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Section 1: 10-Q (10-Q)

hall_Current_Folio_10Q

 

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10‑Q

 

Quarterly report pursuant to Section 13 or 15(d) of the

 

Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2019

 

Commission file number 001‑11252

 

Hallmark Financial Services, Inc.

 

(Exact name of registrant as specified in its charter)

 

Nevada

87-0447375

(State or other jurisdiction of

(I.R.S. Employer

Incorporation or organization)

Identification No.)

 

 

777 Main Street, Suite 1000, Fort Worth, Texas

76102

 

 

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code: (817) 348‑1600

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.18 par value

HALL

Nasdaq Global Market

 

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  ☒ X     No ☐

 

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

 

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

 

Large accelerated filer ☐

Accelerated filer ☒

 

 

 

 

Non-accelerated filer ☐

Smaller reporting company ☒

Emerging growth company  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 15(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).  Yes ☐ No ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, par value $.18 per share –18,123,093 shares outstanding as of May 8, 2019.

 

 

 

1


 

PART I

FINANCIAL INFORMATION

Item 1.   Financial Statements

 

INDEX TO FINANCIAL STATEMENTS

 

 

Page
Number

 

 

Consolidated Balance Sheets at March 31, 2019 (unaudited) and December 31, 2018 

3

 

 

Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2019 and March 31, 2018 

4

 

 

Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2019 and March 31, 2018 

5

 

 

Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 31, 2019 and March 31, 2018 

6

 

 

Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2019 and March 31, 2018 

7

 

 

Notes to Consolidated Financial Statements (unaudited) 

8

 

 

 

2


 

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Balance Sheets

($ in thousands, except par value)

 

 

 

 

 

 

 

 

 

 

March 31,

 

 

December 31,

 

 

2019

 

2018

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

  

 

 

  

Investments:

 

 

  

 

 

  

Debt securities, available-for-sale, at fair value (amortized cost; $523,745 in 2019 and $550,268 in 2018)

 

$

522,977

 

$

545,870

Equity securities (cost; $68,709 in 2019 and $68,709 in 2018)

 

 

88,656

 

 

80,896

Other investments (cost; $3,763 in 2019 and $3,763 in 2018)

 

 

1,184

 

 

1,148

Total investments

 

 

612,817

 

 

627,914

Cash and cash equivalents

 

 

65,490

 

 

35,594

Restricted cash

 

 

3,322

 

 

4,877

Ceded unearned premiums

 

 

132,799

 

 

133,031

Premiums receivable

 

 

132,025

 

 

119,778

Accounts receivable

 

 

1,851

 

 

1,619

Receivable for securities

 

 

2,292

 

 

3,369

Reinsurance recoverable

 

 

268,648

 

 

252,029

Deferred policy acquisition costs

 

 

19,225

 

 

14,291

Goodwill

 

 

44,695

 

 

44,695

Intangible assets, net

 

 

6,940

 

 

7,555

Deferred federal income taxes, net

 

 

1,727

 

 

4,983

Prepaid expenses

 

 

4,128

 

 

2,588

Other assets

 

 

32,772

 

 

12,571

Total assets

 

$

1,328,731

 

$

1,264,894

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

  

 

 

  

Liabilities:

 

 

  

 

 

  

Revolving credit facility payable

 

$

30,000

 

$

30,000

Subordinated debt securities (less unamortized debt issuance cost of $885 in 2019 and $898 in 2018)

 

 

55,817

 

 

55,804

Reserves for unpaid losses and loss adjustment expenses

 

 

530,226

 

 

527,247

Unearned premiums

 

 

316,201

 

 

298,061

Reinsurance balances payable

 

 

68,681

 

 

67,328

Pension liability

 

 

1,982

 

 

2,018

Payable for securities

 

 

1,503

 

 

698

Federal income tax payable

 

 

1,411

 

 

 4

Accounts payable and other accrued expenses

 

 

49,258

 

 

28,202

Total liabilities

 

 

1,055,079

 

 

1,009,362

Commitments and contingencies (Note 17)

 

 

  

 

 

  

Stockholders’ equity:

 

 

  

 

 

  

Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2019 and 2018

 

 

3,757

 

 

3,757

Additional paid-in capital

 

 

122,638

 

 

