Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes included elsewhere in this Annual Report. The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" that could cause actual results to differ materially from those expressed in, or implied by, those forward-looking statements. See "Forward-Looking Statements."
Year ended December 31, 2021 compared to year ended December 31, 2020
For a comparison of years ended December 31, 2021 and December 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended December 31, 2021, which was filed with the SEC on February 25, 2022.
Overview
Founded in 2009, we are an established and growing specialty insurance company. We focus exclusively on the E&S market in the U.S., where we use our underwriting expertise to write coverages for hard-to-place, small- to medium-sized business risks and personal lines risks. We market and sell these insurance products in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands primarily through a network of independent insurance brokers. We have an experienced and cohesive management team that has an average of over 30 years of relevant experience. Many of our employees and members of our management team have also worked together for decades at other E&S insurance companies.
We have one reportable segment, our Excess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2022, the percentage breakdown of our gross written premiums was 77.2% casualty and 22.8% property. Our commercial lines offerings include commercial property, small business casualty, excess casualty, construction, general casualty, allied health, products liability, life sciences, professional liability, energy, management liability, entertainment, small property, environmental, health care, public entity, inland marine, commercial auto, aviation, product recall and ocean marine.We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 2.8% of our gross written premiums in 2022.
Our goal is to deliver long-term value for our stockholders by growing our business and generating attractive returns. We seek to accomplish this by generating consistent and strong underwriting profits while managing our capital prudently. We believe that we have built a company that is entrepreneurial and highly efficient, using our proprietary technology platform and leveraging the expertise of our highly-experienced employees in our daily operations. We believe our systems and technology are at the digital forefront of the insurance industry, allowing us to quickly collect and analyze data, thereby improving our ability to manage our business and reducing response times for our customers. We believe that we have differentiated ourselves from our competitors by effectively leveraging technology, vigilantly controlling expenses and maintaining control over our underwriting and claims management.
COVID-19
We have been closely monitoring the impact of the COVID-19 pandemic and related economic effects on all aspects of our business, including its impact on premium volume, losses and the fair value of our investment portfolio. Consistent with 2021, the Company's results of operations, financial position and cash flows were not materially impacted by COVID-19 and the related economic effects during the year ended December 31, 2022.
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Components of Our Results of Operations
Gross written premiums
Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
•New business submissions;
•Conversion of new business submissions into policies;
•Renewals of existing policies; and
•Average size and premium rate of bound policies.
We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is ceded to third-party reinsurers under our reinsurance agreements.
Ceded written premiums
Ceded written premiums are the amount of gross written premiums ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential large losses. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premiums is impacted by the level of our gross written premiums and any decision we make to increase or decrease retention levels.
Losses and loss adjustment expenses
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
•Frequency of claims associated with the particular types of insurance contracts that we write;
•Trends in the average size of losses incurred on a particular type of business;
•Mix of business written by us;
•Changes in the legal or regulatory environment related to the business we write;
•Trends in legal defense costs;
•Wage inflation;
•Social inflation;
•Inflation in material costs, and
•Inflation in medical costs.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
Underwriting, acquisition and insurance expenses
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs also include deferred underwriting expenses that are directly related to the successful acquisition of policies. The amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the policy life. Other
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underwriting expenses represent the general and administrative expenses of our insurance business such as employment costs, telecommunication and technology costs, and legal and auditing fees.
Net investment income
Net investment income is an important component of our results of operations. We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed-maturity securities, and may also include equity securities, investments in real estate, cash equivalents, and short-term investments. The principal factors that influence the level of net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value), the size of our investment portfolio is mainly a function of our invested equity capital combined with premiums we receive from our insureds less payments on policyholder claims. Net investment income also includes rental income and depreciation expense from our real estate investment property.
Change in fair value of equity securities
Change in fair value of equity securities represents the increase or decrease in the fair value of equity securities held during the period.
Net realized investment gains (losses)
Net realized investment gains (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.
Income tax expense
Currently, substantially all of our income tax expense is comprised of federal income taxes. Our insurance subsidiary, Kinsale Insurance Company, is not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes but have not generated any material taxable income to date. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Key metrics
We discuss certain key metrics, described below, which we believe provide useful information about our business and the operational factors underlying our financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as net income, excluding net investment income, net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other income, other expenses and income tax expense. See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income.
Net operating earnings is a non-GAAP financial measure. We define net operating earnings as net income excluding the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes and change in allowance for credit losses on investments, after taxes. See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Loss ratio, expressed as a percentage, is the ratio of losses and loss adjustment expenses to earned premiums, net of the effects of reinsurance.
Expense ratio, expressed as a percentage, is the ratio of underwriting, acquisition and insurance expenses to net earned premiums.
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Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
Return on equity is net income as a percentage of average beginning and ending total stockholders’ equity during the period.
Operating return on equity is a non-GAAP financial measure. We define operating return on equity as net operating earnings expressed as a percentage of average beginning and ending stockholders’ equity during the period. See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Net retention ratio is the ratio of net written premiums to gross written premiums.
Gross investment return is investment income from fixed-maturity and equity securities (and short-term investments, if any), before any deductions for fees and expenses, expressed as a percentage of the average beginning and ending book values of those investments during the period.
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Results of Operations
Year ended December 31, 2022 compared to year ended December 31, 2021
The following table summarizes our results of operations for the years ended December 31, 2022 and 2021:
Year Ended December 31,
($ in thousands) 2022 2021 Change % Change
Change in allowance for credit losses on investments (366) — (366) NM
Operating return on equity (2) 25.0 % 20.8 %
NM - Percentage change is not meaningful
(1) Underwriting income is a non-GAAP financial measure. See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income.
(2) Net operating earnings and operating return on equity are non-GAAP financial measures. Net operating earnings is defined as net income excluding the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes, and change in allowance for credit losses on investments, after taxes. Operating return on equity is defined as net operating earnings expressed as a percentage of average beginning and ending total stockholders’ equity during the period. See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
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Net income was $159.1 million for the year ended December 31, 2022 compared to $152.7 million for the year ended December 31, 2021, an increase of $6.5 million, or 4.2%. The increase in net income in 2022 over 2021 was primarily due to strong growth in the business from favorable E&S market conditions and continued rate increases and an increase in investment income year over year driven by higher investment balances. These increases were partially offset by a decline in the fair value of our equity investment portfolio driven by adverse movements in the capital markets during the year and higher catastrophe losses incurred.
Our underwriting income was $175.5 million for the year ended December 31, 2022 compared to $133.6 million for the year ended December 31, 2021, an increase of $41.9 million, or 31.4%. The increase in our underwriting income was due to a combination of premium growth and favorable rate increases from a strong underwriting environment and lower levels of operating expenses relative to premium growth and management's cost control efforts. These increases were offset in part by higher catastrophe losses incurred. The corresponding combined ratios were 77.9% for the year ended December 31, 2022 compared to 77.1% for the year ended December 31, 2021.
Premiums
Gross written premiums were $1.1 billion for the year ended December 31, 2022 compared to $764.4 million for the year ended December 31, 2021, an increase of $337.7 million, or 44.2%. The increase in gross written premiums for the year ended December 31, 2022 over the prior year was due to higher submission activity from brokers and higher rates across most lines of business, resulting from continued favorable conditions in the E&S market. The average premium per policy written by us was $12,400 in 2022 compared to $10,400 in 2021. Excluding our personal lines insurance, which has relatively low premiums per policy written, the average premium per policy written was $14,700 in 2022 compared to $12,900 in 2021. The increase in the average premium per policy written was due to changes in the mix of business and higher rates on bound accounts during 2022 compared to the prior year. Gross written premiums increased across substantially all of our lines of business for the year ended December 31, 2022 and were most notable in the following lines of business:
•Commercial Property, which represented approximately 16.8% of our gross written premiums in 2022, increased by $112.3 million, or 154.8%, for the year ended December 31, 2022 over the prior year;
•Small Business Casualty, which represented approximately 13.6% of our gross written premiums in 2022, increased by $36.8 million, or 32.7%, for the year ended December 31, 2022 over the prior year;
•Excess Casualty, which represented approximately 13.4% of our gross written premiums in 2022, increased by $39.0 million, or 35.9%, for the year ended December 31, 2022 over the prior year;
•Construction, which represented approximately 11.1% of our gross written premiums in 2022, increased by $21.1 million, or 20.8%, for the year ended December 31, 2022 over the prior year, and
•General Casualty, which represented approximately 6.3% of our gross written premiums in 2022, increased by $33.7 million, or 93.6%, for the year ended December 31, 2022 over the prior year.
