Unpaid Losses and Loss Adjustment Expenses

The Company establishes reserves for unpaid losses and loss adjustment expenses ("LAE") which represent the estimated ultimate cost of all losses incurred that were both reported and unreported (i.e., incurred but not yet reported losses; or “IBNR”) and LAE incurred that remain unpaid at the balance sheet date. The Company’s reserving process takes into account known facts and interpretations of circumstances and factors including the Company’s experience with similar cases, actual claims paid, historical trends involving claim payment patterns and pending levels of unpaid claims, loss management programs, product mix and contractual terms, changes in law and regulation, judicial decisions, and economic conditions. In the normal course of business, the Company may also supplement its claims processes by utilizing third party adjusters, appraisers, engineers, inspectors, and other professionals and information sources to assess and settle catastrophe and non-catastrophe related claims. The effects of inflation are implicitly considered in the reserving process.

Reserves are estimates of unpaid portions of losses that have occurred, including IBNR losses; therefore the establishment of appropriate reserves is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded amounts, which are based on management’s best estimates. The highest degree of uncertainty is associated with reserves for losses incurred in the current reporting period as it contains the greatest proportion of losses that have not been reported or settled. The Company regularly updates its reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in reserve estimates, which may be material, are reported in the results of operations in the period such changes are determined to be needed and recorded.

Management believes that the reserve for losses and LAE, net of reinsurance recoverables, is appropriately established in the aggregate and adequate to cover the ultimate net cost of reported and unreported claims arising from losses which had occurred by the date of the consolidated financial statements based on available facts and in accordance with applicable laws and regulations.

The table below provides the changes in the reserves for losses and LAE, net of reinsurance recoverables, for the periods indicated as follows (dollars in thousands):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Gross reserves - beginning of period	$	97,981		$	83,662		$	92,807		$	87,896
Less: reinsurance recoverables on unpaid losses	21,396			20,467			29,685			20,066
Plus: deferred gain on ADC	(481		)	(2,412		)	(5,677		)	—
Net reserves - beginning of period	77,066			65,607			68,799			67,830

Add: incurred losses and LAE, net of reinsurance:
Current period	12,154			13,153			36,619			40,079
Prior period	2,703			3,401			7,076			4,871
Total net incurred losses and LAE	14,857			16,554			43,695			44,950

Deduct: loss and LAE payments, net of reinsurance:
Current period	4,933			5,423			8,675			11,448
Prior period	6,515			7,877			23,344			32,471
Total net loss and LAE payments	11,448			13,300			32,019			43,919

Net reserves - end of period	80,475			68,861			80,475			68,861
Plus: reinsurance recoverables on unpaid losses	16,862			27,118			16,862			27,118
Less: deferred gain on ADC	—			(4,933		)	—			(4,933		)
Gross reserves - end of period	$	97,337		$	91,046		$	97,337		$	91,046

On September 28, 2017, the Company entered into an adverse development cover reinsurance agreement (the "ADC") to cover loss development of up to $17.5 million in excess of stated reserves as of June 30, 2017. The agreement provides up to $17.5 million of reinsurance for adverse net loss reserve development for accident years 2005 through 2016. The agreement attaches when net losses exceed $1.4 million of the $36.6 million carried reserves at June 30, 2017, and extends to $19.5 million in coverage up to $57.5 million (inclusive of a 10% co-participation). As of September 30, 2019, the Company has ceded to the limit of the ADC. The Company accounts for the agreement as retroactive reinsurance.

The Company’s incurred losses during the three and nine months ended September 30, 2019 include prior-year adverse reserve development of $2.7 million and $7.1 million, respectively. The reported reserve development is net of the amortization of the deferred gain on the ADC of $481,000 and $5.7 million for the three and nine months ended September 30, 2019, respectively. As of September 30, 2019, the deferred gain on the ADC was fully recognized. The adverse development mainly stemmed from commercial liability and Florida homeowners lines business.

The Company’s incurred losses during the three and nine months ended September 30, 2018 included prior-year adverse reserve development of $3.4 million and $4.9 million, respectively. Before the effect of the ADC deferred gain, the commercial lines of business reported $4.2 million of adverse prior-year development and the personal lines of business reported $612,000 of adverse prior-year development for the three months ended September 30, 2018. Before the effect of the ADC deferred gain, the commercial lines of business reported $5.3 million of adverse prior-year development and the personal lines of business reported $1.9 million of adverse development for the nine months ended September 30, 2018. Included in the unfavorable development was $83,000 and $471,000 attributable to additional 2017 losses from Hurricane Harvey for the three and nine months ended September 30, 2018, respectively. The ADC had a favorable impact of $1.5 million and $2.4 million on prior year reserve development for the three and nine months ended September 30, 2018, respectively.