123,168

Retained earnings

 

 

176,220

 

 

161,195

Accumulated other comprehensive loss

 

 

(3,762)

 

 

(6,660)

Treasury stock (2,749,738 shares in 2019 and 2,846,131 in 2018), at cost

 

 

(25,201)

 

 

(25,928)

Total stockholders’ equity

 

 

273,652

 

 

255,532

Total liabilities and stockholders’ equity

 

$

1,328,731

 

$

1,264,894

 

The accompanying notes are an integral part of the consolidated financial statements

3


 

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

($ in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

2018

 

Gross premiums written

 

$

187,316

 

$

153,505

 

Ceded premiums written

 

 

(69,913)

 

 

(62,072)

 

Net premiums written

 

 

117,403

 

 

91,433

 

Change in unearned premiums

 

 

(18,373)

 

 

514

 

Net premiums earned

 

 

99,030

 

 

91,947

 

 

 

 

 

 

 

 

 

Investment income, net of expenses

 

 

5,111

 

 

4,440

 

Investment gains (losses), net

 

 

11,937

 

 

(4,835)

 

Finance charges

 

 

1,734

 

 

1,040

 

Commission and fees

 

 

293

 

 

703

 

Other income

 

 

16

 

 

46

 

 

 

 

 

 

 

 

 

Total revenues

 

 

118,121

 

 

93,341

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

70,087

 

 

63,675

 

Operating expenses

 

 

27,246

 

 

27,213

 

Interest expense

 

 

1,253

 

 

1,027

 

Amortization of intangible assets

 

 

617

 

 

617

 

 

 

 

 

 

 

 

 

Total expenses

 

 

99,203

 

 

92,532

 

 

 

 

 

 

 

 

 

Income before tax

 

 

18,918

 

 

809

 

Income tax expense

 

 

3,893

 

 

162

 

Net income

 

$

15,025

 

$

647

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

  

 

 

  

 

Basic

 

$

0.83

 

$

0.04

 

Diluted

 

$

0.83

 

$

0.04

 

 

The accompanying notes are an integral part of the consolidated financial statements

4


 

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

($ in thousands)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

2018

 

Net income

 

$

15,025

 

$

647

 

Other comprehensive income (loss):

 

 

  

 

 

  

 

Change in net actuarial gain

 

 

35

 

 

27

 

Tax effect on change in net actuarial gain

 

 

(7)

 

 

(6)

 

Unrealized holding gains (losses) arising during the period

 

 

7,773

 

 

(395)

 

Tax effect on unrealized holding gains (losses) arising during the period

 

 

(1,632)

 

 

83

 

Reclassification adjustment for (gains) losses included in net income

 

 

(4,141)

 

 

15

 

Tax effect on reclassification adjustment for (gains) losses included in net income

 

 

870

 

 

(3)

 

Other comprehensive income (loss), net of tax

 

 

2,898

 

 

(279)

 

Comprehensive income

 

$

17,923

 

$

368

 

 

The accompanying notes are an integral part of the consolidated financial statements

5


 

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

($ in thousands)

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31, 

 

    

2019

    

2018

Common Stock

    

 

  

    

 

  

Balance, beginning of period

 

$

3,757

 

$

3,757

 

 

 

 

 

 

 

Balance, end of period

 

 

3,757

 

 

3,757

 

 

 

 

 

 

 

Additional Paid-In Capital

 

 

  

 

 

  

Balance, beginning of period

 

 

123,168

 

 

123,180

Equity based compensation

 

 

57

 

 

44

Shares issued under employee benefit plans

 

 

(587)

 

 

 —

Balance, end of period

 

 

122,638

 

 

123,224

 

 

 

 

 

 

 

Retained Earnings

 

 

  

 

 

  

Balance, beginning of period

 

 

161,195

 

 

136,474

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1,2018

 

 

 —

 

 

16,993

Reclassification of certain tax effects from accumulated other comprehensive income at January 1,2018

 

 

 —

 

 

(2,619)

Net income

 

 

15,025

 

 

647

Balance, end of period

 

 

176,220

 

 

151,495

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income

 

 

  

 

 

  

Balance, beginning of period

 

 

(6,660)

 

 

12,234

Cumulative effect of adoption of updated accounting guidance for equity financial instruments at January 1,2018