Net written premiums increased by $276.6 million, or 41.9%, to $936.8 million for the year ended December 31, 2022 from $660.2 million for the year ended December 31, 2021. The increase in net written premiums was largely due to higher gross written premiums for the year ended December 31, 2022. Our net retention ratio was 85.0% for the year ended December 31, 2022 compared to 86.4% for the year ended December 31, 2021. The decrease in the net retention ratio was due to higher premiums ceded under the new commercial property quota share reinsurance treaty, effective June 1, 2022, and a change in the mix of business.
Net earned premiums were $794.1 million for the year ended December 31, 2022 compared to $582.9 million for the year ended December 31, 2021, an increase of $211.2 million, or 36.2%. As previously discussed, the increase was due to growth in gross written premiums in 2022 compared to 2021.
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Loss ratio
Our loss ratio was 57.7% for the year ended December 31, 2022 compared to 55.7% for the year ended December 31, 2021. The increase in the loss ratio for the year ended December 31, 2022 was due primarily to higher catastrophe losses incurred and lower net favorable development of loss reserves from prior accident years as a percentage of earned premiums. During the year ended December 31, 2022, current year incurred losses and loss adjustment expenses included $26.6 million of net catastrophe losses primarily related to Hurricane Ian. During the year ended December 31, 2021, current year incurred losses and loss adjustment expenses included $8.6 million of net catastrophe losses primarily attributable to Hurricane Ida and the winter storms in Texas.
During the year ended December 31, 2022, prior accident years developed favorably by $35.9 million, of which $41.8 million was attributable to the 2020 and 2021 accident years due to lower emergence of reported losses than expected across most lines of business. This favorable development was offset in part by adverse development largely from the 2016 and 2018 accident years due to routine variability in reported losses and modest adjustments in actuarial assumptions.
During the year ended December 31, 2021, loss reserves for prior accident years developed favorably by $32.0 million, of which $33.7 million was attributable to the 2020 accident year and was related to a lower-than-expected levels of reported losses. Although we did not have any significant direct COVID-19 exposure, the related disruption in the court system and the general economy created additional uncertainty in estimating loss reserves in 2020. As a result, accident year 2020 actuarial assumptions were adjusted in 2020 to increase IBNR to account for this additional uncertainty. In 2021, our outlook was more favorable than in the prior year and, based on observed trends, we reevaluated and adjusted certain assumptions for accident year 2020 to reflect the favorable experience. In addition, $3.8 million of favorable development was attributable to accident year 2019 due to reported losses emerging at lower levels than expected. This favorable development was offset in part by adverse development, mostly attributable to the 2016 and 2018 accident years due to modest adjustments in actuarial assumptions.
On an inception-to-date basis as of December 31, 2022, all accident years have developed favorably, with the exception of the 2011 accident year.
The following table summarizes the effect of the factors indicated above on the loss ratios for the years ended December 31, 2022 and 2021:
Year Ended December 31,
Loss ratio:
Current accident year - catastrophe losses 26,618 3.4 % 8,640 1.5 %
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Expense ratio
The following table summarizes the components of the expense ratio for the years ended December 31, 2022 and 2021:
Year Ended December 31,
Commissions incurred:
The expense ratio was 20.2% for the year ended December 31, 2022 compared to 21.4% for the year ended December 31, 2021. The decrease in the expense ratio was due to lower net commissions incurred and lower other underwriting expenses as a percentage of earned premiums. The decrease in the net commissions incurred ratio was largely due to higher ceding commissions resulting from the new commercial property quota share treaty, effective June 1, 2022, and a change in the mix of business. The decrease in the other underwriting expense ratio was primarily due to higher net earned premiums, without a proportional increase in the amount of other underwriting expenses, as a result of management's focus on controlling costs. Direct commissions paid as a percent of gross written premiums was 14.6% for the years ended December 31, 2022 and 2021.
Investing results
Our net investment income increased by 65.2% to $51.3 million for the year ended December 31, 2022 from $31.0 million for the year ended December 31, 2021, primarily due to growth in our investment portfolio balance generated from the investment of strong operating cash flows since December 31, 2021 and higher interest rates relative to the prior year.
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The following table summarizes the components of net investment income, change in the fair value of equity securities, net realized investment gains and change in allowance for credit losses on investments for the years ended December 31, 2022 and 2021:
Year Ended December 31,
Cash equivalents and short-term investments 1,251 12 1,239
Real estate investment income 234 — 234
Change in allowance for credit losses on investments (366) — (366)
The weighted average duration of our investment portfolio, including cash equivalents, was 3.5 years and 4.3 years at December 31, 2022 and 2021, respectively. Our investment portfolio, excluding cash equivalents and unrealized gains and losses, had a gross investment return of 3.0% as of December 31, 2022, compared to 2.5% as of December 31, 2021.
During the year ended December 31, 2022, the decrease in fair value of equity securities of $(27.7) million was comprised of higher unrealized losses related to ETF securities of $(19.6) million and higher unrealized losses related to non-redeemable preferred stock of $(8.1) million. The decrease in the fair value of our ETF and common stock portfolio reflected lower valuations in the broader U.S. stock market during the period. The change in unrealized losses during 2022 attributable to non-redeemable preferred stock reflected a higher interest rate environment.
During the year ended December 31, 2021, the increase in the fair value of equity securities of $22.8 million was comprised of unrealized gains related to ETF securities of $23.2 million and unrealized losses related to non-redeemable preferred stock of $0.4 million. The increase in the fair value of our ETF portfolio largely reflected the performance in the broader domestic stock markets.
We perform quarterly reviews of all available-for-sale securities within our investment portfolio to determine whether the decline in a security's fair value is deemed to be a credit loss. Based on our review, we recorded an allowance for credit losses of $0.4 million for the year ended December 31, 2022. There were no credit losses recorded for the year ended December 31, 2021. See Note 2 of the notes to the consolidated financial statements for further information regarding credit losses.
Income tax expense
Our effective tax rate was approximately 18.6% for the year ended December 31, 2022 compared to 19.1% for the year ended December 31, 2021. The effective tax rate was lower than the federal statutory rate of 21% primarily due to the tax benefits from stock-based compensation and tax-exempt investment income.
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Return on equity
Our return on equity was 22.0% for the year ended December 31, 2022 compared to 23.9% for the year ended December 31, 2021. Operating return on equity was 25.0% for 2022, an increase from 20.8% for 2021. The increase in the operating return on equity was due primarily to growth in the business from favorable market conditions and rate increases and a decrease in average stockholders' equity driven by the decline in the fair value of investments as a result of the higher interest rate environment. These increases were offset in part by higher catastrophe losses incurred during 2022.
Liquidity and Capital Resources
Sources and uses of funds
We are organized as a Delaware holding company with our operations primarily conducted by our wholly-owned insurance subsidiary, Kinsale Insurance, which is domiciled in Arkansas. Accordingly, Kinsale may receive cash through (1) loans from banks, (2) issuance of equity and debt securities, (3) corporate service fees from our insurance subsidiary, (4) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions and (5) dividends from our insurance subsidiary. We may use the proceeds from these sources to contribute funds to Kinsale Insurance in order to support premium growth, reduce our reliance on reinsurance, pay dividends and taxes and for other business purposes.
We receive corporate service fees from Kinsale Insurance to reimburse us for most of the operating expenses that we incur. Reimbursement of expenses through corporate service fees is based on the actual costs that we expect to incur with no mark-up above our expected costs.
We file a consolidated federal income tax return with our subsidiaries, and under our corporate tax allocation agreement, each participant is charged or refunded taxes according to the amount that the participant would have paid or received had it filed on a separate return basis with the Internal Revenue Service.
State insurance laws restrict the ability of Kinsale Insurance to declare stockholder dividends without prior regulatory approval. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. The maximum dividend distribution Kinsale Insurance may make absent the approval or non-disapproval of the insurance regulatory authority in Arkansas is limited by Arkansas law to the greater of (1) 10% of policyholder surplus as of December 31 of the previous year, or (2) net income, not including realized capital gains, for the previous calendar year. The Arkansas statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. The maximum amount of dividends Kinsale Insurance can pay us during 2023 without regulatory approval is $153.3 million. Insurance regulators have broad powers to ensure that statutory surplus remains at adequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. In the future, state insurance regulatory authorities that have jurisdiction over the payment of dividends by Kinsale Insurance may adopt statutory provisions more restrictive than those currently in effect. Kinsale Insurance did not pay dividends to us during 2022. See also "Risk Factors — Risks Related to Our Business and Our Industry — Because we are a holding company and substantially all of our operations are conducted by our insurance subsidiary, our ability to pay dividends depends on our ability to obtain cash dividends or other permitted payments from our insurance subsidiary."
