance
with GAAP to underwriting (loss) income and adjusted operating income.
(2) Loss and LAE ratio - excluding catastrophe and Adjusted loss and LAE ratio -
excluding catastrophe is adjusted to exclude the impact of reinsurance
reinstatement premiums related to catastrophe losses incurred during the
period from net earned premium.
(3) Adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined
ratio are non-GAAP financial measures. We define adjusted loss and LAE ratio,
adjusted expense ratio and adjusted combined ratio as the corresponding ratio
excluding the effects of the WAQS. For additional detail on the impact of the
WAQS on our results of operations see "Factors Affecting Our Results of
Operations-The WAQS.
Net Income from Continuing Operations
Net income from continuing operations was$27.8 million for the year endedDecember 31, 2020 compared to$45.5 million for the year endedDecember 31, 2019 , a decrease of$17.7 million , or 39.0%. The decrease in net income from continuing operations is driven by a reduction in net earned premium due to the contraction of gross written premium and reduced insured exposures resulting from the economic downturn caused by the COVID-19 pandemic, combined with a higher net loss ratio due to catastrophe losses in the third quarter. 69 Table of Contents Premiums GWP were$817.1 million for the year endedDecember 31, 2020 compared to$968.0 million for the year endedDecember 31, 2019 , a decrease of$150.9 million , or 15.6%.
The following table presents the GWP by customer segment for the years ended
($ in millions) Years Ended December 31 Customer Segment 2020 2019 % Change Construction$ 110.0 $ 117.9 (6.7) % Consumer Services 123.0 133.7 (8.0) Marine and Energy 110.2 94.7 16.4 Media and Entertainment 88.8 124.9 (28.9) Professional Services 130.9 119.3 9.7 Real Estate 159.2 167.6 (5.0) Sports 23.3 30.1 (22.6) Transportation 64.6 112.2 (42.4) Customer segments subtotal 810.0 900.4 (10.0) Other 7.1 67.6 (89.5) Total$ 817.1 $ 968.0 (15.6) %
Gross written premium contraction in 2020 was primarily driven by decreased new business and reduced insureds exposures within the Transportation andMedia & Entertainment due to the economic downturn from the COVID-19 pandemic.
The changes in GWP were most notable in the following customer segments and niches:
Transportation GWP decreased by 42.4% to
? 2019. The premium contraction is primarily driven by reduced insured exposures
and new business opportunities of
School Bus, and
Media and Entertainment GWP decreased by 28.9% to
ended
? exposure reductions,
million of reduced new business opportunities in the
Film niches primarily due to regulatory restrictions and mandatory social
distancing resulting from COVID-19.
Consumer Services GWP decreased by 8.0% to
? 2019. The premium contraction is primarily driven by the decision to exit
monoline workers' compensation, partially offset by organic growth of the Auto
Dealers niche.
Marine and Energy GWP increased by 16.4% to
?
2019. The premium growth is driven by
primarily in the Propane & Fuel Dealers niche.
Professional Services GWP increased by 9.7% to
? ended
31, 2019. The premium growth is driven by
business in the Credit Unions and Custom Brokers niches.
Net written premiums decreased by
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reduction in gross written premiums due to the economic downturn from the COVID-19 pandemic as well as the exit of monoline workers' compensation.
Net earned premiums decreased by
Loss and LAE Ratio
Our loss and LAE ratio was 64.1% for the year endedDecember 31, 2020 compared to 62.0% for the year endedDecember 31, 2019 . During the year endedDecember 31, 2020 the Company's reserve for unpaid losses and loss adjustment expenses for accident years 2019 and prior developed unfavorably by$0.7 million driven by unfavorable development of$21.8 million in General Liability,$16.8 million unfavorable development in Commercial Multiple Peril and$8.1 million unfavorable development in Commercial Auto, partially offset by$36.5 million of favorable development in Workers' Compensation and$9.5 million of favorable development in All Other lines. In addition, the Company incurred$15.2 million of losses and loss adjustment expenses related to premium adjustments earned during the year endedDecember 31, 2020 , attributable to accident years 2019 and 2018. The unfavorable development in General Liability, Commercial Multiple Peril and Commercial Auto related to 2013 through 2017 accident years due largely to increased severities in runoff components. The favorable development in Workers' Compensation derived from lower than expected claims severity across all customer segments primarily in accident years 2015 through 2018. The favorable development in All Other lines was driven mostly byOcean Marine . Catastrophe losses of$14.3 million for the year endedDecember 31, 2020 were driven primarily by Hurricane Laura and theOregon wildfires, adding 2.0 points to the current accident year loss ratio compared to$3.0 million of catastrophe losses for the year endedDecember 31, 2019 . The Company also incurred$6.1 million of reinsurance reinstatement premiums, related to catastrophe losses during the period, which increased the loss ratio by 0.5 points for the year endedDecember 31, 2020 . The loss and LAE ratio, excluding catastrophe losses and related items was 61.6% for the year endedDecember 31, 2020 . The following tables summarize the effect of the factors indicated above on the loss and LAE ratios and adjusted loss and LAE ratios for the years endedDecember 31, 2020 and 2019: Years Ended December 31 2020 2019 % of Earned % of Earned ($ in thousands) Losses and LAE Premiums Losses and LAE Premiums Loss and LAE:
Current accident year - excluding % catastrophe (1)$ 457,647 61.5 %$ 494,871 61.2 Current accident year - catastrophe losses (2) 14,314 2.5 3,000 0.4 Effect of prior year development 710 0.1
3,154 0.4
Total $ 472,671 64.1 % $ 501,025 62.0 %
Years Ended December 31
2020 2019
% of Earned % of Earned
($ in thousands) Losses and LAE Premiums Losses and LAE Premiums
Adjusted loss and LAE:
Current accident year - excluding
catastrophe (1) $ 457,647 61.5 % $ 494,871 61.2 %
Current accident year - catastrophe
losses (2) 14,314 2.5 3,000 0.4
Effect of prior year development 710 0.1
(1,592) (0.2)
Total $ 472,671 64.1 % $ 496,279 61.4 %
(1) Earned premiums are adjusted to exclude the impact of reinsurance
reinstatement premiums related to catastrophe losses incurred during the
period.
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(2) Catastrophe losses are any one claim, or group of claims, equal or greater
than
is Property Claim Services, a
cause
significant number of policyholders and insurers.
The following table presents the loss and LAE ratio before and after the effects
of reinsurance, for the years ended
Years Ended December 31
2020 2019 % Change
Loss and LAE Ratio:
Gross loss and ALAE 64.7 % 60.4 % 4.3 %
ULAE 1.0 1.8 (0.8)
Gross loss and LAE ratio 65.7 62.2 3.5
Effect of ceded reinsurance (1.6) (0.2) (1.4)
Loss and LAE ratio 64.1 62.0 2.1
Effect of WAQS - (0.6) 0.6
Adjusted loss and LAE ratio 64.1 % 61.4 % 2.7 %
Expense Ratio
Our expense ratio was 37.0% for the year ended December 31, 2020 compared to
36.0% for the year ended December 31, 2019 . This increase is driven by
contraction of net earned premium due to the impact of the economic downturn
from the COVID-19 pandemic on GWP.