 

 

 —

 

 

(16,993)

Reclassification of certain tax effects from accumulated other comprehensive income at January 1,2018

 

 

 —

 

 

2,619

Additional minimum pension liability, net of tax

 

 

28

 

 

21

Unrealized holding gains (losses) arising during period, net of tax

 

 

6,141

 

 

(312)

Reclassification adjustment for (gains) losses included in net income, net of tax

 

 

(3,271)

 

 

12

Balance, end of period

 

 

(3,762)

 

 

(2,419)

 

 

 

 

 

 

 

Treasury Stock

 

 

  

 

 

  

Balance, beginning of period

 

 

(25,928)

 

 

(24,527)

Acquisition of treasury stock

 

 

(1,380)

 

 

(377)

Shares issued under employee benefit plans

 

 

2,107

 

 

 —

Balance, end of period

 

 

(25,201)

 

 

(24,904)

 

 

 

 

 

 

 

Total Stockholders' Equity

 

$

273,652

 

$

251,153

 

The accompanying notes are an integral part of the consolidated financial statements

6


 

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

($ in thousands)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

2018

 

Cash flows from operating activities:

 

 

  

 

 

  

 

Net income

 

$

15,025

 

$

647

 

 

 

 

 

 

 

 

 

Adjustments to reconcile net income to cash used in operating activities:

 

 

  

 

 

  

 

Depreciation and amortization expense

 

 

1,283

 

 

1,238

 

Deferred federal income taxes

 

 

2,486

 

 

(1,146)

 

Investment (gains) losses, net

 

 

(11,937)

 

 

4,835

 

Share-based payments expense

 

 

57

 

 

44

 

Change in ceded unearned premiums

 

 

232

 

 

(442)

 

Change in premiums receivable

 

 

(12,247)

 

 

(4,114)

 

Change in accounts receivable

 

 

(232)

 

 

(296)

 

Change in deferred policy acquisition costs

 

 

(4,934)

 

 

 8

 

Change in unpaid losses and loss adjustment expenses

 

 

2,979

 

 

2,584

 

Change in unearned premiums

 

 

18,140

 

 

(72)

 

Change in reinsurance recoverable

 

 

(16,619)

 

 

(31,441)

 

Change in reinsurance balances payable

 

 

1,353

 

 

3,511

 

Change in current federal income tax payable

 

 

1,407

 

 

1,398

 

Change in all other liabilities

 

 

(553)

 

 

3,701

 

Change in all other assets

 

 

1,600

 

 

330

 

Net cash used in operating activities

 

 

(1,960)

 

 

(19,215)

 

Cash flows from investing activities:

 

 

  

 

 

  

 

Purchases of property and equipment

 

 

(1,847)

 

 

(570)

 

Purchases of investment securities

 

 

(43,841)

 

 

(38,619)

 

Maturities, sales and redemptions of investment securities

 

 

75,849

 

 

48,822

 

Net cash provided by investing activities

 

 

30,161

 

 

9,633

 

Cash flows from financing activities:

 

 

  

 

 

  

 

Proceeds from exercise of employee stock options

 

 

1,520

 

 

 —

 

Purchase of treasury shares

 

 

(1,380)

 

 

(377)

 

Net cash provided by (used in) financing activities

 

 

140

 

 

(377)

 

Increase (decrease) in cash and cash equivalents and restricted cash

 

 

28,341

 

 

(9,959)

 

Cash and cash equivalents and restricted cash at beginning of period

 

 

40,471

 

 

67,633

 

Cash and cash equivalents and restricted cash at end of period

 

$

68,812

 

$

57,674

 

 

The accompanying notes are an integral part of the consolidated financial statements

7


 

Hallmark Financial Services, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1. General

