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Section 1: 10-K (10-K)

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Notes to Consolidated Financial Statements

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2017
OR 
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 For the transition period from                 to
Commission file number 001-37536
 
Conifer Holdings, Inc.
(Exact name of registrant as specified in its charter)
Michigan
 
27-1298795
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
550 West Merrill Street, Suite 200
 
 
Birmingham, Michigan
 
48009
(Address of principal executive offices)
 
(Zip code)
 
(248) 559-0840
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ☐ 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☐
(Do not check if a smaller
reporting company)
Smaller reporting company þ
Emerging growth company þ
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No þ
The number of outstanding shares of the registrant’s common stock, no par value, as of March 15, 2018, was 8,520,328.
 


CONIFER HOLDINGS, INC. AND SUBSIDIARIES
 
Form 10-K
 
INDEX
 
 
 
Page No.
 
 
Business
1
Risk Factors
12
Unresolved Staff Comments
25
Properties
25
Legal Proceedings
25
Mine Safety Disclosures
25
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
26
Item 6.
Selected Consolidated Financial Data
28
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations
30
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
50
Financial Statements and Supplementary Data
51
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
51
Controls and Procedures
51
Other Information
51
 
 
Item 10-14.
 
52
 
 
Exhibits and Financial Statement Schedules
53
 
103


CONIFER HOLDINGS, INC. AND SUBSIDIARIES

PART I

ITEM 1. BUSINESS
Legal Organization
Conifer Holdings, Inc. (Nasdaq: CNFR) is a Michigan‑domiciled insurance holding company formed in 2009. Our principal executive offices are located at 550 W. Merrill, Suite 200, Birmingham, MI 48009 (telephone number: (248) 559-0840). Our corporate website address is www.cnfrh.com.
As used in this Form 10-K, references to “Conifer,” “Conifer Holdings,” “the Company,” “our Company,” “we,” “us,” and “our” refer to Conifer Holdings, Inc., a Michigan corporation, and its wholly owned subsidiaries Conifer Insurance Company (“CIC”), Red Cedar Insurance Company (“RCIC”), White Pine Insurance Company (“WPIC”), American Colonial Insurance Services (“ACIS”) and Sycamore Insurance Agency, Inc. (“SIA”). CIC, RCIC and WPIC are collectively referred to as the "Insurance Company Subsidiaries." On a stand-alone basis Conifer Holdings, Inc is referred to as the "Parent Company." On December 30, 2016, the Company's wholly owned subsidiary, American Colonial Insurance Company ("ACIC") was merged into WPIC.
Business Overview
Through our Insurance Company Subsidiaries, we offer insurance coverage in both specialty commercial and specialty personal product lines. Currently, we are authorized to write insurance as an excess and surplus lines (“E&S”) carrier in 44 states including the District of Columbia. We are also licensed to write insurance in 42 states, including the District of Columbia, as an admitted carrier and we offer our insurance products in all 50 states.
Many of our products are targeted to traditionally profitable classes of policyholders that we believe are underserved by other insurers. We market and sell these insurance products through a growing network of over 6,700 independent agents that distribute our policies through approximately 2,200 sales offices. We are focused on growing our business in non‑commoditized property and casualty insurance markets, while maintaining underwriting discipline and a conservative investment strategy.
We have substantial expertise in serving the unique commercial insurance needs of owner‑operated businesses in the following markets:
•
Hospitality, such as restaurants, bars, taverns, and bowling centers (that require, among other lines, liquor liability insurance), as well as small grocery and convenience stores;
•
Artisan contractors, such as plumbers, painters, carpenters, electricians and other independent contractors; and
•
Security service providers, such as companies that provide security guard services, security alarm products and services, and private investigative services.
In our commercial lines business, we seek to differentiate ourselves and provide value to small business owner‑operators by bundling different insurance products that meet a significant portion of their insurance needs. For example, in the hospitality market we offer property, casualty, and liquor liability, as well as, in some jurisdictions, workers’ compensation coverage. The breadth of our specialty commercial insurance products enables our agents and their small business clients to avoid the administrative costs and time required to seek coverage for each of these items from separate insurers. As such, we compete for commercial lines business based on our flexible product offerings and customer service, rather than on pricing alone. Our target commercial lines customer has an average account size of $4,800 in premium.
We also have substantial expertise in providing specialty homeowners insurance products to targeted customers that are often underserved by other homeowners insurance carriers. Our personal lines products primarily include the following:
•
Low-value dwelling insurance tailored for owners of lower valued homes, which we currently offer in Illinois, Indiana, Louisiana and Texas; and
•
Wind-exposed catastrophe coverage, including hurricane and wind coverage, to under-served homeowners in Hawaii, Texas and Florida.
In our personal lines business, we target homeowners in need of specific catastrophe coverage or dwelling insurance that are currently underserved by the insurance market, due to the modest value of their homes or the

1

exposure to natural catastrophes in their geographic area. Because these homeowners are underserved, this portion of the market is typically subject to less pricing pressure from larger nationwide insurers that offer a more commoditized product. We believe our underwriting expertise enables us to compete effectively in these markets by evaluating and appropriately pricing risk. In addition, we believe our willingness to meet these underserved segments of the personal lines insurance market fosters deeper relationships with, and increased loyalty from, the agents who distribute our products. Our target personal lines customer has an average account size of $1,200 in premium.
Overall, we structure the multi-line distribution of our premium between commercial and personal lines to better diversify our business and mitigate the potential cyclical nature of either market.
Geographic Diversity and Mix of Business
While we pursue top line premium growth, we do not do so at the expense of losing underwriting discipline. Our underwriters have the experience and institutional flexibility to recognize when to exit certain products in favor of more profitable opportunities as insurance market conditions dictate. The following tables summarize our gross written premiums by segment and state for the years indicated therein (dollars in thousands):
 
Gross Written Premium by Segment
 
2017
%
 
2016
%
 
2015
%
Commercial
$
92,112

81
%
 
$
88,242

77
%
 
$
68,197

73
%
Personal
22,172

19
%
 
26,681

23
%
 
25,553

27
%
Total
$
114,284

100
%
 
$
114,923

100
%
 
$
93,750

100
%

 
Gross Written Premiums by State
 
2017
%
 
2016
%
 
2015
%
Florida
$
26,562

23.1
%
 
$
23,910

20.7
%
 
$
23,048

24.6
%
Michigan
21,099

18.5
%
 
17,572

15.4
%
 
16,074

17.1
%
Texas
12,910

11.3
%
 
12,993

11.3
%
 
10,381

11.1
%
Pennsylvania
8,859

7.8
%
 
10,718

9.3
%
 
12,931

13.8
%
Hawaii
4,774

4.2
%
 
3,885

3.4
%
 
2,661

2.8
%
Indiana
4,356

3.8
%
 
4,582

4.0
%
 
6,068

6.5
%
New Jersey
3,960

3.5
%
 
978

0.9
%
 
980

1.0
%
Ohio
3,850

3.4
%
 
3,556

3.1
%
 
3,693

3.9
%
New York
3,095

2.7
%
 
—

—
%
 
589

0.6
%
Colorado
2,998

2.6
%
 
2,544

2.2
%
 
1,249

1.3
%
Montana
2,409

2.1
%
 
3,041

2.6
%
 
2,945

3.1
%
All Other States
19,412

17.0
%
 
31,144

27.1
%
 
13,131

14.2
%
Total
$
114,284

100.0
%
 
$
114,923

100.0
%
 
$
93,750

100.0
%
The Conifer Approach
We have built our business in a manner that is designed to adapt to changing market conditions and deliver predictable results over time. The following highlights key aspects of our model that contribute to our balanced approach:
•
Focus on under-served markets. We focus on providing specialty insurance products to targeted policyholders in under-served markets. We believe that most of our small business customers, many of which are owner‑operated, value the efficiency of dealing with a single insurer for multiple products. By targeting small- to medium-sized accounts, we add value to the business owner directly without competing solely on price.
•
Strong relationships with our agents. We develop strong relationships with our independent agents providing them with responsive service, attractive commissions and competitive products to offer policyholders. We believe our

2

agents understand that we view them as key partners in risk selection that help us serve our ultimate client-the insured.
•
Deep understanding of the business and regulatory landscapes of our markets. The competition for insurance business and the regulatory operating environment vary significantly from state to state. We focus on tailoring our business to concentrate on the geographic markets and regulatory environments with the greatest opportunities for growth and profitability. Our business plan centers on identification of market opportunities in jurisdictions where our insurance products can profitably suit the needs of our potential customers.
•
Emphasis on flexibility. We offer coverage to our insureds both on an E&S and admitted basis. We believe this flexibility enables us to pivot effectively between E&S and admitted policies as customer needs and regulatory conditions dictate.
•
Conservative risk management with an emphasis on lowering volatility. We focus on the risk/reward of insurance underwriting, while maintaining a prudent investment policy. We employ conservative risk management practices and opportunistically purchase reinsurance to minimize our exposure to liability for individual risks. In addition, we seek to maintain a diversified liquid investment portfolio to reduce overall balance sheet volatility. As of December 31, 2017, our investments primarily consisted of fixed income investments with an average credit rating of “AA” and a duration-to-worst average of 3.2 years.
Our Competitive Strengths
We believe the following competitive strengths have allowed us to grow our business and will continue to support our strategic growth initiatives:
•
Talented underwriters with broad expertise. Our underwriters have significant experience managing account profitability across market cycles. With an average of over 27 years of experience, our senior underwriters possess the required expertise to respond appropriately to market forces.
•
Controlled and disciplined underwriting. We underwrite substantially all policies to our specific guidelines with our experienced, in-house underwriting team. We customize the coverages we offer, and continually monitor our markets and respond to changes in our markets by adjusting our pricing, product structures and underwriting guidelines. By tailoring the terms and conditions of our policies, we align our actual underwriting risk with the profit of each insurance account that we write.
•
Proactive claims handling. We employ a proactive claims handling philosophy that utilizes an internal team of experienced in-house attorneys to manage and supervise our claims from inception until resolution. We pay what we owe, contest what we don't, and make sound judgment for those claims that fall in between. Our proactive handling of claims reinforces our relationships with our customers and agents by demonstrating our willingness to defend our insureds aggressively and help them mitigate losses.
•
Proven management team. Our senior management team has an average of over 23 years of experience in the insurance industry. Our senior management team has successfully created, managed and grown numerous insurance companies and books of business, and has longstanding relationships with many independent agents and policyholders in our targeted markets.
•
Ability to leverage technology to drive efficiency. We utilize a web‑based information technology system that creates greater organizational efficiency in our company. Leveraging the infrastructure of programmers and support staff of third‑party vendors allows our in‑house business analysts to focus on new product development and roll‑out. We believe this capability reduces our time to market for new products, enhances services for insureds, increases our ability to capture data, and reduces cost.
Marketing and Distribution
Independent agents are our main distribution source. The selection of an insurance company by a business or individual is strongly influenced by the business or individual’s agent. We seek to maintain favorable relationships with our select group of agents. Our distribution philosophy is to treat our agents as partners, and we provide them with competitive products, personal service and attractive commissions. We believe these factors contribute to our positive agency retention.
In 2017, our top six independent agencies accounted for approximately 33% of our gross written premiums in our commercial lines, and our top four independent agencies, accounted for approximately 41% of our gross written premiums in our personal lines. We have long term relationships with each of these agencies. We anticipate our concentration in these agencies will decrease in future periods as we establish relationships with additional agencies, as part of our strategic growth

3

plan. Our Insurance Company Subsidiaries market and distribute their products mainly through an independent agency network, however we utilize managing general agents and certain key wholesalers when appropriate.
We recruit our producers through referrals from our existing network of agents, word‑of‑mouth, advertisement, as well as direct contacts initiated by potential agents. Our marketing efforts are directed through our offices in Michigan, Florida, Pennsylvania and Tennessee.
We view our agents as key partners in risk selection. We actively solicit their input regarding potential improvements to our business methods and consult with them in developing new products and entering new customer markets. At the same time, we take careful measure to appropriately control and monitor our agents’ operations. Controls include frequent review of the quality of business, loss experience and other mechanisms. We retain sole binding authority on the majority of our business. Binding authority is only granted to select long-term agents. When binding authority is granted, we restrict this authority to a specific set of guidelines that are provided to each agent. Moreover, our experienced underwriters review each risk to ensure the guidelines are followed.
In addition to marketing to individual agents, we formed Sycamore Insurance Agency to review specific opportunities to write select business on a direct basis. SIA also owns 50% of a small insurance agency that places small commercial risks, mainly for alarm and security guard markets.
Underwriting
We are focused on underwriting profitability and effective enterprise risk management. With an average of over 27 years of experience, our senior underwriters have the experience to properly manage account profitability across market cycles.
Our underwriting philosophy for our specialty commercial risks in the hospitality industry is to look at each risk individually and selectively before writing any policies. We remain focused on the small to medium-sized, well-operated business, where the owner is often on site and in a better position to efficiently and safely run the overall operations. We understand the risks associated with the smaller enterprises and, due to lighter competition, believe we can receive a fair premium to compensate for the risk taken.
With respect to commercial property coverages, we believe it is important to focus on the profitability of the insureds’ business, as well as the traditional risk factors. Therefore, in addition to obtaining inspections on commercial risks, we strive to understand the insureds’ business operations and bottom line to verify the underlying business is an acceptable risk.
All commercial and personal policy applications are underwritten according to established guidelines that have been provided to our independent agency force. These guidelines have been integrated into our information technology system framework and only policies that meet our guidelines are accepted by our system. Our underwriting staff has substantial industry experience in matching policy terms, conditions, and pricing to the risk profiles of our policyholders and therefore strengthens our ability to achieve profitability in the product lines we write.
Commercial Lines. In writing commercial lines policies, we frequently employ tailored limiting endorsements, rating surcharges and customized limits to align our product offerings to the risk profile of the class and the specific policyholder being underwritten. Furthermore, we consistently monitor our markets so that we are able to quickly implement changes in pricing, underwriting guidelines and product offerings as necessary to remain competitive. We do not pursue commercial product lines where competition is based primarily on price. We augment our own internally developed pricing models with benchmark rates and policy terms set forth by the Insurance Services Office, or ISO. The ISO system is a widely recognized industry resource for common and centralized rates and forms. It provides advisory ratings, statistical and actuarial services, sample policy provisions and other services to its members.
Personal Lines. We employ internal product managers to review our position relative to our competition, create better segmentation of pricing and originate premium rate changes as appropriate. Consistent with industry practice, we grant our personal lines agents limited binding authority within our specific guidelines. Once a completed application and premium payment are submitted to us, the application is placed in a bound status, and reviewed for final approval. If the agent has underwritten and submitted the account according to our guidelines, we process the application as complete. If our guidelines have not been followed, the application may be cancelled or updated and re‑submitted for further underwriting review.
Claims
We believe that effective claims management is vitally important to our success, allowing us to cost effectively pay valid claims, while vigorously defending those claims that lack merit. Our claims department consists of experienced claims professionals located in Michigan, Florida, Pennsylvania and Tennessee. We utilize a proactive claims handling philosophy to internally manage or supervise all of our claims from inception through final disposition. By handling our claims

4

internally, we can quickly assess claims, improve communication with our policyholders and claimants and better control our claims management costs.
We have several in‑house attorneys with considerable legal experience in trying cases in the lines of business we write. Included among these attorneys is our head in‑house litigator, who consults on all trials and has 24 years of litigation experience. We also have numerous seasoned property and liability adjusters which allow us to manage our claims exposures more carefully, across all markets. In addition, our claims professionals utilize a network of independent local adjusters and appraisers to assist with specific aspects of claims investigations, such as securing witness statements and conducting initial appraisals in states where it is practical to do so. These outside vendors are mainly compensated based on pre‑negotiated fee schedules to control overall costs.
Claims personnel are organized by line of business, with specific managers assigned as supervisors for each line of business. Reserving and payment authority levels of claims personnel are set by our Senior Vice President of claims and our Executive Vice President. Those limits of authority are integrated into our claims information technology systems to ensure strict compliance.
Initial claim reserves are determined and set using our statistical averages of paid indemnity and loss adjustment expenses by line of business. After reviewing statistical data and consulting with our internal actuary, our senior vice president of claims, together with other members of management, set initial reserves by line of business. Once initial reserves have been set, reserves are evaluated periodically as specific claim information changes to generate management’s overall best estimate of reserves. In addition, claim reviews with in‑house adjusters and attorneys provide a regular opportunity to review the adequacy of reserves. Changes to claims reserves are made by senior management based on claim developments and input from these attorneys and adjusters. We utilize an in‑house, experienced and fully credentialed actuary to support our financial efforts.
Reinsurance
We routinely purchase reinsurance for our commercial and personal lines to reduce volatility by limiting our exposure to large losses and to provide capacity for growth. In a reinsurance transaction, an insurance company transfers, or cedes, all or part of its exposure in return for a portion of the premium. We remain legally responsible for the entire obligation to policyholders, irrespective of any reinsurance coverage we may purchase.
Information relating to our reinsurance structure and treaty information is included within Note 6 ~ Reinsurance.