The following table summarizes the components of the expense ratio for the years
ended
Years Ended December 31
2020 2019
% of Earned % of Earned
($ in thousands) Expenses Premiums Expenses Premiums
Underwriting, acquisition and insurance
expenses:
Policy acquisition expenses, net of ceded
reinsurance $ 172,426 23.4 % $ 189,514 23.5 %
Underwriting and insurance expenses 100,418 13.6 105,686 13.1
Underwriting, acquisition and insurance
expenses(1) 272,844 37.0 295,200 36.6
Effect of WAQS - - (4,743) (0.6)
Total underwriting, acquisition and
insurance expenses $ 272,844 37.0 % $ 290,457 36.0 %
Underwriting, acquisition and insurance expenses is calculated based on the (1) net earned premiums excluding the effects of the WAQS for the years ended
Underwriting (Loss) Income
Underwriting loss was$7.8 million for the year endedDecember 31, 2020 compared to an underwriting income of$16.4 million for the year endedDecember 31, 2019 , a decrease of$24.2 million , or 147.4%. The decrease is driven by a reduction in net earned premium due to the contraction of gross written premium and reduced insured exposures resulting from the economic downturn caused by the COVID-19 pandemic, combined with a higher net loss ratio due to catastrophe losses in the third quarter. Combined Ratio
Our combined ratio was 101.1% for the year endedDecember 31, 2020 compared to 98.0% for the year endedDecember 31, 2019 . Our adjusted combined ratio was 101.1% for the year endedDecember 31, 2020 compared to 98.0% for the year
endedDecember 31, 2019 . 72 Table of Contents Investing Results Our net investment income increased by 6.0% to$73.0 million for the year endedDecember 31, 2020 from$68.9 million for the year endedDecember 31, 2019 . Our average invested assets increased 11.6% from$2.0 billion for the year endedDecember 31, 2019 , to$2.2 billion for the year endedDecember 31, 2020 . Net investment yield decreased by 0.1 percentage points, to 3.3% as ofDecember 31, 2020 compared to 3.4% as ofDecember 31, 2019 . Gross investment income increased by$5.3 million to$76.5 million for the year endedDecember 31, 2020 compared to$71.2 million for the year endedDecember 31, 2019 . Realized investment gains, net increased by$4.2 million due to non-recurring realized gains on the sale of certain securities as part of the repositioning of the investment portfolio, calls, and corporate actions during a favorable price environment for the year endedDecember 31, 2020 . The following table summarizes the components of net investment income and realized investment gains, net for the years endedDecember 31, 2020 and 2019: Years Ended December 31 ($ in thousands) 2020 2019 $ Change Fixed maturity securities$ 62,621 $ 66,975 $ (4,354) Other investments 13,863 4,224 9,639 Gross investment income 76,484 71,199 5,285 Investment expenses (3,463) (2,302) (1,161) Net investment income 73,021 68,897 4,124
Realized investment gains, net 4,980 770
4,210
Total$ 78,001 $ 69,667 $
8,334
Average invested assets at book value
The weighted average duration of our fixed income portfolio, including cash
equivalents, was 4.8 years at
Interest and Other Expenses, Net
Our interest and other expenses, net increased by$3.3 million to$31.8 million for the year endedDecember 31, 2020 compared to$28.4 million for the year endedDecember 31, 2019 . The increase is primarily driven by the impairment of goodwill in the fourth quarter of$11.9 million in relation to the acquisition of the Company announced onJanuary 15, 2021 , partially offset by a decline of non-recurring expenses related to the transition of our former CEO and vesting of restricted stock units granted at the IPO in 2019.
Income Tax Expense
Our effective tax rate for the years endedDecember 31, 2020 and 2019 was 27.9% and 21.1%, respectively. The increase in the effective tax rate for the year endedDecember 31, 2020 compared to the same period in 2019 was primarily due to lack of tax benefit from the goodwill impairment. Excluding the goodwill impairment, the effective tax rate was 21.4%. Our income tax expense was$10.7 million and$12.1 million for the years endedDecember 31, 2020 and 2019, respectively. The decrease is primarily due to the decrease in income before income taxes compared to the same period in 2019. OnMarch 27, 2020 , the President ofthe United States signed into law the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). The CARES Act, among other things, includes certain income tax provisions for individuals and corporations; however, these benefits do not impact the Company's current tax provision. 73 Table of Contents Adjusted Operating Income
Adjusted operating income was$40.3 million for the year endedDecember 31, 2020 , a decrease of$17.3 million , or 30.0% from the adjusted operating income of$57.6 million for the year endedDecember 31, 2019 , primarily due to the reduction in underwriting income partially offset by increased net investment income.
Adjusted Operating Return on Equity
Our adjusted operating return on equity was 6.9% for the year endedDecember 31, 2020 , a decrease of 5.5% from 12.4% for the year endedDecember 31, 2019 , primarily due to the reduction in adjusted operating income combined with the increase in average book value.
Liquidity and Capital Resources
Sources and Uses of Funds
We are organized as a holding company with our operations primarily conducted by our wholly owned insurance subsidiaries, New York Marine and Gotham, which are domiciled inNew York , and Southwest Marine, which is domiciled inArizona . Accordingly, the holding company may receive cash through: (i) loans from banks; (ii) draws on a revolving loan agreement; (iii) issuance of equity and debt securities; (iv) corporate service fees from our operating subsidiaries; (v) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions; and (vi) subject to certain limitations discussed below, dividends from our insurance subsidiaries. We also may use the proceeds from these sources to contribute funds to the insurance subsidiaries in order to support premium growth, reduce our reliance on reinsurance, and pay dividends and taxes and for other business purposes. We receive corporate service fees from the operating subsidiaries 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. Our$140.0 million aggregate principal amount of 7.5% Senior Unsecured Notes and$25.0 million aggregate principal amount of 6.5% Senior Notes (collectively, the "Notes") matured inNovember 2020 . InJune 2020 , we entered into a credit agreement (the "Credit Agreement") with certain lenders andTruist Bank, N.A. , as administrative agent ("Truist"), providing for a$165.0 million delayed draw term loan facility (the "Term Loan Facility"). The Company used the Term Loan Facility proceeds to repay$165.0 million in complete satisfaction of the outstanding debt under the Notes. (see "- Credit Agreement" and "-Senior Debt). Management believes that the Company has sufficient liquidity available to meet its operating cash needs and obligations and committed capital expenditures
for the next 12 months. Cash Flows
The most significant source of cash for our operating subsidiaries is from
premiums received from our insureds, which, for most policies, we receive at the
beginning of the coverage period, and net of the related commission amount for
the policies. Our most significant cash outflow is for claims that arise when a
policyholder incurs an insured loss. We also use cash to pay for operating
expenses such as salaries, rent and taxes and capital expenditures such as
technology systems. Because the payment of claims occurs well after the receipt
of the premium, we invest the cash in various investment securities that
generally earn interest and dividends. The operating subsidiaries' investment
portfolios represent an additional source of liquidity that could be accessed if
needed. 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 casualty-focused nature of our products, and limited property exposures,
typically allow us to generate significant operating cash flow. Some of our
payments and receipts, including loss settlements and subsequent reinsurance
receipts, can be significant, and as a result their timing can influence cash
flows from operating activities in any given
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period. Management believes that cash receipts from premiums, proceeds from investment sales and maturities, and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the years ended
Years Ended December 31
2020 2019 2018
($ in thousands)
Cash and cash equivalents provided by (used in):
Operating activities $ 116,390 $ 253,296 $ 231,692
Investing activities (179,866) (288,616) (297,952)
Financing activities 57,106 32,138 18,000
Net change in cash and cash equivalents $ (6,370) $ (3,182) $ (48,260)
The decrease in cash provided by operating activities for the year ended
December 31, 2020 , compared to the year ended December 31, 2019 , was largely
driven by timing of claim payments and premium collection declines due to
COVID-19. Cash used in investing activities is primarily funded by cash flow
from operations. The decrease in cash used in investing activities for the year
ended December 31, 2020 , compared to the year ended December 31, 2019 , primarily
reflected the amount of operating funds available for investment in the year.