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us” or “our”) is an insurance holding company that offers commercial and personal insurance that serves businesses and individuals in specialty and niche markets.  We focus on marketing, distributing, underwriting and servicing property and casualty insurance products that require specialized underwriting expertise or market knowledge. We believe this approach provides us the best opportunity to achieve favorable policy terms and pricing. The insurance policies we produce are written by our six insurance company subsidiaries as well as unaffiliated insurers. We pursue our business activities primarily through subsidiaries whose operations are organized into product-specific business units that are supported by our insurance company subsidiaries. Our Commercial Auto business unit offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit offers primary and excess liability, excess public entity liability and E&S package insurance products and services; our E&S Property business unit offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit offers healthcare and financial lines professional liability insurance products and services primarily for businesses, medical professionals, medical facilities and senior care facilities; and our Aerospace & Programs business unit offers general aviation and satellite launch property/casualty insurance products and services, as well as certain specialty programs. These products and services were previously reported as the Contract Binding and Specialty Commercial operating units. Our Commercial Accounts business unit (f/k/a Standard Commercial P&C operating unit) offers package and monoline property/casualty and occupational accident insurance products. Effective June 1, 2016 we ceased marketing new or renewal occupational accident policies.  Our former Workers Compensation operating unit specialized in small and middle market workers compensation business. Effective July 1, 2015, we no longer market or retain any risk on new or renewal workers compensation policies. Our Specialty Personal Lines business unit offers non-standard personal automobile and renters insurance products and services. Our insurance company subsidiaries supporting these business units are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance Company, Hallmark National Insurance Company and Texas Builders Insurance Company.

 These business units are segregated into three reportable industry segments for financial accounting purposes. The Specialty Commercial Segment includes our Commercial Auto business unit, our E&S Casualty business unit, our E&S Property business unit, our Professional Liability business unit and our Aerospace & Programs business unit. The Standard Commercial Segment includes our Commercial Accounts business unit and the run-off from our former Workers Compensation operating unit. The Personal Segment consists solely of our Specialty Personal Lines business unit. The realignment of our business units did not affect the comparability of our reportable industry segments.

 

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include our accounts and the accounts of our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2018 included in our Annual Report on Form 10‑K filed with the SEC.

The interim financial data as of March 31, 2019 and 2018 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The results of operations for the period ended March 31, 2019 are not necessarily indicative of the operating results to be expected for the full year.

8


 

Income Taxes

We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end. Deferred taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes in effect for the year in which these temporary differences are expected to be recovered or settled.

Reclassifications

Certain prior year amounts have been reclassified to conform with current year presentation.

Use of Estimates in the Preparation of the Financial Statements

Our preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect our reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the date of our consolidated financial statements, as well as our reported amounts of revenues and expenses during the reporting period. Refer to “Critical Accounting Estimates and Judgments” under Item 7 of our Annual Report on Form 10‑K for the year ended December 31, 2018 for information on accounting policies that we consider critical in preparing our consolidated financial statements. Actual results could differ materially from those estimates.

Fair Value of Financial Instruments

Fair value estimates are made at a point in time based on relevant market data as well as the best information available about the financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair value estimates.

Cash and Cash Equivalents:  The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

Restricted Cash:  The carrying amount for restricted cash reported in the balance sheet approximates the fair value.

Revolving Credit Facility Payable: A revolving credit facility with Frost Bank had a carried value of $30.0 million and a fair value of $30.2 million as of March 31, 2019. This revolving credit facility would be included in Level 3 of the fair value hierarchy if it was reported at fair value.

Subordinated Debt Securities:  Our trust preferred securities have a carried value of $55.8 million and a fair value of $44.5 million as of March 31, 2019. The fair value of our trust preferred securities is based on discounted cash flows using a current yield to maturity of 8.0%, which is based on similar issues to discount future cash flows. Our trust preferred securities would be included in Level 3 of the fair value hierarchy if they were reported at fair value.

For reinsurance balances, premiums receivable, federal income tax recoverable/payable, other assets and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.

Variable Interest Entities

On June 21, 2005, we formed Hallmark Statutory Trust I (“Trust I”), an unconsolidated trust subsidiary, for the sole purpose of issuing $30.0 million in trust preferred securities. Trust I used the proceeds from the sale of these securities

9


 

and our initial capital contribution to purchase $30.9 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust I, and the payments under the debt securities are the sole revenues of Trust I.

On August 23, 2007, we formed Hallmark Statutory Trust II (“Trust II”), an unconsolidated trust subsidiary, for the sole purpose of issuing $25.0 million in trust preferred securities. Trust II used the proceeds from the sale of these securities and our initial capital contribution to purchase $25.8 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust II, and the payments under the debt securities are the sole revenues of Trust II.