5

Loss Reserve Development
The following table presents the development of our loss and loss adjustment expenses ("LAE") reserves from 2009 through 2017, net of reinsurance recoverables (dollars in thousands).
 
Year Ended December 31,
 
 
2009
2010
2011
2012
2013
2014
2015
2016
2017
 
 
 
 
 
Net liability for losses and loss expenses
$
911

$
18,795

$
17,164

$
17,547

$
24,956

$
28,307

$
30,017

$
47,993

$67,830
Liability re‑estimated as of:
 
 
 
 
 
 
 
 
 
One year later
764

16,565

12,807

13,508

23,763

29,321

40,239

57,452

 
Two years later
593

13,071

9,870

13,601

25,521

33,274

52,321

 
 
Three years later
495

10,300

10,038

13,821

26,560

38,569

 
 
 
Four years later
452

10,698

10,064

13,860

27,784

 
 
 
 
Five years later
434

10,926

10,227

13,980

 
 
 
 
 
Six years later
434

11,215

10,414

 
 
 
 
 
 
Seven years later
434

11,402

 
 
 
 
 
 
 
Eight years later
$
434

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net cumulative redundancy (deficiency)
$
477

$
7,393

$
6,750

$
3,567

$
(2,828
)
$
(10,262
)
$
(22,304
)
$
(9,459
)
 
 
 
 
 
 
 
 
 
 
 
Cumulative amount of net liability paid as of:
 
 
 
 
 
 
 
 
 
One year later
$
253

$
4,112

$
3,383

$
5,186

$
13,245

$
16,091

$
20,020

$
29,533

 
Two years later
315

6,277

6,092

9,106

19,711

24,060

35,972

 
 
Three years later
426

8,302

7,917

11,444

23,241

32,699

 
 
 
Four years later
434

9,372

8,788

13,015

26,056

 
 
 
 
Five years later
434

9,971

9,730

13,522

 
 
 
 
 
Six years later
434

10,799

10,167

 
 
 
 
 
 
Seven years later
434

11,219

 
 
 
 
 
 
 
Eight years later
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross liability‑end of year
911

32,047

29,574

24,843

28,908

31,532

35,422

54,651

87,896

Reinsurance recoverable on unpaid losses
—

13,252

12,410

7,296

3,952

3,225

5,405

6,658

20,066

Net liability‑end of year
911

18,795

17,164

17,547

24,956

28,307

30,017

47,993

67,830

 
 
 
 
 
 
 
 
 
 
Gross liability re‑estimated‑latest
434

21,879

18,407

20,094

34,012

43,856

62,707

73,313

 
Reinsurance recoverable on unpaid losses re‑estimated‑latest
—

10,477

7,993

6,113

6,229

5,287

10,387

15,860

 
Net liability re‑estimated‑latest
434

11,402

10,414

13,981

27,783

38,569

52,320

57,453

 
 
 
 
 
 
 
 
 
 
 
Gross cumulative redundancy (deficiency)
$
477

$
10,168

$
11,167

$
4,749

$
(5,104
)
$
(12,324
)
$
(27,285
)
$
(18,662
)
 
Data from 2009 relates only to American Equable, Inc., which is now known as CIC and the 2010 through 2017 data column includes CIC and WPIC.
The first line of the table presents the unpaid loss and LAE reserves at December 31 for each year, including the incurred but not reported ("IBNR") reserve. The next section of the table sets forth the re‑estimates of incurred losses from later years, including payments, for the years indicated. The increase/decrease from the original estimate would generally be a combination of factors, including, but not limited to:
•
Claims being settled for amounts different from the original estimates;

6

•
Reserves being increased or decreased for individual claims that remain open as more information becomes known about those individual claims; and
•
More or fewer claims being reported after the related year end, than had been expected to be reported before that date.
As our historical data for a particular line of business increases, both in terms of the number of years of loss experience and the size of our data pool, we will increasingly rely upon our own loss experience rather than industry loss experience in establishing our loss and LAE reserves. We plan to continue to apply reserving practices consistent with historical methodologies.
Additional information relating to our reserves is included within the Losses and Loss Adjustment Expenses section of Note 1 ~ Summary of Significant Accounting Policies and Note 5 ~ Unpaid Losses and Loss Adjustment Expenses of the Notes to the Consolidated Financial Statements, as well as in the Critical Accounting Policies ~ Unpaid Losses and Loss Adjustment Expenses section of Item 7, Management’s Discussion and Analysis.
Regulation
Insurance Company Regulation
Our Insurance Company Subsidiaries are subject to regulation in the states where they conduct business. State insurance regulations generally are designed to protect the interests of policyholders, consumers or claimants rather than shareholders or other investors. The nature and extent of such state regulation varies by jurisdiction, but generally involves:
•
Prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company;
•
Regulation of certain transactions entered into by such insurance company subsidiary with any of its affiliates;
•
Approval of premium rates, forms and policies used for many lines of admitted insurance;
•
Standards of solvency and minimum amounts of capital and surplus that must be maintained;
•
Limitations on types and concentration of investments;
•
Licensing of insurers and agents;
•
Deposits of securities for the benefit of policyholders; and
•
The filing of periodic reports with state insurance regulators with respect to financial condition and other matters.
In addition, state regulatory examiners perform periodic examinations of our Insurance Company Subsidiaries. The results of these examinations can give rise to regulatory orders requiring remedial, injunctive or other corrective action.
Insurance Holding Company Regulation
We operate as an insurance holding company and are subject to regulation in the jurisdictions in which we conduct business. These regulations require that each of our Insurance Company Subsidiaries register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. The insurance laws similarly provide that all transactions among members of a holding company system must be fair and reasonable. Certain types of transactions between our Insurance Company Subsidiaries and the Company and our other affiliates generally must be disclosed to the state regulators, and prior approval of the state insurance regulator generally is required for any material or extraordinary transaction. In addition, a change of control of a domestic insurer or of any controlling person requires the prior approval of the state of domicile insurance regulator.
Various State and Federal Regulation
Insurance companies are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. In addition, for some classes of insureds individual state insurance departments may prevent premium rates for some classes of insureds from reflecting the level of risk assumed by the insurer for those classes. Such developments may adversely affect the profitability of various lines of insurance. In some cases, if permitted by applicable regulations, these adverse effects on profitability can be minimized through repricing of coverages or limitations or cessation of the affected business.

7

Reinsurance Intermediary
Our reinsurance intermediaries are also subject to regulation. Under applicable regulations, an intermediary is responsible, as a fiduciary, for funds received on account of the parties to the reinsurance transaction. The intermediaries are required to hold such funds in appropriate bank accounts subject to restrictions on withdrawals and prohibitions on commingling.
Licensing and Agency Contracts
We, or certain of our designated employees, must be licensed to act as agents by regulatory authorities in the states in which we conduct business. Regulations and licensing laws vary in each state and are often complex.
Insurance licenses are issued by state insurance regulators upon application and may be of perpetual duration or may require periodic renewal. There are often requirements to obtain appropriate new licenses before we can begin writing or offer new coverages in a new state. The requirements are more stringent when writing on an admitted basis, as opposed to on an E&S basis where there is greater form and rate flexibility.
Insurers operating on an admitted basis must file premium rate schedules and policy or coverage forms for review and approval by the insurance regulators. In many states, rates and policy forms must be approved prior to use, and insurance regulators have broad discretion in judging whether or not an insurer’s rates are adequate, excessive and unfairly discriminatory.
The applicable licensing laws and regulations in all states are subject to amendment or reinterpretation by state regulatory authorities, and such authorities are vested in most cases with relatively broad discretion as to the granting, revocation, suspension and renewal of licenses. We, or our employees, could be excluded, or temporarily suspended, from continuing with some or all of our activities in, or otherwise subjected to penalties by, a particular state.
Membership in Insolvency Funds and Associations, Mandatory Pools and Insurance Facilities
Most states require admitted property and casualty insurers to become members of insolvency funds or associations, which generally protect policyholders against the insolvency of insurers. Members of the fund or association must contribute to the payment of certain claims made against insolvent insurers. The Company's assessments from insolvency funds were minimal for the years ended December 31, 2017, 2016, and 2015.
Our Insurance Company Subsidiaries are also required to participate in various mandatory insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for consumers who are unable to obtain insurance in the voluntary insurance market. Among the pools participated in are those established in certain states to provide windstorm and other similar types of property coverage. These pools typically require all companies writing applicable lines of insurance in the state for which the pool has been established to fund deficiencies experienced by the pool based upon each company’s relative premium writings in that state, with any excess funding typically distributed to the participating companies on the same basis. To the extent that reinsurance treaties do not cover these assessments, they may have an adverse effect on the Company. For the years ended December 31, 2017, 2016, and 2015, total assessments paid to all such facilities were minimal.
Restrictions on Dividends and Risk-Based Capital
For information on Restrictions on Dividends and Risk-based Capital that affect us please refer to Note 9 ~ Statutory Financial Data, Risk-Based Capital and Dividend Restrictions of the Notes to the Consolidated Financial Statements and the Regulatory and Rating Issues section within Item 7, Management’s Discussion and Analysis.
NAIC-IRIS Ratios
The National Association of Insurance Commissioners’ (“NAIC”) Insurance Regulatory Information System (“IRIS”) was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more ratios generally leads to inquiries or possible further review from individual state insurance commissioners. However, the generation of ratios outside of the usual values does not necessarily indicate a financial problem. For example, premium growth, alone, can trigger one or more unusual values. Refer to the Regulatory and Rating Issues section within Item 7, Management’s Discussion and Analysis.

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Effect of Federal Legislation
The Terrorism Risk Insurance Act, (“TRIA”), was enacted in November 2002. After several extensions, Congress enacted the Terrorism Risk Insurance Program Reauthorization of 2015 (“Act”). The Act extends the Federal Terrorism Insurance Program until December 31, 2020. The Act continues to require insurance companies to offer terrorism coverage. There is minimal exposure to this coverage as most of our policyholders decline this coverage option.
Employees
At December 31, 2017, we had 143 employees. Substantially all of our employees are full-time. Our employees are not subject to any collective bargaining agreement, and we are not aware of any current efforts to implement such an agreement. We believe we have good working relations with our employees.
Effective March 13, 2017, the Company entered into employment agreements (the “Employment Agreements”) with each of Mr. James G. Petcoff, the Company’s Chairman and CEO, Mr. Brian J. Roney, the Company’s President, Mr. Nicholas J. Petcoff, the Company’s Executive Vice President, and Mr. Andrew D. Petcoff, the Company’s Senior Vice President. The Employment Agreements are the same except for the individuals’ titles and annual base salaries, which are $550,000 for Mr. James G. Petcoff; $425,000 for Mr. Brian J. Roney; $425,000 for Mr. Nicholas J. Petcoff; and $375,000 for Mr. Andrew D. Petcoff. The initial term for each of the Employment Agreements ends on March 13, 2018, with unlimited one-year automatic extensions unless the Employee gives written notice of non-extension, not less than 30 days prior to the expiration of the term, or the Company gives written notice of non-extension prior to the expiration of the term. The Employment Agreements provide for an annual base salary, participation in the annual bonus plan, participation in any long-term incentive plan made generally available to senior executive officers of the Company and other fringe benefits and perquisites as are generally made available to the Company’s executives.
If any of the executives’ employment is terminated for cause, the executive will receive the accrued and unpaid portion of base salary. If any of the executives’ employment is terminated due to death or permanent disability, the executive (or his legal representative or beneficiary) will receive the accrued and unpaid portion of base salary and any earned but not yet paid incentive awards for already completed years or award cycles. If any of the executives’ employment is terminated without cause or if he terminates his employment for good reason (assuming the change of control provisions below do not apply), the executive will receive the accrued and unpaid portion of base salary, any earned but not yet paid incentive awards for already completed years or award cycles, plus one times his annual base salary. In addition, any unvested equity awards will immediate vest. If any of the executives’ employment is terminated without cause (other than due to death or permanent disability) or he terminates such employment for good reason, in each case within 24 months after a change of control, the executive will receive the accrued and unpaid portion of base salary, any earned but not yet paid incentive awards for already completed years or award cycles and 2.99 times the sum of (i) his annual base salary and (ii) the greater of his annual target bonus or his average bonus for the prior three years. In addition, any unvested equity awards will immediate vest.
The employment agreements also provide for confidentiality and non-solicitation provisions, the latter for one year after termination of employment.


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Available Information
We maintain an internet website at http://www.cnfrh.com, where we make available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Statements of Beneficial Ownership (Forms 3, 4, and 5), and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish to, the SEC. In addition, the SEC maintains an Internet site that contains reports, proxy statements, and other information that we file at www.sec.gov. The public may read and copy any materials we file with the Commission at the SEC's Public Reference Room at 100 F Street, NE., Washington, DC 20549, on official business days during the hours of 10 a.m. to 3 p.m. The public may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. Information found on our website or any other website is not part of this annual report on Form 10-K or any other report we file with, or furnish to the SEC.
Glossary
Accident year

The annual calendar accounting period in which loss events occurred, regardless of when the losses are actually reported, booked or paid.
Accident year combined ratio
The accident year combined ratio is an insurance industry measure that excludes changes in net ultimate loss estimates from prior accident year loss reserves. The accident year combined ratio provides management with an assessment of the specific policy year’s profitability (which matches policy pricing with related losses) and assists management in their evaluation of product pricing levels and quality of business written. Management uses accident year combined ratio as one component to assess the Company's current year performance and as a measure to evaluate, and if necessary, adjust current year pricing and underwriting.
Adjusted operating income (loss)
Net income (loss) excluding the after-tax impact of net realized investment gains (losses), other gains (losses), the tax effect of changes in unrealized gains (to the extent included in net income), and cumulative effect of changes in accounting principles when applicable.
Adjusted operating income (loss), per share
Adjusted operating income (loss) on a per share basis.
Amended Credit Agreement / Amended and Restated Credit Agreement
The Amended and Restated Credit Agreement, dated September 29, 2014, is between the Company and Comerica Bank, N.A. (refer to the exhibits hereto, as amended from time to time). The Agreement defines our previous credit facility and its terms; it was terminated in September 2017 (refer to the exhibit listing for details of the term changes, maturity dates, etc.).
Assignment of Benefits
A legal tool that allows a third party to assert a claim and be paid for services performed for an insured who would normally be reimbursed directly by the insurance company after making a claim themselves.
Book value per share
Total common shareholders' equity divided by the number of common shares outstanding.
Case reserves
Estimates of anticipated future payments to be made on each specific individual known, or reported claim.
Combined Ratio based on accounting principles generally accepted in the United States of America (“GAAP”)
The Combined Ratio is the sum of the Loss and LAE Ratio and the Expense Ratio as defined below. These ratios differ from statutory ratios to reflect GAAP accounting, as management evaluates the performance of our underwriting operations using the GAAP combined ratio.
Combined Ratio based on statutory accounting practices (“SAP”)
The combined loss and expense ratio (or combined ratio), expressed as a percentage, is the key measure of underwriting profitability traditionally used in the property and casualty insurance business. The combined ratio is a statutory accounting measurement, which represents the sum of (i) the ratio of losses and loss expenses to net earned premiums (loss ratio), plus (ii) the ratio of underwriting expenses to net written premiums (expense ratio).
Combined Ratio (Overall)
When the combined ratio is under 100%, underwriting results are generally considered profitable; when the combined ratio is over 100%, underwriting results are generally considered unprofitable.
Deferred policy acquisition costs

Primarily commissions and premium-related taxes that vary with, and are primarily related to, the production of new contracts and are deferred and amortized to achieve a matching of revenues and expenses when reported in financial statements prepared in accordance with GAAP.

