LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSE

We generally use the term loss(es) to collectively refer to both loss and loss adjusting expenses. We establish reserves for both reported and unreported unpaid losses that have occurred at or before the balance sheet date for amounts we estimate we will be required to pay in the future. Our policy is to establish these loss reserves after considering all information known to us at each reporting period. At any given point in time, our loss reserve represents our best estimate of the ultimate settlement and administration cost of our insured claims incurred and unpaid. Since the process of estimating loss reserves requires significant judgment due to a number of variables, such as fluctuations in inflation, judicial decisions, legislative changes and changes in claims handling procedures, our ultimate liability will likely differ from these estimates. We revise our reserve for unpaid losses as additional information becomes available, and reflect adjustments, if any, in our earnings in the periods in which we determine the adjustments are necessary.

General Discussion of the Loss Reserving Process

Reserves for unpaid losses fall into two categories: case reserves and reserves for claims incurred but not reported.

•

Case reserves - When a claim is exported, we establish an automatic minimum case reserve for that claim type that represents our initial estimate of the losses that will ultimately be paid on the reported claim. Our initial estimate for each claim is based upon averages of loss payments for our prior closed claims made for that claim type. Then, our claims personnel perform an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss and adjust the reserve as necessary. As claims mature, we increase or decrease the reserve estimates as deemed necessary by our claims department based upon additional information we receive regarding the loss, the results of on-site reviews and any other information we gather while reviewing the claims.

•

Reserves for losses incurred but not reported (IBNR reserves) - Our IBNR reserves include true IBNR reserves plus “bulk” reserves. Bulk reserves represent additional amounts that cannot be allocated to particular claims, but which are necessary to estimate ultimate losses on reported and unreported claims. We estimate our IBNR reserves by projecting the ultimate losses using the methods discussed below and then deducting actual loss payments and case reserves from the projected ultimate losses. We review and adjust our IBNR reserves on a quarterly basis based on information available to us at the balance sheet date.

When we establish our reserves, we analyze various factors such as our historical loss experience and that of the insurance industry, claims frequency and severity, our business mix, our claims processing procedures, legislative enactments, judicial decisions and legal developments in imposition of damages, and general economic conditions, including inflation. A change in any of these factors from the assumptions implicit in our estimates will cause our ultimate loss experience to be better or worse than indicated by our reserves, and the difference could be material. Due to the interaction of the aforementioned factors, there is no precise method for evaluating the impact of any one specific factor in isolation, and an element of judgment is ultimately required. Due to the uncertain nature of any projection of the future, the ultimate amount we will pay for losses will be different from the reserves we record. However, in our judgment, we employ techniques and assumptions that are appropriate, and the resulting reserve estimates are reasonable, given the information available at the balance sheet date.

We determine our ultimate losses by using multiple actuarial methods to determine an actuarial estimate within a relevant range of indications that we calculate using generally accepted actuarial techniques. Our selection of the actuarial estimate is influenced by the analysis of our historical loss and claim experience. For each accident year, we estimate the ultimate incurred losses for both reported and unreported claims. In establishing this estimate, we review the results of various actuarial methods discussed below.

Estimation of the Reserves for Unpaid Losses and Allocated Loss Adjustment Expenses

We calculate our estimate of ultimate losses by using the following actuarial methods. We separately calculate the methods using paid loss data and incurred loss data. In the versions of these methods based on incurred loss data, the incurred losses are defined as paid losses plus case reserves. For this discussion of our loss reserving process, the word “segment” refers to a subgrouping of our claims data, such as by geographic area and/or by particular line of business; it does not refer to operating segments.

•

Incurred Development Method - The incurred development method is based upon the assumption that the relative change in a given year’s incurred loss estimates from one evaluation point to the next is similar to the relative change in prior years’ reported loss estimates at similar evaluation points. In utilizing this method, actual annual historical incurred loss data is evaluated. Successive years can be arranged to form a triangle of data. Loss development factors (LDFs) are calculated to measure the change in cumulative incurred costs from one evaluation point to the next. These historical LDFs and comparable industry benchmark factors form the basis for selecting the LDFs used in projecting the current valuation of losses to an ultimate basis. This method’s implicit assumption is that the relative adequacy of case reserves has been consistent over time, and that there have been no material changes in the rate at which claims have been reported. The paid development method is similar to the incurred development method. While the paid development methods have the disadvantage of not recognizing the information by current case reserves, it has the advantage of avoiding potential distortions in the data due to changes in case reserving methodology. The paid development method’s implicit assumption is that the rate of payment of claims has been relatively consistent over time.