We evaluate on an ongoing basis our investments in Trust I and Trust II (collectively the “Trusts”) and have determined that we do not have a variable interest in the Trusts. Therefore, the Trusts are not included in our consolidated financial statements.

We are also involved in the normal course of business with variable interest entities (“VIE’s”) primarily as a passive investor in mortgage-backed securities and certain collateralized corporate bank loans issued by third party VIE’s. The maximum exposure to loss with respect to these investments is the investment carrying values included in the consolidated balance sheets.

Adoption of New Accounting Pronouncements

In February 2018, the FASB issued updated guidance that allows a reclassification of the stranded tax effects in accumulated other comprehensive income (AOCI) resulting from the Tax Cuts and Jobs Act of 2017 (TCJA). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of TCJA related to items in AOCI. The updated guidance was effective for reporting periods beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the TCJA related to items remaining in AOCI are recognized or at the beginning of the period of adoption. Early adoption is permitted. The Company adopted the updated guidance effective January 1, 2018 and elected to reclassify the income tax effects of the TCJA from AOCI to retained earnings as of January 1, 2018. This reclassification resulted in a decrease in retained earnings of $2.6 million as of January 1, 2018 and an increase in AOCI by the same amount.

In March 2017, the FASB issued ASU 2017‑08, “Premium Amortization on Purchased Callable Securities” (Subtopic 310‑20). ASU 2017‑08 is intended to enhance the accounting for amortization of premiums for purchased callable debt securities. The guidance amends the amortization period for certain purchased callable debt securities held at a premium. Securities that contain explicit, noncontingent call features that are callable at fixed prices and on preset dates should shorten the amortization period for the premium to the earliest call date (and if the call option is not exercised, the effective yield is reset using the payment terms of the debt security). The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The adoption of ASU 2017‑08 had no impact on our financial results and disclosures.

In January 2017, the FASB issued ASU 2017‑01, “Clarifying the Definition of a Business (Topic 715)”. ASU 2017‑01 is intended to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017‑01 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of this standard did not have a material impact on our financial condition or results of operations.

In January 2016, the FASB issued ASU 2016‑01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Subtopic 825‑10). ASU 2016‑01 requires equity investments that are not consolidated or accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income. ASU 2016‑01 also requires us to assess the ability to realize our deferred tax assets (“DTAs”) related to an available-for-sale debt security in combination with our other DTAs. ASU 2016‑01 was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance resulted in the

10


 

recognition of $17.0 million of net after-tax unrealized gains on equity investments as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and decreased AOCI by the same amount. The Company elected to report changes in the fair value of equity investments in investment gains (losses) in the Consolidated Statement of Operations. At December 31, 2017, equity investments were classified as available-for-sale on the Company’s balance sheet. However, upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity investments.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. ASU 2016-02 requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additionally, ASU 2016-02 modifies current guidance for lessors' accounting. ASU 2016-02 is effective for interim and annual reporting periods beginning on or after January 1, 2019, with early adoption permitted. During 2018, the FASB issued several amendments and targeted improvements to ease the application of the standard, including the addition of a transition approach that gives the Company the option of applying the standard at either the beginning of the earliest comparative period presented or the beginning of the period of adoption. We adopted the standard on its effective date of January 1, 2019. We also elected certain practical expedients that allow us not to reassess existing leases under the new guidance. As of March 31, 2019, $17.7 million of right-of-use assets and $18.0 million of lease liabilities for operating leases were added to the other assets and other liabilities line items of the balance sheet, respectively, as a result of the adoption of this update.

In August 2016, the FASB issued ASU 2016‑15, “Classification of Certain Cash Receipts and Cash Payments” (Topic 230). ASU 2016‑15 will reduce diversity in practice on how eight specific cash receipts and payments are classified on the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. The adoption of this new guidance did not have a material impact on our financial results or disclosures.