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Deficiency

With regard to reserves for a given liability, a deficiency exists when it is estimated or determined that the reserves are insufficient to pay the ultimate settlement value of the related liabilities. Where the deficiency is the result of an estimate, the estimated amount of deficiency (or even the finding of whether or not a deficiency exists) may change as new information becomes available.
Expense Ratio
For GAAP, it is the ratio of GAAP underwriting expenses incurred to net earned premiums plus other income. For SAP, it is the ratio of Statutory underwriting expenses incurred to net written premiums.
Incurred but not reported (IBNR) reserves

Reserves for estimated losses and LAE that have been incurred but not yet reported to the insurer. This includes amounts for unreported claims, development on known cases, and re-opened claims.
Loss

An occurrence that is the basis for submission and/or payment of a claim. Losses may be covered, limited or excluded from coverage, depending on the terms of the policy.
Loss adjustment expenses (LAE)

The expenses of settling claims, including legal and other fees and the portion of general expenses allocated to claim settlement costs.
Loss and LAE ratio
The ratio of incurred losses and loss adjustment expenses to net earned premiums plus other income.
Loss reserves

Liabilities established by insurers and reinsurers to reflect the estimated cost of claims incurred that the insurer or reinsurer will ultimately be required to pay in respect of insurance or reinsurance it has written. Reserves are established for losses and for LAE, and consist of case reserves and IBNR reserves. As the term is used in this document, “loss reserves” is meant to include reserves for both losses and LAE, unless stated otherwise.
Loss reserve development

The increase or decrease in Loss or LAE as a result of the re-estimation of claims and claim adjustment expense reserves at successive valuation dates for a given group of claims. Loss reserve development may be related to prior year or current year development.
Losses incurred
The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for IBNR.
NAIC-IRIS ratios
Financial ratios calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies.
Policyholders' surplus

As determined under SAP, the amount remaining after all liabilities, including loss reserves, are subtracted from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by a state to be recognized on the statutory balance sheet. Policyholders' surplus is also referred to as “surplus” or “statutory surplus” for statutory accounting purposes.
Premium leverage ratio
The ratio of written premium (gross or net) to consolidated statutory surplus.
Redundancy

With regard to reserves for a given liability, a redundancy exists when it is estimated or determined that the reserves are greater than what will be needed to pay the ultimate settlement value of the related liabilities. Where the redundancy is the result of an estimate, the estimated amount of redundancy (or even the finding of whether or not a redundancy exists) may change as new information becomes available.
Risk-Based Capital (RBC)
A measure adopted by the NAIC and enacted by states for determining the minimum statutory policyholders' surplus requirements of insurers. Insurers having total adjusted capital less than that required by the RBC calculation will be subject to varying degrees of regulatory action.
Statutory accounting practices (SAP)
The practices and procedures prescribed or permitted by domiciliary state insurance regulatory authorities in the United States for recording transactions and preparing financial statements.
Underwriting gain or loss
Net earned premiums plus other income, less losses, LAE, commissions, and operating expenses.


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ITEM 1A. RISK FACTORS
Summary Risk Factors
You should read the following risk factors carefully in connection with evaluating our business and the forward-looking information contained in this Annual Report on Form 10-K. Any of the following risks could materially and adversely affect our business, operating results, financial condition and the actual outcome of matters as to which forward-looking statements are made in this Annual Report on Form 10-K. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, operating results or financial condition in the future.
Our actual incurred losses may be greater than our loss and loss adjustment expense reserves, which could have a material adverse effect on our financial condition and results of operations.
Insurance companies’ financial condition and results of operations depend upon their ability to accurately assess the potential losses and loss adjustment expenses under the terms of the insurance policies they underwrite. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what the expected ultimate settlement and administration of claims will cost, and the ultimate liability may be greater or less than the current estimate. In the insurance industry, there is always the risk that reserves may prove inadequate as it is possible for insurance companies to underestimate the cost of claims.
We base our estimates on our assessment of known facts and circumstances, as well as estimates of future trends in claim severity, claim frequency, judicial theories of liability and other factors. These variables are affected by both internal and external events that could increase our exposure to losses, including changes in actuarial projections, claims handling procedures, inflation, severe weather, climate change, economic and judicial trends, and legislative changes. We continually monitor reserves using new information on reported claims and a variety of statistical techniques to update our current estimate. Our estimates could prove to be inadequate, and this underestimation could have a material adverse effect on our financial strength.
Among the uncertainties we encounter in establishing our reserves for losses and related expenses in connection with our insurance businesses are as follows:
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When we write “occurrence” policies, we are obligated to pay covered claims, up to the contractually agreed amount, for any covered loss that occurs while the policy is in force. Accordingly, claims may be reported and develop many years after a policy has lapsed;
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Even when a claim is received (irrespective of whether the policy is a "claims-made”, which requires claims to be reported during the policy period, or an “occurrence” based form), it may take considerable time to fully appreciate the extent of the covered loss suffered by the insured and, consequently, estimates of loss associated with specific claims can increase over time;
•
New theories of liability are enforced retroactively from time to time by courts;
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Volatility in the financial markets, economic events, weather events and other external factors may result in an increase in the number of claims and the severity of the claims reported. In addition, elevated inflationary conditions would, among other things, drive loss costs to increase;
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If claims became more frequent, even if we had no liability for those claims, the cost of evaluating these potential claims could escalate beyond the amount of the reserves we have established. If we enter new lines of business, or encounter new theories of claims liability, we may encounter an increase in claims frequency and greater claims handling costs than we had anticipated; and
•
Estimation of “IBNR” losses is a complex and inherently uncertain process which involves a considerable degree of judgment and expertise, which adds to the overall difficulty of estimating loss reserves.
If any of our insurance reserves should prove to be inadequate for the reasons discussed above, or for any other reason, we will be required to increase reserves, resulting in a reduction in our net income and shareholders’ equity in the period in which the deficiency is identified. Future loss experience substantially in excess of established reserves could also have a material adverse effect on future earnings and liquidity and financial rating, which would affect our ability to attract business and could affect our ability to retain or hire qualified personnel.

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Severe weather conditions and other catastrophes are inherently unpredictable and may have a material adverse effect on our financial results and financial condition.
Our property insurance business is exposed to the risk of severe weather conditions and other catastrophes. Catastrophes can be caused by various events, including natural events such as hurricanes, winter weather, tornadoes, windstorms, earthquakes, hailstorms, severe thunderstorms, fires and other non-natural events such as explosions or riots.
The incidence and severity of catastrophes and severe weather conditions are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Severe weather conditions and catastrophes can cause greater losses in our property lines and cause our liquidity and financial condition to deteriorate. In addition, our inability to obtain reinsurance coverage at reasonable rates and in amounts adequate to mitigate the risks associated with severe weather conditions and other catastrophes could have a material adverse effect on our business and results of operation.
Our investment portfolio is subject to significant market and credit risks, which could result in an adverse impact on our financial conditions or results of operations.
Our results of operations depend, in part, on the performance of our investment portfolio. We seek to hold a diversified portfolio of investments that is managed by professional investment advisory management firms in accordance with our investment policy and routinely reviewed by our Investment Committee. However, our investments are subject to general economic conditions and market risks as well as risks inherent to particular securities.
The value of our investment portfolio is subject to the risk that certain investments may default or become impaired due to deterioration in the financial condition of one or more issuers of the securities held, or due to deterioration in the financial condition of an insurer that guarantees an issuer’s payments of such investments. Such defaults and impairments could reduce our net investment income and result in realized investment losses.
Risks for all types of securities are managed through application of our investment policy, which establishes investment parameters that include but are not limited to maximum percentages of investment in certain types of securities and minimum levels of credit quality, which we believe are within guidelines established by the NAIC and various state insurance departments, as applicable.
A severe economic downturn could cause us to incur substantial realized and unrealized investment losses in future periods, which would have an adverse impact on our financial condition, results of operations, debt and financial strength ratings, Insurance Company Subsidiaries’ capital liquidity and ability to access capital markets.
Although we seek to preserve our capital, we cannot be certain that our investment objectives will be achieved, and results may vary substantially over time. In addition, although we seek to employ investment strategies that are not correlated with our insurance exposures, losses in our investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate the adverse effect of the losses on us.
Our ability to meet ongoing cash requirements, service debt and pay dividends may be limited by our holding company structure and regulatory constraints restricting dividends or other distributions by our Insurance Company Subsidiaries.
We are a holding company that transacts the majority of our business through our Insurance Company Subsidiaries. Our ability to meet our obligations on our outstanding debt, and to pay our expenses and shareholder dividends, depends upon the dividend paying capacity of our Insurance Company Subsidiaries. We will be limited by the earnings of our Insurance Company Subsidiaries, and the distribution or other payment of such earnings to it in the form of dividends, loans, advances or the reimbursement of expenses. Payments of dividends to us by our Insurance Company Subsidiaries are subject to various business considerations and restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds, and could be subject to revised restrictions in the future. The ability to pay ordinary and extraordinary dividends must be reviewed in relation to the impact on key financial measurement ratios, including RBC ratios. The Insurance Company Subsidiaries’ ability to pay future dividends without advance regulatory approval is dependent upon maintaining a positive level of unassigned surplus. As a result, at times, we may not be able to receive dividends from our Insurance Company Subsidiaries in amounts necessary to meet our debt obligations, to pay shareholder dividends on our capital stock or to pay corporate expenses. Therefore, the inability of our Insurance Company Subsidiaries to pay dividends or make other distributions could have a material adverse effect on our business and financial condition.

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The price of our common stock may be volatile and limited public float and low trading volume for our shares may have an adverse impact on the share price or make it difficult to liquidate.
The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control and may not be related to our operating performance. These fluctuations could be significant and could cause a loss in the amount invested in our shares of common stock. Factors that could cause fluctuation are listed in the “Industry Risks” and “Risks Related to our Business” listed above.
In addition, the stock market in general, and the market for insurance companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results, and financial condition.
As a result of these factors, investors in our common stock may not be able to resell their shares at or above their purchase price or may not be able to resell them at all. These market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and the trading volume of our common stock remain low.
We may be adversely affected by interest rate changes.
Our investment portfolio is predominantly comprised of fixed income securities. These securities are sensitive to changes in interest rates. An increase in interest rates typically reduces the fair market value of fixed income securities. In addition, if interest rates decline, investment income earned from future investments in fixed income securities will be lower. We generally hold our fixed income securities to maturity, so our interest rate exposure does not usually result in realized losses. However, as noted above, rising interest rates could result in a significant reduction of our book value. A low investment yield environment could adversely impact our net earnings, as a result of fixed income securities maturing and being replaced with lower yielding securities which impact investing results.
Interest rates are highly sensitive to many factors beyond our control including general economic conditions, governmental monetary policy, and political conditions. As discussed above, fluctuations in interest rates may adversely impact our business. See “Item 7A. Qualitative and Quantitative Disclosures About Market Risk” for further discussion on interest rate risk.
A decline in our financial strength rating may result in a reduction of new or renewal business.
Participants in the insurance industry use ratings from independent ratings agencies, such as A.M. Best Company, Inc. (“A.M. Best”), Demotech, Inc. (“Demotech”), and Kroll Bond Rating Agency ("Kroll") as an important means of assessing the financial strength and quality of insurers. In setting their ratings, A.M. Best, Demotech and Kroll utilize a quantitative and qualitative analysis of a company’s balance sheet strength, operating performance and business profile. These analyses include comparisons to peers and industry standards as well as assessments of operating plans, philosophy and management. For A.M. Best, the ratings range from A++, or superior, to F for in liquidation. Demotech’s ratings range from “A” (unsurpassed) to M (moderate). Kroll's ratings range from AAA (extremely strong) to R (under regulatory supervision). As of the date of this Form 10-K, A.M. Best has assigned financial strength ratings of B++ with a negative outlook to CIC (the fifth highest rating level out of sixteen rating levels) and B+ with a stable outlook for WPIC (the sixth highest out of sixteen). A rating of B++ for CIC and a rating of B+ for WPIC means A.M. Best considers both companies to have a “good” ability to meet ongoing financial obligations. Both CIC, WPIC are rated “A” by Demotech (the third highest rating level out of six rating levels) as of the date of this Form 10-K. A financial stability rating of “A” from Demotech indicates “exceptional” financial stability related to maintaining surplus at an acceptable level. Kroll has given CIC and WPIC an insurance financial strength rating of BBB+ with a stable outlook (fourth highest rating level out of eleven) as of the date of this Form 10-K. A BBB+ rating indicates that the insurer's financial condition is adequate.
A.M. Best, Demotech and Kroll assign ratings that are intended to provide an independent opinion of an insurance company’s ability to meet its financial obligations to policyholders and such ratings are not evaluations directed to investors. A.M. Best, Demotech and Kroll periodically review our ratings and may revise ratings downward or revoke them at their sole discretion based primarily on their analyses of our balance sheet strength (including capital adequacy and loss and loss adjustment expense reserve adequacy), operating performance and business profile. Factors that could affect such analyses include but are not limited to:

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If we change our business practices from our organizational business plan in a manner that no longer supports A.M. Best’s, Demotech’s or Kroll's rating;
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If unfavorable financial, regulatory or market trends affect us, including excess market capacity;
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If we incur operating losses;
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If we have unresolved issues with government regulators;
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If we are unable to retain our senior management or other key personnel;
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If our investment portfolio incurs significant losses; or
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If A.M. Best, Demotech or Kroll alters its capital adequacy assessment methodology in a manner that would adversely affect our rating.
These and other factors could result in a downgrade of our rating. A downgrade of our rating could cause our current and future agents, retail brokers and insureds to choose other, more highly‑rated competitors. A downgrade of this rating could also increase the cost or reduce the availability of reinsurance to us.
In addition, in view of the earnings and capital pressures recently experienced by many financial institutions, including insurance companies, it is possible that rating organizations will heighten the level of scrutiny that they apply to such institutions and may increase the capital and other requirements employed in the rating organizations’ models for maintenance of certain ratings levels. It is possible that such reviews of us may result in adverse ratings consequences, which could have a material adverse effect on our financial condition and results of operations. A downgrade or withdrawal of any rating could severely limit or prevent us from writing new and renewal insurance contracts.
We distribute our insurance products through a select group of agents, several of which account for a significant portion of our business, and there can be no assurance that such relationships will continue, or if they do continue, that the relationship will be on favorable terms to us. In addition, reliance on agents subjects us to their credit risk.
Our distribution model depends almost entirely on the agencies that distribute our products. In 2017, our top six independent agencies accounted for approximately 33% of our gross written premiums in our commercial lines, and our top four agencies accounted for approximately 41% of our gross written premiums in our personal lines. We cannot assure you that these relationships, or our relationships with any of our agencies will continue. Even if the relationships do continue, they may not be on terms that are profitable for us. The termination of a relationship with one or more significant agents could result in lower direct written premiums and could have a material adverse effect on our results of operations or business prospects.
Certain premiums from policyholders, where the business is produced by agents, are collected directly by the agents and forwarded to our Insurance Company Subsidiaries. In certain jurisdictions, when the insured pays its policy premium to these agents for payment on behalf of our Insurance Company Subsidiaries, the premiums might be considered to have been paid under applicable insurance laws and regulations. Accordingly, the insured would no longer be liable to us for those amounts, whether or not we have actually received the premiums from that agent. Consequently, we assume a degree of credit risk associated with agents. There may be instances where agents collect premiums but do not remit them to us and we may be required under applicable law to provide the coverage set forth in the policy despite the absence of premiums. If we are unable to collect premiums from agents in the future, underwriting profits may decline and our financial condition and results of operations could be materially and adversely affected.
The property and casualty insurance business is historically cyclical in nature, and we may experience periods with excess underwriting capacity and unfavorable premium rates, which could adversely affect our business.
Historically, insurers have experienced significant fluctuations in operating results due to competition, frequency and severity of catastrophic events, levels of capacity, adverse litigation trends, regulatory constraints, general economic conditions and other factors. The supply of insurance is related to prevailing prices, the level of insured losses and the level of capital available to the industry that, in turn, may fluctuate in response to changes in rates of return on investments being earned in the insurance industry. As a result, the insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity increased premium levels. Demand for insurance depends on numerous factors, including the frequency and severity of catastrophic events, levels of capacity, the introduction of new capital providers, and general economic conditions. All of these factors fluctuate and may contribute to price declines generally in the insurance industry.
We cannot predict with certainty whether market conditions will improve, remain constant or deteriorate. Negative market conditions may impair our ability to underwrite insurance at rates we consider appropriate and commensurate relative to the risk assumed. If we cannot underwrite insurance at appropriate rates, our ability to transact business will be materially and adversely affected. Any of these factors could lead to an adverse effect on our business, financial condition and results of operations.