The increase in cash provided by financing activities for the year ended
December 31, 2020 , compared to the year ended December 31, 2019 , was primarily
due to proceeds from the Revolving Credit Facility of $42.0 million and the
issuance of the $24.9 million secured loan in 2020, compared to $50.9 million of
proceeds related to the IPO offset by the $18.0 million utilized to pay down the
Citizens Revolving Credit agreement in 2019. The Term Loan Facility proceeds of
$165.0 million received in November 2020 were used to repay all outstandingdebt under the maturing Notes. Credit Agreement
OnJune 12, 2020 (the "Effective Date"), we entered into a credit agreement (the "Credit Agreement") with certain lenders andTruist Bank, N.A. , as administrative agent ("Truist"), providing for a$165.0 million delayed draw term loan facility (the "Term Loan Facility"). Borrowings under the Term Loan Facility were used to refinance the Notes at maturity. The Credit Agreement includes a letter of credit sub-limit of up to$5.0 million and a swingline loan sub-limit of up to$5.0 million . Further, the Credit Agreement provided for an uncommitted revolving loan facility (the "Revolving Credit Facility") in an initial aggregate amount of$35.0 million , which subsequently became committed and increased to an aggregate of$65.0 million pursuant to the Incremental Agreement (defined below). At our option, borrowings under the Term Loan Facility and the Revolving Credit Facility would be (i) a "Base Rate Borrowing" which would bear interest at the Base Rate (as defined below) plus the Applicable Margin (as described below), or (ii) an "Eurodollar Borrowing" which would bear interest at the Adjusted LIBO Rate (defined as reserve-adjusted LIBOR, subject to a floor of 0.75%), for periods of one, two, three or six months, plus the Applicable Margin. The Base Rate is the highest of (a) the rate of interest announced publicly by Truist as its prime lending rate, (b) 0.5% above the federal funds rate, (c) the Adjusted LIBO Rate determined on a daily basis for a one-month period (subject to a floor of 0.75%) plus 1.00%, and (d) zero percent. The Applicable Margin for a Eurodollar Borrowing will range from 2.00% to 3.25% per annum based upon ProSight's Debt to Capitalization Ratio (as defined in the Credit Agreement) in effect on such date. The initial Applicable Margin for Base Rate Borrowings is 100 basis points lower than the Applicable Margin for Eurodollar Borrowings. The Applicable Margin at the Effective date for Eurodollar Borrowings was 3.00% and this rate was in effect as of the date of filing of this Annual Report. Following such date, the Applicable Margin will be determined as set forth above. We agreed to pay a ticking fee with respect to the undrawn portion of the commitments for the Term Loan Facility, ranging from 0.20% to 0.30% per annum based upon our Debt to Capitalization Ratio (as defined in the Credit Agreement) in effect on such date. We also agreed to pay a commitment fee on the unused portion of the Revolving Credit Facility, ranging from 0.20% to 0.30% at the Effective Date. We ceased payment of the ticking fee upon the drawdown of the Term Loan Facility inNovember 2020 . We continue to pay the commitment fee of 0.30% on the unused portion of the Revolving 75
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Credit Facility as of the filing date of this Annual Report. Following such date, the commitment fee will be determined as set forth above.
The Credit Agreement includes certain covenants, including restrictions on the disposition of assets, restrictions on the incurrence of liens and indebtedness, limits on making restricted payments and requirements to maintain specified capitalization levels. As a condition precedent to entry into the Credit Agreement, we terminated our amended and restated revolving loan agreement, dated as ofMarch 15, 2019 , withCitizens Bank, N.A. ("Citizens"), which had previously provided for a$50.0 million revolving credit facility. No amounts were outstanding under this facility at termination.
Revolving Credit Facility
OnJune 30, 2020 , we entered into an incremental facility agreement and amendment (the "Incremental Agreement") with certain lenders and Truist as administrative agent. The Incremental Agreement supplemented the Credit Agreement by obtaining from lenders commitments with respect to the Revolving Credit Facility provided for under the Credit Agreement, and increasing the Revolving Credit Facility from$35.0 million as stated in the Credit Agreement to an aggregate amount of$65.0 million . The Revolving Credit Facility may be used for general corporate purposes, including, without limitation, to support business growth and to provide additional liquidity if needed. OnJuly 14, 2020 , the Company drew down$5.0 million on the Revolving Credit Facility and onAugust 3, 2020 , the Company drew down an additional$30.0 million , primarily to make capital contributions to its insurance subsidiaries. OnNovember 25,2020 , the Company drew down an additional$7.0 million on the Revolving Credit Facility, primarily to make interest payments on its Senior Unsecured Notes dueNovember 2020 and for additional liquidity needs. As of the date of this filing, there is$42.0 million outstanding under the Revolving Credit Facility.
Master Lease Agreement
OnJune 26, 2020 , we sold certain assets, in exchange for approximately$24.9 million of proceeds and agreed to lease such assets back from Citizens in exchange for monthly payments bearing interest at 4.83%. The lease expires onJuly 1, 2025 , on which date we will repurchase the assets from Citizens forone dollar . This transaction is treated as a secured loan payable underU.S. GAAP. For a discussion of the secured loan payable, see Note 14. Debt - Secured Loan Payable. Revolving Loan Agreement
OnJanuary 29, 2018 , ProSight entered into a revolving loan agreement with certain lenders andCitizens Bank, N.A. , as agent, providing for a revolving loan facility of up to$25.0 million . OnMarch 15, 2019 , the Company entered into an amended and restated revolving loan agreement, which increased the facility to$50.0 million . As previously noted, we terminated this revolving loan agreement as a condition precedent to entry into the Credit Agreement inJune 2020 . No amounts were outstanding under this facility at termination.
