LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSE (LAE)

We generally use the term loss(es) to collectively refer to both loss and LAE. 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.

To determine our ultimate losses, we first use multiple actuarial techniques to establish a range of reasonable estimates. These techniques are in line with actuarial standards of practice and actuarial literature. A brief overview of each of these techniques is provided below. We then make additional qualitative considerations for many of the previously mentioned factors and select a point within this range. These ultimate loss estimates include reserves for both reported and unreported claims.

Estimation of the Reserves for Unpaid Losses and Allocated LAE

We calculate our estimate of ultimate losses with the following actuarial methods. The methods are applied to paid and incurred loss data. Incurred losses are defined as paid losses plus case reserves. For 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.

•

Development Method - The development method is based upon the assumption that the relative change in a given year’s 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 loss data is evaluated. Loss development factors (LDFs) are calculated to measure the change in cumulative losses 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. When applied to incurred loss data, the 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. Applying this method to paid losses avoids potential distortions in the data due to changes in case reserving methodology, but also loses any potentially useful information contained in the current case reserves. The paid development method’s implicit assumption is that the rate of payment of claims has been relatively consistent over time.

•

Expected Loss Method - Ultimate loss projections are based upon a prior measure of the anticipated losses, usually relative to a measure of exposure (such as earned house years). An expected loss cost is applied to each year’s measure of exposure to determine estimated ultimate losses for that year. Actual losses are not considered in this calculation. Because the ultimate loss estimates do not change unless the exposures or loss costs change, this method has the advantage of being stable over time. However, the advantage of this stability is offset by a lack of responsiveness since this method does not consider actual loss experience as it emerges. This method assumes 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 Bornhuetter-Ferguson (B-F) method is a credibility weighting procedure that blends the responsiveness of the Development Method with the stability of the Expected Loss Method by setting ultimate losses equal to actual losses plus the expected unreported losses which are based on the Expected Loss Method. As an experience year matures, actual losses gradually move closer to their ultimate levels so reliance on the Expected Loss Method can be reduced.

•

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 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

Each of these methods has its own 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, and 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 LDFs 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 consulting actuary’s opinion and compare the projected ultimate losses to our own estimates to ensure that the reserve for unpaid losses recorded at each annual balance sheet date is based upon 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, 2018, 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, IIC, and AmCo in February 2015, April 2016, and April 2017, respectively, on a retrospective basis (includes FSIC, IIC and AmCo 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, 2009 to 2015 is presented as supplementary information.

Personal Homeowners’ Insurance

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2018
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
	Unaudited														Audited
Accident Year	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	46,952	$	46,089	$	45,515	$	45,583	$	45,316	$	45,116	$	44,959	$	44,996	$	44,617	$	44,574	$	2	4,152
2010	—		51,144		51,292		51,862		52,239		51,685		51,841		51,674		51,836		51,796		11		5,095
2011	—		—		53,878		56,840		57,670		58,047		59,517		60,215		60,288		60,522		72		6,224
2012	—		—		—		65,112		69,438		68,923		68,388		69,000		69,064		67,934		159		11,046
2013	—		—		—		—		98,461		94,755		93,041		92,702		92,792		66,709		174		8,373
2014	—		—		—		—		—		130,090		130,488		131,402		132,096		104,222		619		12,822
2015	—		—		—		—		—		—		181,609		195,902		195,864		196,549		1,795		19,152
2016	—		—		—		—		—		—		—		249,276		250,774		236,050		4,208		30,572
2017	—		—		—		—		—		—		—		—		208,537		165,375		9,730		73,280
2018	—		—		—		—		—		—		—		—		—		268,275		44,495		35,629
																	Total		$	1,262,006



