10-K 1 pphi-10k_20191231.htm 10-K pphi-10k_20191231.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2019

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number 001-38814

 

POSITIVE PHYSICIANS HOLDINGS, INC.

(Exact name of Registrant as specified in its Charter)

 

 

Pennsylvania

 

83-0824448

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 Berwyn Park, Suite 220

850 Cassatt Road, Berwyn, PA

 

19312

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (888) 335-5335

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading

Symbol(s)

 

Name of each exchange on which registered

Common Stock

 

PPHI

 

The NASDAQ Stock Market

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  NO 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  YES NO 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  NO 

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).  YES  NO 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

 

 

 

 

 

 

 

Non-accelerated filer

 

Smaller reporting company

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES  NO 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The NASDAQ Stock Market on June 28, 2019 (the last business day of the Registrant’s most recently completed second quarter) was approximately $50,617,000.

The number of shares of Registrant’s Common Stock outstanding as of May 11, 2020 was 3,615,500 with a par value of $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933.  The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

 

 

 

 


 

Table of Contents

 

 

 

Page

PART I

 

 

Item 1.

Business

2

Item 1A.

Risk Factors

14

Item 1B.

Unresolved Staff Comments

14

Item 2.

Properties

14

Item 3.

Legal Proceedings

14

Item 4.

Mine Safety Disclosures

14

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

15

Item 6.

Selected Financial Data

15

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

34

Item 8.

Financial Statements and Supplementary Data

36

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

63

Item 9A.

Controls and Procedures

63

Item 9B.

Other Information

63

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

64

Item 11.

Executive Compensation

69

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

71

Item 13.

Certain Relationships and Related Transactions, and Director Independence

72

Item 14.

Principal Accounting Fees and Services

73

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

74

Item 16

Form 10-K Summary

74

 

 

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PART I

Forward-Looking Statements

This report may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 with respect to the Company’s business, financial condition and results of operations and the plans and objectives of its management.  Forward-looking statements can generally be identified by use of forward-looking terminology such as “may,” “will,” “plan,” “expect,” “intend,” “anticipate,” and “believe.”  These forward-looking statements may include estimates, assumptions or projections and are based on currently available financial, industry, competitive and economic data and our current operating plans.  All forward-looking statements are subject to risks and uncertainties, including risks regarding the effects and duration of the COVID-19 pandemic, that could cause actual results to differ materially from those expressed or implied by the forward-looking statements.

The effect of the COVID-19 pandemic on our operations could have a material adverse effect on our business, financial condition, results of operations, or cash flows.  The World Health Organization has declared the outbreak of COVID-19, which began in December 2019, a pandemic and the U.S. federal government has declared it a national emergency. Our business and operations could be materially and adversely affected by the effects of COVID-19. The global spread of COVID-19 has already created significant volatility, uncertainty and economic disruption in the markets in which we operate. Governments, public institutions, and other organizations in countries and localities where cases of COVID-19 have been detected are taking certain emergency measures to mitigate its spread, including implementing travel restrictions and closing factories, schools, public buildings, and businesses. While the full impact of this outbreak is not yet known, we are closely monitoring the spread of COVID-19 and continually assessing its potential effects on our business. 

As a result of current restrictions put in place to address COVID-19 and the related economic downturn, the Company has experienced business disruptions including, but not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force.  The extent to which our results continue to be affected by COVID-19 will largely depend on future developments which cannot be accurately predicted, including the duration and scope of the pandemic, governmental and business responses to the pandemic and the impact on the global economy.  While these factors are uncertain, the COVID-19 pandemic or the perception of its effects could continue to have a material adverse effect on our business, financial condition, results of operations, or cash flows.