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If we are unable to underwrite risks accurately and charge competitive yet profitable rates to our policyholders, our business, financial condition and results of operations will be adversely affected.
In general, the premiums for our insurance policies are established at the time a policy is issued and, therefore, before all of our underlying costs are known. Like other insurance companies, we rely on estimates and assumptions in setting our premium rates. Establishing adequate premium rates is necessary, together with investment income, to generate sufficient revenue to offset losses, LAE and other underwriting costs and to earn a profit. If we do not accurately assess the risks that we underwrite, we may not charge adequate premiums to cover our losses and expenses, which would adversely affect our results of operations and our profitability. Alternatively, we could set our premiums too high, which could reduce our competitiveness and lead to lower revenues.
Pricing involves the acquisition and analysis of historical loss data and the projection of future trends, loss costs and expenses, and inflation trends, among other factors, for each of our products in multiple risk tiers and many different markets. In order to accurately price our policies, we:
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Collect and properly analyze a substantial volume of data from our insureds;
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Develop, test and apply appropriate actuarial projections and rating formulas;
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Closely monitor and timely recognize changes in trends; and
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Project both frequency and severity of our insureds’ losses with reasonable accuracy.
We seek to implement our pricing accurately in accordance with our assumptions. Our ability to undertake these efforts successfully and, as a result, accurately price our policies, is subject to a number of risks and uncertainties, including:
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Insufficient or unreliable data;
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Incorrect or incomplete analysis of available data;
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Uncertainties generally inherent in estimates and assumptions;
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Our failure to implement appropriate actuarial projections and rating formulas or other pricing methodologies;
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Regulatory constraints on rate increases; and
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Our failure to accurately estimate investment yields and the duration of our liability for loss and loss adjustment expenses, as well as unanticipated court decisions, legislation or regulatory action.
In addition, as a result of current industry non-weather factors, such as the increase in litigation surrounding the Assignment of Benefits claims and lawsuits in Florida, in particular, we may experience additional losses that could adversely affect our financial position or results of operations.
We operate in a highly competitive environment and we may not continue to be able to compete effectively against larger or more well‑established business rivals.
We compete with a large number of other companies in our selected lines of business. Many of our competitors are substantially larger and may enjoy better name recognition, substantially greater financial resources, higher financial strength ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships than us. Insurers in our markets generally compete on the basis of price, consumer recognition, coverages offered, claims handling, financial stability, customer service and geographic coverage. Although pricing is influenced to some degree by that of our competitors, it is not in our best interests to compete solely on price, and we may from time-to-time experience a loss of market share during periods of intense price competition. A number of new, proposed or potential legislative or industry developments could further increase competition in our industry including, but not limited to:
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An increase in capital‑raising by companies in our lines of business, which could result in new entrants to our markets and an excess of capital in the industry;
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The deregulation of commercial insurance lines in certain states and the possibility of federal regulatory reform of the insurance industry, which could increase competition from standard carriers for our E&S lines of insurance business; and
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Changing practices caused by the Internet may lead to greater competition in the insurance business. Among the possible changes are shifts in the way insurance is purchased. If our distribution model was to be significantly altered by changes in the way products were marketed, including, without limitation, through use of the Internet, it could have a material adverse effect on our premiums, underwriting results and profits.

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There is no assurance that we will be able to continue to compete successfully in the insurance market. Increased competition in our market could result in a change in the supply and/or demand for insurance, affect our ability to price our products at risk‑adequate rates and retain existing business, or underwrite new business on favorable terms. If this increased competition so limits our ability to transact business, our operating results could be adversely affected.
Adverse economic factors, including recession, inflation, periods of high unemployment or lower economic activity could result in the sale of fewer policies than expected or an increase infrequency or severity of claims and premium defaults or both, which, in turn, could affect our growth and profitability.
Factors, such as business revenue, economic conditions, the volatility and strength of the capital markets and inflation can all affect the business and economic environment in which we operate. These same factors affect our ability to generate revenue and profits. In an economic downturn that is characterized by higher unemployment, declining spending and reduced corporate revenues, the demand for insurance products is adversely affected, which directly affects our premium levels and profitability. Negative economic factors may also affect our ability to receive the appropriate rate for the risk we insure with our policyholders and may adversely affect the number of policies we can write, including with respect to our opportunities to underwrite profitable business. In an economic downturn, our customers may have less need for insurance coverage, cancel existing insurance policies, modify their coverage or not renew with us. Existing policyholders may exaggerate or even falsify claims to obtain higher claims payments. These outcomes would reduce our underwriting profit to the extent these factors are not reflected in the rates we charge.
We are subject to extensive regulation, which may adversely affect our ability to achieve our business objectives. In addition, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations.
As a holding company which owns insurance companies domiciled in the United States, we and our admitted Insurance Company Subsidiaries are subject to extensive regulation, primarily by Michigan (the domiciliary state for CIC and WPIC) and to a lesser degree, the other jurisdictions in which we operate. Most insurance regulations are designed to protect the interests of insurance policyholders, as opposed to the interests of shareholders. These regulations generally are administered by a department of insurance in each state and relate to, among other things, authorizations to write certain lines of business, capital and surplus requirements, reserve requirements, rate and form approvals, investment and underwriting limitations, affiliate transactions, dividend limitations, cancellation and non‑renewal of policies, changes in control, solvency and a variety of other financial and non‑financial aspects of our business. These laws and regulations are regularly re‑examined and any changes in these laws and regulations or new laws may be more restrictive, could make it more expensive to conduct business or otherwise adversely affect our operations. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may impose timing and expense or other constraints that could adversely affect our ability to achieve some or all of our business objectives.
In addition, regulatory authorities have broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, where there is uncertainty as to applicability, we follow practices based on our interpretations of regulations or practices that we believe are generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business.
The admitted market is subject to more state regulation than the E&S market, particularly with regard to rate and form filing requirements, restrictions on the ability to exit lines of business, premium tax payments and membership in various state associations, such as guaranty associations. Some states have deregulated their commercial insurance markets. We cannot predict the effect that further deregulation would have on our business, financial condition or results of operations.
The NAIC has developed a system to test the adequacy of statutory capital of U.S.‑based insurers, known as Risk-Based Capital ("RBC"), that many states have adopted. This system establishes the minimum amount of RBC necessary for a company to support its overall business operations. It identifies property‑casualty insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer’s assets and liabilities and its mix of premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation or liquidation. Failure to maintain adequate risk‑based capital at the required levels could adversely affect the ability of our Insurance Company Subsidiaries to maintain regulatory authority to conduct their business.
In addition, the various state insurance regulators have increased their focus on risks within an insurer’s holding company system that may pose enterprise risk to the insurer. In 2012, the NAIC adopted significant changes to the insurance

17

holding company act and regulations (the “NAIC Amendments”). The NAIC Amendments, when adopted by the various states, are designed to respond to perceived gaps in the regulation of insurance holding company systems in the United States. One of the major changes is a requirement that an insurance holding company system’s ultimate controlling person submit annually to its lead state insurance regulator an “enterprise risk report” that identifies activities, circumstances or events involving one or more affiliates of an insurer that, if not remedied properly, are likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole. Other changes include requiring a controlling person to submit prior notice to its domiciliary insurance regulator of a divestiture of control, having detailed minimum requirements for cost sharing and management agreements between an insurer and its affiliates and expanding of the agreements between an insurer and its affiliates to be filed with its domiciliary insurance regulator. The NAIC Amendments must be adopted by the individual state legislatures and insurance regulators in order to be effective. Michigan (i.e., our main domiciliary state for both our CIC and WPIC subsidiaries), requires a form of the enterprise risk report.
In 2012, the NAIC also adopted the Risk Management and Own Risk and Solvency Assessment Model Act (the “ORSA Model Act”). The ORSA Model Act, when adopted by the various states, will require an insurance holding company system’s Chief Risk Officer to submit annually to its lead state insurance regulator an Own Risk and Solvency Assessment Summary Report (“ORSA”). The ORSA is a confidential internal assessment appropriate to the nature, scale and complexity of an insurer, conducted by that insurer of the material and relevant risks identified by the insurer associated with an insurer’s current business plan and the sufficiency of capital resources to support those risks. The ORSA Model Act must be adopted by the individual state legislature and insurance regulators in order to be effective. Michigan has adopted the ORSA Model Act.  ORSA filings will be required in Michigan starting in 2018.  The Company is currently exempt from providing an ORSA summary report as it does not meet the minimum premium requirements.
We cannot predict the impact, if any, that the NAIC Amendments, compliance with the ORSA Model Act or any other regulatory requirements may have on our business, financial condition or results of operations.
We may become subject to additional government or market regulation which may have a material adverse impact on our business.
Market disruptions like those experienced during the credit‑driven financial market collapse in 2008, as well as the dramatic increase in the capital allocated to alternative asset management during recent years, have led to increased governmental as well as self‑regulatory scrutiny of the insurance industry in general. In addition, certain legislation proposing greater regulation of the industry is periodically considered by governing bodies of some jurisdictions, and the credit‑driven equity market collapse may increase the likelihood that some increased regulation of the industry is mandated.
Our business could be adversely affected by changes in state laws, including those relating to asset and reserve valuation requirements, surplus requirements, limitations on investments and dividends, enterprise risk and risk‑based capital requirements and, at the federal level, by laws and regulations that may affect certain aspects of the insurance industry, including proposals for preemptive federal regulation. The U.S. federal government generally has not directly regulated the insurance industry except for certain areas of the market, such as insurance for flood, nuclear and terrorism risks. However, the federal government has undertaken initiatives or considered legislation in several areas that may affect the insurance industry, including tort reform and corporate governance. The Dodd‑Frank Wall Street Reform and Consumer Protection Act (the “Dodd‑Frank Act”) also established the Federal Insurance Office, which is authorized to study, monitor and report to Congress on the insurance industry and to recommend that the Financial Stability Oversight Council (the “FSOC”) designate an insurer as an entity posing risks to U.S. financial stability in the event of the insurer’s material financial distress or failure. In December 2013, the Federal Insurance Office issued a report on alternatives to modernize and improve the system of insurance regulation in the United States, including increasing national uniformity through either a federal charter or effective action by the states. Any additional regulations established as a result of the Dodd‑Frank Act or actions in response to the Federal Insurance Office Report could increase our costs of compliance or lead to disciplinary action. In addition, legislation has been introduced from time to time that, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry, including federal licensing in addition to or in lieu of state licensing and reinsurance for natural catastrophes. We are unable to predict whether any legislation will be enacted or any regulations will be adopted, or the effect any such developments could have on our business, financial condition or results of operations.
It is impossible to predict what, if any, changes in the regulations applicable to us, the markets in which we operate, trade and invest or the counterparties with which we do business may be instituted in the future. Any such regulation could have a material adverse impact on our business.

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The effect of emerging claim and coverage issues on our business is uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either broadening coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after we have issued insurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued.
We may not be able to manage our growth effectively.
We intend to continue to grow our business, which could require additional capital, systems development and skilled personnel. We cannot assure you that we will be able to locate profitable business opportunities, meet our capital needs, expand our systems and our internal controls effectively, allocate our human resources optimally, identify qualified employees or agents or incorporate effectively the components of any businesses we may acquire in our effort to achieve growth. The failure to manage our growth effectively and maintain underwriting discipline could have a material adverse effect on our business, financial condition and results of operations.
We may be unable to obtain reinsurance coverage at reasonable prices or on terms that provide us adequate protection.
We purchase reinsurance in many of our lines of business to help manage our exposure to insurance risks that we underwrite and to reduce volatility in our results.
The availability and cost of reinsurance are subject to prevailing market conditions, both in terms of price and available capacity, each of which can affect our business volume and profitability. The availability of reasonably affordable reinsurance is a critical element of our business plan. One important way we utilize reinsurance is to reduce volatility in claims payments by limiting our exposure to losses from large risks. Another way we use reinsurance is to purchase substantial protection against concentrated losses when we enter new markets. As a result, our ability to manage volatility and avoid significant losses, expand into new markets or grow by offering insurance to new kinds of enterprises may be limited by the unavailability of reasonably priced reinsurance. We may not be able to obtain reinsurance on acceptable terms or from entities with satisfactory creditworthiness. In such event, if we are unwilling to accept the terms or credit risk of potential reinsurers, we would have to reduce the level of our underwriting commitments, which would reduce our revenues.
Many reinsurance companies have begun to exclude certain coverages from, or alter terms in, the reinsurance contracts we enter into with them. Some exclusions relate to risks that we cannot in turn exclude from the policies we write due to business or regulatory constraints. In addition, reinsurers are imposing terms, such as lower per occurrence and aggregate limits, on direct insurers that do not wholly cover the risks written by these direct insurers. As a result, we, like other direct insurance companies, write insurance policies which to some extent do not have the benefit of reinsurance protection. These gaps in reinsurance protection expose us to greater risk and greater potential losses. For example, certain reinsurers have excluded coverage for terrorist acts or priced such coverage at unreasonably high rates.
If we are unable to retain key management and employees or recruit other qualified personnel, we may be adversely affected.
We believe that our future success depends, in large part, on our ability to retain our experienced management team and key employees, particularly our chairman and chief executive officer, James G. Petcoff. There can be no assurance that we can attract and retain the necessary employees to conduct our business activities on a timely basis or at all. Our competitors may offer more favorable compensation arrangements to our key management or employees to incentivize them to leave our Company. Furthermore, our competitors may make it more difficult for us to hire their personnel by offering excessive compensation arrangements to certain employees to induce them not to leave their current employment and bringing litigation against employees who do leave (and possibly us as well) to join us. The loss of any of our executive officers or other key personnel, or our inability to recruit and retain additional qualified personnel as we grow, could materially and adversely affect our business and results of operations, and could prevent us from fully implementing our growth strategies.
We may require additional capital in the future, which may not be available or available only on unfavorable terms.
Our future capital requirements depend on many factors, including our ability to write new and renewal business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite depends largely upon the expected quality of our claims paying process and our perceived financial strength as estimated by potential insureds, agents, brokers, other intermediaries and independent rating agencies. To the extent that our existing capital is insufficient to fund our future operating requirements, cover claim losses, or satisfy ratings agencies in order to maintain a