Senior Debt
InNovember 2013 , ProSight issued$140.0 million of 7.5% Senior Unsecured Notes dueNovember 2020 and inJanuary 2015 , issued an additional$25.0 million of 6.5% Senior Notes dueNovember 2020 . The notes provided for semi-annual interest payments and matured onNovember 26, 2020 . The Note Purchase Agreements required us, upon the occurrence of certain change of control events that result in a downgrade of the ratings assigned to the notes, to offer to each holder to prepay such holder's notes at a price equal to 100% of the principal amount thereof plus any accrued interest. The Note Purchase Agreements also included certain covenants that restrict our ability to incur indebtedness, make restricted payments, incur liens, and require that we maintain specified liquidity levels. 76 Table of Contents OnNovember 25, 2020 , the Company used the Term Loan Facility proceeds to repay$165.0 million in complete satisfaction of the outstanding debt under the 7.5% Senior Unsecured Notes dueNovember 2020 and the 6.5% Senior Notes dueNovember 2020 .
Interest payments of
Reinsurance
We actively use ceded reinsurance across our book of business to reduce our overall risk position and to protect our capital. Reinsurance involves a primary insurance company transferring, or "ceding", a portion of its premium and losses in order to limit its exposure. The ceding of liability to a reinsurer does not relieve the obligation of the primary insurance to the policyholder. The primary insurer remains liable for the entire loss if the reinsurer fails to meet its obligations under the reinsurance agreement. Our reinsurance agreements are primarily contracted under excess of loss agreements. 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. We use quota share and facultative reinsurance. 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. Facultative coverage refers to a reinsurance contract on individual risks as opposed to a group or class of business. It is used for a variety of reasons, including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance. Our largest quota share reinsurance agreements were the WAQS. In connection with the divestment of ourU.K. business, New York Marine as reinsured entered into the WAQS with third party reinsurers to maintain reasonable underwriting leverage within New York Marine and its subsidiary insurance companies during a transition period following theU.K. divestment. During 2018, and following the transition of theU.S. business back to New York Marine, the WAQS were terminated. EffectiveJanuary 1, 2020 , the WAQS were commuted.
The following is a summary of our significant in-force excess of loss
reinsurance programs as of
Line of Business Covered Summary Reinsurance Coverage Property - per risk$37.0 million excess of$3.0 million Property - catastrophe$195.0 million excess of$5.0 million Casualty Supported Umbrella:$6.0 million excess of$4.0 million Unsupported Umbrella:$5.0 million excess of$5.0 million Professional Liability:$5.0 million excess of$5.0 million Primary Workers' Compensation$37.0 million excess of$3.0 million Marine$42.5 million excess of$2.5 million Custom Bonds$38.0 million excess of$2.0 million
Our excess of loss reinsurance reduces the financial impact of a loss (1) occurrence. Our excess of loss reinsurance includes reinstatement provisions,
inuring relationships, and other clauses that may impact the amount recovered
on a loss occurrence.
At each annual renewal, we consider any plans to change the underlying insurance coverage we offer, as well as updated loss activity, the level of our capital and surplus, changes in our risk appetite and the cost and availability of
reinsurance treaties.
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Reinsurance contracts do not relieve us from our obligations to policyholders.
Failure of the reinsurer to honor its obligations could result in losses to us,
and therefore, we establish allowances for amounts considered uncollectible. The
allowance related to credit default with respect to our reinsurance assets as of
December 30, 2020 and December 31, 2019 , was $0.7 million and $0.5 million
respectively. In formulating our reinsurance programs, we are selective in our
choice of reinsurers and we consider numerous factors, the most important of
which are the financial stability of the reinsurer, its history of responding to
claims and its overall reputation. In an effort to minimize our exposure to the
insolvency of our reinsurers, we review the financial condition of each
reinsurer annually. In addition, we continually monitor for rating downgrades
involving any of our reinsurers.
Ratings
ProSight and its insurance subsidiaries have a financial strength rating of "A-" (Excellent) fromA.M. Best .A.M. Best assigns 16 ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). 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-A downgrade in our Financial Strength Ratings ("FSRs") fromA.M. Best could negatively affect our results of operations." The financial strength ratings assigned byA.M. Best have an impact on the ability of the insurance subsidiaries to attract and retain our distribution partners and on the risk profiles of the submissions for insurance that the insurance subsidiaries receive. The "A-" (Excellent) rating affirmed byA.M. Best onDecember 17, 2020 is consistent with our business plan and allows us to actively pursue relationships with the distribution partners identified in our marketing plan.
Contractual Obligations and Commitments
The following table illustrates our contractual obligations and commercial
commitments by due date as of
Expected Payments
One Year to Three Years to
Less Than Less Than Less Than More Than
One Year Three Years Five Years Five Years Total
($ in thousands)Gross reserves for losses and LAE$ 383,870 $ 502,524 $ 273,535 $ 442,973 $ 1,602,902 Senior debt and credit agreements(1) - 207,000 - - 207,000 Interest on senior debt and credit agreements(2) 7,852 11,725 - - 19,577 Secured loan payable(3) 4,241 9,934 8,575 - 22,750 Interest on secured loan payable(4) 926 1,341
351 - 2,618
Operating lease obligations 3,527 1,427 808 - 5,762
Total $ 400,416 $ 733,951 $ 283,269 $ 442,973 $ 1,860,609 Amounts represent the principal balance and are not necessarily the carrying (1) value of the Company's debt on the balance sheet, which includes unamortized
debt issuance costs.
(2) Amounts represent anticipated cash interest payments and commitment fees
related to the Company's senior debt and credit agreements.
Amounts represent the principal balance and are not necessarily the carrying (3) value of the Company's debt on the balance sheet, which includes unamortized
issuance costs.
(4) Amounts represent anticipated cash interest payments related to the Company's
secured loan payable.
Reserves for losses and LAE represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. Estimating reserves for losses and LAE 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 financial statements. Similarly, the timing for payment of our estimated losses is not fixed and
is
not
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determinable on an individual or aggregate basis. The assumptions used in
estimating the payments due by period are based on industry and peer group
claims payment experience. Due to the uncertainty inherent in the process of
estimating the timing of such payments, there is a risk that the amounts paid in
any period will be significantly different than the amounts disclosed above.
Amounts disclosed above are gross of anticipated amounts recoverable from
reinsurers. Reinsurance balances recoverable on reserves for losses and LAE are
reported separately as assets, instead of being netted with the related
liabilities, since reinsurance does not discharge us of our liability to
policyholders. Reinsurance balances recoverable on reserves for paid and unpaid
losses and LAE totaled $181.0 million , $197.4 million and $197.7 million at
December 31, 2020 , 2019 and 2018, respectively. These recoverable balances
include $0.0 million and $33.1 million related to the WAQS at December 31 ,2020 and 2019, respectively. Financial Condition Stockholders' equity AtDecember 31, 2020 , total stockholders' equity was$624.0 million and tangible stockholders' equity was$606.7 million compared to total stockholders' equity of$543.0 million and tangible stockholders' equity of$513.8 million atDecember 31, 2019 . The increase in both total and tangible stockholders' equity was primarily due to net income of$22.2 million and net increase in accumulated other comprehensive income of$51.7 million for the year endedDecember 31, 2020 . Tangible stockholders' equity is a non-GAAP financial measure. We define tangible stockholders' equity as stockholders' equity less goodwill and net intangible assets. Our definition of tangible stockholders' equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders' equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at
December 31
2020 2019 2018
($ in thousands)
Stockholders' equity $ 623,968 $ 543,031 $ 389,830 Less: goodwill and net intangible assets 17,248 29,189 29,219 Tangible stockholders' equity
$ 606,720 $ 513,842 $
360,611
Book value per share$ 14.37 $ 12.61 $
10.03
Tangible book value per share$ 13.97 $ 11.93 $
9.28 Equity-based compensation 2019 Equity Incentive Plan
In connection with, and prior to the completion of the IPO, the Company's Amended and Restated 2010 Equity Incentive Plan (the "2010 Plan") was terminated, and the Company adopted a new plan, the 2019 Equity Incentive Plan (the "2019 Plan")
OnJuly 24, 2019 , the 2019 Plan became effective immediately prior to the effectiveness of the registration statement filed in connection with the IPO. The 2019 Plan provides for the grant of stock options, stock appreciation rights, restricted share awards ("RSAs"), RSUs, dividend equivalent rights, performance-based shares, performance-vesting share awards ("PSAs") or other equity-based or equity-related awards. The 2019 Plan is administered by the compensation committee of the Company's Board of Directors. Subject to the provisions of the 2019 Plan, the compensation committee determines in its discretion, the persons to whom and the 79
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times at which awards are granted, the size of awards (subject to certain limitations set forth in the compensation committee charter) and the terms and conditions of awards.