Other factors that could cause actual results to differ materially from those in the forward-looking statements, include, but are not limited to:

 

the potential impact of fraud, operational errors, system malfunctions, or cybersecurity incidents;

 

financial market conditions, including, but not limited to, changes in interest rates and the stock markets causing a reduction of investment income or investment gains and reduction in the value of our investment portfolio;

 

future economic conditions in the market in which we compete that are less favorable than expected;

 

the effect of legislative, judicial, economic, demographic, and regulatory events in the jurisdictions where we do business;

 

our ability to successfully implement steps to optimize the business portfolio, ensure capital efficiency, and enhance investment returns;

 

the risks associated with the management of capital on behalf of investors;

 

our ability to enter new markets successfully and capitalize on growth opportunities either through acquisitions or the expansion of our producer network;

 

the success with which our brokers sell our products and our ability to collect payments from our insureds;

 

heightened competition, including specifically the intensification of price competition, the entry of new competitors and the development of new products by new or existing competitors, resulting in a reduction in the demand for our products;

 

our concentration in medical professional liability insurance, which makes us particularly susceptible to adverse changes in that industry segment;

 

changes in general economic conditions, including inflation, unemployment, interest rates and other factors;

 

estimates and adequacy of loss reserves and trends in loss and loss adjustment expenses;

 

changes in the coverage terms required by state laws, including higher limits;

 

our inability to obtain regulatory approval of, or to implement, premium rate increases;

 

inadequacy of premiums we charge to compensate us for our losses incurred;

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the effectiveness of our risk management loss limitation methods;

 

our ability to obtain reinsurance coverage at reasonable prices or on terms that adequately protect us and to collect amounts that we believe we are entitled to under such reinsurance;

 

our ability to attract and retain qualified management personnel;

 

dependence upon our relationship with Diversus Management, LLC and the management fee under our agreement with them;

 

the potential impact on our reported net income (loss) that could result from the adoption of future accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies;

 

unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;

 

statutory requirements that limit our ability to receive dividends from our insurance subsidiary;

 

the impact of future results on the recoverability of our deferred tax asset;

 

adverse litigation or arbitration results; and

 

adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, including tax or accounting matters, limitations on premium levels, increases in minimum capital and reserves, other financial viability requirements, and changes that affect the cost of, or demand for, our products.

Because forward-looking information is subject to various risks and uncertainties, actual results may differ materially from that expressed or implied by the forward-looking information. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. These forward-looking statements speak only as of the date of the report. The Company expressly disclaims any obligation to publicly release any updates or revisions to reflect any change in the Company’s expectations with regard to any change in events, conditions or circumstances on which any such statement is based.

Item 1. Business.

Positive Physicians Holdings, Inc. (the “Company”) is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”).  In connection with the completion of the Company’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies and were merged together to form Positive Physicians Insurance Company (“Positive Insurance Company”), a wholly owned subsidiary of the Company.  The Company’s initial public offering and its acquisition of Positive Insurance Company were completed on March 27, 2019.  Prior to that time, the Company had minimal assets and liabilities and had not engaged in any operations.  References to the Company or Positive Insurance Company financial information in this Annual Report prior to the conversion and merger date is to the financial information of PPIX, PCA, and PIPE on a combined basis.  When used in this Annual Report, “we” and “our” mean PPIX, PCA, and PIPE prior to March 27, 2019, and Positive Insurance Company thereafter.

Positive Insurance Company

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Diversus Management, LLC (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement.  Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement, effective March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based upon a percentage of Positive Insurance Company’s gross written premiums, less return premiums.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued by Positive Insurance Company and for all sales commissions paid to producers.

At December 31, 2019, the Company had total assets of $156,620,361 and shareholders’ equity of $73,193,405. For the year ended December 31, 2019, the Company had total revenues of $27,965,606 and a net loss of $238,951.

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The executive offices of the Company are located at 100 Berwyn Park, 850 Cassatt Road, Suite 220, Berwyn, PA 19312, and its telephone number is 888-335-5335. The Company’s web site address is www.positivephysicians.com. Information contained on such website is not incorporated by reference into this Annual Report on Form 10-K, and such information should not be considered to be part of this Annual Report on Form 10-K.

Option Agreement

Upon completion of the conversions of PPIX, PCA, and PIPE and the securities offering on March 27, 2019, the Company and Diversus entered into an option agreement whereby either party has the option to cause Diversus, subject to shareholder approval, to merge with and become a wholly owned subsidiary of the Company.  Under the terms of the agreement, the option may be exercised by either the Company or Diversus at any time (1) during the period beginning 2 years after completion of the conversions of the exchanges and ending 54 months after the completion of the conversions, or (2) if earlier than 2 years after the completion of the conversions, then such date that the majority stockholder of the Company no longer has the right to appoint a majority of the board of directors of the Company.  In connection with any merger, the common stock shareholders of Diversus will receive either cash, common stock shares of the Company, or some combination thereof for their shares of Diversus’ common stock.  With respect to the preferred stock shares of Diversus, they will either be paid out in cash or converted into common stock shares of Diversus as if such preferred stock shares were converted into Diversus’ common stock shares immediately prior to the effective date of the merger.