As of December 31, 2022, our holding company had $34.8 million in cash and investments, compared to $14.6 million as of December 31, 2021.
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Management believes there is sufficient liquidity available at the holding company and in its insurance subsidiary, Kinsale Insurance, as well as in its other operating subsidiaries, to meet its operating cash needs and obligations for the next 12 months.
Real Estate Investment
In December of 2022, we acquired real estate property adjacent to our current headquarters for $76.6 million. The property is comprised of two office buildings totaling over 580,000 square feet situated on approximately 29 acres of land. The property is expected to provide flexibility for future expansion of our operations as well as serve as an investment opportunity. The acquisition was funded primarily through a draw down on our revolving credit facility. Concurrent with the purchase of the real estate investment property, the Company entered into two operating lease agreements for office space on the property as the lessor. The terms of these two leases are 5 years and 12 years.
Debt
On July 22, 2022, we entered into a Note Purchase and Private Shelf Agreement (the “Note Purchase Agreement”), which provides for the issuance of senior promissory notes with an aggregate principal amount of up to $150.0 million. Pursuant to the Note Purchase Agreement, on July 22, 2022 we issued $125.0 million aggregate principal amount of 5.15% senior promissory notes (the “Series A Notes”), the proceeds of which were used to fund surplus at Kinsale Insurance Company, refinance indebtedness and for general corporate purposes. See Note 11 for further information regarding the Note Purchase Agreement.
On July 22, 2022, we entered into an Amended and Restated Credit Agreement, which extended the maturity date to July 22, 2027, and increased the aggregate commitment to $100.0 million, with the option to increase the aggregate commitment by $30.0 million, subject to certain conditions. Borrowings under the Amended and Restated Credit Agreement may be used for general corporate purposes (which may include, without limitation, to fund future growth, to finance working capital needs, to fund capital expenditures, and to refinance, redeem or repay indebtedness). See Note 11 for further information regarding the Amended and Restated Credit Agreement.
On July 25, 2022, a portion of the proceeds from the Series A Notes were used to pay off outstanding loans of $43.0 million, plus accrued interest, under our Amended and Restated Credit Agreement.
Shelf registration
In August 2022, we filed a universal shelf registration statement with the SEC that expires in 2025. We can use this shelf registration to issue an unspecified amount of common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements.
In November 2022, we completed an underwritten public offering and sold and issued 155,000 shares of our common stock at a price of $308.30 per share, to the underwriter. We received net proceeds from the offering of $47.5 million, which was used for general corporate purposes, including to fund organic growth.
Cash flows
Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends. We also use cash to pay commissions to brokers, as well as to pay for ongoing operating expenses such as salaries, consulting services and taxes. As described under "—Reinsurance" below, we use reinsurance to manage the risk that we take on our
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policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid.
The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the years ended December 31, 2022 and 2021 were:
Year Ended December 31,
(in thousands)
Cash and cash equivalents provided by (used in):
Change in cash and cash equivalents $ 35,234 $ 43,947
We have historically generated positive operating cash flows allowing our cash and invested assets to grow. The increase in cash provided by operating activities in 2022 compared to 2021 was due primarily to growth in business and the timing of claim payments and reinsurance recoverable balances.
For the year ended December 31, 2022, net cash used in investing activities of $708.6 million reflected growth in our business operations. For the year ended December 31, 2022, funds from operations were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of $713.2 million, and to a lesser extent, municipal bonds of $22.2 million and sovereigns of $16.0 million. During 2022, we received proceeds of $63.1 million from sales of fixed-maturity securities, largely corporate bonds and mortgage- and asset-backed securities and $110.4 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year ended December 31, 2022, purchases of common stocks and ETFs were $10.0 million and $1.5 million, respectively. In addition, net purchases of short-term investments of $40.6 million consisted of U.S. Treasuries and corporate bonds. Net cash used in investing activities also included the purchase of a real estate investment property for $76.6 million in December of 2022 and property and equipment of $6.9 million.
For the year ended December 31, 2021, net cash used in investing activities was $352.0 million. For the year ended December 31, 2021, these funds were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of $633.6 million, and to a lesser extent, municipal bonds of $14.4 million and sovereigns of $6.9 million. During 2021, we received proceeds of $113.0 million from sales of fixed-maturity securities, largely corporate bonds in order to take advantage of favorable valuations. In addition, we received proceeds of $216.1 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year ended December 31, 2021, purchases of ETFs and nonredeemable preferred stock were $2.1 million and $22.7 million, respectively. Net cash used in investing activities included purchases of property and equipment of $5.9 million.
For the year ended December 31, 2022, net cash provided by financing activities was $186.0 million and reflected proceeds of $125.0 million from the issuance of the Series A Notes on July 22, 2022, a portion of which were used to pay off the outstanding loans of $43.0 million under the Amended and Restated Credit Agreement on July 25, 2022, and proceeds of $47.5 million from our equity offering in November 2022. In December 2022, we drew down
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$73.0 million from our revolving credit facility to finance the purchase of our real estate investment property. Financing activities also reflected dividends of $0.52 per common share, or $11.9 million in the aggregate. Proceeds received from our equity compensation plans were $1.1 million, offset by payroll taxes withheld and remitted on restricted stock awards of $3.3 million for the year ended December 31, 2022.
For the year ended December 31, 2021, net cash used in financing activities was $11.1 million and reflected dividends of $0.44 per common share, or $10.0 million in the aggregate. Proceeds received from our equity compensation plans were $1.0 million, offset by payroll taxes withheld and remitted on restricted stock awards of $2.1 million for the year ended December 31, 2021.
Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large losses. Our reinsurance is primarily contracted under quota-share reinsurance treaties and excess of loss treaties. In quota-share reinsurance, the reinsurer agrees to assume a specified percentage of the ceding company's losses arising out of a defined class of business in exchange for a corresponding percentage of premiums, net of a ceding commission. In excess of loss reinsurance, the reinsurer agrees to assume all or a portion of the ceding company's losses, in excess of a specified amount. In excess of loss reinsurance, the premium payable to the reinsurer is negotiated by the parties based on their assessment of the amount of risk being ceded to the reinsurer because the reinsurer does not share proportionately in the ceding company's losses.
For the year ended December 31, 2022, property insurance represented 22.8% of our gross written premiums. When we write property insurance, we buy reinsurance to significantly mitigate our risk to large losses. We use sophisticated computer models to analyze the risk of severe losses from weather-related events and earthquakes. We measure exposure to these catastrophe losses in terms of PML, which is an estimate of what level of loss we would expect to experience in a windstorm or earthquake event occurring once in every 100 or 250 years. We manage this PML by purchasing catastrophe reinsurance coverage. Effective June 1, 2022, we purchased catastrophe reinsurance coverage of $75.0 million per event in excess of our $25.0 million per event retention. Our property catastrophe reinsurance includes a reinstatement provision which requires us to pay reinstatement premiums after a loss has occurred in order to preserve coverage. Including the reinstatement provision, the maximum aggregate loss recovery limit is $150 million and is in addition to the per-occurrence coverage provided by our treaty coverages.
Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to us, and therefore, we established an allowance for credit risk based on historical analysis of credit losses for highly rated companies in the insurance industry. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. As of December 31, 2022, Kinsale Insurance has only contracted with reinsurers with A.M. Best financial strength ratings of "A-" (Excellent) or better. At December 31, 2022, the net reinsurance receivable, defined as the sum of paid and unpaid reinsurance recoverables, ceded unearned premiums less reinsurance payables, from five reinsurers represented 67.8% of the total balance. At December 31, 2022, we recorded an allowance for credit losses of $0.5 million related to our reinsurance balances.
Ratings
Kinsale Insurance has a financial strength rating of "A" (Excellent) from A.M. Best. A.M. Best assigns ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A" (Excellent) is the third highest rating issued by A.M. Best. The "A" (Excellent) rating is assigned to insurers that have, in A.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. See also "Risk Factors — Risks Related to Our Business and Our Industry — A decline in our financial strength rating may adversely affect the amount of business we write."
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The financial strength ratings assigned by A.M. Best have an impact on the ability of the insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that the insurance companies receive. The "A" (Excellent) rating obtained by Kinsale Insurance is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
Contractual obligations and commitments
Reserves for losses and loss adjustment expenses
Reserves for losses and loss adjustment expenses represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. The estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our consolidated financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis due to the uncertainty inherent in the process of estimating such payments.