A total of 4,500,000 shares of common stock are initially authorized and reserved for issuance under the 2019 Plan, including shares underlying RSUs granted under the 2010 Plan.
The following is a summary of the equity-based compensation included in the 2019 Plan, including the number of common stock shares granted to each award:
Annual long-term equity incentive plan awards ("Annual LTIP Awards"): Annual
(i) LTIP Awards in 2019 included time-vesting RSUs and performance-vesting RSUs
("PSUs). Annual LTIP Awards in 2020 included RSUs, PSUs, RSAs, and PSAs.
RSUs vest annually over three years subject to continued employment through each such date. 142,739 and 90,559 time-vesting RSUs were granted in 2020 and 2019 and the fair value of the awards on grant date was$1.8 million and$1.3 million , respectively. RSAs vest annually over three years subject to continued employment through each such date. 110,466 time-vesting RSAs were granted in 2020 and the fair value of the awards on grant date was$1.5 million . PSUs vest based on the average book value per share growth over a three-year performance period and cliff vest on the third anniversary of the grant date to the extent performance metrics are met, subject to continued service. 123,016 and 90,559 PSUs were granted in 2020 and 2019 and the fair value of the awards on grant date was$1.6 million and$1.3 million , respectively. PSAs vest based on the average book value per share growth over a three-year performance period and cliff vest on the third anniversary of the grant date to the extent performance metrics are met, subject to continued service. 110,466 PSAs were granted in 2020 and the fair value of the awards on grant date was$1.5 million .
Supplemental RSUs: 1,267,912 supplemental RSU awards, 100% of which are
time-vesting RSUs, were granted to management on
with the IPO and are subject to vesting as follows: 25% vested at grant
(ii) date, 25% will vest on the second anniversary of the grant date, subject to
continued service and 50% will vest on the third anniversary of the grant
date, subject to continued service. The fair value of the supplemental RSUs
at grant date was
Founders grant awards: 250,000 founders grant awards in the form of
(iii) time-vesting RSUs were granted on
grants was
grant date.
Non-employee Director RSUs: In 2020, 106,460 RSUs with a fair value of
million were granted to non-employee directors. In 2019, 33,839 RSUs, 26,399
(iv) of which were granted on
November 15, 2019 , with a fair value of$0.5 million were granted to non-employee directors. These awards were fully vested on grant date. Pre-IPO RSUs: 668,170 RSUs initially granted under the 2010 Plan were
(v) converted into RSUs based on shares of the Company's common stock upon the
consummation of the IPO merger of PGHL into PGI.
Stock-based compensation expense was$8.9 million ,$8.6 million and$0.9 million for the years endedDecember 31, 2020 , 2019 and 2018, respectively. The tax benefit recognized for the same was$1.9 million ,$1.8 million and$0.2 million for the years endedDecember 31, 2020 , 2019 and 2018, respectively.
Vested RSUs awaiting conversion into common stock were 489,439 for the year
ended
The Company began recognizing stock-based compensation expense relating to its
2019 Plan upon its inception and initial stock grants in
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The following table summarizes equity award transactions for the 2019 Plan for
the years ended
Weighted
Average Grant
Number of Date Fair Value
Shares Per Share
Unvested at December 31, 2018 55,264 $ 11.09
Granted in 2019 1,732,869 14.00
Vested in 2019 (406,081) 13.61
Forfeited in 2019 (92,656) 14.00
Unvested at December 31, 2019 1,289,396 14.00
Granted in 2020 593,147 12.30
Vested in 2020 (134,001) 9.96
Forfeited in 2020 (43,101) 13.58
Unvested at December 31, 2020 1,705,441 $ 13.46
As of
2019 Employee Stock Purchase Plan
OnJuly 24, 2019 , the 2019 Employee Stock Purchase Plan (the "2019 ESPP") became effective immediately prior to the effectiveness of the registration statement filed in connection with the IPO. A total of 1,000,000 shares of the Company's common stock are reserved and available for sale under the 2019 ESPP. The compensation committee of the Board of Directors administers the 2019 ESPP and has full authority to interpret the terms of the 2019 ESPP. The 2019 ESPP is a shareholder-approved plan under which substantially all employees may purchase the Company's common stock through payroll deductions at a price equal to 90% of the fair market value of the stock on the purchase date at the end of the offering period. An employee's payroll deductions under the Purchase Plan are limited to 15% of the employee's compensation and employees may not purchase more than$25,000 of stock during any calendar year.
Dividend declarations
We did not declare any dividends in the years ended
Investment portfolio
Our cash and invested assets consist of debt securities, cash and cash equivalents, short-term investments and alternative investments.
