REINSURANCE

Our reinsurance program is designed, utilizing our risk management methodology, to address our exposure to catastrophes. According to the Insurance Service Office (ISO), a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25,000,000 or more in U.S. industry-wide direct insured losses to property and that affect a significant number of policyholders and insurers (ISO catastrophe). In addition to ISO catastrophes, we also include as catastrophes those events (non-ISO catastrophes), which may include losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made.

Our program provides reinsurance protection for catastrophes including hurricanes, tropical storms, and tornadoes. These reinsurance agreements are part of our catastrophe management strategy, which is intended to provide our shareholders an acceptable return on the risks assumed in our property business, and to reduce variability of earnings, while providing protection to our policyholders.

During the second quarter of 2016, we placed our reinsurance program for the 2016 treaty year beginning June 1, 2016 and ending on May 31, 2017. The agreements incorporate the mandatory coverage required by and placed with the Florida Hurricane Catastrophe Fund (FHCF). The FHCF is a Florida state-sponsored trust fund that provides reimbursement in Florida against storms that the National Hurricane Center designates as hurricanes. The private agreements provide coverage against severe weather events such as hurricanes, tropical storms and tornadoes.

For the treaty year beginning June 1, 2016 and ending on May 31, 2017, UPC Insurance has obtained reinsurance protection of $1,515,197,000 excess $10,000,000, providing sufficient protection for a 1-in-100 year hurricane event and a second 1-in-50 year hurricane event in the same year as calculated using a blended model result predominately based on our licensed modeling software, AIR model version 17, using long-term event rates excluding demand surge. For a single first event hurricane or tropical storm, UPC Insurance will pay, or “retain”, 100% of losses up to $30,000,000 including the $20,000,000 layer funded by UPC Re. The catastrophe excess of loss reinsurance program provides our insurance subsidiaries 100% coverage for all losses in excess of $10,000,000 up to $1,415,197,000 for a first event and $1,515,197,000 for any number of subsequent events until all limit is exhausted.

For the 2016 contract year, UPC Insurance has elected a 45% participation rate with the FHCF and purchased replacement coverage from private insurers for the remaining 45%. Of the $1,515,197,000 in excess of $10,000,000, we estimate the mandatory FHCF layer will provide approximately $354,015,000 (45% of $786,700,000) of aggregate coverage for losses in excess of $246,002,000. The private market FHCF replacement coverage provides another $346,182,000 of aggregate protection (45% of $769,293,000) in excess of $244,206,000 layer for Florida only on a fully collateralized basis that also inures to the benefit of all other private reinsurance coverage.

In addition to the FHCF and FHCF replacement coverage, we purchase $685,000,000 of aggregate catastrophe reinsurance coverage in excess of $10,000,000 from 55 unaffiliated private reinsurers and catastrophe bond investors who either carry A.M. Best financial strength ratings of A- or higher, or have fully collateralized their maximum potential obligations in dedicated trusts for the benefit of UPC Insurance. Our 2016 agreements with these private reinsurers structure coverage into 5 layers, with a cascading feature such that all layers attach at $10,000,000. If the aggregate limit of the preceding layer is exhausted, the next layer drops down (cascades) in its place. Additionally, any unused layer protection drops down for subsequent events until exhausted ensuring there are no potential gaps in coverage up to the $1,415,197,000 first event program exhaustion point. The Company also secured up to $100,000,000 of limit that can be utilized at our option for the second and subsequent events at an additional cost, but the Company is under no obligation to activate this layer.

The total cost of the 2016-17 catastrophe reinsurance program is estimated to be $191,500,000.

Effective December 1, 2016, UPC Insurance, through our wholly owned insurance subsidiary UPC entered into a quota share reinsurance agreement (the "quota share agreement") with private reinsurers. Also, effective January 1, 2017, we renewed our aggregate excess of loss reinsurance agreement (the "aggregate excess of loss agreement," and, together with the quota share agreement, the "agreements") with private reinsurers. These agreements provide coverage for in-force, new and renewal business. The quota share agreement provides coverage only for UPC, while the aggregate excess of loss agreement provides coverage for UPC, IIC, and FSIC. These new reinsurance programs are designed to work in conjunction with our catastrophe excess of loss reinsurance program to provide us broad risk transfer protection and to lessen financial volatility.