Accident Year	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
	Unaudited														Audited
	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	31,525	$	41,134	$	43,149	$	44,114	$	44,413	$	44,737	$	44,898	$	44,966	$	44,577	$	44,572
2010	—		32,993		43,932		46,711		49,256		50,215		50,704		51,163		51,435		51,484
2011	—		—		36,419		48,558		52,412		55,532		58,069		59,461		59,806		60,289
2012	—		—		—		42,699		60,640		64,675		66,739		68,337		68,655		67,487
2013	—		—		—		—		63,732		85,346		89,068		90,627		91,789		65,989
2014	—		—		—		—		—		88,375		119,612		125,951		129,636		102,550
2015	—		—		—		—		—		—		123,888		174,993		188,199		192,065
2016	—		—		—		—		—		—		—		170,527		232,266		227,052
2017	—		—		—		—		—		—		—		—		138,112		158,114
2018	—		—		—		—		—		—		—		—		—		195,168
																	Total		$	1,164,770
All outstanding liabilities before 2009, net of reinsurance																			2
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	97,238

The following is supplementary information about average historical claims duration as of December 31, 2018.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	74.4	%	25.4	%	6.2	%	3.3	%	(2.5	)%	(6.9	)%	—	%	0.5	%	(0.4	)%	—	%

Commercial Residential Insurance

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2018
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
	Unaudited														Audited
Accident Year	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	11,323	$	5,233	$	4,054	$	3,853	$	4,182	$	3,459	$	3,490	$	3,489	$	3,486	$	3,484	$	—	383
2010	—		12,134		5,603		5,374		5,489		4,291		4,160		4,112		4,112		4,112		—		580
2011	—		—		12,702		11,280		10,197		8,972		9,142		9,030		8,985		9,026		54		757
2012	—		—		—		11,404		9,540		9,690		9,771		8,671		12,615		12,641		65		802
2013	—		—		—		—		8,359		6,420		11,826		8,382		7,573		7,426		163		740
2014	—		—		—		—		—		15,845		15,752		16,311		16,816		16,070		686		679
2015	—		—		—		—		—		—		16,554		20,434		24,568		26,619		2,039		836
2016	—		—		—		—		—		—		—		38,632		25,599		23,079		2,591		1,194
2017	—		—		—		—		—		—		—		—		76,910		102,408		4,254		4,254
2018	—		—		—		—		—		—		—		—		—		62,043		14,004		3,218
																	Total		$	266,908



	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
	Unaudited														Audited
Accident Year	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	1,639	$	3,616	$	3,410	$	3,415	$	3,920	$	3,446	$	3,471	$	3,485	$	3,484	$	3,483
2010	—		1,968		3,127		3,461		3,966		3,909		3,909		4,112		4,112		4,112
2011	—		—		3,541		6,241		7,605		7,846		8,825		8,851		8,933		8,972
2012	—		—		—		4,583		6,942		6,893		7,543		8,552		12,575		12,576
2013	—		—		—		—		2,958		5,127		5,317		7,248		7,254		7,256
2014	—		—		—		—		—		6,379		9,452		13,212		14,420		15,336
2015	—		—		—		—		—		—		10,188		17,139		20,645		22,983
2016	—		—		—		—		—		—		—		10,917		16,687		19,606
2017	—		—		—		—		—		—		—		—		42,744		86,775
2018	—		—		—		—		—		—		—		—		—		28,092
																	Total		$	209,191
All outstanding liabilities before 2009, net of reinsurance																			—
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	57,717

The following is supplementary information about average historical claims duration as of December 31, 2018.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	41.5	%	29.9	%	7.8	%	8.9	%	6.3	%	3.7	%	1.6	%	0.3	%	—	%	—	%

Remaining Product Lines

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2018
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
	Unaudited														Audited
Accident Year	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	10,610	$	10,135	$	10,093	$	10,026	$	9,902	$	9,844	$	9,837	$	10,009	$	10,007	$	10,007	$	—	1,072
2010	—		9,911		11,042		10,733		11,126		11,020		11,105		11,072		11,072		11,072		—		1,096
2011	—		—		11,126		11,022		10,896		10,630		10,575		10,740		10,741		10,741		—		1,171
2012	—		—		—		10,760		9,651		9,350		9,412		9,147		9,138		9,140		3		1,001
2013	—		—		—		—		6,657		5,817		5,401		5,736		5,857		5,843		41		508
2014	—		—		—		—		—		9,073		7,927		8,016		7,956		7,936		38		593
2015	—		—		—		—		—		—		19,669		19,723		19,352		19,340		134		1,009
2016	—		—		—		—		—		—		—		17,053		17,898		18,222		202		52
2017	—		—		—		—		—		—		—		—		46,892		77,864		1,417		32
2018	—		—		—		—		—		—		—		—		—		30,601		3,491		5
																	Total		$	200,766