AtDecember 31, 2020 , the majority of the portfolio, or$2.2 billion , was comprised of securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. Also included in our investments were$348.3 million of alternative investments carried at fair value. Our securities, including cash equivalents, had a weighted average duration of 4.8 years and an average rating of "A" atDecember 31, 2020 . 81 Table of Contents
At
December 31, 2020 December 31, 2019
Estimated % of Total Estimated % of Total
Amortized Cost Fair Value Fair Value Amortized Cost Fair Value Fair Value
($ in thousands)
Fixed and floating rate
securities $ 1,905,891 $ 2,008,210 82.3 % $ 1,848,964 $ 1,891,148 86.3 %
Alternatives
available-for-sale 253,852 257,847 10.6 150,439 149,534 6.8
Total fixed maturity
securities 2,159,743 2,266,057 92.9 1,999,403 2,040,682 93.1
Other investments:
Commercial levered loans 12,308 12,180 0.5 14,069 13,950 0.6
Bond exchange-traded funds 44,679 44,882 1.8 - - -
Non-redeemable preferred
stock securities 6,541 7,049 0.3 - - -
Limited partnerships and
limited liability companies 90,468 90,468 3.7 66,660 66,660 3.0
Short-term investments 154 154 0.0 43,873 43,873 2.0
Total other investments 154,150 154,733 6.3 124,602 124,483 5.6
Total investments 2,313,893 2,420,790 99.2 2,124,005 2,165,165 98.7
Cash, cash equivalents, and
restricted cash 19,603 19,603 0.8 27,497 27,497 1.3
Total $ 2,333,496 $ 2,440,393 100.0 % $ 2,151,502 $ 2,192,662 100.0 %
The table below presents the credit quality of total fixed maturity securities
at December 31, 2020 and 2019, as rated by Standard & Poor's Financial Services,
LLC ("Standard & Poor's") or Equivalent Designation:
December 31, 2020 December 31, 2019
Estimated % of Total Estimated % of Total
Standard & Poor's or Equivalent Designation Fair Value Fair Value Fair Value Fair Value
($ in thousands)
AAA $ 192,038 8.5 % $ 219,696 10.8 %
AA 543,875 24.0 356,924 17.5
A 679,409 30.0 719,394 35.3
BBB 662,816 29.2 563,680 27.6
Below BBB/Not rated 187,919 8.3 180,988 8.9
Total $ 2,266,057 100.0 % $ 2,040,682 100.0 %
The table below presents the credit quality of total fixed maturity securities
at December 31, 2020 and 2019, either rated below BBB or not rated by Standard &
Poor's and their National Association of Insurance Commissioners ("NAIC")
designation:
December 31, 2020
NAIC Designation (Estimated Fair Value)
Standard & Poor's or Equivalent
Designation 1 2 3 4 5 6 Total
($ in thousands)
BB $ 4,402 $ 31,031 $ 52,667 $ 874 $ 482 $ - $ 89,456
B 5,081 510 3,779 6,574 - - 15,944
CCC 32,089 - 681 237 2,408 - 35,416
CC or lower 24,138 - - 187 - 22,779 47,103
Total $ 65,710 $ 31,541 $ 57,127 $ 7,872 $ 2,890 $ 22,779 $ 187,919
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December 31, 2019
NAIC Designation (Estimated Fair Value)
Standard & Poor's or Equivalent
Designation 1 2 3 4 5 6 Total
($ in thousands)
BB $ 11,533 $ - $ 60,917 $ 2,516 $ - $ - $ 74,966
B 698 - 111 12,691 - - 13,500
CCC 33,893 - - - - - 33,893
CC or lower 35,590 32 - - - 23,007 58,629
Total $ 81,714 $ 32 $ 61,028 $ 15,207 $ - $ 23,007 $ 180,988 The amortized cost and fair value of our available-for-sale investments in fixed maturity securities presented by contractual maturity as ofDecember 31, 2020 and 2019, were as follows: December 31, 2020 December 31, 2019 Amortized Estimated % of Total Amortized Estimated % of Total Cost Fair Value Fair Value Cost Fair Value Fair Value ($ in thousands) Due in one year or less$ 103,243 $ 104,316 4.6 %$ 99,035 $ 99,326 4.9 % Due after one year through five years 628,897 657,996 29.1 679,649 692,219 33.9 Due after five years through ten years 522,749 561,775 24.8 507,803 523,276 25.6 Due after ten years 311,799 332,195 14.7 157,628 160,322 7.9 Government agency securities 30,446 31,007 1.4 - - - Asset-backed securities 54,989 55,258 2.4 73,068 73,582 3.6 Collateralized loan obligations 140,615 139,126 6.1 181,704 179,549 8.8 Commercial mortgage backed securities 111,313 117,960 5.2 95,810 97,526 4.8 Residential mortgage backed securities- non-agency 109,110 116,136 5.1 62,343 71,610 3.5 Residential mortgage backed securities - agency 146,582 150,288 6.6 142,363 143,272 7.0 Total fixed maturity securities$ 2,159,743 $ 2,266,057 100.0 %$ 1,999,403 $ 2,040,682 100.0 % 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$489.8 million atDecember 31, 2020 . This includes$76.9 million of funds in trust for the mutual benefit of our insurance companies due to participation in our intercompany pooling agreement. Restricted investments decreased 15.2%, or$88.1 million , when compared toDecember 31, 2019 primarily due to the closure of three collateral trust accounts in the third and fourth quarter, offset by an increase in reinsurance collateral and state deposits, and market appreciation from fixed maturity securities during the year. 83
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Off-balance sheet arrangements
We do not have any material off-balance sheet arrangements as of
As part of the 2017 sale transaction to divest ourU.K. business, we entered into Aggregate Stop-Loss and 100% Quota Share reinsurance agreements as reinsurer, with Lloyd's Syndicate 1110 as our reinsured and committed to fund Lloyd's Syndicate 1110's "Funds At Lloyd's" requirements untilJune 30, 2020 . The facility has a principal amount of £17.7 million and contains certain covenants that require us, among other items, to maintain a minimum net worth, to remain within maximum leverage ratios, meet a minimum RBC ratio and maintain specified liquidity levels. The requirement for us to provide the Funds At Lloyd's were expected to terminate byJune 30, 2020 . However, the buyer disputed its contractual obligation with respect to substituting our Funds At Lloyd's at that time. InFebruary 2021 , aU.K. court granted summary judgment in our favor requiring the buyer to substitute our Funds At Lloyds; however, such judgment is subject to appeal by the buyer.
Reconciliation of Non-GAAP Financial Measures
Reconciliation of underwriting income
Underwriting (loss) income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting (loss) income represents the pre-tax profitability of our insurance operations and is derived by subtracting losses and LAE and underwriting, acquisition and insurance expenses from net earned premiums. We use underwriting (loss) 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 (loss) income should not be considered in isolation or viewed as a substitute for net income calculated in accordance with GAAP, and other companies may calculate underwriting (loss) income differently.
Net income from continuing operations for the years ended
Years Ended December 31
($ in thousands) 2020 2019 2018Net income from continuing operations$ 27,750 $ 45,494 $
53,729
Income tax expense 10,740 12,137
13,389
Income from continuing operations before taxes 38,490 57,631
67,118
Net investment income 73,021 68,897
55,971
Realized investment gains (losses), net 4,980 770
(1,557)
Interest and other expense, net 31,751 28,408
11,704 Underwriting (loss) income$ (7,760) $ 16,372 $ 24,409
Reconciliation of adjusted operating income
Adjusted operating income is a non-GAAP financial measure that we use as an
internal performance measure in the management of our operations because we
believe it gives our management and other users of our financial information
useful insight into our results of operations and underlying business
performance, by excluding items that are not part of our underlying
profitability drivers or likely to re-occur in the foreseeable future. Adjusted
operating income should not be considered in isolation or viewed as a substitute
for our net income calculated in accordance with GAAP. Other companies may
calculate adjusted operating income differently.
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Net income from continuing operations for the years ended
Years Ended December 31
($ in thousands) 2020 2019 2018Net income from continuing operations$ 27,750 $ 45,494 $ 53,729 Income tax expense 10,740 12,137
13,389
Income from continuing operations before taxes 38,490 57,631
67,118
Other expense 17,739 16,151
-
Realized investment (gains) losses, net (4,980) (770)
1,557
Adjusted operating income before taxes 51,249 73,012
68,675
Less: income tax expense on adjusted operating income 10,921 15,376 13,389 Adjusted operating income$ 40,328 $ 57,636 $ 55,286 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. 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 Note 2. Summary of Significant Accounting Policies in Item 8. Financial Statement and Supplementary Data on this Annual Report on Form 10-K.