19

satisfactory rating, we may need to raise additional capital in the future through offerings of debt or equity securities or otherwise to:
•
Fund liquidity needs caused by underwriting or investment losses;
•
Replace capital lost in the event of significant reinsurance losses or adverse reserve developments;
•
Satisfy letters of credit or guarantee bond requirements that may be imposed by our clients or by regulators;
•
Meet rating agency or regulatory capital requirements; or
•
Respond to competitive pressures.
Any equity or debt financing, if available at all, may be on terms that are unfavorable to us. Further, any additional capital raised through the sale of equity could dilute your ownership interest in the Company and may cause the value of our shares to decline. Additional capital raised through the issuance of debt may result in creditors having rights, preferences and privileges senior or otherwise superior to those of the holders of our shares and may limit our flexibility in operating our business and make it more difficult to obtain capital in the future. Disruptions, uncertainty, or volatility in the capital and credit markets may also limit our access to capital required to operate our business. If we are not able to obtain adequate capital, our business, financial condition and results of operations could be materially adversely affected.
We are subject to credit risk with regard to our reinsurance counterparties.
Although reinsurance makes the assuming reinsurer liable to us to the extent of the risk ceded, we are not relieved of our primary liability to our insureds as the direct insurer. We cannot be sure that our reinsurers will pay all reinsurance claims on a timely basis or at all. For example, reinsurers may default in their financial obligations to us as the result of insolvency, lack of liquidity, operational failure, fraud, asserted defenses based on agreement wordings or the principle of utmost good faith, asserted deficiencies in the documentation of agreements or other reasons. The failure of a reinsurer to pay us does not lessen our contractual obligations to insureds. If a reinsurer fails to pay the expected portion of a claim or claims, our net losses might increase substantially and adversely affect our financial condition. Any disputes with reinsurers regarding coverage under reinsurance contracts could be time‑consuming, costly and uncertain of success.
Downgrades to the credit ratings of our reinsurance counterparties may result in the reduction of rating agency capital credit provided by those reinsurance contracts and could, therefore, result in a downgrade of our own credit ratings. We evaluate each reinsurance claim based on the facts of the case, historical experience with the reinsurer on similar claims and existing case law and include any amounts deemed uncollectible from the reinsurer in our reserve for uncollectible reinsurance.
Our Insurance Company Subsidiaries are subject to minimum capital and surplus requirements. Failure to meet these requirements could subject us to regulatory action.
Our Insurance Company Subsidiaries are subject to minimum capital and surplus requirements imposed under the laws of their respective states of domicile and each state in which they issue policies. As of December 31, 2017, our Insurance Company Subsidiaries were in compliance with all such reserves. Any failure by one of our Insurance Company Subsidiaries to meet minimum capital and surplus requirements imposed by applicable state law will subject it to corrective action. This may include requiring adoption of a comprehensive financial plan, revocation of its license to sell insurance products or placing the subsidiary under state regulatory control. A decline in the risk based capital ratios of our Insurance Company Subsidiaries could limit their ability to make a dividend to us and could be a factor in causing rating agencies to downgrade our ratings. Any new minimum capital and surplus requirements adopted in the future may require us to increase the capital and surplus of our Insurance Company Subsidiaries, which we may not be able to do.
Any debt service obligations will reduce the funds available for other business purposes, and the terms and covenants relating to our current and future indebtedness could adversely impact our financial performance and liquidity.
As of December 31, 2017, we had $30 million of interest-only Subordinated Notes ("Notes") outstanding. We are subject to risks typically associated with debt financing, such as insufficient cash flow to meet required debt service payment obligations and the inability to refinance existing indebtedness.
The Notes contain various restrictive covenants that relate to the Company’s tangible net worth, fixed-charge coverage
ratios, dividend paying capacity, reinsurance retentions, and risk-based capital ratios. If we are unable to meet debt covenant requirements or to obtain future waivers regarding such failures, we could be in breach of our credit agreement. Any such breach could cause significant disruption to our operations, including a requirement to immediately repay our indebtedness, and would have severe adverse effects on our liquidity and financial flexibility.

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The failure of any of the loss limitations or exclusions we employ, or changes in other claims or coverage issues, could have a material adverse effect on our financial condition or results of operations.
Although we seek to mitigate our loss exposure through a variety of methods, the future is inherently unpredictable. It is difficult to predict the timing, frequency and severity of losses with statistical certainty. It is not possible to completely eliminate our exposure to un‑forecasted or unpredictable events and, to the extent that losses from such risks occur, our financial condition and results of operations could be materially adversely affected.
For instance, various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, which have been negotiated to limit our risks, may not be enforceable in the manner we intend. At the present time, we employ a variety of endorsements to our policies that limit exposure to known risks. As industry practices and legal, judicial, social and other conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond the underwriting intent or by increasing the size or number of claims.
In addition, we design our policy terms to manage our exposure to expanding theories of legal liability like those which have given rise to claims for lead paint, asbestos, mold, construction defects and environmental matters. Many of the policies we issue also include conditions requiring the prompt reporting of claims to us and entitle us to decline coverage in the event of a violation of that condition. Also, many of our policies limit the period during which a policyholder may bring a claim under the policy, which in many cases is shorter than the statutory period under which such claims can be brought against our policyholders. While these exclusions and limitations help us assess and reduce our loss exposure and help eliminate known exposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or legislation could be enacted modifying or barring the use of such endorsements and limitations. These types of governmental actions could result in higher than anticipated losses and loss adjustment expenses, which could have a material adverse effect on our financial condition or results of operations. In some instances, these changes may not become apparent until sometime after we have issued insurance policies that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued.
Increased information technology security threats and more sophisticated computer crimes pose a risk to our systems, networks, products and services.
Our business is dependent upon the uninterrupted functioning of our information technology and telecommunication systems. We rely upon our systems, as well as the systems of our vendors, to underwrite and process our business; make claim payments; provide customer service; provide policy administration services, such as endorsements, cancellations and premium collections; comply with insurance regulatory requirements; and perform actuarial and other analytical functions necessary for pricing and product development. We have established security policies, processes and layers of defense designed to help identify and protect against intentional and unintentional misappropriation or corruption of our systems and information and disruption of our operations. Our security measures are focused on the prevention, detection and remediation of damage from computer viruses, natural disasters, unauthorized access, cyber attack and other similar disruptions.
Despite these efforts, our systems may be damaged, disrupted, or shut down due to attacks by unauthorized access, malicious software, undetected intrusion, hardware failures, or other events, and in these circumstances our disaster recovery planning may be ineffective or inadequate. Information technology security threats from user error to cybersecurity attacks are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crime and advanced threats. These threats pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. The potential consequences of a material cybersecurity attack include reputational damage, litigation with third parties, and increased cybersecurity protection and remediation costs. A sustained business interruption or system failure could adversely impact our ability to process our business, provide customer service, pay claims in a timely manner or perform other necessary business functions. We could also be subject to fines and penalties from a security breach. The cost to remedy a severe breach could be substantial.
We rely on our systems and employees, and those of certain third‑party vendors and service providers in conducting our operations, and certain failures, including internal or external fraud, operational errors, or systems malfunctions, could materially adversely affect our operations.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical and recordkeeping errors and computer or telecommunications systems malfunctions. Our business depends on our ability to process a large number of increasingly complex transactions. If any of our operational, accounting, or other data processing systems fail or have other significant shortcomings, we could be materially adversely affected. Similarly, we depend on our employees. We could be materially adversely affected if one or more of our employees cause a significant operational

21

breakdown or failure, either as a result of human error or intentional sabotage or fraudulent manipulation of our operations or systems.
Third parties with whom we do business, including vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns, failures, or capacity constraints of their own systems or employees. Any of these occurrences could diminish our ability to operate our business, or cause financial loss, potential liability to insureds, inability to secure insurance, reputational damage or regulatory intervention, which could materially adversely affect us.
Our geographic concentration ties our performance to the business, economic, natural perils, man-made perils, and regulatory conditions within our most concentrated region.
Our revenues and profitability are subject to the prevailing regulatory, legal, economic, political, demographic, competitive, weather and other conditions in the principal states in which we do business. Changes in any of these conditions could make it less attractive for us to do business in such states and would have a more pronounced effect on us compared to companies that are more geographically diversified. In addition, our exposure to severe losses from localized perils, such as earthquakes, hurricanes, tropical storms, tornadoes, wind, ice storms, hail, fires, terrorism, riots and explosions, is increased in those areas where we have written significant numbers of insurance policies.
Litigation and legal proceedings against our subsidiaries could have a material adverse effect on our business, financial condition and/or results of operations.
As an insurance holding company, our subsidiaries are named as defendants in various legal actions in the ordinary course of business. We believe that the outcome of presently pending matters, individually and in the aggregate, will not have a material adverse effect on our consolidated financial position, operating results or liquidity. However, the outcomes of lawsuits cannot be predicted and, if determined adversely, could require us to pay significant damage amounts or to change aspects of our operations, which could have a material adverse effect on our financial results.
We are subject to assessments and other surcharges from state guaranty funds, and mandatory state insurance facilities, which may reduce our profitability.
Our Insurance Company Subsidiaries are subject to assessments in most states where we are licensed for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies. These assessments, which are levied by guaranty associations within the state in proportion to premiums written by member insures in the lines of business in which the impaired, insolvent or failed insurer was engaged. Maximum contributions required by law in any one year vary by state, and have historically been less than one percent of annual premiums written. We cannot predict with certainty the amount of future assessments because they depend on factors outside our control, such as insolvencies of other insurance companies. Significant assessments could have a material adverse effect on our financial condition and results of operations.
Risks Related to Ownership of Our Common Stock
Our principal shareholders and management own a significant percentage of our stock and will be able to exert significant control over matters subject to shareholder approval.
As of December 31, 2017, our executive officers, directors, 5% shareholders and their affiliates owned approximately 45.8% of our voting stock. Therefore, these shareholders will have the ability to influence us through their ownership position. These shareholders may be able to significantly influence all matters requiring shareholder approval. For example, these shareholders may be able to significantly influence elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our shareholders.
We cannot assure you that we will declare or pay dividends on our common shares in the future so any returns may be limited to the value of our stock.
We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. Any return to shareholders will therefore be limited to appreciation in value of their stock, if any.
In addition, any determination to declare or pay future dividends to our shareholders will be at the discretion of our board of directors and will depend on a variety of factors, including (1) our financial condition, liquidity, results of operations (including our ability to generate cash flow in excess of expenses and our expected or actual net income), retained earnings and collateral and capital requirements, (2) general business conditions, (3) legal, tax and regulatory limitations,

22

(4) contractual prohibitions and other restrictions, (5) the effect of a dividend or dividends upon our financial strength ratings and (6) any other factors that our board of directors deems relevant. See “Dividend Policy.”
We incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, we are subject to the reporting requirements of the Exchange Act, which require, among other things, that we file with the SEC, annual, quarterly and current reports with respect to our business and financial condition. We are also subject to other reporting and corporate governance requirements, including certain requirements of Nasdaq and certain provisions of the Sarbanes‑Oxley Act and the regulations promulgated thereunder, which will impose significant compliance obligations upon us.
The Sarbanes‑Oxley Act and the Dodd‑Frank Act, as well as new rules subsequently implemented by the SEC and Nasdaq, have increased regulation of, and imposed enhanced disclosure and corporate governance requirements on, public companies. Our efforts to comply with these evolving laws, regulations and standards have increased our operating costs and may divert management’s time and attention from revenue‑generating activities.
Other expenses associated with being a public company include increases in auditing, accounting and legal fees and expenses, investor relations expenses, increased directors’ fees and director and officer liability insurance costs, registrar and transfer agent fees and listing fees, as well as other expenses.
Certain provisions of our corporate governance documents and Michigan law could discourage, delay or prevent a merger or acquisition at a premium price.
Our amended and restated articles of incorporation and bylaws will contain provisions that may make the acquisition of our Company more difficult without the approval of our board of directors (our “Board”). These include provisions that, among other things:
•
Permit the Board to issue up to 10 million shares of preferred stock, with any rights, preferences and privileges as they may determine (including the right to approve an acquisition or other change in control);
•
Provide that the authorized number of directors may be fixed only by the Board in accordance with our amended and restated bylaws;
•
Do not provide for cumulative voting rights (therefore allowing the holders of a majority of the shares entitled to vote in any election of directors to elect all of the directors standing for election);
•
Provide that all vacancies and newly created directorships may be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;
•
Prohibit removal of directors without cause;
•
Prohibit shareholders from calling special meetings of shareholders;
•
Requires unanimous consent for shareholders to take action by written consent without approval of the action by our Board;
•
Provide that shareholders seeking to present proposals before a meeting of shareholders or to nominate candidates for election as directors at a meeting of shareholders must provide advance notice in writing and also comply with specified requirements related to the form and content of a shareholder’s notice;
•
Require at least 80% supermajority shareholder approval to alter, amend or repeal certain provisions of our amended and restated articles of incorporation; and
•
Require at least 80% supermajority shareholder approval in order for shareholders to adopt, amend or repeal our amended and restated bylaws.
These provisions may frustrate or prevent any attempts by our shareholders to replace or remove our current management by making it more difficult for shareholders to replace members of the Board of Directors, which is responsible for appointing members of our management.
In addition, the 2015 Omnibus Incentive Plan permits the Board or a committee thereof to accelerate, vest or cause the restrictions to lapse with respect to outstanding equity awards, in the event of, or immediately prior to, a change in control. Such vesting or acceleration could discourage the acquisition of our Company.

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We could also become subject to certain anti‑takeover provisions under Michigan law which may discourage, delay or prevent someone from acquiring us or merging with us, whether or not an acquisition or merger is desired by or beneficial to our shareholders. If a corporation’s board of directors chooses to “opt in” to certain provisions of Michigan Law, such corporation may not, in general, engage in a business combination with any beneficial owner, directly or indirectly, of 10% of the corporation’s outstanding voting shares unless the holder has held the shares for five years or more or, among other things, the board of directors has approved the business combination. Our Board of Directors has not elected to be subject to this provision, but could do so in the future. Any provision of our amended and restated articles of incorporation or bylaws or Michigan law that has the effect of delaying or deterring a change in control could limit the opportunity for our shareholders to receive a premium for their shares, and could also affect the price that some investors are willing to pay for our common stock otherwise.


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ITEM 1B.  UNRESOLVED STAFF COMMENTS
None.

ITEM 2.  PROPERTIES
We lease office space in Birmingham, Michigan, where our principal executive office is located. We also lease offices in Southfield, Michigan; Jacksonville, Orlando and Miami, Florida; Somerset, Pennsylvania; and Brentwood, Tennessee. We believe that our facilities are adequate for our current needs and that suitable additional or substitute space will be available as needed.

ITEM 3.  LEGAL PROCEEDINGS
We are party to legal proceedings which arise in the ordinary course of business. We believe that the outcome of such matters, individually and in the aggregate, will not have a material adverse effect on our consolidated financial position, operating results or liquidity.

ITEM 4.  MINE SAFETY DISCLOSURES
Not Applicable.