The quota share agreement includes a cession rate of 20% (15% on single year and 5% over a two-year period) for all subject business. The quota share agreement provides coverage for all catastrophe perils (e.g. hurricanes, tropical storms, tropical depressions and earthquakes), other-catastrophe perils (e.g. weather-related perils other than hurricanes, tropical storms, tropical depressions and earthquakes), and attritional losses. For other-catastrophe perils, the quota share agreement provides coverage alongside the aggregate excess of loss program described herein, after our retention has been satisfied. For catastrophe perils, the quota share agreement provides ground-up protection that effectively reduces our retention for catastrophe losses. Quota share agreement reinsurers' participation in paying attritional losses is subject to an attritional loss ratio cap.

The aggregate excess of loss agreement provides coverage only for other-catastrophe perils. Under this agreement, for other-catastrophe losses in excess of $1,000,000 but less than $15,000,000, UPC will retain, in the aggregate, 100% of those losses up to $30,000,000. The reinsurers will then be liable for all losses excess of $30,000,000 in the aggregate not to exceed an annual aggregate limit of $30,000,000. This program was placed at 85% rather than 100% because of the quota share agreement reinsurers' participation in paying other-catastrophe losses after the $30,000,000 retention.

We amortize our prepaid reinsurance premiums over the annual agreement period, and we record that amortization in ceded premiums earned on our Consolidated Statements of Comprehensive Income. The table below summarizes the amounts of our ceded premiums written under the various types of agreements, as well as the amortization of prepaid reinsurance premiums:



	Year Ended December 31,
	2016			2015			2014
Excess-of-loss	$	(235,236	)	$	(163,106	)	$	(125,638	)
Equipment & identity theft	(8,313		)	(6,169		)	(4,370		)
Novation of Auto Policies ⁽¹⁾	(2,396		)	—			—
Flood	(16,395		)	(14,533		)	(14,396		)
Ceded premiums written	$	(262,340	)	$	(183,808	)	$	(144,404	)
Increase in ceded unearned premiums	52,442			15,551			8,559
Ceded premiums earned	$	(209,898	)	$	(168,257	)	$	(135,845	)

⁽¹⁾Reflects ceding of auto policy premiums to Maidstone Insurance Company as part of the settlement of the novation agreement entered into at the closing of the IIC transaction.

Current year catastrophe losses by the event magnitude are shown in the following table.



	Number of Events	Incurred Loss and LAE ⁽¹⁾		Combined Ratio Impact
December 31, 2016
Current period catastrophe losses incurred
Greater than $5 million ⁽²⁾	1	$	29,987	6.5	%
$1 million to $5 million ⁽³⁾	12	21,506		4.7	%
Less than $1 million ⁽⁴⁾	6	4,349		1.0	%
Total	19	$	55,842	12.2	%

December 31, 2015
Current period catastrophe losses incurred
$5 million to $10 million ⁽⁵⁾	2	$	11,523	3.4	%
$1 million to $5 million⁽⁶⁾	7	14,699		4.4	%
Less than $1 million ⁽⁷⁾	5	2,343		0.7	%
Total	14	$	28,565	8.5	%

December 31, 2014
Current period catastrophe losses incurred
Less than $1 million ⁽⁸⁾	3	$	829	0.3	%
Total	3	$	829	0.3	%

⁽¹⁾ Incurred loss and LAE is equal to losses and LAE paid plus the change in case and incurred but not reported reserves. Shown net of losses ceded to reinsurers.

⁽²⁾Reflects losses from Hurricane Matthew in 2016.

⁽³⁾ Reflects losses from Hurricane Hermine, Winter Storm Olympia, Tropical Storm Colin, tornadoes, wind storms, hail storms, and flooding in 2016.

⁽⁴⁾ Reflects losses from Tropical Storm Julia, tornadoes, wind storms, hail storms, and flooding in 2016.


⁽⁵⁾	Reflects losses from winter storms in 2015.