•

Expected Loss Method - In the expected loss method, ultimate loss projections are based upon some prior measure of the anticipated losses, usually relative to some measure of exposure (e.g., earned house years). An expected loss cost is applied to the measure of exposure to determine estimated ultimate losses for each year. Actual losses are not considered in this calculation. This method has the advantage of stability over time, because the ultimate loss estimates do not change unless the exposures or loss costs change. However, this advantage of stability is offset by a lack of responsiveness, since this method does not consider actual loss experience as it emerges. This method is based on the assumption that the loss cost per unit of exposure is a good indication of ultimate losses. It can be entirely dependent on pricing assumptions (e.g., historical experience adjusted for loss trend).

•

Bornhuetter-Ferguson Method - The incurred Bornhuetter-Ferguson (B-F) method is essentially a blend of two other methods. The first method is the loss development method whereby actual incurred losses are multiplied by an expected LDF. For slow reporting coverages, the loss development method can lead to erratic and unreliable projections because a relatively small swing in early reporting can result in a large swing in ultimate projections. The second method is the expected loss method whereby the IBNR estimate equals the difference between a predetermined estimate of expected losses and actual incurred losses. The incurred B-F method combines these two methods by setting ultimate losses equal to actual incurred losses plus expected unreported losses. As an experience year matures and expected unreported losses become smaller, the initial expected loss assumption becomes gradually less important. Two parameters are needed to apply the B-F method: the initial expected loss cost and the expected reporting pattern (LDFs). This method is often used for long-tail lines and in situations where the incurred loss experience is relatively immature or lacks sufficient credibility for the application of other methods. The paid B-F method is analogous to the incurred B-F method using paid losses and development patterns in place of incurred losses and patterns.

•

Paid-to-Paid Development Method - In addition to the aforementioned methods, we also rely upon the paid-to-paid development method to project ultimate unallocated loss adjustment expense (ULAE). Ratios of paid ULAE to paid loss and allocated loss adjustment expense (ALAE) are compiled by calendar year and a paid-to-paid ratio selection is made. The selected ratio is applied to the estimated IBNR amounts and one half of this ratio is applied to case reserves. This method is derived from rule of thumb that half of ULAE is incurred when a claim is opened and the other half is incurred over the remaining life of the claim.

Reliance and Selection of Methods

The various methods we use have strengths and weaknesses that depend upon the circumstances of the segment and the age of the claims experience we analyze. The nature of our book of business allows us to place substantial, but not exclusive, reliance on the loss development methods, the selected LDFs, represent the most critical aspect of our loss reserving process. We use the same set of LDFs in the methods during our loss reserving process that we also use to calculate the premium necessary to pay expected ultimate losses.

Reasonably-Likely Changes in Variables

As previously noted, we evaluate several factors when exercising our judgment in the selection of the loss development factors that ultimately drive the determination of our loss reserves. The process of establishing our reserves is complex and necessarily imprecise, as it involves using judgment that is affected by many variables. We believe a reasonably-likely change in almost any of these aforementioned factors could have an impact on our reported results, financial condition and liquidity. However, we do not believe any reasonably-likely changes in the frequency or severity of claims would have a material impact on us.

On an annual basis, our consulting actuary issues a statement of actuarial opinion that documents the actuary’s evaluation of the adequacy of our unpaid loss obligations under the terms of our policies. We review the analysis underlying the actuary’s opinion and compare the projected ultimate losses per the actuary’s analysis to our own projection of ultimate losses to ensure that our reserve for unpaid losses recorded at each annual balance sheet date is based upon our analysis of all internal and external factors related to known and unknown claims against us and to ensure our reserve is within guidelines promulgated by the National Association of Insurance Commissioners (NAIC).