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PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Shareholder Information
Corporate Headquarters
Transfer Agent & Registrar
550 W. Merrill Street
American Stock Transfer & Trust Co, LLC
Birmingham, MI 48009
6201 15th Avenue
Phone: (248) 559-0840
Brooklyn, NY 11219
 
 
Independent Registered
Public Accounting Firm
 
Deloitte & Touche, LLP
Stock Listing
200 Renaissance Center
Nasdaq
Suite 3900
Symbol: CNFR
Detroit, MI 48243
 
 
 
Corporate Counsel
 
Honigman Miller Schwartz and Cohn, LLP
 
600 Woodward Avenue
 
2290 First National Building
 
Detroit, MI 48226-3506
 
Shareholder Relations and Form 10-K
A copy of our 2017 Annual Report and Form 10-K, as filed with the Securities and Exchange Commission, may be obtained upon written request to our Financial Reporting Department at our corporate headquarters at ir@cnfrh.com.
Share Price and Dividend Information
Our common stock is traded on the Nasdaq under the symbol “CNFR.” The following table sets forth the high and low sale prices of our common shares as reported by the Nasdaq for each period shown:
 
High
 
Low
2017
 
 
 
First Quarter
7.75
 
6.55
Second Quarter
8.05
 
6.75
Third Quarter
7.30
 
6.05
Fourth Quarter
7.15
 
5.55
 
 
 
 
2016
 
 
 
First Quarter
9.22
 
6.04
Second Quarter
7.00
 
6.27
Third Quarter
8.59
 
7.15
Fourth Quarter
8.55
 
6.65
Neither Michigan law nor our amended and restated articles of incorporation requires our board of directors to declare dividends on our common stock. Conifer Holdings, Inc. is a holding company that has no substantial revenues of its own, and relies primarily on intercompany service fees, cash dividends or distributions from its subsidiaries to pay operating expenses, service debts, and pay dividends to shareholders. The payment of dividends by the Insurance Company Subsidiaries is limited

26

under the laws and regulations of their respective state of domicile. These regulations stipulate the maximum amount of annual dividends or other distributions available to shareholders without prior approval of the relevant regulatory authorities. Any future determination to declare cash dividends on our common stock will be made at the discretion of the board of directors and will depend on the financial condition, results of operations, capital requirements, general business conditions and other factors that the board of directors may deem relevant. The Parent Company has not historically paid dividends and does not anticipate paying cash dividends on its common stock for the foreseeable future.
For additional information regarding dividend restrictions, refer to the Liquidity and Capital Resources section of Management’s Discussion and Analysis.
Shareholders of Record
As of March 15, 2018, there were 35 shareholders of record of our common stock. A substantially greater number of holders are beneficial owners whose shares are held of record by banks, brokers and other nominees.
Recent Sales of Unregistered Securities
In the past three years, we have sold and issued the following unregistered securities:
On September 27, 2017, the Company’s Board of Directors authorized a private placement stock purchase offering wherein the Company was authorized to sell a maximum of $7.0 million of the Company’s common stock, no par value per share, pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506(b) of Regulation D as promulgated under the Securities Act and in accordance with applicable federal securities laws, including Rule 10b5-1 and 10b-18 of the Securities Exchange Act of 1934 as amended. The participants in the private placement consisted mainly of members of the Company’s management team and Board of Directors, including the Company’s Chairman and CEO, James Petcoff.
Under this private placement offering, the Company issued $5.0 million of common equity consisting of 800,000 shares at the price of $6.25 per share on September 28, 2017. The Company’s common stock closing market price on the Nasdaq Stock Market on September 28, 2017, was $6.05 per share. The offering was made to accredited investors only. No commissions or other remuneration were paid in connection with the issuance. The actual timing, number and value of shares to be issued under the private placement offering was determined by management in its discretion and depended on a number of factors, including the market price of the Company’s stock, general marketing conditions, and other factors. The Company used the proceeds from the issuance to strengthen its balance sheet through contributions to the Insurance Company Subsidiaries to support future growth, as well as to cover the cost of the ADC and reserve strengthening.
On February 25, 2016, the Company's Board of Directors authorized a stock repurchase program, under which the Company may repurchase up to $2.1 million of its outstanding common stock. Under this program, management was authorized to repurchase shares at prevailing market prices through open market purchases, privately negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended. The actual timing, number and value of shares repurchased under the program was determined by management in its discretion and depended on a number of factors, including the market price of the Company’s stock, general market conditions, and other factors. The Company did not repurchase any of its outstanding common stock during 2017.
In the fourth quarter of 2014, in a series of transactions ranging from September 30, 2014 through January 16, 2015, we sold an aggregate of 1,535,814 shares of our common stock at a per share price of $13.63, resulting in aggregate gross proceeds of $20.9 million. These shares were sold to certain of our officers and directors and other third party accredited investors.
No underwriters were involved in the foregoing sales of securities. The issuances of the securities described above were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering.

27

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following tables set forth selected consolidated historical financial information of Conifer Holdings, Inc. and Subsidiaries as of the dates and for the periods indicated. The selected financial data for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 were derived from our audited consolidated financial statements and related notes thereto.
These historical results are not necessarily indicative of results to be expected for any future period. The following financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes thereto included elsewhere in this report (dollars in thousands, except for per share data).
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Operating Results:
 
 
 
 
 
 
 
 
 
Gross written premiums
$
114,284

 
$
114,923

 
$
93,750

 
$
83,847

 
$
44,087

Ceded written premiums
(23,044
)
 
(14,994)

 
(14,076)

 
(17,548)

 
(6,439)

Net written premiums
$
91,240

 
$
99,929

 
$
79,674

 
$
66,299

 
$
37,648

 
 
 
 
 
 
 
 
 
 
Net earned premiums
$
91,729

 
$
89,627

 
$
66,765

 
$
57,528

 
$
27,629

Net investment income
2,728

 
2,173

 
1,902

 
1,175

 
1,000

Net realized investment gains
70

 
1,365

 
285

 
417

 
299

Other gains (losses) (1)
750

 
(400)

 
104

 
—

 
3,714

Other income
1,560

 
1,118

 
1,667

 
1,809

 
834

Total revenue
96,837

 
93,883

 
70,723

 
60,929

 
33,476

Losses and loss adjustment expenses, net
73,917

 
59,003

 
38,882

 
40,730

 
15,824

Policy acquisition costs
26,245

 
25,280

 
16,183

 
14,696

 
7,667

Operating expenses
17,367

 
17,596

 
14,806

 
12,139

 
9,161

Interest expense
1,362

 
647

 
769

 
584

 
541

Total expenses
118,891

 
102,526

 
70,640

 
68,149

 
33,193

Income (loss) before income taxes
(22,054)

 
(8,643)

 
83

 
(7,220)

 
283

Income tax expense (benefit)
(447
)
 
(77)

 
48

 
(281)

 
3

Equity earnings (losses) in affiliates, net of tax
65

 
129

 
(52)

 
—

 
—

Net income (loss)
(21,542)

 
(8,437)

 
(17)

 
(6,939)

 
280

Less net income (loss) attributable to non-controlling interest
—

 
—

 
(81)

 
(4)

 
(69)

Net income (loss) attributable to Conifer
$
(21,542
)
 
$
(8,437
)
 
$
64

 
$
(6,935
)
 
$
349

Net income (loss) allocable to common shareholders   
$
(21,542
)
 
$
(8,437
)
 
$
(476
)
 
$
(7,200
)
 
$
349

Net income (loss) per share allocable to common shareholders, basic and diluted
$
(2.74
)
 
$
(1.11
)
 
$
(0.09
)
 
$
(2.69
)
 
$
0.20

Weighted average common shares outstanding, basic and diluted
7,867,344

 
7,618,588

 
5,369,960

 
2,672,440

 
1,749,626


28

 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and invested assets
$
169,518

 
$
141,023

 
$
130,427

 
$
123,726

 
$
68,445

Reinsurance recoverables
24,539

 
7,498

 
7,044

 
5,139

 
4,394

Total assets
239,032

 
203,701

 
177,927

 
163,738

 
96,856

Unpaid losses and loss adjustment expenses
87,896

 
54,651

 
35,422

 
31,531

 
28,908

Unearned premiums
57,672

 
58,126

 
47,916

 
43,381

 
26,505

Debt
29,027

 
17,750

 
12,750

 
27,562

 
13,087

Total liabilities
186,206

 
135,907

 
100,665

 
113,460

 
75,605

Preferred stock (2)
—

 
—

 
—

 
6,119

 
—

Total shareholders’ equity attributable to Conifer
52,826

 
67,794

 
77,262

 
44,182

 
21,270

Other Data:
 
 
 
 
 
 
 
 
 
Shareholders’ equity per common share outstanding
$
6.20

 
$
8.88

 
$
10.11

 
$
11.06

 
$
12.16

Regulatory capital and surplus (3)
62,451

 
62,189

 
71,153

 
65,974

 
34,817

 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Underwriting Ratios:
 
 
 
 
 
 
 
 
 
Loss ratio
79.2
%
 
65.0
%
 
56.8
%
 
68.6
%
 
55.6
%
Expense ratio
46.8
%
 
47.2
%
 
45.3
%
 
45.2
%
 
59.1
%
Combined ratio
126.0
%
 
112.2
%
 
102.1
%
 
113.8
%
 
114.7
%

(1)
In 2017, the Company recognized a $750,000 gain on the sale of the renewal rights of a portion of the low value dwelling book of business to another insurer. In 2016, as a result of the merger of ACIC into WPIC, the value of intangible assets recorded for insurance licenses on ACIC were written off resulting in a loss. In 2015, the Company recognized a gain as a result of the deconsolidation of an affiliate. In 2013, the Company recognized a gain on the acquisitions of EGI Insurance Services, Inc. and MLBA Mutual Insurance Company. The acquisitions were accounted for as bargain purchases.
(2)
In March 2015, the Company reclassified the then carrying amount of its preferred stock of $6,180 from temporary equity to permanent equity as the redemption of the preferred stock became within the Company’s control as a result of the amendments to the preferred stock designations.
(3)
For our Insurance Company Subsidiaries, the excess of assets over liabilities are determined in accordance with statutory accounting principles as determined by the domiciliary state for each Insurance Company Subsidiary.

29

 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K, filed with the U. S. Securities and Exchange Commission (“SEC”).
Forward-Looking Statements
Certain statements contained in this Annual Report on Form 10-K, which are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as “anticipate,” “believe,” “estimate,” “expect,” "will," “intend,” “may,” “plan,” “seek” and similar terms and phrases, or the negative thereof, may be used to identify forward-looking statements.
The forward-looking statements contained in this report are based on management’s good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks and uncertainties, many of which are beyond our control, which could cause our actual results to differ materially from those in the forward-looking statements, including those described above in Item 1A Risk Factors and subsequent reports filed with or furnished to the SEC. Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified herein. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable laws or regulations.
Business Overview
We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 44 states, including the District of Columbia. We are licensed to write insurance in 42 states, including the District of Columbia, as an admitted carrier and we offer our insurance products in all 50 states.
Our revenues are primarily derived from premiums earned from our insurance operations. We also generate other revenues through investment income and other income which mainly consists of: installment fees and policy issuance fees generally related to the policies we write and commission income from SIA's 50% owned agency (the "Affiliate"). The Affiliate places small commercial risks mainly for alarm and security guard markets.
Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions, and other underwriting and administrative expenses. We organize our operations in two insurance businesses: commercial insurance lines and personal insurance lines.
Through our commercial insurance lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers’ compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis.
Through our personal insurance lines, we offer homeowners insurance and dwelling fire insurance products to individuals in several states. Our specialty homeowners insurance line is primarily comprised of either wind-exposed homeowners insurance providing hurricane and wind coverage to underserved homeowners in Texas, Hawaii and Florida or low-value dwelling insurance tailored for owners of lower valued homes, which we offer in Illinois, Indiana, Louisiana and Texas. Due to certain Florida-based industry events, we have been de-emphasizing our Florida homeowners' business and reducing our exposures in that state. Otherwise, there has been little change in our approach to managing or evaluating these lines.

30

Critical Accounting Policies and Estimates
General
We identified the accounting estimates below as 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 which 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 the reported amounts of assets, liabilities, revenues and expenses and the disclosure of material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. See the Consolidated Financial Statements Note 1 – Summary of Significant Accounting Policies, for further details.
Loss and Loss Adjustment Expense Reserves
Our recorded loss and loss adjustment expenses ("LAE") reserves represent management’s best estimate of unpaid loss and LAE at each balance sheet date, based on information, facts and circumstances known at such time. Our loss and LAE reserves reflect our estimates at the balance sheet date of:
•    Case reserves, which are unpaid loss and LAE amounts that have been reported; and
•    Incurred but not reported ("IBNR") reserves, which are (1) unpaid loss and LAE amounts that have been incurred but not yet reported; and (2) the expected development on case reserves.
We do not discount the loss and LAE reserves for the time value of money.
Case reserves are initially set by our claims personnel. When a claim is reported to us, our claims department completes a case‑basis valuation and establishes a case reserve for the estimated amount of the probable ultimate losses and LAE associated with that claim. Our claims department updates their case‑basis valuations upon receipt of additional information and reduces case reserves as claims are paid. The case reserve is based primarily upon an evaluation of the following factors:
•    The type of loss;
•    The severity of injury or damage;
•    Our knowledge of the circumstances surrounding the claim;
•    The jurisdiction of the occurrence;
•    Policy provisions related to the claim;
•    Expenses intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims, costs of outside adjusters and experts, and all other expenses which are identified to the case; and
•
Any other information considered pertinent to estimating the indemnity and expense exposure presented by the claim.
IBNR reserves are determined by subtracting case reserves and paid loss and LAE from the estimated ultimate loss and LAE. Our actuarial department develops estimated ultimate loss and LAE on a quarterly basis. Our Reserve Review Committee (which includes our Chief Executive Officer, President, Chief Financial Officer, other members of executive management, and key actuarial, underwriting and claims personnel) meets each quarter to review our actuaries’ estimated ultimate expected loss and LAE.
We use several generally accepted actuarial methods to develop estimated ultimate loss and LAE estimates by line of business and accident year. This process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is a reasonable basis for predicting future outcomes. These methods utilize various inputs, including:
•    Written and earned premiums;
•    Paid and reported losses and LAE;
•    Expected initial loss and LAE ratio, which is the ratio of incurred losses and LAE to earned premiums; and