Products and Services

Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers.  Medical professional liability insurance (“MPLI”) protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services.  We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Our policies include coverage for the cost of defending claims.  Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage.  We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires.  Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported.  Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.

The Company accounts for its medical professional liability insurance business as a single reporting segment line of business.

Marketing and Distribution

Our marketing philosophy is to sell profitable business in our core states, using a focused, cost-effective distribution system. Our medical professional liability insurance products are currently sold through approximately 93 retail producers in our territories of Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  All of these producers represent multiple insurance companies and are established businesses in the communities in which they operate. While we view our insureds as our primary customer, we view our independent insurance producers as important partners because they are in a position to recommend either our insurance products or those of a competitor to their customers. We consider our relationships with these producers to be good.

We review our producers annually with respect to both premium volume and profitability. Our producers will be monitored and supported primarily by our marketing employees, who have the principal responsibility for recruiting and training new producers. We meet regularly with producers to provide both technical training about our products and sales training about how to effectively market our products.

Producers are compensated through a fixed base commission. Agents receive commission as a percentage of premiums (generally 10% to 12%) as their primary compensation from us. No profit-sharing commissions are paid to agents based upon the profitability of the business they produce.

Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service and claims processing, resulting in a positive experience for producers and policyholders. We believe that these positive experiences result in higher policyholder retention and new business opportunities when communicated by producers and policyholders to potential customers. While we rely on our independent agents for distribution and customer support, underwriting and claim handling responsibilities are retained by us. Many of our agents have had direct relationships with us for a number of years.

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Underwriting, Risk Assessment and Pricing

Although we are willing to consider physicians in most specialties and classifications for insurance coverage, we recognize that certain specialties present a higher exposure to frequency or severity of claims. Although the number of medical malpractice claims filed in Pennsylvania has decreased significantly since 2008, the severity of the claims brought has not decreased. Accordingly, we rely heavily on individual risk characteristics in determining which medical professionals to whom we will offer coverage.

Our underwriting philosophy is aimed at consistently generating profits through sound risk selection and pricing discipline. Through the management and underwriting staff of Diversus Management, we regularly establish rates and rating classifications for our physician and medical group insureds based on loss and loss adjustment expense experience that we have developed over the years and the loss and loss adjustment expense experience for the entire medical professional liability market. We have various rating classifications based on practice location, medical specialty and other liability factors.

The nature of our business requires that we remain sensitive to the marketplace and the pricing strategies of our competitors. Using the market information as our background, we normally set our prices based on our estimated future costs. From time to time, we may reduce or increase our discounts or apply a premium surcharge to achieve an appropriate return. Pricing flexibility allows us to provide a fair rate commensurate with the assumed liability. If our pricing strategy cannot yield sufficient premium to cover our costs on a particular type of risk, we may determine not to underwrite that risk. It is our philosophy not to sacrifice profitability for premium growth.

We also encourage our insureds to adopt and practice loss reduction methods and loss mitigation practices. Our integrated risk management platform can reduce claims occurring from lack of informed consent, surgical complications, or missed diagnoses. Similarly, required educational sessions for doctors and other medical professionals regarding record keeping, patient follow-up and other basic practices can reduce the frequency of claims. Premium credits are provided to physicians in higher risk specialties who take advantage of these loss reduction methods and loss mitigation practices. Medical professionals who do not commit to these practices and methods can be refused coverage.

Our competitive strategy in underwriting is to provide very high-quality service to our producers and insureds by responding quickly and effectively to information requests and policy submissions. Each policy undergoes the entire underwriting process prior to renewal. We maintain information on all aspects of our business, which is regularly reviewed to determine both agency and policyholder profitability. Specific information regarding individual insureds is monitored to assist us in making decisions about policy renewals or modifications.

Claims and Litigation Management

Our policies require us to provide a defense for our insureds in any suit involving a medical incident covered by the policy. The defense costs we incur are in addition to the limit of liability under the policy. Medical professional liability claims often involve the evaluation of highly technical medical issues, severe injuries and conflicting expert opinions.

