Discontinued Operations

3 Months Ended

Mar. 31, 2020

Discontinued Operations

Discontinued Operations

T

3. Discontinued Operations

NLC Sale

On January 30, 2020, Hilltop entered into an agreement to sell all of the outstanding capital stock of NLC, which comprises the operations of the insurance segment, for a cash purchase price of $150.0 million, subject to post-closing adjustments. Consummation of the transaction is subject to customary closing conditions, including required regulatory approvals. Management determined that the pending sale of NLC represents a strategic shift away from one of the historically core business units of the Company. Accordingly, as of March 31, 2020 and for all prior periods, NLC’s results have been presented as discontinued operations and its assets and liabilities have been classified as held for sale in the consolidated financial statements. Hilltop anticipates that this transaction will result in a net gain.

All related notes to consolidated financial statements for discontinued operations have been included in this note.

The following table details the carrying amounts of assets and liabilities of NLC reflected in the consolidated balance sheets under the caption “Assets held for sale” and “Liabilities held for sale”, respectively.

	March 31,		December 31,
	2020		2019
Assets
Cash and due from banks	$	58,103	$	51,333
Securities:
Available for sale, at fair value		86,101		86,899
Equity, at fair value		15,440		19,841
		101,541		106,740
Premises and equipment, net		9,058		9,607
Operating lease right-of-use assets		2,674		2,739
Other assets		50,966		50,533
Goodwill		23,988		23,988
Other intangible assets, net		3,428		3,489
Total assets held for sale	$	249,758	$	248,429
Liabilities
Notes payable	$	27,500	$	27,500
Operating lease liabilities		2,727		2,783
Other liabilities		109,503		110,391
Total liabilities held for sale	$	139,730	$	140,674

The following table presents the results of discontinued operations for NLC for the periods indicated.

	Three Months Ended March 31,
	2020		2019
Interest income:
Securities:
Taxable	$	938	$	960
Other		67		142
Total interest income		1,005		1,102
Interest expense:
Notes payable		406		460
Noninterest income:
Net insurance premiums earned		32,637		33,203
Other		(2,246)		3,302
Total noninterest income		30,391		36,505
Noninterest expense:
Employees' compensation and benefits		2,777		3,202
Occupancy and equipment, net		247		244
Professional services		8,527		8,833
Loss and loss adjustment expenses		12,949		14,926
Other		2,476		3,133
Total noninterest expense		26,976		30,338
Income from discontinued operations before income taxes		4,014		6,809
Income tax expense		863		1,449
Income from discontinued operations, net of income taxes	$	3,151	$	5,360

Securities

The available for sale securities held by NLC at March 31, 2020 and December 31, 2019 reflected in the consolidated balance sheets under the caption “Assets held for sale” were primarily comprised of U.S. Treasury, residential mortgage-backed and corporate debt securities with aggregate unrealized gross gains of $3.5 million and $2.5 million, respectively, and measured using Level 2 inputs on a recurring basis. NLC’s available for sale portfolio had no unrealized gross losses at March 31, 2020 and nominal unrealized gross losses at December 31, 2019.

NLC had unrealized net losses of $3.3 million and unrealized net gains of $1.1 million from the equity securities held at March 31, 2020 and December 31, 2019, respectively, measured using Level 1 inputs on a recurring basis. NLC recognized net losses of $4.4 million and net gains of $1.2 million during the three months ended March 31, 2020 and 2019, respectively, due to changes in the fair value of equity securities still held at the balance sheet date.

At March 31, 2020 and December 31, 2019, NLC had investments on deposit in custody for various state insurance departments with aggregate carrying values of $9.5 million and $9.3 million, respectively.

Notes Payable

The NLIC and ASIC notes payable of $27.5 million, with maturities ranging from May 2033 to April 2034, to unaffiliated companies are each subordinated in right of payment to all policy claims and other indebtedness of NLIC and ASIC, respectively.

Regulatory Matters

The statutory financial statements of the Company's insurance subsidiaries, which are domiciled in the State of Texas, are presented on the basis of accounting practices prescribed or permitted by the Texas Department of Insurance. Texas has adopted the statutory accounting practices of the National Association of Insurance Commissioners (“NAIC”) as the basis of its statutory accounting practices with certain differences that are not significant to the insurance company subsidiaries’ statutory equity.

A summary of statutory capital and surplus and statutory net income (loss) of each insurance subsidiary is as follows (in thousands).

	March 31,		December 31,
	2020		2019
Statutory capital and surplus:
National Lloyds Insurance Company	$	73,892	$	70,112
American Summit Insurance Company		17,999		19,201

	Three Months Ended March 31,
	2020		2019
Statutory net income (loss):
National Lloyds Insurance Company	$	6,527	$	3,417
American Summit Insurance Company		(185)		417

Regulations of the Texas Department of Insurance require insurance companies to maintain minimum levels of statutory surplus to ensure their ability to meet their obligations to policyholders. At March 31, 2020, the Company's insurance subsidiaries had statutory surplus in excess of the minimum required.