In November 2016, the FASB issued ASU 2016‑18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The purpose of ASU 2016‑18 is to eliminate the diversity in classifying and presenting changes in restricted cash in the statement of cash flows. The new guidance requires restricted cash to be combined with cash and cash equivalents when reconciling the beginning and ending balances of cash on the statement of cash flows, thereby no longer requiring transactions such as transfers between restricted and unrestricted cash to be treated as a cash flow activity. Further, the new guidance requires the nature of the restrictions to be disclosed, as well as a reconciliation between the balance sheet and the statement of cash flows on how restricted and unrestricted cash are segregated. The new guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within that fiscal year, with early adoption permitted. Effective January 1, 2018, we retrospectively adopted this new guidance which did not have a material impact on our financial results or disclosures.

In May 2014, the FASB issued ASU 2014‑09, guidance which revises the criteria for revenue recognition. Under the guidance, the transaction price is attributed to underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. Incremental costs of obtaining a contract may be capitalized to the extent the entity expects to recover those costs. The guidance is effective for reporting periods beginning after December 15, 2017 and is to be applied retrospectively. Revenue from insurance contracts is excluded from the scope of this new guidance. While insurance contracts are excluded from this guidance, policy fee income, billing and other fees and fee income related to property business written as a cover-holder through a Lloyds Syndicate is subject to this updated guidance. The adoption of  this new guidance did not have a material impact on our financial results or disclosures.

Recently Issued Accounting Pronouncements

On August 28, 2018, the FASB issued ASU 2018-13, “Fair Value Measurement: Disclosure Framework- Changes to the Disclosure Requirements for Fair Value Measurement” (Topic 820), which amends ASC 820 to add, remove, and modify fair value measurement disclosure requirements.  The requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements have all been removed. However, the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the

11


 

reporting period must be disclosed along with the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements (or other quantitative information if it is more reasonable). Finally, for investments measured at net asset value, the requirements have been modified so that the timing of liquidation and the date when restrictions from redemption might lapse are only disclosed if the investee has communicated the timing to the entity or announced the timing publicly. This ASU is effective for annual and interim reporting periods beginning after December 15, 2019. As the amendments are only disclosure related our financial statements will not be materially impacted by this update.

In January 2017, the FASB issued ASU 2017‑04, “Simplifying the Test for Goodwill Impairment” (Topic 350). ASU 2017‑04 requires only a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill. The ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently evaluating the impact that the adoption of ASU 2017‑04 will have on our financial results and disclosures.

In June 2016, the FASB issued ASU 2016‑13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU 2016‑13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. ASU 2016‑13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU 2016‑13 requires a modified retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the adoption of this standard will have on our financial results and disclosures, but do not anticipate that any potential impact would be material.

 

3. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, among other things, requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair value of instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.

We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with ASC 820, we utilize the following fair value hierarchy:

·

Level 1: quoted prices in active markets for identical assets;

·

Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument; and

·

Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.

This hierarchy requires the use of observable market data when available.

Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated based upon our pricing policy, the economic and competitive

12


 

environment, the characteristics of the asset or liability and other factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement of the asset or liability.

Where quoted prices are available on active exchanges for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include common and preferred stock and an equity warrant classified as Other Investments.

Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed securities for which quoted prices are not available on active exchanges for identical instruments. We use third party pricing services to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used by the pricing services and have determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. We have not adjusted any prices received from third party pricing sources. There were no transfers between Level 1 and Level 2 securities.

In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value. This data may be internally developed and consider risk premiums that a market participant would require. Investment securities classified within Level 3 include other less liquid investment securities.

The following table presents for each of the fair value hierarchy levels, our assets that are measured at fair value on a recurring basis at March 31, 2019 and December 31, 2018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2019

 

    

Quoted Prices in

    

 

 

    

 

 

    

 

 

 

 

Active Markets for

 

 

 

 

 

 

 

 

 

 

 

Identical Assets

 

Other Observable

 

Unobservable

 

 

 

 

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

48,209

 

$

 -

 

$

48,209

Corporate bonds

 

 

 —

 

 

218,544

 

 

291

 

 

218,835

Collateralized corporate bank loans

 

 

 —

 

 

128,840

 

 

 -

 

 

128,840

Municipal bonds

 

 

 —

 

 

114,359

 

 

 -

 

 

114,359

Mortgage-backed

 

 

 —

 

 

12,734

 

 

 -

 

 

12,734

Total debt securities

 

 

 —

 

 

522,686

 

 

291

 

 

522,977

Total equity securities

 

 

88,656

 

 