See Note 7 of the notes to the consolidated financial statements and "—Critical Accounting Estimates" for a discussion of estimates and assumptions related to the reserves for unpaid losses and loss adjustment expenses.
Reinsurance balances recoverable on reserves for losses and loss adjustment expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. The method for determining reinsurance recoverables for unpaid losses and loss adjustment expenses involves reviewing actuarial estimates of gross unpaid losses and loss adjustment expenses to determine the Company's ability to cede unpaid losses and loss adjustment expenses under the Company's existing reinsurance contracts.
See Note 8 to the consolidated financial statements and "—Critical Accounting Estimates" for a discussion of reinsurance recoverables.
Debt
As of December 31, 2022, we had $125 million of 5.15% Series A Senior Notes outstanding, net of debt issuance costs. Principal payments are required annually beginning on July 22, 2030 in equal installments of $25.0 million through July 22, 2034, the maturity date. Interest accrues quarterly and is payable in arrears.
As of December 31, 2022, we had $72.5 million outstanding, net of debt issuance costs, under the Amended and Restated Credit Agreement, which has a maturity of July 22, 2027. Interest on the outstanding amounts is based on 3-month Adjusted Term SOFR plus a margin of 1.625%. Interest accrues over the term of the interest rate and is payable in arrears.
See Note 11 to the consolidated financial statements for further details regarding our debt obligations.
Financial Condition
Stockholders' equity
At December 31, 2022, total stockholders' equity was $745.4 million and tangible stockholders' equity was $742.7 million, compared to total stockholders' equity of $699.3 million and tangible stockholders' equity of $696.5 million at December 31, 2021. The increase in both total stockholders' equity and tangible stockholders' equity in 2022 compared to 2021 was primarily due to profits generated during the period, proceeds from our equity offering in November 2022 and net activity related to stock-based compensation plans. These increases were offset in part by an increase in unrealized losses on available-for-sale investments, net of taxes, due to the higher interest rate environment and dividends declared during 2022. Tangible stockholders’ equity is a non-GAAP financial measure.
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See "—Reconciliation of Non-GAAP Financial Measures" for a reconciliation of stockholders' equity in accordance with GAAP to tangible stockholders' equity.
See Note 9 to the consolidated financial statements for further details regarding our stock-based compensation plans.
Dividend declarations
On February 14, 2022, the Company’s Board of Directors declared a cash dividend of $0.13 per share of common stock. This dividend was paid on March 14, 2022 to all stockholders of record on March 2, 2022.
On May 10, 2022, the Company’s Board of Directors declared a cash dividend of $0.13 per share of common stock. This dividend was paid on June 13, 2022 to all stockholders of record on May 31, 2022.
On August 15, 2022, the Company’s Board of Directors declared a cash dividend of $0.13 per share of common stock. This dividend was paid on September 13, 2022 to all stockholders of record on August 29, 2022.
On November 15, 2022, the Company’s Board of Directors declared a cash dividend of $0.13 per share of common stock. This dividend was paid on December 13, 2022 to all stockholders of record on November 30, 2022.
On February 15, 2023, the Company’s Board of Directors declared a cash dividend of $0.14 per share of common stock. This dividend is payable on March 13, 2023 to all stockholders of record on February 28, 2023.
Investment portfolio
At December 31, 2022, our cash and invested assets of $2.2 billion consisted of fixed-maturity securities, cash and cash equivalents, equity securities, short-term investments and real estate investments. At December 31, 2022, the majority of the investment portfolio was comprised of fixed-maturity securities of $1.8 billion that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on those securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. At December 31, 2022, we also held $152.5 million of equity securities, which were comprised of ETFs, common stocks and non-redeemable preferred stock, $156.3 million of cash and cash equivalents, $76.4 million of real estate investments and $41.3 million of short-term investments. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 3.5 years and an average rating of "AA-" at December 31, 2022. Our investment portfolio, excluding cash equivalents and real estate investments, had a gross investment return of 3.0% as of December 31, 2022, compared to 2.5% as of December 31, 2021.
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At December 31, 2022, the amortized cost and estimated fair value of our fixed-maturity, equity, and short-term investments were as follows:
Amortized Cost Estimated Fair Value % of Total Fair Value
($ in thousands)
Fixed maturities:
Equity securities:
The table below summarizes the credit quality of our fixed-maturity securities as of December 31, 2022, as rated by Standard & Poor’s Financial Services, LLC ("Standard & Poor's") or equivalent designation:
Standard & Poor’s or Equivalent Designation Estimated Fair Value % of Total
($ in thousands)
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The amortized cost and estimated fair value of our available-for-sale investments in fixed-maturity securities summarized by contractual maturity as of December 31, 2022, were as follows:
Amortized Cost Estimated Fair Value % of Fair Value
($ in thousands)
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 $5.9 million and $6.7 million at December 31, 2022 and 2021, respectively.
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Reconciliation of Non-GAAP Financial Measures
Reconciliation of underwriting income
Underwriting income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting income is defined as net income excluding net investment income, the net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other expenses, other income and income tax expense. We use underwriting income as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define underwriting income differently.
Net income for the years ended December 31, 2022 and 2021 reconciles to underwriting income as follows:
Year Ended December 31,
Change in the fair value of equity securities 27,723 (22,812)
Net realized investment gains (1,191) (2,828)
Change in allowance for credit losses on investments 366 —
(1) Other expenses are comprised of corporate expenses not allocated to our insurance operations.
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Reconciliation of net operating earnings
Net operating earnings is defined as net income excluding the effects of the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes, and the change in allowance for credit losses on investments, after taxes. Management believes the exclusion of these items provides a useful comparison of the Company's underlying business performance from period to period. Net operating earnings and percentages or calculations using net operating earnings (e.g., operating return on equity) are non-GAAP financial measures. Net operating earnings should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define net operating earnings differently.
Net income for the years ended December 31, 2022 and 2021 reconciles to net operating earnings as follows:
Year Ended December 31,
Adjustments:
Change in the fair value of equity securities, before taxes 27,723 (22,812)
Income tax (benefit) expense (1) (5,822) 4,791
Change in the fair value of equity securities, after taxes 21,901 (18,021)
Net realized investment gains, before taxes (1,191) (2,828)
Net realized investment gains, after taxes (941) (2,234)
Change in allowance for credit losses on investments, before taxes 366 —
Income tax benefit (1) (77) —
Change in allowance for credit losses on investments, after taxes 289 —
Operating return on equity:
Operating return on equity (4) 25.0 % 20.8 %
(1) Income taxes on adjustments to reconcile net income to net operating earnings use an effective tax rate of 21%.
(2) Computed by adding the total stockholders' equity as of the date indicated to the prior year-end total and dividing by two.
(3) Return on equity is net income expressed as a percentage of average beginning and ending stockholders’ equity during the period.
(4) Operating return on equity is net operating earnings expressed as a percentage of average beginning and ending stockholders’ equity during the period.
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Reconciliation of tangible stockholders' equity
Tangible stockholders’ equity is a non-GAAP financial measure. We define tangible stockholders’ equity as stockholders’ equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders’ equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders’ equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at December 31, 2022 and 2021 reconciles to tangible stockholders' equity as follows:
December 31,
Less: Intangible assets, net of deferred taxes 2,795 2,795
Critical Accounting Estimates
We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities, if any. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the "Notes to Consolidated Financial Statements" included in this Annual Report on Form 10-K.
Reserves for unpaid losses and loss adjustment expenses
The reserves for unpaid losses and loss adjustment expenses are the largest and most complex estimate in our consolidated balance sheet. The reserves for unpaid losses and loss adjustment expenses represent our estimated ultimate cost of all unreported and reported but unpaid insured claims and the cost to adjust these losses that have occurred as of or before the consolidated balance sheet date. As a relatively new company, our historical loss experience is limited. We estimate the reserves using individual case-basis valuations of reported claims and statistical analyses. Those estimates are based on our historical information, industry information and our estimates of future trends in variable factors such as loss severity, loss frequency and other factors such as inflation. We regularly review our estimates and adjust them as necessary as experience develops or as new information becomes known to us. Such adjustments are included in current operations. Additionally, during the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates. Accordingly, the ultimate settlement of losses and the related loss adjustment expenses may vary significantly from the estimate included in our consolidated financial statements.