	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
	Unaudited														Audited
Accident Year	2009		2010		2011		2012		2013		2014		2015		2016		2017		2018
2009	$	4,807	$	7,507	$	8,470	$	9,062	$	9,471	$	9,570	$	9,688	$	10,009	$	10,007	$	10,007
2010	—		4,346		8,128		9,036		10,182		10,242		10,327		11,073		11,072		11,072
2011	—		—		4,587		8,013		9,444		9,837		10,128		10,740		10,741		10,741
2012	—		—		—		5,112		7,631		8,242		8,626		9,124		9,126		9,137
2013	—		—		—		—		2,925		4,496		4,811		5,566		5,626		5,802
2014	—		—		—		—		—		4,008		6,237		7,868		7,898		7,898
2015	—		—		—		—		—		—		11,104		18,129		18,817		18,970
2016	—		—		—		—		—		—		—		12,432		16,116		17,111
2017	—		—		—		—		—		—		—		—		37,127		68,994
2018	—		—		—		—		—		—		—		—		—		24,105
																	Total		$	183,837
All outstanding liabilities before 2009, net of reinsurance																			—
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	16,929

The following is supplementary information about average historical claims duration as of December 31, 2018.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	51.8	%	28.3	%	7.0	%	5.5	%	2.3	%	2.1	%	2.0	%	1.0	%	—	%	—	%

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,
	2018		2017
Net outstanding liabilities
Personal Homeowners’ Only	$	97,238	$	101,544
Commercial Residential Only	57,717		49,810
All other lines of business	16,929		12,384
Liabilities for unpaid claims and claim adjustment expenses, net of reinsurance	$	171,884	$	163,738

Reinsurance recoverable on unpaid claims
Personal Homeowners’ Only	$	318,678	$	131,581
Commercial Residential Only	155,717		165,313
All other lines of business	3,475		8,779
Total reinsurance recoverable on unpaid claims	$	477,870	$	305,673

Unallocated claims adjustment expenses	11,449		12,821

Total gross liability for unpaid claims and claims adjustment expense	$	661,203	$	482,232

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



	2018		2017			2016
Balance at January 1	$	482,232	$	140,855		$	76,792
Less: reinsurance recoverable on unpaid losses	305,673		18,724			2,114
Net balance at January 1	$	176,559	$	122,131		$	74,678

Acquired reserves, net of reinsurance recoverables⁽¹⁾	—		40,299			22,576
Incurred related to:
Current year	404,271		368,148			281,365
Prior years	4,318		(2,613		)	16,988
Total incurred	$	408,589	$	365,535		$	298,353
Paid related to:
Current year	283,821		256,134			210,970
Prior years	117,994		95,272			62,506
Total paid	$	401,815	$	351,406		$	273,476

Net balance at December 31	$	183,333	$	176,559		$	122,131
Plus: reinsurance recoverable on unpaid losses	477,870		305,673			18,724
Balance at December 31	$	661,203	$	482,232		$	140,855

Composition of reserve for unpaid losses and LAE:
Case reserves	$	270,601	$	236,253		$	83,447
IBNR reserves	390,602		245,979			57,408
Balance at December 31	$	661,203	$	482,232		$	140,855

⁽¹⁾ Acquired reserves, net of reinsurance recoverables of $19,945,000 for 2017 and $2,391,000 for 2016 related to our acquisitions of AmCo and IIC, respectively.

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 unfavorable development experienced in 2018 was primarily the result of losses related to the 2017 accident year coming in worse than expected and the favorable development in 2017 was primarily the result of losses related to the 2016 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.