Reserves for unpaid losses and LAE
The reserves for unpaid losses and LAE are the largest and most complex estimate in our consolidated balance sheets. The reserves for unpaid losses and LAE 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 balance sheet date. The loss reserves are not discounted, with the exception of certain workers' compensation claims loss reserves. The amounts of discount related to workers' compensation reserves were$48.2 million ,$47.4 million and$37.0 million atDecember 31, 2020 , 2019 and 2018, respectively. Those estimates are based on our historical information blended with industry and peer group information and our estimates of future trends in variable factors such as loss severity, loss frequency and other factors such as inflation. We review our estimates quarterly and adjust them as necessary as experience develops or as new information becomes known to us. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates. Accordingly, the ultimate settlement of losses and LAE may vary significantly from the estimate included in our consolidated financial statements. We categorize our reserves for unpaid losses and LAE into two types: case reserves and incurred but not reported ("IBNR"). Our gross reserves for losses and LAE atDecember 31, 2020 were$1.6 billion , and of this amount, 69.0% related to IBNR. Our net reserves for losses and LAE atDecember 31, 2020 were$1.4 billion , and of this amount, 69.1% related to IBNR. Our gross reserves for losses and LAE atDecember 31, 2019 were$1.5 billion , and of this amount, 70.6% related to IBNR. Our net reserves for losses and LAE atDecember 31, 2019 were$1.3 billion , and of this amount, 69.4% related to IBNR. 85 Table of Contents Our gross reserves for losses and LAE atDecember 31, 2018 were$1.4 billion , and of this amount, 69.8% related to IBNR. Our net reserves for losses and LAE atDecember 31, 2018 were$1.2 billion , and of this amount, 67.8% related to IBNR.
The following tables present our gross and net reserves for unpaid losses and
LAE at
December 31, 2020
Gross % of Total Net % of Total
($ in thousands)Case reserves$ 497,426 31.0 %$ 442,469 30.9 % IBNR 1,105,476 69.0 989,912 69.1 Total$ 1,602,902 100.0 %$ 1,432,380 100.0 % December 31, 2019 Gross % of Total Net % of Total ($ in thousands) Case reserves$ 447,736 29.4 %$ 406,375 30.6 % IBNR 1,073,912 70.6 921,321 69.4 Total$ 1,521,648 100.0 %$ 1,327,696 100.0 % December 31, 2018 Gross % of Total Net % of Total ($ in thousands) Case reserves$ 422,231 30.2 %$ 390,025 32.2 % IBNR 974,581 69.8 821,492 67.8 Total$ 1,396,812 100.0 %$ 1,211,517 100.0 %
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. We utilize the services of two Third Party Administrators ("TPAs") to
assist in the adjustment of workers' compensation claims and one TPA to assist
in the adjustment of builders' risk claims within the Real Estate customer
segment. Our TPAs are not affiliated with our distribution partners. Other than
in limited cases, our managing general underwriters ("MGUs") do not handle
claims. Our internal claims managers oversee TPA and MGU claims-related
activities and monitor their individual claim handling activities to prescribed
ProSight standards.
Our IBNR reserves are developed in accordance with Actuarial Standards of
Practice promulgated by the American Academy of Actuaries . Our reserve review
utilizes several accepted loss reserving methods to arrive at our best estimate
of loss reserves. We give consideration to the relative strengths and weaknesses
of each of the methods in deriving our actuarial best estimate of the
liabilities. Where we have limited years of loss experience compared to the
period over which we expect losses to be reported, we use industry and/or
peer-group data in addition to our own data as a basis for selecting the
parameters underlying our reserving methods. We monitor loss emergence monthly.
We carefully consider other internal or external factors such as underwriting,
claims handling, economic, or environmental changes that could adversely affect
the accuracy of the assumptions underlying our standard actuarial methods and
when necessary we will adjust these assumptions, methods, and/or procedures to
ensure that they appropriately reflect these changing conditions. The average
duration of loss reserves is 5.6 years, as of December 31, 2020 .
Our Reserve Committee includes our Chief Actuary, Chief Executive Officer, Chief
Financial Officer, Chief Underwriting and Risk Officer, and Chief Claims
Officer. The Reserve Committee meets quarterly to review the actuarial reserving
recommendations made by the Chief Actuary. In establishing the actuarial
recommendation for the reserves for losses and LAE, our actuary's estimate of
the current Initial Expected Loss Ratio ("IELR") is derived from the pricing
IELR at the niche level, policy year, and reserving group. Our reserve estimate
is derived from our proprietary reserving
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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 external actuarial firm to perform an annual loss reserve analysis. The independent actuarial firm is not involved in the establishment and recording of our loss reserve. The independent actuarial firm prepares its own estimate of our reserves for loss and LAE, and we review their estimate to the reserves for losses and LAE reviewed and approved by the Reserve Committee. The table below quantifies the impact of potential reserve deviations from our carried reserve atDecember 31, 2020 . We applied sensitivity factors to incurred losses for the three most recent accident years and to the carried reserve for all prior accident years combined. In the selection of the volatility factors, we have considered the potential impact of changes in current loss trends, pricing trends, and other actuarial reserving assumptions. The aggregate development depicted in the sensitivity analysis is consistent with the average development in recent calendar periods and a reasonable depiction of the potential volatility of the reserve estimates for the current calendar period. We believe that potential changes such as these would not have a material impact on our liquidity. December 31, 2020 Potential Impact on 2020 Net Ultimate Loss Net Ultimate Accident and ALAE Incurred Losses Net Loss and Pre-tax Stockholders' Sensitivity Year Sensitivity Factor and ALAE ALAE Reserve income Equity(1) ($ in thousands) Sample increases 2020 4.0 % $ 430,179$ 363,953 $ (17,207) $ (13,594) 2019 3.0 % 460,080 305,838 (13,802) (10,904) 2018 2.0 % 403,545 239,667 (8,071) (6,376) Prior 1.0 % 516,967 (5,170) (4,084) Sample decreases 2020 (4.0) % 430,179$ 363,953 $ 17,207 $ 13,594 2019 (3.0) % 460,080 305,838 13,802 10,904 2018 (2.0) % 403,545 239,667 8,071 6,376 Prior (1.0) % 516,967 5,170 4,084
In 2020, the effective rate was consistent with the
equity.
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 on unresolved
claims. We reflect favorable or unfavorable development of loss reserves in the
results of operations in the period the estimates are changed.
During the year ended December 31, 2020 the Company's reserve for unpaid losses
and loss adjustment expenses for accident years 2019 and prior developed
unfavorably by $0.7 million driven by unfavorable development of $21.8 million
in General Liability, $16.8 million unfavorable development in Commercial
Multiple Peril and $8.1 million unfavorable development in Commercial Auto,
partially offset by $36.5 million of favorable development in Workers'
Compensation and $9.5 million of favorable development in All Other lines. In
addition, the Company incurred $15.2 million of losses and loss adjustment
expenses related to premium adjustments earned during the year ended December
31, 2020 , attributable to accident years 2019 and 2018. The unfavorable
development in General Liability, Commercial Multiple Peril and Commercial Auto
related to 2013 through 2017 accident years due largely to increased severities
in runoff components. The favorable development in Workers' Compensation derived
from lower than expected claims severity across all customer segments primarily
in accident years 2015 through 2018. The favorable development in All Other
lines was driven mostly by Ocean Marine .