We categorize our reserves for unpaid losses and loss adjustment expenses into two types: case reserves and reserves for incurred but not reported losses ("IBNR"). Our gross reserves for losses and loss adjustment expenses at December 31, 2022 were $1.2 billion, and of this amount, 85.6% related to IBNR. Our reserves for losses and loss adjustment expenses, net of reinsurance, at December 31, 2022 were $1.1 billion, and of this amount, 87.0% related
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to IBNR. A 5% change in net IBNR reserves would equate to a $46.1 million change in the reserve for losses and loss adjustment expenses at such date, as well as a $36.5 million change in net income, a 4.9% change in both stockholders' equity and tangible stockholders' equity, in each case at or for the year ended December 31, 2022.
The following tables summarize our reserves for unpaid losses and loss adjustment expenses, on a gross basis and net of reinsurance, at December 31, 2022 and 2021:
Gross % of Total Net % of Total
($ in thousands)
Gross % of Total Net % of Total
($ in thousands)
Case reserves are established for individual claims that have been reported to us. We are notified of losses by our insureds or their brokers. Based on the information provided, we establish case reserves by estimating the ultimate losses from the claim, including defense costs associated with the ultimate settlement of the claim. Our claims department personnel use their knowledge of the specific claim along with advice from internal and external experts, including underwriters and legal counsel, to estimate the expected ultimate losses. During the life cycle of a particular claim, as more information becomes available, we may revise our estimate of the ultimate value of the claim either upward or downward. The amount of the individual claim reserve is based on the most recent information available.
Methodology
IBNR reserves are determined using actuarial methods to estimate losses that have occurred but have not yet been reported to us. We principally use the incurred Bornhuetter-Ferguson actuarial method ("BF method") to arrive at our loss reserve estimates for each line of business. This method estimates the reserves based on our initial expected loss ratio and expected reporting patterns for losses. Because we have a limited number of years of loss experience compared to the period over which we expect losses to be reported, we use industry and peer-group data, in addition to our own data, as a basis for selecting our expected reporting patterns. Since the incurred BF method does not directly use reported losses in the estimation of IBNR, it is less sensitive to our level of reported losses than other actuarial methods. This method avoids some of the distortions that could result from a large loss development factor being applied to a small base of reported losses to calculate ultimate losses. However, this method will react more slowly than some other loss development methods if reported loss experience deviates significantly from our expected losses.
We reserve for large catastrophes after an event has occurred. Shortly after an occurrence, we review insured locations exposed to the event, modeled losses for our portfolio, and industry loss estimates for the event. We also consider frequency and severity from early claims reports to determine an appropriate reserve for the catastrophe. These reserves are reviewed frequently to reflect actual reported losses and changes to our estimates are made to reflect the new information.
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Our Reserve Committee consists of our Chief Actuary and other select members of senior management. The Reserve Committee meets quarterly to review the actuarial recommendations made by the Chief Actuary. In establishing the actuarial recommendation for the reserves for losses and loss adjustment expenses, our actuary estimates an initial expected ultimate loss ratio for our statutory lines of business by accident year. Input from our underwriting and claims departments, including premium pricing assumptions and historical experience, is considered by our actuary in estimating the initial expected loss ratios. During each quarter, the Reserve Committee reviews the emergence of actual losses relative to expectations by line of business to assess whether the assumptions used in the reserving process continue to form a reasonable basis for the projection of liabilities for those product lines. Our reserving methodology uses a loss reserving model that calculates a point estimate for our ultimate losses. Although we believe that our assumptions and methodology are reasonable, our ultimate payments may vary, potentially materially, from the estimates we have made.
In addition, we retain an independent actuary annually to review our reserve levels. The independent actuary is not involved in the establishment and recording of our loss reserve. The actuarial consulting firm prepares its own estimate of our reserves for loss and loss adjustment expenses, and we compare their estimate to the reserves for losses and loss adjustment expenses reviewed and approved by the Reserve Committee in order to gain additional comfort on the adequacy of those reserves.
While we believe that loss reserves at December 31, 2022 are adequate, new information, events, or circumstances may result in ultimate losses that are materially greater or less than our estimates. As previously noted, there are many factors that may cause reserves to increase or decrease, particularly those related to catastrophe losses and long-tailed lines of business.
Key assumptions
Expected loss ratios are a key assumption in estimates of ultimate losses for business at an early stage of development. A higher expected loss ratio results in a higher ultimate loss estimate, and vice versa. Assumed loss development patterns are another significant assumption in estimating loss reserves. Accelerating a loss development pattern results in lower ultimate losses, as the estimated proportion of losses already incurred would be higher. The uncertainty in estimating the loss development patterns is generally greater for a company with a relatively limited operating history, therefore, we rely on industry benchmarks to a certain extent when establishing loss reserve estimates.
Each of the impacts described below is estimated individually, without consideration for any correlation among key indicators or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for our reserves in total. For any one reserving line of business, the estimated variation in reserves due to changes in key indicators is a reasonable estimate of possible variation that may occur in the future. The variation discussed is not meant to be a worst-case scenario and, therefore, it is possible that future variation may be greater than the amounts shown below.
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The impact of reasonably likely changes in the two key assumptions used to estimate net loss reserves at December 31, 2022 is as follows:
Development Pattern Expected Loss Ratio
Property 10% lower Unchanged 10% higher
($ in millions)
Unchanged (3.6) — 3.6
Casualty Occurrence 5% lower Unchanged 5% higher
Casualty Claims-Made 5% lower Unchanged 5% higher
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. Refer to Note 7 to the consolidated financial statements for discussion on our reserve development for the years ended December 31, 2022 and 2021.
Fair value measurements
Like other accounting estimates, fair value measurements may be based on subjective information and generally involve uncertainty and judgment. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Fair value hierarchy disclosures are based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. The three levels of the fair value hierarchy are described below:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities traded in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
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Level 3 - Inputs to the valuation methodology are unobservable for the asset or liability and are significant to the fair value measurement.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3). The use of valuation methodologies may require a significant amount of judgment. During periods of financial market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable. We review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities.
Fair values of financial instruments in our investment portfolio are estimated using unadjusted prices obtained by our investment accounting vendor from nationally recognized third-party pricing services, where available. For securities where we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from our investment accounting vendor. We perform several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements at December 31, 2022, including (1) obtaining and reviewing the internal control report from our investment accounting vendor that obtain fair values from third party pricing services, (2) discussing with our investment accounting vendor their process for reviewing and validating pricing obtained from outside pricing services and (3) reviewing the security pricing received from our investment accounting vendor and monitoring changes in unrealized gains and losses at the individual security level.
Investment securities are subject to fluctuations in fair value due to changes in issuer-specific circumstances, such as credit rating, and changes in industry-specific circumstances, such as movements in credit spreads based on the market’s perception of industry risks. In addition, fixed maturities are subject to fluctuations in fair value due to changes in interest rates. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security.
Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large losses. Reinsurance refers to an arrangement in which a company called a reinsurer agrees in a contract (often referred to as a treaty) to assume specified risks written by an insurance company (known as a ceding company) by paying the insurance company all or a portion of the insurance company's losses arising under specified classes of insurance policies in return for a share in premiums.
Reinsurance recoverables recorded on insurance losses ceded under reinsurance contracts are subject to judgments and uncertainties similar to those involved in estimating gross loss reserves. In addition to these uncertainties, our reinsurance recoverables may prove uncollectible if the reinsurers are unable or unwilling to perform under the reinsurance contracts. In establishing our reinsurance allowance for credit losses, we evaluate the financial condition of our reinsurers and monitor concentration of credit risk arising from our exposure to individual reinsurers. To determine if an allowance is necessary, we consider, among other factors, published financial information, reports from rating agencies, payment history, collateral held and our legal right to offset balances recoverable against balances we may owe. Our reinsurance allowance for credit losses is subject to uncertainty and volatility due to the time lag involved in collecting amounts recoverable from reinsurers. Over the period of time that losses occur, reinsurers are billed and amounts are ultimately collected, economic conditions, as well as the operational and financial performance of particular reinsurers may change and these changes may affect the reinsurers’ willingness and ability to meet their contractual obligations to us. It is difficult to fully evaluate the impact of major catastrophic events on the financial stability of reinsurers, as well as the access to capital that reinsurers may have when such
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events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear the collection risk if any reinsurer fails to meet its obligations under the reinsurance contracts. We target reinsurers with A.M. Best financial strength ratings of "A-" (Excellent) or better. Based on our evaluation of the factors discussed above, the allowance for credit losses related to reinsurance balances was $0.5 million at December 31, 2022.
Recent Accounting Pronouncements
Refer to Note 1 – "Summary of significant accounting policies" of the Notes to Consolidated Financial Statements for further discussion.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as the result of changes in interest rates, equity prices, foreign currency exchange rates and commodity prices. The primary components of market risk affecting us are credit risk, interest rate risk, and equity rate risk. We do not have significant exposure to foreign currency exchange rate risk or commodity risk.