 —

 

 

 —

 

 

88,656

Total other investments

 

 

1,184

 

 

 —

 

 

 —

 

 

1,184

Total investments

 

$

89,840

 

$

522,686

 

$

291

 

$

612,817

 

13


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

    

Quoted Prices in

    

 

 

    

 

 

    

 

 

 

 

Active Markets for

 

 

 

 

 

 

 

 

 

 

 

Identical Assets

 

Other Observable

 

Unobservable

 

 

 

 

    

(Level 1)

    

Inputs (Level 2)

    

Inputs (Level 3)

    

Total

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

48,106

 

$

 —

 

$

48,106

Corporate bonds

 

 

 —

 

 

241,861

 

 

291

 

 

242,152

Collateralized corporate bank loans

 

 

 —

 

 

126,528

 

 

 —

 

 

126,528

Municipal bonds

 

 

 —

 

 

115,527

 

 

 —

 

 

115,527

Mortgage-backed

 

 

 —

 

 

13,557

 

 

 —

 

 

13,557

Total debt securities

 

 

 —

 

 

545,579

 

 

291

 

 

545,870

Total equity securities

 

 

80,896

 

 

 —

 

 

 —

 

 

80,896

Total other investments

 

 

1,148

 

 

 —

 

 

 —

 

 

1,148

Total investments

 

$

82,044

 

$

545,579

 

$

291

 

$

627,914

 

Due to significant unobservable inputs into the valuation model for one corporate bond as of March 31, 2019 and December 31, 2018, we classified this investment as Level 3 in the fair value hierarchy. The corporate bond is a convertible senior note and its fair value was estimated by the sum of the bond value using an income approach discounting the scheduled interest and principal payments and the conversion feature utilizing a binomial lattice model. We also estimated the fair value of the corporate bond utilizing an as-if converted basis into the underlying securities. Significant changes in the unobservable inputs in the fair value measurement of this corporate bond could result in a significant change in the fair value measurement.

The following table summarizes the changes in fair value for all financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three months ended March 31, 2019 and 2018 (in thousands):

 

 

 

 

Beginning balance as of January 1, 2019

    

$

291

Sales

 

 

 —

Settlements

 

 

 —

Purchases

 

 

 —

Issuances

 

 

 —

Total realized/unrealized gains included in net income

 

 

 —

Net gain included in other comprehensive income

 

 

 —

Transfers into Level 3

 

 

 —

Transfers out of Level 3

 

 

 —

Ending balance as of March 31, 2019

 

$

291

 

 

 

 

 

Beginning balance as of January 1, 2018

    

$

3,757

Sales

 

 

 —

Settlements

 

 

 —

Purchases

 

 

 —

Issuances

 

 

 —

Total realized/unrealized gains included in net income

 

 

 —

Net gains included in other comprehensive income

 

 

65

Transfers into Level 3

 

 

 —

Transfers out of Level 3

 

 

 —

Ending balance as of March 31, 2018

 

$

3,822

 

 

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4. Investments

The amortized cost and estimated fair value of investments in debt and equity securities by category is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

Gross

    

Gross

    

 

 

 

 

 

 

 

Unrealized

 

Unrealized

 

 

 

 

    

Amortized Cost

    

Gains

    

Losses

    

Fair Value

As of March 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. Government

 

$

48,490

 

$

 7

 

$

(288)

 

$

48,209

Corporate bonds

 

 

217,979

 

 

1,296

 

 

(440)

 

 

218,835

Collateralized corporate bank loans

 

 

130,526

 

 

66

 

 

(1,752)

 

 

128,840

Municipal bonds

 

 

113,812

 

 

845

 

 

(298)

 

 

114,359

Mortgage-backed

 

 

12,938

 

 

14

 

 

(218)

 

 

12,734

Total debt securities

 

 

523,745

 

 

2,228

 

 

(2,996)

 

 

522,977

Total equity securities

 

 

68,709

 

 

25,549

 

 

(5,602)

 

 

88,656

Total other investments

 

 

3,763

 

 

 —

 

 

(2,579)

 

 

1,184

Total investments

 

$

596,217

 

$

27,777

 

$

(11,177)

 

$

612,817

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

 

  

 

 

  

 

 

 

 

 

  