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During the year endedDecember 31, 2019 our reserve for unpaid losses and loss adjustment expenses for accident years 2018 and prior developed unfavorably by$3.2 million driven primarily by unfavorable development of$16.4 million in Commercial Multiple Peril and$11.3 million in General Liability, partially offset by favorable development of$22.8 million in Workers' Compensation. The unfavorable development in Commercial Multiple Peril was primarily from theMedia and Entertainment customer segment in accident years 2013 through 2016 from a longer development trend than that underlying the historical performance of premises liability. The unfavorable development in General Liability primarily related to 2013 through 2016 accident years due to increased severities in the Real Estate customer segment and run off components within the Other customer segment. The favorable development in Workers Compensation derived from lower than expected claims severity across all customer segments primarily in accident years 2013 through 2015 and accident year 2017. In addition, the Company incurred$14.9 million of loss and loss adjustment expenses related to premium earned during the year endedDecember 31, 2019 , attributable to accident year 2018. During the year endedDecember 31, 2018 , our reserve for unpaid losses and loss adjustment expenses for accident years 2017 and prior developed favorably by$5.0 million . Favorable development of$5.0 million for the year endedDecember 31, 2018 , was driven primarily by favorable development of$14.4 million in Workers' Compensation,$15.6 million in Commercial Auto and$4.1 million from Marine Liability within the All Other Lines category, partially offset by$16.5 million adverse development in General Liability and$12.2 million adverse development in Commercial Multiple Peril. Lower than expected claim severity was the main driver of the favorable development in Workers' Compensation of which$6.2 million came from 2014, 2015 and 2016 accident years in primary Workers' Compensation and$8.2 million came from 2014 and 2015 accident years in excess Workers' Compensation. Favorable development in Commercial Auto was driven mainly by the 2013, 2015 and 2016 accident years where severity trends of the previous two calendar year periods improved during 2018 across multiple niches. Marine Liability is a low frequency, high severity line of business and as a result, development often varies significantly from the average expectation. The$16.5 million adverse development in General Liability primarily related to 2013, 2014 and 2015 accident years due to increased severities in the Construction customer segment from reduced effectiveness of risk transfer from our general contractor insureds to subcontractors. The$12.2 million in adverse development in Commercial Multiple Peril is primarily from theMedia and Entertainment customer segment driven by a longer development trend than that underlying the historic performance of premises liability. Investments Fair value measurements The Company has established a framework for valuing financial assets and financial liabilities. The framework is based on a hierarchy of inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company's significant market assumptions. The standard describes three levels of inputs that may be used to measure fair value and categorize the assets and liabilities within the hierarchy: Level 1 - Fair value is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets or liabilities. These prices generally provide the most reliable evidence and are used to measure fair value whenever available. Active markets are defined as having the following for the measured asset/liability: (i) many transactions; (ii) current prices; (iii) price quotes not varying substantially among market makers; (iv) narrow bid/ask spreads; and (v) most information publicly available. Level 2 - Fair value is based on significant inputs, other than Level 1 inputs, that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, nonbinding quotes in markets that are not active for identical or similar assets and other market observable inputs (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.). 88 Table of Contents Level 3 - Fair value is based on at least one or more significant unobservable inputs that are supported by little or no market activity for the asset. These inputs reflect the Company's understanding about the assumptions market. The Company generally obtains valuations from third-party pricing services and/or security dealers for identical or comparable assets or liabilities by obtaining nonbinding broker quotes (when pricing service information is not available) in order to determine an estimate of fair value. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third-party market participant would be willing to pay in an arm's-length transaction. Credit Losses The Company analyzes fixed maturity securities in an unrealized loss position for credit losses if they meet the following criteria: (i) they are trading in a significant loss position; (ii) failure of the issuer of the security to make scheduled interest or principal payments; (iii) there have been negative credit events with respect to the issuer; or (iv) there have been negative current events surrounding an issuer or the environment in which an issuer operates For fixed maturity securities in an unrealized loss position that require a credit loss analysis, the Company estimates a present value of expected cash flows. If the results of the cash flow analysis indicate that the Company will not recover the full amount of its amortized cost basis, the Company records a credit loss for the excess of amortized cost over the present value of expected cash flows, not to exceed the unrealized loss. Changes in the credit loss allowance are recognized through realized investment gains, net on the consolidated statements of operations.
Deferred income taxes
We record deferred income taxes as assets or liabilities on our balance sheet to reflect the net tax effect of the temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and their respective tax bases. Deferred tax assets and liabilities are measured by applying enacted tax rates in effect for the years in which such differences are expected to reverse. Our deferred tax assets result from temporary differences primarily attributable to loss reserves, unearned premium reserves and net adjusted operating losses from prior periods. Our deferred tax liabilities result primarily from unrealized gains in the investment portfolio and deferred acquisition costs. We review the need for a valuation allowance related to our deferred tax assets each quarter. We reduce our deferred tax assets by a valuation allowance when we determine that it is more likely than not that some portion or all of the deferred tax assets will not be realized. The assessment of whether or not a valuation allowance is needed requires us to use significant judgment. See Note 12 Income Taxes in Item 8. Financial Statements and Supplementary Data on this Annual Report on Form 10-K for further discussion regarding our deferred tax assets and liabilities. OnDecember 22, 2017 , the President ofthe United States signed into law the TCJA, which significantly changedU.S. tax law by, among other things, lowering corporate income tax rates from 35% to 21%. TheSEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application ofU.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. The Company has recognized a tax impact of$6.1 million related to the transition adjustment for loss discounting which has been included in its components of deferred tax assets and liabilities as part of its consolidated financial statements for the year endedDecember 31, 2020 . The ultimate impact may differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the TCJA. The accounting is expected to be complete when theU.S. Treasury issues further guidance.
Reinsurance
The Company's insurance subsidiaries participate in various reinsurance agreements. The Company uses various types of reinsurance, including quota share, excess of loss and facultative agreements, to spread the risk of loss among several reinsurers and to limit its exposure from losses on any one occurrence. Any recoverable due from reinsurers is
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recorded in the period in which the related gross liability is established. Reinsurance reinstatement premiums are incurred by the Company based upon the provisions of the reinsurance contracts. In the event of a loss, the Company may be obligated to pay additional reinstatement premiums under its excess of loss reinsurance treaties. In such instances, the respective reinstatement premium is expensed immediately. The Company accounts for reinsurance receivables and prepaid reinsurance premiums as assets. The Company maintains an allowance for doubtful accounts, which includes amounts in dispute, amounts due from insolvent or financially impaired companies and other balances deemed uncollectible. Management continually reviews and updates such estimates. Profit commission revenue derived from reinsurance transactions is recognized when such amounts become earned as provided in the treaties with the respective reinsurers.
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