Our claims management philosophy involves: (i) closure of claims through prompt and thorough investigation of the facts related to the claim; (ii) equitable settlement of meritorious claims; (iii) vigorous defense of unfounded claims as to coverage, liability or the amount claimed; and (iv) the use of mediation and arbitration combined, when appropriate, with agreements with plaintiff’s counsel limiting the range of damage awards. Our claims team supports our underwriting strategy by working to provide a timely, good faith claims handling response to our policyholders. Claims excellence is achieved by timely investigation and handling of claims, settlement of meritorious claims for equitable amounts, maintenance of adequate case reserves, and control of loss adjustment expenses.

Claims on insurance policies are received directly from the insured or through our independent producers. Our claims department supports our producer relationship strategy by working to provide a consistently responsive level of claim service to our policyholders. Positive Insurance Company is required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses for reported claims and for claims incurred but not reported, arising from policies that have been issued. Generally, these laws and regulations require that we provide for the ultimate cost of those claims, subject to our policy limits, without regard to how long it takes to settle them or the time value of money. We are also required to maintain reserves for extended reporting coverage we provide in the event of a physician’s death, disability and retirement, or DDR reserves, which are included in our reserves as a component of unearned premiums. The determination of reserves involves actuarial and statistical projections of what we expect to be the cost of the ultimate settlement and administration of such claims based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and potential changing judicial theories of liability.

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Our actuaries utilize standard actuarial techniques to project ultimate losses based on our paid and incurred loss information, as well as drawing from industry data. These projections are done using actual loss dollars and claim counts. We analyze loss trends and claims frequency and severity to determine our best estimate of the required reserves. We then record this best estimate in Positive Insurance Company’s financial statements. Our reserve methodology is discussed in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.”

We have contracts with Gateway Risk Services, LLC and Andrews Outsource Solutions LLC, both of which are wholly owned subsidiaries of Diversus, under which those companies provide claims processing and risk management services.

Technology

Diversus Management uses commercially available software to provide the information management systems platform that runs its accounting, policy underwriting and issuance, and claims processing functions. These systems permit Diversus Management to integrate the accounting and reporting functions of our insurance operations. We have adopted a disaster recovery plan tailored to meet our needs and geographic location. A portion of the operations of Diversus Management is managed in a cloud environment using an outside service provider.

Reinsurance

Reinsurance Ceded. In accordance with insurance industry practice, we reinsure a portion of our exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by us are reinsured with other insurance companies principally to:

 

reduce net liability on individual risks and clash occurrences;

 

mitigate the effect of individual loss occurrences;

 

cover us against losses in excess of policy limits and extra contractual obligation claims;

 

stabilize underwriting results; and

 

increase our underwriting capacity.

Under Pennsylvania law, each insured must maintain MPLI of at least $1,000,000 for each claim and $3,000,000 of annual aggregate coverage.  We provide primary insurance coverage up to $500,000 per claim and $1,500,000 of annual aggregate coverage. The Pennsylvania Medical Care Availability and Reduction of Error (“MCARE”) Fund provides coverage for any losses above $500,000 per claim up to $1,000,000.  In cases where coverage under the Pennsylvania MCARE Fund does not apply, the primary insurance provides coverage up to $1,000,000 per claim and $3,000,000 of annual aggregate coverage.  We retain the first $300,000 in loss on all Pennsylvania claims and reinsurance covers the excess up to $1,000,000 that is not covered by the Pennsylvania MCARE Fund.  We cede to reinsurers any Pennsylvania claims in excess of $1,000,000.      

Other states in which we write insurance require doctors to maintain certain minimum coverage and provide a fund that provides coverage for losses above a certain amount, but some states do not prescribe insurance requirements for doctors.

We offer primary coverage up to $1,000,000 for each claim and $3,000,000 of annual aggregate coverage in Delaware, Maryland, Michigan, Ohio, New Jersey, and South Carolina.  We retain the first $300,000 in loss for claims from these states, and reinsurance covers the excess up to $1,000,000.  If an insured in New Jersey requests, additional coverage of $1,000,000, each claim, each insured, each policy can be provided and is fully ceded to the reinsurer up to a maximum aggregate liability of $2,000,000 to the reinsurer per the term of the reinsurance agreement.  In South Carolina and Michigan, the insured can elect policy limits of $200,000 per claim and, on these claims, we retain the first $100,000 and the reinsurer covers the next $100,000.  