We maintain an in-house claims staff that monitors and directs all aspects of our claims process. We assign the fieldwork to our wholly-owned claims subsidiary, or to third-party claims adjusting companies, none of whom have the authority to settle or pay any claims on our behalf. The third-party claims adjusting companies conduct inspection of the damaged property and prepare initial estimates. We review the inspection reports and initial estimates to determine the amounts to be paid to the policyholder in accordance with the terms and conditions of the policy in effect at the time that the policyholder incurs the loss. We maintain strategic relationships with multiple claims adjusting companies that we can engage should we need additional non-catastrophe claims servicing capacity. We believe the combination of our internal resources and relationships with external claims servicing companies provide an adequate level of claims servicing in the event catastrophes affect our policyholders.

The following is information about incurred claims development and paid claims development as of December 31, 2016, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liability plus expected development on reported claims included within the net incurred claims amounts. The incurred claims development and paid claims development data reflect the acquisitions of FSIC and IIC in February 2015 and April 2016, respectively, on a retrospective basis (includes FSIC and IIC data for years prior to our acquisition of the insurance affiliates). The information about incurred claims development and paid claims development for the years ended December 31, 2007, to 2015 is presented as supplementary information.

Homeowners' Insurance

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2016
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
	Unaudited
Accident Year	2007		2008		2009		2010		2011		2012		2013		2014		2015		2016
2007	$	28,232	$	25,780	$	24,828	$	24,852	$	24,641	$	24,563	$	24,665	$	24,725	$	24,596	$	24,601	$	—	2,332,000
2008	—		30,073		28,126		27,174		27,161		27,358		27,597		27,564		27,468		27,453		—		3,170,000
2009	—		—		46,952		46,089		45,515		45,583		45,316		45,116		44,959		44,996		—		4,044,000
2010	—		—		—		51,144		51,292		51,862		52,239		51,685		51,841		51,674		3		4,839,000
2011	—		—		—		—		53,878		56,840		57,670		58,047		59,517		60,215		62		5,913,000
2012	—		—		—		—		—		65,112		69,438		68,923		68,388		69,000		167		10,649,000
2013	—		—		—		—		—		—		98,461		94,755		93,041		92,702		677		7,809,000
2014	—		—		—		—		—		—		—		130,090		130,488		131,402		2,025		10,857,000
2015	—		—		—		—		—		—		—		—		181,609		195,902		6,784		17,918,000
2016	—		—		—		—		—		—		—		—		—		249,276		34,483		28,430,000
																	Total		$	947,221



Accident Year	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
	Unaudited
	2007		2008		2009		2010		2011		2012		2013		2014		2015		2016
2007	$	16,713	$	22,017	$	23,131	$	24,155	$	24,277	$	24,382	$	24,439	$	24,483	$	24,596	$	24,601
2008	—		17,915		23,806		25,264		26,360		27,044		27,358		27,390		27,445		27,451
2009	—		—		31,525		41,134		43,149		44,114		44,413		44,737		44,898		44,966
2010	—		—		—		32,993		43,932		46,711		49,256		50,215		50,704		51,163
2011	—		—		—		—		36,419		48,558		52,412		55,532		58,069		59,461
2012	—		—		—		—		—		42,699		60,640		64,675		66,739		68,337
2013	—		—		—		—		—		—		63,732		85,346		89,068		90,627
2014	—		—		—		—		—		—		—		88,375		119,612		125,951
2015	—		—		—		—		—		—		—		—		123,888		174,993
2016	—		—		—		—		—		—		—		—		—		170,527
																	Total		$	838,077
All outstanding liabilities before 2007, net of reinsurance																			176
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	109,320

The following is supplementary information about average historical claims duration as of December 31, 2016.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	65.4	%	22.4	%	4.7	%	3.6	%	2.0	%	1.1	%	0.4	%	0.2	%	0.2	%	—	%

Remaining Product Lines

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2016
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
	Unaudited
Accident Year	2007		2008		2009		2010		2011		2012		2013		2014		2015		2016
2007	$	11,491	$	9,605	$	8,313	$	7,825	$	7,553	$	7,554	$	7,504	$	7,464	$	7,464	$	7,507	$	—	1,191,000
2008	—		13,504		12,871		12,324		11,833		11,877		12,661		12,761		12,885		12,884		—		1,170,000
2009	—		—		10,610		10,135		10,093		10,026		9,902		9,844		9,837		10,009		—		1,097,000
2010	—		—		—		9,911		11,042		10,733		11,126		11,020		11,105		11,072		—		1,160,000
2011	—		—		—		—		11,126		11,022		10,896		10,630		10,575		10,740		—		1,217,000
2012	—		—		—		—		—		10,760		9,651		9,350		9,412		9,147		11		1,061,000
2013	—		—		—		—		—		—		6,657		5,817		5,401		5,736		5		553,000
2014	—		—		—		—		—		—		—		9,073		7,927		8,016		76		682,000
2015	—		—		—		—		—		—		—		—		19,669		19,723		581		1,384,000
2016	—		—		—		—		—		—		—		—		—		17,053		1,952		46,000
																	Total		$	111,887