Credit risk
Credit risk is the potential loss resulting from adverse changes in an issuer's ability to repay its debt obligations. We have exposure to credit risk as a holder of fixed-maturity investments. Our risk management strategy and investment policy are designed to primarily invest in debt instruments of high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. At December 31, 2022, our fixed-maturity portfolio, including cash equivalents, had an average rating of "AA-." Additionally, at December 31, 2022, approximately 78.6% of our fixed-maturity portfolio, excluding cash equivalents, was rated "A-" or better by at least one nationally recognized rating organization. Our policy is to invest in investment grade securities and to minimize investments in fixed maturities that are unrated or rated below investment grade. At December 31, 2022, approximately 3.6% of our fixed-maturity portfolio, excluding cash equivalents, was unrated or rated below investment grade. We monitor the financial condition of all of the issuers of fixed-maturity securities in our portfolio.
In addition, we are subject to credit risk with respect to our third-party reinsurers. Although our third-party reinsurers are obligated to reimburse us to the extent we cede risk to them, we are ultimately liable to our policyholders on all risks we have ceded. As a result, reinsurance contracts do not limit our ultimate obligations to pay claims covered under the insurance policies we issue and we might not collect amounts recoverable from our reinsurers. We address this credit risk by selecting reinsurers that have an A.M. Best rating of "A-" (Excellent) or better at the time we enter into the agreement and by performing, along with our reinsurance broker, periodic credit reviews of our reinsurers. If one of our reinsurers suffers a credit downgrade, we may consider various options to lessen the risk of asset impairment, including commutation, novation and letters of credit.
Interest rate risk
Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. The primary market risk to the investment portfolio is interest rate risk associated with investments in fixed-maturity securities and non-redeemable preferred stock. Fluctuations in interest rates have a direct effect on the market valuation of these securities. When market interest rates rise, the fair value of our fixed-maturity securities and non-redeemable preferred stock decreases. Conversely, as interest rates fall, the fair value of our fixed-maturity securities and non-redeemable preferred stock increases. We manage this interest rate risk by investing in securities with varied maturity dates and by managing the duration of our investment portfolio to the duration of our reserves. Expressed in years, duration is the weighted average payment period of cash flows, where the weighting is based on the present value of the cash flows. We set duration targets for our fixed-maturity investment portfolios after consideration of the estimated duration of our liabilities and other factors. The effective weighted-average duration of the portfolio, including cash equivalents, was 3.5 years as of December 31, 2022.
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We had fixed-maturity securities and non-redeemable preferred stock with a fair value of $1.8 billion at December 31, 2022 and $1.4 billion at December 31, 2021 that were subject to interest rate risk. The table below illustrates the sensitivity of the fair value of our fixed-maturity securities and non-redeemable preferred stock to selected hypothetical changes in interest rates as of December 31, 2022 and 2021.
($ in thousands)
Changes in interest rates will have an immediate effect on comprehensive income and stockholders’ equity but will not ordinarily have an immediate effect on net income. Actual results may differ from the hypothetical change in market rates assumed in this disclosure. This sensitivity analysis does not reflect the results of any action that we may take to mitigate such hypothetical losses in fair value.
Equity risk
Equity risk represents the potential economic losses due to adverse changes in equity security prices. A portion of our portfolio is invested in ETF securities and common stock, which have historically produced higher long-term returns relative to fixed-maturity investments. As of December 31, 2022, approximately 5.4% of the fair value of our investment portfolio (including cash and cash equivalents) was invested in ETF securities and common stocks. We manage equity price risk of our equity portfolio primarily through asset allocation techniques.
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Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
Page
Audited Consolidated Financial Statements
Management's Report on Internal Control Over Financial Reporting 66
Reports of Independent Registered Public Accounting Firm 66
Consolidated Balance Sheets as of December 31, 2022 and 2021 70
Notes to Consolidated Financial Statements 74
Schedule V - Valuation and Qualifying Accounts 109
Schedules other than those listed are omitted for the reason that they are not required, are not applicable or that equivalent information has been included in the financial statements or notes thereto or elsewhere herein.
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Management's Report on Internal Control Over Financial Reporting:
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Management does not expect that its internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. The design of any system of internal control over financial reporting also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors. Based on our evaluation, we have concluded that we maintained effective internal control over financial reporting as of December 31, 2022.
KPMG LLP, our independent registered public accounting firm, has issued an opinion on the effectiveness of the Company's internal control over financial reporting, as stated in their report which is included herein.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Kinsale Capital Group, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Kinsale Capital Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedules I, II, and V (collectively, the consolidated financial statements), and our report dated February 24, 2023 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the
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U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Richmond, Virginia
February 24, 2023
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Kinsale Capital Group, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Kinsale Capital Group, Inc. and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedules I, II, and V (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2023 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Reserves for unpaid losses and loss adjustment expenses
As described in Notes 1 and 7 to the consolidated financial statements, the Company records reserves for unpaid losses and loss adjustment expenses (reserves), which represent the Company’s best estimate of ultimate unpaid cost of all reported and unreported losses and loss adjustment expenses incurred prior to the financial statement date. This estimate is based on an actuarial method that uses the Company’s initial expected loss ratios, expected reporting patterns for losses based on historical Company and industry data, and the Company’s actual reported losses and loss adjustment expenses. All estimates are regularly reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. As of December 31, 2022, the Company recorded $1,238.4 million of reserves for unpaid losses and loss adjustment expenses.
We identified the evaluation of the estimation of reserves as a critical audit matter. The evaluation of the Company’s best estimate of reserves required complex auditor judgment due to the inherent uncertainty in the ultimate amount and timing of claim payments and required specialized actuarial skills and knowledge. In addition, the evaluation of
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the ultimate expected loss assumptions required subjective auditor judgment due to the Company’s limited historical claims data and, therefore, also involved a consideration of industry data.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s reserving process. These included internal controls over the actuarial method and certain assumptions used to derive the Company’s best estimate of reserves and the comparison of the Company’s best estimate to the annual independent actuarial reserve estimate performed by an external consulting actuary. We also involved actuarial professionals with specialized skills and knowledge, who assisted in:
•comparing the actuarial methodology the Company used to determine the reserves to generally accepted actuarial standards and practices
•performing independent estimates of reserves for each line of business, using a combination of the Company’s underlying historical claims data and industry data
•developing an independent range of reserves using both the Company’s underlying historical claims data and industry data with respect to future claim reporting amounts and payment patterns and prior year independent selected loss rates
•assessing the position of the Company’s recorded reserves within this independent range in the current year and comparing to its relative position in the prior year.
/s/ KPMG LLP
We have served as the Company’s auditor since 2009.
Richmond, Virginia
February 24, 2023
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KINSALE CAPITAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
(in thousands, except share and per share data)
Assets
Real estate investments, net 76,387 —
Short-term investments 41,337 —
Investment income due and accrued 14,451 7,658
Deferred policy acquisition costs, net of ceding commissions 61,594 41,968
Indefinite-lived intangible assets 3,538 3,538
Liabilities and Stockholders' Equity
Reserves for unpaid losses and loss adjustment expenses $ 1,238,402 $ 881,344
Accounts payable and accrued expenses 31,361 23,250
Contingencies
Stockholders’ equity:
Accumulated other comprehensive (loss) income (134,918) 18,125
See accompanying notes to consolidated financial statements.
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KINSALE CAPITAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
Year Ended December 31,
(in thousands, except per share data)
Revenues:
Change in allowance for credit losses on investments (366) — —
Expenses:
Other comprehensive (loss) income:
Earnings per share:
Weighted-average shares outstanding:
See accompanying notes to consolidated financial statements.
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KINSALE CAPITAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(in thousands, except for per share data)
Adoption of new accounting standard for credit losses, net — — — 78 — 78
Issuance of common stock, net of issuance costs 311 3 56,695 — — 56,698
Stock-based compensation expense — — 3,575 — — 3,575
Restricted shares withheld for taxes (12) — (1,803) — — (1,803)
Dividends declared ($0.36 per share) — — — (8,093) — (8,093)
Other comprehensive income, net of income taxes — — — — 27,862 27,862
Issuance of common stock under stock-based compensation plan 90 — 982 — — 982
Stock-based compensation expense — — 4,844 — — 4,844
Restricted shares withheld for taxes (13) — (2,101) — — (2,101)
Other comprehensive loss, net of income taxes — — — — (23,255) (23,255)
Issuance of common stock, net of issuance costs 155 2 47,496 — — 47,498
Stock-based compensation expense — — 6,678 — — 6,678
Restricted shares withheld for taxes (15) — (3,288) — — (3,288)
Other comprehensive loss, net of income taxes — — — — (153,043) (153,043)
See accompanying notes to consolidated financial statements.