⁽⁶⁾	Reflects losses from winter storms, hail storms and wind storms in 2015.


⁽⁷⁾	Reflects losses from winter storms, hail storms, Texas flooding, Hurricane Anna and Tropical Storm Bill in 2015.


⁽⁸⁾	Reflects losses from the Richland hailstorm, Hurricane Arthur and the Revere Tornado in 2014.

Reinsurance recoverable at the balance sheet dates consists of the following:



	December 31,
	2016		2015
Reinsurance recoverable on unpaid losses and LAE	$	18,724	$	2,114
Reinsurance recoverable on paid losses and LAE	5,304		847
Reinsurance recoverable	$	24,028	$	2,961

During the years ended December 31, 2016 and 2015, we realized recoveries under our reinsurance agreements totaling $18,412,000 and $10,282,000, respectively. These recoveries were primarily related to losses from Hurricane Matthew, Hurricane Hermine, Winter Storm Olympia, Tropical Storm Colin, tornadoes, thunderstorms, hail storms, and flooding in 2016.

We write flood insurance under an agreement with the National Flood Insurance Program. We cede 100% of the premiums written and the related risk of loss to the federal government. We earn commissions for the issuance of flood policies based upon a fixed percentage of net written premiums and the processing of flood claims based upon a fixed percentage of incurred losses, and we can earn additional commissions by meeting certain growth targets for the number of in-force policies. We recognized commission revenue from our flood program of $1,056,000, $959,000, and $1,078,000 for the years ended December 31, 2016, 2015, and 2014, respectively.

The following table depicts written premiums, earned premiums and losses, showing the effects that our reinsurance transactions have on these components of our Consolidated Statements of Comprehensive Income:



	Year ended December 31,
	2016			2015			2014
Premium written:
Direct	$	708,252		$	548,916		$	417,769
Assumed	(96		)	20,820			18,984
Ceded	(262,340		)	(183,808		)	(144,404		)
Net premium written	$	445,816		$	385,928		$	292,349
Change in unearned premiums:
Direct	$	(57,759	)	$	(65,300	)	$	(38,995	)
Assumed	16,432			(221		)	2,937
Ceded	52,442			15,551			8,559
Net decrease (increase)	$	11,115		$	(49,970	)	$	(27,499	)
Premiums earned:
Direct	$	650,493		$	483,616		$	378,774
Assumed	16,336			20,599			21,921
Ceded	(209,898		)	(168,257		)	(135,845		)
Net premiums earned	$	456,931		$	335,958		$	264,850
Losses and LAE incurred:
Direct	$	335,542		$	188,270		$	111,820
Assumed	3,747			7,861			8,672
Ceded	(40,936		)	(13,023		)	(2,415		)
Net losses and LAE incurred	$	298,353		$	183,108		$	118,077

Ceded losses incurred increased by $27,913,000 during the year ended December 31, 2016, compared to the year ended December 31, 2015, primarily because we paid more ceded losses in 2016 than in 2015. A portion of the losses we incurred in 2016 and 2015 exceeded our retained loss thresholds, therefore we received reinsurance recoveries for some of the losses that we incurred on these storms. The losses we incurred in 2014 related to storms that occurred in the same year but did not exceed our retained loss thresholds.

The following table highlights the effects that our reinsurance transactions have on unpaid losses and loss adjustment expenses and unearned premiums in our Consolidated Balance Sheets:



	December 31,
	2016			2015			2014
Unpaid losses and LAE:
Direct	$	138,345		$	72,373		$	49,734
Assumed	2,510			4,419			4,702
Gross unpaid losses and LAE	140,855			76,792			54,436
Ceded	(18,724		)	(2,114		)	(1,252		)
Net unpaid losses and LAE	$	122,131		$	74,678		$	53,184
Unearned premiums:
Direct	$	371,149		$	287,148		$	212,201
Assumed	1,074			17,506			17,285
Gross unearned premiums	372,223			304,654			229,486
Ceded	(132,564		)	(79,400		)	(63,827		)
Net unearned premiums	$	239,659		$	225,254		$	165,659