We also purchase additional reinsurance coverage for clash, losses in excess of policy limits and extra contractual obligation claims.

Our premiums under our current treaty year reinsurance agreement are based on a percentage of our earned premiums during the term of the agreement. The agreement was renewed on April 1, 2020.

Reinsurance does not legally discharge the insurance company issuing the policy from primary liability for the full amount due under the reinsured policies.  A primary factor in the selection of reinsurers from whom we purchase reinsurance is their financial strength. Our reinsurance arrangements are generally renegotiated annually.  The insolvency or inability of any reinsurer to meet its

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obligations to us could have a material adverse effect on our results of operations or financial condition.  Our reinsurance providers, the majority of whom are longstanding partners that understand our business, are all carefully selected with the help of our reinsurance broker.  We monitor the solvency of reinsurers through regular review of their financial statements and, if available, their A.M. Best ratings. Hannover Re, our current reinsurance partner, has an “A+ (Superior)” rating from A.M. Best.  According to A.M. Best, companies with a rating of “A” or better “have an excellent ability to meet their ongoing obligations to policyholders.”

Reinsurance Assumed. We generally do not assume risks from other insurance companies.  However, we could be required by statute to participate in guaranty funds, which are formed to pay claims on policies issued by insolvent property and casualty insurers domiciled in certain states, such as Pennsylvania.  This participation, where applicable, requires us to pay an annual assessment based on our premiums written and determined on a market share basis.  At December 31, 2019, our participation was not material.

Captive Insurance.  On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and is a wholly owned subsidiary of Positive Insurance Company.  PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018.  PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”).  Keystone is owned by an insured of Positive Insurance Company.  Effective October 16, 2018, Positive Insurance Company entered into a reinsurance agreement with Keystone and that agreement was endorsed in 2019 for continuous annual renewal.

Losses and Loss Adjustment Expenses

We are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (“LAE”). These reserves are established for both reported claims and for claims incurred but not reported (“IBNR”), arising from the policies we have issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what we expect to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and potential changing judicial theories of liability.

Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Our reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. We do not discount our reserves to recognize the time value of money. For a more detailed overview of our estimation process for reserves for losses and loss adjustment expenses see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.”

When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of our claims staff. In estimating the appropriate reserve, our claims staff considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss, to the extent determinable at the time. Case reserves are adjusted by our claims staff as more information becomes available and discovery progresses. It is our policy to settle each claim as expeditiously as possible.

We maintain IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating our ultimate net liability for both reported and IBNR claims and then subtracting the case reserves and paid losses and LAE for reported claims.

Each quarter, we compute our estimated ultimate liability using principles and procedures we have developed over several years. However, because the establishment of loss reserves is an inherently uncertain process, we cannot assure you that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made.

The following table provides a reconciliation of beginning and ending unpaid losses and LAE reserve balances of Positive Insurance Company for the years ended December 31, 2019 and 2018, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

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2019

 

 

2018

 

Balance at January 1

 

$

68,392,333

 

 

$

68,374,554

 

Less:  Reinsurance recoverable on liability for losses

   and loss adjustment expenses

 

 

7,956,043

 

 

 

8,585,851

 

Add:  Reinsurance recoverable on claims paid

 

 

5,791

 

 

 

1,196,573

 

Net liability at January 1

 

 

60,442,081

 

 

 

60,985,276

 

Losses and loss adjustment expenses incurred, net:

 

 

 

 

 

 

 

 

Current year

 

 

15,438,338

 

 

 

15,525,397

 

Prior years

 

 

136,271

 

 

 

4,057,821

 

Total incurred losses and loss adjustment

   Expenses

 

 

15,574,609

 

 

 

19,583,218

 

Less losses and loss adjustment expenses paid, net:

 

 

 

 

 

 

 

 

Current year

 

 

1,334,938

 

 

 

714,198

 

Prior years

 

 

18,588,912

 

 

 

19,412,215

 

Total losses and loss adjustment expenses paid

 

 

19,923,850

 

 

 

20,126,413

 

Net liability for losses and loss adjustment expenses,

   at December 31

 

 

56,092,840

 

 

 

60,442,081

 

Add:  Reinsurance recoverable on liability for losses

   and loss adjustment expenses

 

 

7,850,409

 

 

 

7,956,043

 

Less:  Reinsurance recoverable on claims paid

 

 

335,274

 

 

 

5,791

 

Liability for losses and loss adjustment expenses,

   at December 31

 

$

63,607,975

 

 

$

68,392,333

 

 

The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or anticipated to be settled for amounts less than originally estimated (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or anticipated to be settled for amounts greater than originally estimated (unfavorable or adverse development).