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KINSALE CAPITAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year Ended December 31,
(in thousands)
Operating activities:
Change in allowance for credit losses on investments 366 — —
Change in operating assets and liabilities:
Investing activities:
Purchase of real estate investment (76,623) — —
Sale of property and equipment — — 5,077
Change in short-term investments, net (40,638) — —
Financing activities:
Proceeds from issuance of common stock, net of issuance costs 47,498 — 56,698
Proceeds from borrowings under credit facility 73,000 — 25,700
Proceeds from notes payable 125,000 — —
Repayment of credit facility (43,000) — —
Debt issuance costs (2,381) — —
Common stock issued, stock options exercised 1,090 982 3,622
See accompanying notes to consolidated financial statements.
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Kinsale Capital Group, Inc. and subsidiaries
Notes to consolidated financial statements
Description of business
Kinsale Capital Group, Inc., an insurance holding company, is a Delaware corporation that was formed in 2009 and conducts its operations through its wholly-owned subsidiaries (referred to as "Kinsale" or, with its subsidiaries, the "Company"). Kinsale Capital Group, Inc. writes excess and surplus lines insurance on a non-admitted basis principally through its insurance subsidiary, Kinsale Insurance Company ("Kinsale Insurance"), which is authorized to write business in 50 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands. Kinsale Capital Group, Inc. also markets certain products through its subsidiary, Aspera Insurance Services, Inc. ("Aspera"), an insurance broker.
1.Summary of significant accounting policies
Principles of consolidation
The accompanying consolidated financial statements include the accounts of Kinsale Capital Group, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year's presentation.
Use of estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, if any, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management periodically reviews its estimates and assumptions. These reviews include evaluating the adequacy of reserves for unpaid losses and loss adjustment expenses, allowance for credit losses and uncollectible reinsurance, fair value of investments, as well as evaluating the investment portfolio for credit impairments.
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Short-term investments
Short-term investments are carried at amortized cost, which approximates fair value. Short-term investments have maturities greater than three months but less than one year at the date of purchase.
Fixed-maturity and equity securities
Fixed-maturity securities are classified as available-for-sale and reported at fair value. Unrealized gains and losses on these securities are excluded from earnings but are recorded as a separate component of other comprehensive income and stockholders' equity, net of deferred income taxes.
Equity securities are reported at fair value. Changes in unrealized gains and losses in fair value of these investments are recognized in net income.
The Company regularly reviews all its available-for-sale investments with unrealized losses to assess whether the decline in the fair value is deemed to be a credit loss. See Note 2 for further discussion regarding the determination of credit losses.
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Interest on fixed-maturity securities is credited to earnings as it accrues. Premiums and discounts are amortized or accreted using the effective interest method over the lives of the related fixed maturities, or to the earliest call date for securities purchased at a premium. This method includes an adjustment for estimated principal prepayments, if any, on asset- and mortgage-backed securities. To the extent that the estimated lives of such securities change as a result of changes in estimated prepayment rates, the adjustments are included in net investment income using the retrospective method.
Dividends on equity securities are included in earnings on the ex-dividend date.
Realized gains and losses on disposition of investments are based on specific identification of the investments sold on the trade date.
Real estate investments
Real estate investments include real estate and the related assets purchased for investment purposes. Real estate and the related depreciable assets are carried at cost, net of accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the assets and is included in net investment income. Rental income is recognized on a straight-line basis over the term of the respective lease and is included in net investment income. Land is not depreciated. Real estate is evaluated for impairment when events or circumstances indicate the carrying value of the real estate may not be recoverable.
Intangibles related to real estate investments consist of the value attributable to the acquired in-place leases. These intangibles are amortized to expense over the related lease term of 12 years. Amortization of the intangibles related to real estate investments is reflected in net investment income in the consolidated statement of income. See Note 2 for further details regarding real estate investments.
Reinsurance
Reinsurance premiums, commissions, and ceded unearned premiums on reinsured business are accounted for on a basis consistent with that used in accounting for the original policies issued and the terms of the reinsurance contracts. The Company receives ceding commissions in accordance with certain reinsurance treaties. The ceding commissions are capitalized and amortized as a reduction of underwriting, acquisition and insurance expenses.
Reinsurance recoverables represent paid losses and loss adjustment expenses and reserves for unpaid losses and loss adjustment expenses ceded to reinsurers that are subject to reimbursement under reinsurance treaties. The method for determining reinsurance recoverables for unpaid losses and loss adjustment expenses involves reviewing actuarial estimates of gross unpaid losses and loss adjustment expenses to determine the Company's ability to cede unpaid losses and loss adjustment expenses under the Company's existing reinsurance contracts. This method is continually reviewed and updated and any resulting adjustments are reflected in earnings in the period identified. See Note 8 for a further discussion of the Company's reinsurance program.
Premiums receivable, net
Premiums receivable balances are carried at face value, net of any allowance for credit losses. The allowance for credit losses represents an estimate of amounts considered uncollectible based on the Company’s assessment of the collectability of receivables that are past due. The estimate considers historical loss data, current and future economic conditions and specific identification of collectability concerns where applicable. The following table presents the rollforward of the allowance for credit losses for premiums receivable for the years ended December 31, 2022 and 2021:
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Year Ended December 31,
(in thousands)
Current period change for estimated uncollectible premiums 5,988 2,189
Write-offs of uncollectible premiums receivable (1,312) (1,885)
Deferred policy acquisition costs, net of ceding commissions
The Company defers commissions, net of ceding commissions, and certain other costs that are directly related to the successful acquisition of insurance contracts. All eligible costs are capitalized and charged to expense in proportion to premium earned over the estimated policy life. To the extent that unearned premiums on existing policies are not adequate to cover the related costs and expenses, referred to as a premium deficiency, deferred policy acquisition costs are charged to earnings. The Company considers anticipated investment income in determining whether a premium deficiency exists.
Property and equipment, net
Property and equipment are stated at cost less accumulated depreciation. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives range from 39 years for the building and parking deck, 15 to 20 years for land improvements, 7 to 10 years for furniture and equipment, and 3 to 7 years for electronic data processing hardware and software.
Property and equipment are included in "other assets" in the accompanying consolidated balance sheets and consists of the following:
December 31,
(in thousands)
Construction in progress - building 2,618 —
Total property and equipment, net $ 53,475 $ 49,295
Indefinite-lived intangible assets
Indefinite-lived intangible assets are recorded at fair value at the date of acquisition. The Company's indefinite-lived intangible assets are comprised solely of regulatory approvals granted by the various state insurance departments to write insurance business in the respective states on a non-admitted basis. In accordance with U.S. GAAP, amortization of indefinite-lived intangible assets is not permitted. Indefinite-lived intangible assets are tested for impairment during the fourth quarter on an annual basis, or earlier if there is reason to suspect that their values may have been diminished or impaired. There were no impairments recognized in December 31, 2022, 2021, or 2020. In addition, as of December 31, 2022, no triggering events occurred that suggested an updated review was necessary.
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Reserves for unpaid losses and loss adjustment expenses
Reserves for unpaid losses and loss adjustment expenses represent management's best estimate of ultimate unpaid cost of all reported and unreported losses and loss adjustment expenses incurred prior to the financial statement date. The estimates are based on an actuarial method that uses management’s initial expected loss ratios, expected reporting patterns for losses based on industry data and the Company’s actual reported losses and loss adjustment expenses. All estimates are regularly reviewed and, as experience develops and new information becomes known, the reserves for unpaid losses and loss adjustment expenses are adjusted as necessary. Such adjustments are reflected in the results of operations in the period in which they are determined. Although management believes that the reserves for losses and loss adjustment expenses are reasonable, due to the inherent uncertainty in estimating reserves for unpaid losses and loss adjustment expenses, it is possible that the Company’s actual incurred losses and loss adjustment expenses will not develop in a manner consistent with the assumptions inherent in the determination of these reserves. If actual liabilities exceed recorded amounts, there will be an increase to the Company’s reserves resulting in a reduction in net income and stockholders’ equity in the period in which the deficiency is identified. Furthermore, management may determine that recorded reserves are more than adequate to cover expected losses which will result in a reduction to the reserves. The Company believes that the reserves for unpaid losses and loss adjustment expenses at December 31, 2022 and 2021 are adequate and represent a reasonable estimate of the Company's future obligations. See Note 7 for a further discussion of reserves for unpaid losses and loss adjustment expenses.