U.S. Treasury securities and obligations of U.S. Government

 

$

48,609

 

$

 5

 

$

(508)

 

$

48,106

Corporate bonds

 

 

243,314

 

 

440

 

 

(1,602)

 

 

242,152

Collateralized corporate bank loans

 

 

131,779

 

 

19

 

 

(5,270)

 

 

126,528

Municipal bonds

 

 

112,574

 

 

3,791

 

 

(838)

 

 

115,527

Mortgage-backed

 

 

13,992

 

 

11

 

 

(446)

 

 

13,557

Total debt securities

 

 

550,268

 

 

4,266

 

 

(8,664)

 

 

545,870

Total equity securities

 

 

68,709

 

 

20,693

 

 

(8,506)

 

 

80,896

Total other investments

 

 

3,763

 

 

 —

 

 

(2,615)

 

 

1,148

Total investments

 

$

622,740

 

$

24,959

 

$

(19,785)

 

$

627,914

 

Major categories of net investment gains (losses) on investments are summarized as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 

 

    

2019

    

2018

    

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

 —

 

Corporate bonds

 

 

23

 

 

(8)

 

Collateralized corporate bank loans

 

 

17

 

 

12

 

Municipal bonds

 

 

4,101

 

 

(21)

 

Mortgage-backed

 

 

 —

 

 

 2

 

Equity securities

 

 

 —

 

 

 —

 

Gain (loss) on investments

 

 

4,141

 

 

(15)

 

Unrealized gains (losses) on other investments

 

 

36

 

 

(363)

 

Unrealized gains (losses) on equity investments

 

 

7,760

 

 

(4,457)

 

Investment gains (losses), net

 

$

11,937

 

$

(4,835)

 

 

We realized gross gains on investments of $4.2 million and $60 thousand during the three months ended March 31, 2019 and 2018, respectively. We realized gross losses on investments of $0.1 million and $75 thousand for the three months ended March 31, 2019 and 2018, respectively. We had no proceeds from the sale of investment securities during the three months ended March 31, 2019 or 2018. Realized investment gains and losses are recognized in operations on the first in-first out method.

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The following schedules summarize the gross unrealized losses showing the length of time that investments have been continuously in an unrealized loss position as of March 31, 2019 and December 31, 2018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2019

 

 

12 months or less

 

Longer than 12 months

 

Total

 

    

 

 

    

Unrealized

    

 

 

    

Unrealized

    

 

 

    

Unrealized

 

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

U.S. Treasury securities and obligations of U.S. Government

 

$

 —

 

$

 —

 

$

47,205

 

$

(288)

 

$

47,205

 

$

(288)

Corporate bonds

 

 

13,462

 

 

(72)

 

 

85,392

 

 

(368)

 

 

98,854

 

 

(440)

Collateralized corporate bank loans

 

 

115,083

 

 

(1,660)

 

 

4,832

 

 

(92)

 

 

119,915

 

 

(1,752)

Municipal bonds

 

 

11,463

 

 

(79)

 

 

25,229

 

 

(219)

 

 

36,692

 

 

(298)

Mortgage-backed

 

 

769

 

 

 -

 

 

8,825

 

 

(218)

 

 

9,594

 

 

(218)

Total debt securities

 

 

140,777

 

 

(1,811)

 

 

171,483

 

 

(1,185)

 

 

312,260

 

 

(2,996)

Total equity securities

 

 

16,082

 

 

(1,518)

 

 

5,537

 

 

(4,084)

 

 

21,619

 

 

(5,602)

Total other investments

 

 

914

 

 

(1,873)

 

 

270

 

 

(706)

 

 

1,184

 

 

(2,579)

Total investments

 

$

157,773

 

$

(5,202)

 

$

177,290

 

$

(5,975)

 

$

335,063

 

$

(11,177)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

 

12 months or less

 

Longer than 12 months

 

Total

 

    

 

 

    

Unrealized

    

 

 

    

Unrealized

    

 

 

    

Unrealized

 

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

U.S. Treasury securities and obligations of U.S. Government

 

$

18,902

 

$

(181)

 

$

28,201

 

$

(327)

 

$

47,103

 

$

(508)

Corporate bonds

 

 

117,450

 

 

(907)

 

 

100,060