31

•    Expected claim reporting and payout patterns based on our own loss experience and supplemented with insurance industry data where applicable.
The principal standard actuarial methods used by our actuaries for their comprehensive reviews include:
•    Loss ratio method—This method uses loss and LAE ratios for prior accident years, adjusted for current trends, to determine an appropriate expected loss and LAE ratio for a given accident year;
•    Loss development methods—Loss development methods assume that the losses and LAE yet to emerge for an accident year are proportional to the paid or reported loss and LAE amounts observed to‑date. The paid loss development method uses losses and LAE paid to date, while the reported loss development method uses losses and LAE reported to date;
•    Bornheutter‑Ferguson method—This method is a combination of the loss ratio and loss development methods, where the loss development factor is given more weight as an accident year matures; and
•    Frequency/severity method—This method projects claim counts and average cost per claim on a paid or reported basis for high frequency, low severity products.
Our actuaries give different weights to each of these methods based upon the amount of historical experience data by line of business and by accident year, and based on judgment as to what method is believed to result in the most accurate estimate. The application of each method by line of business and by accident year may change in the future if it is determined that a different emphasis for each method would result in more accurate estimates.
Our actuaries also analyze several diagnostic measures by line of business and accident year, including but not limited to: reported and closed frequency and severity, claim reporting and claim closing patterns, paid and incurred loss ratio development, and ratios of paid loss and LAE to incurred loss and LAE. After the actuarial methods and diagnostic measures have been performed and analyzed, our actuaries use their judgment and expertise to select an estimated ultimate loss and LAE by line of business and by accident year.
Our actuaries estimate an IBNR reserve for our unallocated LAE not specifically identified to a particular claim, namely our internal claims department salaries and associated general overhead and administrative expenses associated with the adjustment and processing of claims. These estimates, which are referred to as unallocated loss adjustment expense ("ULAE") reserves, are based on internal cost studies and analyses reflecting the relationship of ULAE paid to actual paid and incurred losses. We select factors that are applied to case reserves and IBNR reserve estimates in order to estimate the amount of ULAE reserves applicable to estimated loss reserves at the balance sheet date.
We allocate the applicable portion of our estimated loss and LAE reserves to amounts recoverable from reinsurers under reinsurance contracts and report those amounts separately from our loss and LAE reserves as an asset on our balance sheet.
The estimation of ultimate liability for losses and LAE is a complex, imprecise and inherently uncertain process, and therefore involves a considerable degree of judgment and expertise. Our loss and LAE reserves do not represent an exact measurement of liability, but are estimates based upon various factors, including but not limited to:
•    Actuarial projections of what we, at a given time, expect to be the cost of the ultimate settlement and administration of claims reflecting facts and circumstances then known;
•    Estimates of future trends in claims severity and frequency;
•    Assessment of asserted theories of liability; and
•    Analysis of other factors, such as variables in claims handling procedures, economic factors, and judicial and legislative trends and actions.
Most or all of these factors are not directly or precisely quantifiable, particularly on a prospective basis, and are subject to a significant degree of variability over time. In addition, the establishment of loss and LAE reserves makes no provision for the broadening of coverage by legislative action or judicial interpretation or for the extraordinary future emergence of new types of losses not sufficiently represented in our historical experience or which cannot yet be quantified. As a result, an integral component of our loss and LAE reserving process is the use of informed subjective estimates and judgments about our ultimate exposure to losses and LAE. Accordingly, the ultimate liability may vary significantly from the current estimate. The effects of change in the estimated loss and LAE reserves are included in the results of operations in the period in which the estimate is revised.
Our reserves consist entirely of reserves for property and liability losses, consistent with the coverages provided for in the insurance policies directly written or assumed by us under reinsurance contracts. Occasionally, several years may elapse

32

between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss. The level of IBNR reserves in relation to total reserves depends upon the characteristics of the specific line of business, particularly related to the speed with which claims are reported and outstanding claims are paid. Lines of business for which claims are reported slowly will have a higher percentage of IBNR reserves than lines of business that report and settle claims more quickly.
The following table shows the ratio of IBNR reserves to total reserves net of reinsurance recoverables as of December 31, 2017 (dollars in thousands):
Line of Business
Case
Reserves
 
IBNR
Reserves
 
Total
Reserves
 
Ratio of
IBNR to
Total
Reserves
 
 
Commercial Lines
$
32,280

 
$
27,041

 
$
59,321

 
45.6
%
Personal Lines
5,569

 
2,940

 
8,509

 
34.6
%
Total Lines
$
37,849

 
$
29,981

 
$
67,830

 
44.2
%
Although we believe that our reserve estimates are reasonable, it is possible that our actual loss and LAE experience may not conform to our assumptions and may, in fact, vary significantly from our assumptions. Accordingly, the ultimate settlement of losses and the related LAE may vary significantly from the estimates included in our financial statements. We continually review our estimates and adjust them as we believe appropriate as our experience develops or new information becomes known to us. Such adjustments are included in current operations.
Our loss and LAE reserves do not represent an exact measurement of liability, but are estimates. The most significant assumptions affecting our IBNR reserve estimates are the loss development factors applied to paid losses and case reserves to develop IBNR by line of business and accident year. Although historical loss development provides us with an indication of future loss development, it typically varies from year to year. Thus, for each accident year within each line of business we select one loss development factor out of a range of historical factors.
We generated a sensitivity analysis of our net reserves which represents reasonably likely levels of variability in our selected loss development factors. We believe the most meaningful approach to the sensitivity analysis is to vary the loss development factors that drive the ultimate loss and LAE estimates. We applied this approach on an accident year basis, reflecting the reasonably likely differences in variability by level of maturity of the underlying loss experience for each accident year. Generally, the most recent accident years are characterized by more unreported losses and less information available for settling claims, and have more inherent uncertainty than the reserve estimates for more mature accident years. Therefore, we used variability factors of plus or minus 10% for the most recent accident year, 5% for the preceding accident year, and 2.5% for the second preceding accident year. There is minimal expected variability for accident years at four or more years’ maturity.
    

33

The following table displays ultimate net loss and LAE and net loss and LAE reserves by accident year for the year ended December 31, 2017. We applied the sensitivity factors to each accident year amount and have calculated the amount of potential net loss and LAE reserve change and the impact on 2017 reported pre-tax income and on net income and shareholders’ equity at December 31, 2017. We believe it is not appropriate to sum the illustrated amounts as it is not reasonably likely that each accident year’s reserve estimate assumptions will vary simultaneously in the same direction to the full extent of the sensitivity factor. We also believe that such changes to our reserve balance would not have a material impact on our operating results, financial position, or liquidity. The net income and shareholders' equity amounts include an income tax rate assumption of 21%. The dollar amounts in the table are in thousands.
 
Ultimate
Loss and LAE
Sensitivity
Factor
 
December 31, 2017
Ultimate
Loss and LAE
 
December 31, 2017
Loss and LAE
Reserves
 
Potential
Impact on
2017 Pre-
Tax Income
 
Potential
Impact on 2017
Net Income and
December 31, 2017
Shareholders'
Equity
 
 
Increased Ultimate Losses & LAE
 
 
 
 
 
 
 
 
 
Accident Year 2017
10.0
 %
 
$
63,785

 
$
39,910

 
$
6,379

 
$
5,039

Accident Year 2016
5.0
 %
 
45,599

 
11,571

 
2,280

 
1,801

Accident Year 2015
2.5
 %
 
49,709

 
10,479

 
1,243

 
982

Prior to 2015 Accident Years
—
 %
 
—

 
5,870

 
—

 
—

 
 
 
 
 
 
 
 
 
 
Decreased Ultimate Losses & LAE
 
 
 
 
 
 
 
 
 
Accident Year 2017
(10.0
)%
 
63,785

 
39,910

 
(6,379
)
 
(5,039
)
Accident Year 2016
(5.0
)%
 
45,599

 
11,571

 
(2,280
)
 
(1,801
)
Accident Year 2015
(2.5
)%
 
49,709

 
10,479

 
(1,243
)
 
(982
)
Prior to 2015 Accident Years
—
 %
 
—

 
5,870

 
—

 
—

Investment Valuation and Impairment
We carry debt and equity securities classified as available‑for‑sale at fair value, and unrealized gains and losses on such securities, net of any deferred taxes, are reported as a separate component of accumulated other comprehensive income. We do not have any securities classified as trading or held‑to‑maturity.
We evaluate our available‑for‑sale investments regularly to determine whether there have been declines in value that are other‑than‑temporary. Our outside investment managers assist us in this evaluation. When we determine that a security has experienced an other‑than‑temporary impairment, the impairment loss is recognized as a realized investment loss.
We consider a number of factors in assessing whether an impairment is other‑than‑temporary, including (1) the amount and percentage that current fair value is below cost or amortized cost, (2) the length of time that the fair value has been below cost or amortized cost and (3) recent corporate developments or other factors that may impact an issuer’s near term prospects. In addition, for debt securities, we consider the credit quality ratings for the securities, with a special emphasis on securities downgraded to below investment grade. We also consider our intent to sell available‑for‑sale debt securities in an unrealized loss position, and if it is more likely than not that we will be required to sell these securities before a recovery in fair value to their cost or amortized cost basis. For equity securities, we evaluate the near‑term prospect of these investments in relation to the severity and duration of the impairment, and we consider our ability and intent to hold these investments until they recover their fair value.
Fair values are measured in accordance with ASC 820, Fair Value Measurements. The guidance establishes a framework for measuring fair value and a three‑level hierarchy based upon the quality of inputs used to measure fair value. The three levels of the fair value hierarchy are: (1) Level 1: inputs are based on quoted prices (unadjusted) in active markets for identical assets or liabilities, (2) Level 2: inputs are other than quoted prices that are observable for the asset or liabilities, either directly or indirectly, for substantially the full term of the asset or liability and (3) Level 3: unobservable inputs that are

34

supported by little or no market activity. The unobservable inputs represent the Company’s best assumption of how market participants would price the assets or liabilities.
The fair values of debt and equity securities have been determined using fair value prices provided by our investment managers, who utilize internationally recognized independent pricing services. The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities).
The values for publicly‑traded equity securities are generally based on Level 1 inputs which use the market approach valuation technique. The values for debt securities generally incorporate significant Level 2 inputs. The carrying value of cash and short‑term investments approximate their fair values due to their short‑term maturity.
We review fair value prices provided by our outside investment managers for reasonableness by comparing the fair values provided by the managers to those provided by our investment custodian. We also review and monitor changes in unrealized gains and losses. We obtain an understanding of the methods, models and inputs used by our investment managers and independent pricing services, and controls are in place to validate that prices provided represent fair values. Our control process includes initial and ongoing evaluation of the methodologies used, a review of specific securities and an assessment for proper classification within the fair value hierarchy.
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in the United States and numerous state jurisdictions. Significant judgment is required in determining the consolidated income tax expense.
On December 22, 2017, the U.S. federal government enacted H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Act”). The Act provides for significant changes to corporate taxation including the decrease of the corporate tax rate from 34% to 21%. We have completed an analysis of the impact of the Act and has followed the additional guidance provided by the Security and Exchange Commission's Staff Accounting Bulletin No. 118. We believe there are no material provisional balances as of December 31, 2017.
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax‑planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results and incorporate assumptions about the amount of future state and federal pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income or loss.
As of December 31, 2017, we have federal and state income tax net operating loss (“NOL”) carryforwards of $43.6 million and $11 million, respectively, which will expire at various dates from 2029 through 2037. Of the federal NOL amount, $15.1 million are subject to limitations under Section 382 of the Internal Revenue Code. These net NOL carryforwards are limited in the amount that can be utilized in any one year and may expire before they are realized. At this time we do not expect that any of the remaining NOL carryforwards will expire before utilized.
The carrying value of our gross deferred tax asset for the NOL carryforwards is equal to the total NOL carryforward amount times the applicable federal and state tax rates, and was $9.5 million and $8.0 million as of December 31, 2017 and 2016, respectively. Total gross deferred tax assets were $13.3 million and $13.0 million as of December 31, 2017 and 2016. A valuation allowance of $9.9 million and $8.4 million has been recorded against the gross deferred tax assets as of December 31, 2017 and 2016, respectively, as the Company has recognized a three year cumulative loss as of December 31, 2017 which is significant negative evidence to support the lack of recoverability of those deferred tax assets in accordance with ASC 740, Income Taxes. The net deferred tax liability was $115,000 and $179,000 as of December 31, 2017 and 2016, respectively.
If, in the future, we determine we can support the recoverability of a portion or all of the deferred tax assets under the guidance, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets will be accounted for as a reduction of income tax expense and result in an increase in equity. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and our effective tax rate in the future.

35

Non-GAAP Financial Measures
Adjusted Operating Income (Loss) and Adjusted Operating Income (Loss) Per Share
Adjusted operating income (loss) and adjusted operating income (loss) per share are non-GAAP measures that represent net income allocable to common shareholders excluding net realized investment and other gains (losses), net of tax, the effects of tax reform, and the tax effect of changes in unrealized gains to the extent included in net income. The most directly comparable financial GAAP measures to adjusted operating income and adjusted operating income per share are net income and net income per share, respectively. Adjusted operating income and adjusted operating income per share are intended as supplemental information and are not meant to replace net income or net income per share. Adjusted operating income and adjusted operating income per share should be read in conjunction with the GAAP financial results. Our definition of adjusted operating income may be different from that used by other companies. The following is a reconciliation of net income to adjusted operating income (dollars in thousands), as well as net income per share to adjusted operating income per share:
 
For the Years Ended December 31,
 
2017
 
2016
 
2015
 
 
Net income (loss) allocable to common shareholders
$
(21,542
)
 
$
(8,437
)
 
$
(476
)
Less:
 
 
 
 
 
Net realized investment gains and other gains (losses)
820

 
965

 
389

Effect of tax law change
63

 
—

 
—

Tax effect of unrealized gains and losses on investments
356

 
147

 
—

Adjusted operating income (loss)
$
(22,781
)
 
$
(9,549
)
 
$
(865
)
 
 
 
 
 
 
Weighted average common shares, diluted
7,867,344

 
7,618,588

 
5,369,960

 
 
 
 
 
 
Diluted (loss) per common share:
 
 
 
 
 
Net income (loss) allocable to common shareholders
$
(2.74
)
 
$
(1.11
)
 
$
(0.09
)
Net realized investment gains and other gains (losses) per share
0.10

 
0.13

 
0.07

Effect of tax law change
0.01

 
—

 
—

Tax effect of unrealized gains and losses on investments
0.05

 
0.02

 
—

Adjusted operating (loss) per share
$
(2.90
)
 
$
(1.26
)
 
$
(0.16
)
We use adjusted operating income and adjusted operating income per share, in conjunction with other financial measures, to assess our performance and to evaluate the results of our business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the effect of investment gains and losses as a result of our market risk sensitive instruments, which primarily relate to fixed income securities that are available for sale and not held for trading purposes. Realized investment gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, adjusted operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying loss or profitability of our business. We believe that it is useful for investors to evaluate adjusted operating income and adjusted operating income per share, along with net income and net income per share, when reviewing and evaluating our performance.
Executive Overview
In 2017, we continued to expand our commercial lines and reposition our personal lines of business. Our commercial lines gross written premiums grew by 4.4% in 2017, and personal line gross written premiums decreased by 16.9% in 2017, as compared to 2016.
In September 2017, we entered into an adverse development cover reinsurance agreement (the "ADC") to protect against loss development of up to $17.5 million in excess of stated reserves as of June 30, 2017. The agreement provides up to $17.5 million of reinsurance for adverse net loss reserve development for accident years 2005 through 2016. The agreement attaches when net losses exceed $1.4 million of the $36.6 million carried reserves at June 30, 2017, and extends to $19.5 million in coverage up to $57.5 million (inclusive of a 10% co-participation).

36

The 2017 results were mainly driven by adverse development on prior-year reserves which were incurred through September 30, 2017, the cost of the ADC, and losses from hurricanes Irma and Harvey.
Our expense ratio continues to improve as we have executed on rationalizing costs with growing earned premiums. In the fourth quarter of 2017, the expense ratio was 41.4%, down 4.2 percentage points from the fourth quarter of 2016.
The Company reported a net loss of $21.5 million, or $2.74 per share, for the year ended December 31, 2017, compared to a net loss of $8.4 million, or $1.11 per share, for the year ended December 31, 2016.
Adjusted operating loss, a non-GAAP measure, was $22.8 million, or $2.90 per share, for the year ended December 31, 2017, compared to an adjusted operating loss of $9.5 million, or $1.26 per share, for the year ended December 31, 2016.
Potential impact of ADC on future periods
We purchased the ADC to greatly reduce our exposure to prior-year adverse development. The benefits of the ADC can be seen in the fourth quarter wherein we experienced $2.1 million of adverse development, but retained only $33,000 of that development. In 2017, we paid $7.20 million in ceded premiums under the ADC, and ceded $7.19 million in losses. There remains available $10.3 million of cover in the event of additional adverse development.
In the event there is additional adverse development that exceeds the cost of the ADC, that excess amount will be deemed a gain under retroactive reinsurance accounting rules and is required to be deferred and only recognized in earnings in proportion to the actual paid recoveries under the ADC. Over the life of the contract, the accounting benefit will align with economic benefit of the ADC, however we may be required to recognize losses in near-term future periods, only to recognize offsetting gains in periods further out.