Revenue recognition
Premiums are recognized as revenue ratably over the term of the insurance contracts, net of ceded reinsurance. Unearned premiums are calculated on a daily pro rata basis.
Income taxes
Deferred income tax assets and liabilities are determined based on the differences between the recorded amounts and the tax bases of assets and liabilities, using enacted tax rates expected to be in effect during the year in which the basis differences reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period in which such change was enacted. Valuation allowances on deferred tax assets are estimated based on the Company's assessment of the realizability of such amounts. Valuation allowances are recorded when it is more likely than not that some portion, or all, of the deferred tax assets will not be realizable.
The Company provides for uncertain tax positions, and the related interest and penalties, based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. To the extent that the anticipated tax outcome of these uncertain tax positions changes, such changes in estimate will impact the income tax provision in the period in which such determination is made. The Company recognizes accrued interest and penalties related to uncertain tax positions as a component of income tax expense.
The Company uses the portfolio approach to release stranded tax effects in accumulated other comprehensive income ("AOCI") related to its available-for-sale fixed-maturity securities. Under this approach, stranded tax effects remaining in AOCI are released only when the entire portfolio of the available-for-sale fixed-maturity securities are liquidated, sold or extinguished.
Contingencies
Liabilities for loss contingencies, arising from noninsurance policy claims, assessments, litigation, fines, and penalties and other sources, are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred.
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Fair value of financial instruments
Fair value is estimated for each class of financial instrument based on the framework established in the fair value accounting guidance. This guidance requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value hierarchy disclosures are based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).
See Note 3 for further details regarding fair value disclosures.
Stock-based compensation
Stock-based compensation is expensed based upon the estimated fair value of employee stock awards. Compensation cost for awards of equity instruments to employees is measured based on the grant-date fair value of those awards and compensation expense is recognized over the service period that the awards vest. Forfeitures of stock-based compensation awards are recognized as they occur. See Note 9 for further discussion and related disclosures regarding stock-based compensation.
Recently adopted accounting pronouncements
Accounting Standards Update ("ASU") 2016-13, Financial Instruments – Credit Losses (Topic 326)
On June 16, 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)" to provide more useful information about the expected credit losses on financial instruments. The update requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net income. Credit losses relating to available-for-sale fixed-maturity securities must also be recorded through an allowance for credit losses, which is limited to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale securities is similar under previous U.S. GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through an irreversible write-down. The FASB has issued additional ASUs on Topic 326 that do not change the core principle of the guidance in ASU 2016-13 but clarify certain aspects of it.
Effective January 1, 2020, the Company adopted this ASU using the modified-retrospective approach and recorded a cumulative effect adjustment to beginning retained earnings. The adoption of this ASU resulted in the recognition of an allowance for credit loss related to the Company’s reinsurance recoverables. However, since the Company enters into contracts with reinsurers that have A.M. Best ratings of “A” (Excellent) or better, the allowance was not material to the Company’s consolidated financial statements.
ASU 2019-12, Income Taxes - Simplifying the Accounting for Income Taxes
In December 2019, the FASB issued updated guidance for the accounting for income taxes. The updated guidance is intended to simplify the accounting for income taxes by removing several exceptions contained in existing guidance and amending other existing guidance to simplify several income tax accounting matters. Effective January 1, 2021, the Company adopted ASU 2019-12 using a modified-retrospective approach. The adoption of ASU 2019-12 did not have a material impact on the Company's consolidated financial statements.
Prospective accounting pronouncements
There are no other prospective accounting standards which, upon their effective date, would have a material impact on the Company's consolidated financial statements.
2. Investments
Available-for-sale investments
The following tables summarize the Company’s available-for-sale investments at December 31, 2022 and 2021:
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(in thousands)
Fixed maturities:
(in thousands)
Fixed maturities:
Available-for-sale investments in a loss position
The Company regularly reviews all its available-for-sale investments with unrealized losses to assess whether the decline in the fair value is deemed to be a credit loss. The Company considers a number of factors in completing its review of credit losses, including the extent to which a security's fair value has been below cost and the financial condition of an issuer. In addition to specific issuer information, the Company also evaluates the current market and interest rate environment. Generally, a change in a security’s value caused by a change in the market or interest rate environment does not constitute a credit loss.
For fixed-maturity securities, the Company also considers whether it intends to sell the security or if it is more likely than not that it will be required to sell the security before recovery and the ability to recover all amounts outstanding when contractually due. When assessing whether it intends to sell a fixed-maturity security or if it is likely to be required to sell a fixed-maturity security before recovery of its amortized cost, the Company evaluates facts and circumstances including, but not limited to, decisions to reposition the investment portfolio, potential sales of investments to meet cash flow needs and potential sales of investments to capitalize on favorable pricing.
For fixed-maturity securities where a decline in fair value is below the amortized cost basis and the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost, an impairment is recognized in net income based on the fair value of the security at the time of assessment. For fixed-maturity securities that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before recovery of its amortized cost, the Company compares the
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estimated present value of the cash flows expected to be collected to the amortized cost of the security. Inputs into the present value cash flow analysis include default rates and recoverability rates based on credit rating. The extent to which the estimated present value of the cash flows expected to be collected is less than the amortized cost of the security represents the credit-related portion of the impairment, which is recognized in net income through an allowance for credit losses. Any remaining decline in fair value represents the noncredit portion of the impairment, which is recognized in other comprehensive income.
The Company reports investment income due and accrued separately from fixed-maturity securities, available for sale, and has elected not to measure an allowance for credit losses for investment income due and accrued. Investment income due and accrued is written off through earnings at the time the issuer of the bond defaults or is expected to default on payments.
As of December 31, 2022, the Company's credit loss review resulted in an allowance for credit losses on 7 securities. The following table presents changes in the allowance for expected credit losses on available-for-sale securities:
Year Ended December 31,
(in thousands)
Beginning balance $ — $ —
Reduction from securities sold during the period — —
Ending balance $ 366 $ —
The following tables summarize gross unrealized losses and estimated fair value for available-for-sale investments by length of time that the securities have continuously been in an unrealized loss position:
Less than 12 Months 12 Months or Longer Total
(in thousands)
Fixed maturities:
At December 31, 2022, in addition to the securities included in the allowance for credit losses, the Company held 944 fixed-maturity securities with a total estimated fair value of $1.6 billion and gross unrealized losses of $174.6 million. Of those securities, 210 were in a continuous unrealized loss position for greater than one year. As discussed above, the Company regularly reviews all fixed-maturity securities within its investment portfolio to determine whether a credit loss has occurred. Based on the Company's review as of December 31, 2022, except for securities previously discussed, the
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securities' in unrealized loss positions were caused by interest rate changes or other market factors and were not credit-specific issues, nor did the Company intend to sell these securities. At December 31, 2022, 78.6% of the Company’s fixed-maturity securities were rated "A-" or better and all of Company's fixed-maturity securities made expected coupon payments under the contractual terms of the securities.
Less than 12 Months 12 Months or Longer Total
(in thousands)
Fixed maturities:
Contractual maturities of available-for-sale fixed-maturity securities
The amortized cost and estimated fair value of available-for-sale fixed-maturity securities at December 31, 2022 are summarized, by contractual maturity, as follows:
Amortized Estimated
Cost Fair Value
(in thousands)
Commercial mortgage-backed securities 65,353 58,867
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.
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Real estate investments
During the year ended December 31, 2022, the Company completed the purchase of a real estate investment property. Real estate investments consisted of the following at December 31, 2022 and 2021:
December 31,
(in thousands)
Intangible in-place lease 9,749 —
Site improvements 2,686 —
Accumulated depreciation (236) —
Total real estate investments, net $ 76,387 $ —
Concurrent with the purchase of the real estate investment property, the Company entered into two operating lease agreements for office space as the lessor. The terms of these two leases are 5 years and 12 years. Future minimum rental income expected on these operating leases is $4.4 million in 2023, $4.5 million in 2024, $4.6 million in 2025, $4.8 million in 2026, $4.9 million in 2027 and $36.2 million thereafter.
Net investment income
The following table presents the components of net investment income:
Year Ended December 31,
(in thousands)
Interest:
Cash equivalents and short-term investments 1,251 12 262
Real estate investment income 234 — —
Investment expenses included depreciation expense related to real estate investments of $0.2 million for the year ended December 31, 2022. There were no real estate investments for the years ended December 31, 2021 and 2020.
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Realized investment gains and losses
The following table presents realized investment gains and losses:
Year Ended December 31,