	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
	Unaudited
Accident Year	2007		2008		2009		2010		2011		2012		2013		2014		2015		2016
2007	$	3,974	$	5,885	$	6,627	$	7,001	$	7,127	$	7,303	$	7,442	$	7,449	$	7,452	$	7,507
2008	—		6,169		9,309		10,647		11,104		11,404		12,360		12,403		12,557		12,884
2009	—		—		4,807		7,507		8,470		9,062		9,471		9,570		9,688		10,009
2010	—		—		—		4,346		8,128		9,036		10,182		10,242		10,327		11,073
2011	—		—		—		—		4,587		8,013		9,444		9,837		10,128		10,740
2012	—		—		—		—		—		5,112		7,631		8,242		8,626		9,124
2013	—		—		—		—		—		—		2,925		4,496		4,811		5,566
2014	—		—		—		—		—		—		—		4,008		6,237		7,868
2015	—		—		—		—		—		—		—		—		11,104		18,129
2016	—		—		—		—		—		—		—		—		—		12,432
																	Total		$	105,332
All outstanding liabilities before 2007, net of reinsurance																			42
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	6,597

The following is supplementary information about average historical claims duration as of December 31, 2016.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	48.3	%	25.7	%	7.2	%	6.5	%	2.8	%	3.5	%	2.5	%	1.5	%	1.3	%	0.7	%

The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expenses in the consolidated statement of financial position is as follows.



	December 31, 2016
Net outstanding liabilities
Homeowners' Only	$	109,320
All other lines of business	6,597
Liabilities for unpaid claims and claim adjustment expenses, net of reinsurance	$	115,917

Reinsurance recoverable on unpaid claims
Homeowners' Only	$	14,223
All other lines of business	4,501
Total reinsurance recoverable on unpaid claims	$	18,724

Unallocated claims adjustment expenses	6,214

Total gross liability for unpaid claims and claims adjustment expense	$	140,855

The table below shows the analysis of our reserve for unpaid losses for each of our last three fiscal years on a GAAP basis:



	2016		2015			2014
Balance at January 1	$	76,792	$	54,436		$	47,451
Acquisition of IIC reserves	22,576		—			—
Acquisition of FSIC reserves	—		2,390			—
Less: reinsurance recoverable on unpaid losses	2,114		1,252			1,957
Net balance at January 1	$	97,254	$	55,574		$	45,494
Incurred related to:
Current year	281,365		185,476			122,114
Prior years	16,988		(2,368		)	(4,037		)
Total incurred	$	298,353	$	183,108		$	118,077
Paid related to:
Current year	210,970		127,306			83,967
Prior years	62,506		36,698			26,420
Total paid	$	273,476	$	164,004		$	110,387

Net balance at December 31	$	122,131	$	74,678		$	53,184
Plus: reinsurance recoverable on unpaid losses	18,724		2,114			1,252
Balance at December 31	$	140,855	$	76,792		$	54,436

Composition of reserve for unpaid losses and LAE:
Case reserves	$	83,447	$	45,502		$	29,726
IBNR reserves	57,408		31,290			24,710
Balance at December 31	$	140,855	$	76,792		$	54,436

Based upon our internal analysis and our review of the statement of actuarial opinion provided by our actuarial consultants, we believe that the reserve for unpaid losses reasonably represents the amount necessary to pay all claims and related expenses which may arise from incidents that have occurred as of the balance sheet date.

As reflected by our losses incurred related to prior years, the favorable development experienced in 2015 was primarily the result of losses related to the 2014 and 2013 accident years coming in better than expected. The favorable development experienced in 2014 was primarily the result of losses related to the 2013 and 2012 accident years coming in better than expected. During 2016, we had a reserve deficiency. Since we place substantial reliance on loss-development-based actuarial models when determining our estimate of ultimate losses, the deficiencies resulted from additional development on prior accident years which caused our ultimate losses to increase.