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.

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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.

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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.

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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.

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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).

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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.

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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, 2019, 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, 2010 to 2018 is presented as supplementary information.

During 2019, three of our insurance subsidiaries, UPC, FSIC and ACIC, entered into an intercompany property and casualty reinsurance pooling arrangement. Under this arrangement, the participating companies share substantially all business that is written and allocate the combined premiums, losses and expenses. The Company performed an analysis and concluded that the nature of our claims cash flows and development patterns, along with the structure of our reinsurance program, are similar among all products. Therefore, we have elected to reclassify our prior year disclosures of three separate tables into one single property and casualty homeowners’ insurance table which is consistent with our single reporting segment.

In addition, we have revised our disclosure of the 2018 cumulative incurred and cumulative paid claims to reflect the addition of $1,380,000, $26,154,000, $27,809,000 and $16,434,000 for accident years 2012, 2013, 2014 and 2016 respectively, amounts which were incorrectly omitted from our prior period disclosure.

Property & Casualty Homeowners’ Insurance

$ In thousands (except number of reported claims)



	Incurred Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance																				As of December 31, 2019
																					Total of IBNR Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
	For the Years Ended December 31,
																			Audited
Accident Year	2010		2011		2012		2013		2014		2015		2016		2017		2018		2019
2010	$	73,189	$	67,937	$	67,969	$	68,854	$	66,996	$	67,106	$	66,858	$	67,020	$	66,980	$	66,937	$	—	6,769
2011	—		77,706		79,142		78,763		77,649		79,234		79,985		80,014		80,289		80,199		43		8,154
2012	—		—		87,276		88,629		87,963		87,571		86,818		90,817		91,095		90,879		101		12,852
2013	—		—		—		113,477		106,992		110,268		106,820		106,222		106,132		106,450		255		9,631
2014	—		—		—		—		155,008		154,167		155,729		156,868		156,037		155,956		461		14,123
2015	—		—		—		—		—		217,832		236,059		239,784		242,508		242,610		2,168		21,078
2016	—		—		—		—		—		—		304,961		294,271		293,785		295,611		3,749		32,005
2017	—		—		—		—		—		—		—		332,339		345,647		359,018		16,039		83,969
2018	—		—		—		—		—		—		—		—		360,919		389,841		15,465		47,757
2019	—		—		—		—		—		—		—		—		—		421,426		103,909		33,368
																	Total		$	2,208,927



Accident Year	Cumulative Paid Claims and Allocated Claim Adjustment Expenses, Net of Reinsurance
	For the Years Ended December 31,
																			Audited
	2010		2011		2012		2013		2014		2015		2016		2017		2018		2019
2010	$	39,307	$	55,187	$	59,208	$	63,404	$	64,366	$	64,940	$	66,348	$	66,619	$	66,668	$	66,684
2011	—		44,547		62,812		69,461		73,215		77,022		79,052		79,480		80,002		80,020
2012	—		—		52,394		75,213		79,810		82,908		86,013		90,356		90,580		90,447
2013	—		—		—		69,615		94,969		99,196		103,441		104,669		105,201		105,686
2014	—		—		—		—		98,762		135,301		147,031		151,954		153,593		154,597
2015	—		—		—		—		—		145,180		210,261		227,661		234,018		237,573
2016	—		—		—		—		—		—		193,876		265,069		280,203		288,425
2017	—		—		—		—		—		—		—		217,983		313,883		327,986
2018	—		—		—		—		—		—		—		—		247,365		352,422
2019	—		—		—		—		—		—		—		—		—		240,533
																	Total		$	1,944,373
All outstanding liabilities before 2010, net of reinsurance																			2
Liabilities for claims and claim adjustment expenses, net of reinsurance																			$	264,556

The following is supplementary information about average historical claims duration as of December 31, 2019.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Unaudited
Years	1		2		3		4		5		6		7		8		9		10
	60.5	%	24.6	%	5.7	%	3.9	%	2.2	%	1.9	%	0.8	%	0.3	%	0.1	%	—	%

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,
	2019		2018
Net outstanding liabilities
Property and Casualty Homeowners’ Insurance	$	264,556	$	171,884
Liabilities for unpaid claims and claim adjustment expenses, net of reinsurance	$	264,556	$	171,884

Reinsurance recoverable on unpaid claims
Property and Casualty Homeowners’ Insurance	482,315		477,870
Total reinsurance recoverable on unpaid claims	482,315		477,870

Unallocated claims adjustment expenses	13,486		11,449

Total gross liability for unpaid claims and claims adjustment expense	$	760,357	$	661,203

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



	2019		2018		2017
Balance at January 1	$	661,203	$	482,232	$	140,855
Less: reinsurance recoverable on unpaid losses	477,870		305,673		18,724
Net balance at January 1	$	183,333	$	176,559	$	122,131

Acquired reserves, net of reinsurance recoverables⁽¹⁾	—		—		40,299
Incurred related to:
Current year	466,359		404,271		368,148
Prior years	33,134		4,318		(2,613		)
Total incurred	$	499,493	$	408,589	$	365,535
Paid related to:
Current year	275,488		283,821		256,134
Prior years	129,296		117,994		95,272
Total paid	$	404,784	$	401,815	$	351,406

Net balance at December 31	$	278,042	$	183,333	$	176,559
Plus: reinsurance recoverable on unpaid losses	482,315		477,870		305,673
Balance at December 31	$	760,357	$	661,203	$	482,232

Composition of reserve for unpaid losses and LAE:
Case reserves	$	300,858	$	270,601	$	236,253
IBNR reserves	459,499		390,602		245,979
Balance at December 31	$	760,357	$	661,203	$	482,232

⁽¹⁾ Acquired reserves, net of reinsurance recoverables of $19,945,000 for 2017 related to our acquisition of AmCo.

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 2019 and 2018 was primarily the result of worse than expected losses on the named storms that occurred in the 2017 and 2018 accident years and the favorable development in 2017 was primarily the result of losses related to the 2016 accident years coming in better than expected.