The NAIC has adopted a risk based capital (“RBC”) formula for insurance companies that establishes minimum capital requirements indicating various levels of available regulatory action on an annual basis relating to insurance risk, asset credit risk, interest rate risk and business risk. The RBC formula is used by the NAIC and certain state insurance regulators as an early warning tool to identify companies that require additional scrutiny or regulatory action. At March 31, 2020, the Company's insurance subsidiaries' RBC ratio exceeded the level at which regulatory action would be required.

Reserve for Losses and Loss Adjustment Expenses

A rollforward of NLC’s reserve for unpaid losses and LAE, as included in other liabilities and reflected as a part of liabilities held for sale for all periods within the consolidated balance sheets, is as follows (in thousands).

		March 31,
	2020		2019
Balance, beginning of period	$	15,342	$	20,552
Less reinsurance recoverables		(1,005)		(3,214)
Net balance, beginning of period		14,337		17,338
Incurred related to:
Current year		11,657		13,993
Prior years		1,474		935
Total incurred		13,131		14,928
Payments related to:
Current year		(7,377)		(7,029)
Prior years		(6,329)		(7,152)
Total payments		(13,706)		(14,181)
Net balance, end of period		13,762		18,085
Plus reinsurance recoverables		746		2,506
Balance, end of period	$	14,508	$	20,591

A summary of claims loss reserve development activity is presented in the following table (dollars in thousands).

	Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance								March 31, 2020
										Total of
										Incurred
										But Not
										Reported
										Reserves Plus	Cumulative
										Development	Number of
Accident	March 31, 2020									On Reported	Reported
Year	2017		2018		2019		2020			Claims	Claims
2017	$	87,899	$	88,025	$	87,534	$	87,568	$	216	20,174
2018				75,217		73,261		73,314		927	14,713
2019						71,687		73,072		4,009	13,798
2020								11,657		1,565	2,317
							$	245,611
	Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
Accident	March 31, 2020
Year	2017		2018		2019		2020
2017	$	77,675	$	86,319	$	87,203	$	87,291
2018				61,922		70,958		72,255
2019						55,014		66,150
2020								7,377
Total							$	233,073
All outstanding reserves prior to 2017, net of reinsurance								466
Reserve for unpaid losses and allocated loss adjustment expenses, net of reinsurance							$	13,004

Reinsurance Activity

NLC limits the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risk. Substantial amounts of business are ceded, and these reinsurance contracts do not relieve NLC from its obligations to policyholders. Such reinsurance includes quota share, excess of loss, catastrophe, and other forms of reinsurance on essentially all property and casualty lines of insurance. Net insurance premiums earned, losses and LAE and policy acquisition and other underwriting expenses are reported net of the amounts related to reinsurance ceded to other companies. Amounts recoverable from reinsurers related to the portions of the liability for losses and LAE and unearned insurance premiums ceded to them are reported as assets. Failure of reinsurers to honor their obligations could result in losses to NLC; consequently, an allowance for credit losses is established for amounts deemed uncollectible as NLC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At March 31, 2020, total reinsurance recoverables and receivables had a carrying value of $1.5 million, which is included in other assets within the consolidated balance sheets. There was no allowance for credit losses on reinsurance receivables at March 31, 2020, based on NLC’s quality requirements.

The effects of reinsurance on premiums written and earned are included within discontinued operations for all periods presented and are summarized as follows (in thousands).

	Three Months Ended March 31,
	2020				2019
	Written		Earned		Written		Earned
Premiums from direct business	$	29,980	$	30,746	$	30,790	$	31,737
Reinsurance assumed		2,952		3,244		3,129		3,191
Reinsurance ceded		(1,353)		(1,353)		(1,725)		(1,725)
Net premiums	$	31,579	$	32,637	$	32,194	$	33,203

The effects of reinsurance on incurred losses and LAE are included within discontinued operations for all periods and are as follows (in thousands).

	Three Months Ended March 31,
	2020		2019
Losses and LAE incurred	$	12,763	$	14,985
Reinsurance recoverables		186		(59)
Net loss and LAE incurred	$	12,949	$	14,926

Catastrophic coverage

Effective July 1, 2019, NLC renewed its catastrophic excess of loss reinsurance coverage for a one-year period. At March 31, 2020, NLC had catastrophic excess of loss reinsurance coverage of losses per event in excess of $8 million retention by NLIC and $2 million retention by ASIC. ASIC maintained an underlying layer of coverage, providing $6 million of reinsurance coverage in excess of its $2 million retention to bridge to the primary program. The reinsurance for NLIC and ASIC in excess of $8 million is comprised of three layers of protection: $12 million in excess of $8 million retention and/or loss; $25 million in excess of $20 million loss; and $50 million in excess of $45 million loss. NLIC and ASIC retain no participation in any of the layers, beyond the first $8 million and $2 million, respectively. At March 31, 2020, total retention for any one catastrophe that affects both NLIC and ASIC was limited to $8 million in the aggregate.

NLC did not renew its underlying excess of loss contract that provides $10.0 million aggregate coverage in excess of NLC’s per event retention of $1.0 million and aggregate retention of $15.0 million for sub-catastrophic events through December 31, 2019. During 2019, NLC retained 37.5% participation in this coverage.