37

Results of Operations - 2017 Compared to 2016
The following table summarizes our operating results for the years indicated (dollars in thousands):
Summary Operating Results
 
Years Ended December 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
 
Gross written premiums
$
114,284

 
$
114,923

 
$
(639
)
 
(0.6
%)
Net written premiums
$
91,240

 
$
99,929

 
$
(8,689
)
 
(8.7
%)
Net earned premiums
$
91,729

 
$
89,627

 
$
2,102

 
2.3
%
Other income
1,560

 
1,118

 
442

 
39.5
%
Losses and loss adjustment expenses, net
73,917

 
59,003

 
14,914

 
25.3
%
Policy acquisition costs
26,245

 
25,280

 
965

 
3.8
%
Operating expenses
17,367

 
17,596

 
(229
)
 
(1.3
%)
Underwriting gain (loss)
(24,240
)
 
(11,134
)
 
(13,106
)
 
*

Net investment income
2,728

 
2,173

 
555

 
25.5
%
Net realized investment gains
70

 
1,365

 
(1,295
)
 
(94.9
%)
Other gains (losses)
750

 
(400
)
 
1,150

 
*

Interest expense
1,362

 
647

 
715

 
110.5
%
Income (loss) before income taxes
(22,054
)
 
(8,643
)
 
(13,411
)
 
*

Income tax expense (benefit)
(447
)
 
(77
)
 
(370
)
 
*

Equity earnings (losses) in affiliates, net of tax
65

 
129

 
(64
)
 
*

Net income (loss)
$
(21,542
)
 
$
(8,437
)
 
$
(13,105
)
 
*

 
 
 
 
 
 
 
 
Underwriting Ratios:
 
 
 
 
 
 
 
Loss ratio
79.2
%
 
65.0
%
 
 
 
 
Expense ratio
46.8
%
 
47.2
%
 
 
 
 
Combined ratio
126.0
%
 
112.2
%
 
 
 
 
* Percentage change is not meaningful
Premiums
Earned premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. All commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. Almost all personal automobile policies are six month term policies under which premiums are earned evenly over a six-month period. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over time.
    

38

Our premiums are presented below for the years ended December 31, 2017 and 2016 (dollars in thousands):
Summary of Premium Revenue
 
Years Ended December 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
 
Gross written premiums
 
 
 
 
 
 
 
Commercial lines
$
92,112

 
$
88,242

 
$
3,870

 
4.4
%
Personal lines
22,172

 
26,681

 
(4,509
)
 
(16.9
%)
Total
$
114,284

 
$
114,923

 
$
(639
)
 
(0.6
%)
 
 
 
 
 
 
 
 
Net written premiums
 
 
 
 
 
 
 
Commercial lines
$
78,217

 
$
78,439

 
$
(222
)
 
(0.3
%)
Personal lines
13,023

 
21,490

 
(8,467
)
 
(39.4
%)
Total
$
91,240

 
$
99,929

 
$
(8,689
)
 
(8.7
%)
 
 
 
 
 
 
 
 
Net Earned premiums
 
 
 
 
 
 
 
Commercial lines
$
76,786

 
$
68,921

 
$
7,865

 
11.4
%
Personal lines
14,943

 
20,706

 
(5,763
)
 
(27.8
%)
Total
$
91,729

 
$
89,627

 
$
2,102

 
2.3
%
Gross written premiums remained flat for the year ended December 31, 2017, as compared to 2016. These results reflect our continued execution of our growth initiatives in the niche commercial insurance markets and our strategic change in the mix of business of our personal lines.
Commercial lines gross written premiums increased $3.9 million, or 4.4%, to $92.1 million for the year ended December 31, 2017, as compared to $88.2 million for the year ended December 31, 2016. This increase was seen across almost every commercial product line as a result of our continued strategic expansion efforts.
Personal lines gross written premiums decreased $4.5 million, or 16.9%, to $22.2 million for the year ended December 31, 2017, as compared to $26.7 million for the same period in 2016. This was largely driven by a reduction in wind-exposed homeowners business in both Florida and Texas.
Net written premiums decreased $8.7 million, or 8.7%, to $91.2 million for the year ended December 31, 2017, as compared to $99.9 million for the year ended December 31, 2016. The decrease was primarily due to $7.2 million of ceded written premium recorded in the third quarter of 2017 relating to the ADC.
Other Income
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings or policy issuance costs. Commission income is also received by the Company’s insurance agencies for writing policies for third party insurance companies. Other income for the year December 31, 2017 increased $442,000, or 39.5%, to $1.5 million as compared to $1.1 million for the year ended December 31, 2016. The increase was due to continued expansion into lines of business in which various fees are charged to the policyholders.

39

Losses and Loss Adjustment Expenses
The tables below detail our losses and LAE and loss ratios for the years ended December 31, 2017 and 2016 (dollars in thousands).
Year Ended December 31, 2017
Commercial
Lines
 
Personal
Lines
 
Total
 
 
Accident year net losses and LAE
$
48,520

 
$
15,937

 
$
64,457

Net (favorable) adverse development
7,181

 
2,279

 
9,460

Calendar year net loss and LAE
$
55,701

 
$
18,216

 
$
73,917

 
 
 
 
 
 
Accident year loss ratio
62.7
%
 
101.4
%
 
69.1
%
Net (favorable) adverse development
9.3
%
 
14.5
%
 
10.1
%
Calendar year loss ratio
72.0
%
 
115.9
%
 
79.2
%
Year Ended December 31, 2016
Commercial
Lines
 
Personal
Lines
 
Total
 
 
Accident year net losses and LAE
$
35,652

 
$
13,130

 
$
48,782

Net (favorable) adverse development
6,789

 
3,432

 
10,221

Calendar year net loss and LAE
$
42,441

 
$
16,562

 
$
59,003

 
 
 
 
 
 
Accident year loss ratio
51.4
%
 
61.8
%
 
53.7
%
Net (favorable) adverse development
9.8
%
 
16.1
%
 
11.3
%
Calendar year loss ratio
61.2
%
 
77.9
%
 
65.0
%
Net losses and LAE increased by $14.9 million, or 25.3%, for the year ended December 31, 2017, as compared to the same period in 2016. The increase was due to a combination of $9.5 million of adverse reserve development from prior years and $5.4 million of net losses from Hurricanes Harvey and Irma. The calendar year loss ratios were 79.2% and 65.0% for the years ended December 31, 2017 and 2016, respectively. The hurricanes contributed 6.4 percentage points to the 2017 loss ratio. The ADC resulted in approximately a 1.5 percentage point increase in the loss ratio as slightly more premiums were ceded under the ADC than losses in 2017. The 14.2 percentage point increase in our loss ratio was primarily attributable to the reserve strengthening in our Florida homeowners, commercial automobile and commercial liability lines of business.
The $9.5 million of adverse development in 2017 consisted of $7.18 million from commercial lines and $2.3 million from personal lines and mostly related to the 2016 and 2015 accident years. Substantially all of this development occurred in the first three quarters of 2017 and primarily consisted of $5.1 million from commercial liability business, $1.6 million from the commercial property, $1.7 million from Florida homeowners and $0.5 million from commercial auto business.
Overall reserve development on prior accident years for the year ended December 31, 2016, was unfavorable by $10.2 million, or 11.3 percentage points of the loss ratio. The development included $2.7 million of adverse development in both the wind-exposed homeowners and commercial auto lines of business as well as $2.6 million and $760,000 of adverse development in the hospitality line of business and personal auto lines of business, respectively.
Expense Ratio
Our expense ratio is calculated by dividing the sum of policy acquisition costs and operating expenses by the sum of net earned premiums and other income. We use the expense ratio to evaluate the operating efficiency of our consolidated operations and each segment. Costs that are not readily identifiable as a direct cost of a segment or product line remain in Corporate and Other for segment reporting purposes.
    




40

The table below provides the expense ratio by major component:
 
Years Ended December 31,
 
2017
 
2016
 
Before ADC or Reinstatement Costs
 
Impact of ADC & Reinstatement Costs
Total
 
 
Commercial Lines
 
 
 
 
 
 
Policy acquisition costs
24.7
%
 
1.7
%
26.4
%
 
26.8
%
Operating expenses
13.7
%
 
1.0
%
14.7
%
 
9.7
%
Total
38.4
%
 
2.7
%
41.1
%
 
36.5
%
 
 
 
 
 
 
 
Personal Lines
 
 
 
 
 
 
Policy acquisition costs
31.5
%
 
5.2
%
36.7
%
 
31.6
%
Operating expenses
14.0
%
 
2.3
%
16.3
%
 
13.7
%
Total
45.5
%
 
7.5
%
53.0
%
 
45.3
%
 
 
 
 
 
 
 
Corporate and Other
 
 
 
 
 
 
Operating expenses
3.7
%
 
—
%
3.7
%
 
8.7
%
Total
3.7
%
 
—
%
3.7
%
 
8.7
%
 
 
 
 
 
 
 
Consolidated
 
 
 
 
 
 
Policy acquisition costs
25.9
%
 
2.2
%
28.1
%
 
27.8
%
Operating expenses
17.2
%
 
1.4
%
18.6
%
 
19.4
%
Total
43.1
%
 
3.6
%
46.7
%
 
47.2
%
Our expense ratio decreased by half of a percentage point, to 46.7% for the year ended December 31, 2017, as compared to the same period in 2016. The decrease in the ratio was primarily due to continued improvement in our operating efficiencies as our earned premium grew faster than our more fixed expense structure. The decrease was dampened by the impact of both the hurricanes and ADC which occurred in the third quarter of 2017. During 2017, $7.2 million was ceded to the ADC (a one-time charge) and $806,000 was ceded as reinstatement costs of catastrophe reinsurance relating to Hurricane Irma. Before these two costs, the expense ratio would have declined even further, to 43.1% for the year, and 41.1% in the fourth quarter of 2017.
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income increased to 28.1% for the year ended December 31, 2017, compared to 27.8% in 2016. The increase was primarily due to the decrease in net earned premiums related to the ADC and reinstatement ceded premiums. Before the $7.2 million and $806,000 of ceded earned premiums, the policy acquisition cost ratio in 2017, was 25.9%, a 1.9 percentage point reduction. Our direct commission expense rate was consistent between 2016 and 2017.
Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other income was 18.6% and 19.4% for the years ended December 31, 2017 and 2016, respectively. Earned premium growth on a more fixed operating expense structure has helped to reduce the operating expense ratio, which is expected to continue to decline as our earned premium grows. In addition, there have been Company-wide efforts to reduce operating expenses even with growing earned premiums. Dampening the effects of the growth in earned premium and expense reductions was the impact of the ADC and reinstatement premiums. Before the impact of the ADC and reinstatement premiums, the operating expense ratio was 17.2% for the year and only 15.4% in the fourth quarter of 2017.

41

Underwriting Results
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the years ended December 31, 2017 and 2016 (dollars in thousands):
Underwriting Gain (Loss)
 
Years Ended December 31,
 
 
 
 
 
2017
 
2016
 
$ Change
 
% Change
 
 
Commercial Lines
$
(10,096
)
 
$
1,531

 
$
(11,627
)
 
(759.4
)%
Personal Lines
(10,838
)
 
(4,929
)
 
(5,909
)
 
119.9
 %
Corporate and Other
(3,306
)
 
(7,736
)
 
4,430

 
(57.3
)%
Total
$
(24,240
)
 
$
(11,134
)
 
$
(13,106
)
 
*

* Percentage change is not meaningful
Investment Income
Net investment income increased by $555,000, or 25.5%, to $2.7 million for the year ended December 31, 2017, as compared to $2.1 million for the year ended December 31, 2016. This increase was mainly due to the growth of the investment portfolio. Average invested assets as of December 31, 2017, were $143.1 million as compared to $123.1 million at December 31, 2016, an increase of $20.0 million, or 16.2%. As of December 31, 2017, the average invested asset balance was comprised of 87.3% debt securities, 5.0% equity securities and 7.9% short-term investments, compared to the December 31, 2016 mix of 89.4% debt securities, 3.6% equity securities and 7.0% short term investments.
The portfolio’s average quality was AA at December 31, 2017 and 2016. The portfolio produced a tax equivalent book yield of 2.5% and 2.2% for the years ended December 31, 2017 and 2016, respectively. The duration-to-worst average of the debt securities portfolio was 3.2 years at December 31, 2017 and 2016.
Other Gains (Losses)
In 2017, we recognized a $750,000 gain on the sale of the renewal rights of a portion of the low value dwelling book of business to another insurer. In 2016, as a result of the merger of ACIC into WPIC, the value of intangible assets recorded for insurance licenses on ACIC were written off resulting in a $400,000 loss.
Interest Expense
Interest expense was $1.4 million and $647,000 for the years ended December 31, 2017 and 2016, respectively. Interest expense increased due to the increase in outstanding debt throughout the year. We issued $30.0 million of subordinated notes in the third quarter of 2017, with a current interest rate of 8.0% per annum. We paid off all of the senior debt facility from the proceeds of the subordinated notes. Interest expense includes the amortization of debt issuance costs relating to the new subordinated notes which is $66,000 per annum over the 15-year life of the notes.
Income Tax Expense (Benefit)
On December 22, 2017, the U.S. federal government enacted H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Act”). The Act provides for significant changes to corporate taxation including the decrease of the corporate tax rate from 34% to 21%. We have completed an analysis of the impact of the Act and have followed the additional guidance provided by the Security and Exchange Commission's Staff Accounting Bulletin No. 118. We believe there are no material provisional balances as of December 31, 2017.
We accounted for the impacts of the Act by remeasuring our deferred tax assets and liabilities at the 21% enacted tax rate. The approximate impact of the change in tax rate was a decrease in net deferred tax assets (before valuation allowance) of $5.6 million with a corresponding deferred income tax expense of $5.6 million. The valuation allowance also decreased by $5.7 million with a corresponding deferred income tax benefit of $5.7 million. Accordingly, the net deferred income tax impact on the results of operations relating to the Act was a $63,000 deferred tax benefit in 2017. The Company’s net deferred tax assets for the year ended December 31, 2016, remain at the previously enacted tax rate.
For the year ended December 31, 2017, the Company reported $16,000 of current federal income tax benefit and $12,000 of current state income tax benefit. The Company also reported a deferred tax benefit of $419,000 which was largely the

42

result of changes in the net deferred tax asset valuation allowance related to changes in unrealized gains. For the year ended December 31, 2016, the Company reported $0 of current federal income tax expense and $70,000 of current state income tax expense. The Company also reported a deferred tax benefit of $147,000 related to a $400,000 write-off of intangible assets resulting from the merger of ACIC into WPIC in 2016.
There is a $9.9 million valuation allowance against 100% of the net deferred tax assets at December 31, 2017, which would increase book value by $1.16 per share if reversed in the future. The valuation allowance was $8.4 million for 2016. As of December 31, 2017, the Company has net operating loss carryforwards for federal income tax purposes of $43.6 million, which expire in tax years 2029 through 2037. Of this amount, $15.1 million are limited in the amount that can be utilized in any one year and may expire before they are realized under Section 382 of the Internal Revenue Code. The Company has state net operating loss carryforwards of $11.0 million, which expire in tax years 2029 through 2037.

Results of Operations - 2016 Compared to 2015
The following table summarizes our operating results for the years indicated (dollars in thousands):
Summary Operating Results
 
Years Ended December 31,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
 
 
Gross written premiums
$
114,923

 
$
93,750

 
$
21,173

 
22.6
%
Net written premiums
$
99,929

 
$
79,674

 
$
20,255

 
25.4
%
Net earned premiums
$
89,627

 
$
66,765

 
$
22,862

 
34.2
%
Other income
1,118

 
1,667

 
(549
)
 
(32.9
%)
Losses and loss adjustment expenses, net
59,003

 
38,882

 
20,121

 
51.7
%
Policy acquisition costs
25,280

 
16,183

 
9,097

 
56.2
%
Operating expenses
17,596

 
14,806