Reconciliation of Reserves for Losses and Loss Adjustment Expenses

The following tables set forth information about Positive Insurance Company’s incurred and paid loss development at December 31, 2019, net of reinsurance. The information about incurred and paid claims development for the years ended December 31, 2010 to December 31, 2018 is presented as supplementary information.

 

 

 

Incurred Losses and Loss Adjustment Expenses, Net of Reinsurance (in thousands)

 

Accident Year

 

2010

 

 

2011

 

 

2012

 

 

2013

 

 

2014

 

 

2015

 

 

2016

 

 

2017

 

 

2018

 

 

2019

 

2010

 

$

18,592

 

 

$

15,072

 

 

$

15,710

 

 

$

14,490

 

 

$

12,665

 

 

$

11,901

 

 

$

10,774

 

 

$

11,288

 

 

$

10,533

 

 

$

10,836

 

2011

 

 

 

 

 

19,524

 

 

 

18,783

 

 

 

18,591

 

 

 

21,175

 

 

 

21,079

 

 

 

21,030

 

 

 

21,329

 

 

 

20,586

 

 

 

21,028

 

2012

 

 

 

 

 

 

 

 

20,305

 

 

 

18,496

 

 

 

18,813

 

 

 

19,107

 

 

 

18,478

 

 

 

19,744

 

 

 

19,592

 

 

 

21,124

 

2013

 

 

 

 

 

 

 

 

 

 

 

17,753

 

 

 

16,879

 

 

 

15,219

 

 

 

13,224

 

 

 

11,447

 

 

 

12,022

 

 

 

12,349

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

17,307

 

 

 

15,108

 

 

 

13,798

 

 

 

11,087

 

 

 

11,062

 

 

 

11,606

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

19,999

 

 

 

17,785

 

 

 

16,494

 

 

 

16,373

 

 

 

15,830

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18,465

 

 

 

18,861

 

 

 

21,376

 

 

 

22,528

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16,588

 

 

 

19,143

 

 

 

18,262

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15,161

 

 

 

16,990

 

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15,438

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

165,991

 

7


 

 

 

 

Cumulative Losses and Loss Adjustment Expenses Paid, Net of Reinsurance (in thousands)

 

Accident Year

 

2010

 

 

2011

 

 

2012

 

 

2013

 

 

2014

 

 

2015

 

 

2016

 

 

2017

 

 

2018

 

 

2019

 

2010

 

$

464

 

 

$

1,721

 

 

$

4,162

 

 

$

6,312

 

 

$

6,883

 

 

$

7,774

 

 

$

8,328

 

 

$

9,621

 

 

$

9,921

 

 

$

10,166

 

2011

 

 

 

 

 

578

 

 

 

1,888

 

 

 

5,047

 

 

 

12,117

 

 

 

16,911

 

 

 

17,774

 

 

 

18,870

 

 

 

19,773

 

 

 

20,641

 

2012

 

 

 

 

 

 

 

 

1,002

 

 

 

2,621

 

 

 

5,637

 

 

 

9,772

 

 

 

14,376

 

 

 

17,365

 

 

 

17,805

 

 

 

19,672

 

2013

 

 

 

 

 

 

 

 

 

 

 

526

 

 

 

1,896

 

 

 

4,249

 

 

 

6,942

 

 

 

7,625

 

 

 

9,470

 

 

 

10,962

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

417

 

 

 

1,676

 

 

 

4,069

 

 

 

6,448

 

 

 

7,780

 

 

 

9,717

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

523

 

 

 

2,476

 

 

 

5,186

 

 

 

7,446

 

 

 

11,758

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

944

 

 

 

3,818

 

 

 

9,691

 

 

 

13,320

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

728

 

 

 

5,057

 

 

 

8,360

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

499

 

 

 

4,873

 

2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,335

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

110,804

 

All outstanding liabilities before 2010, net of reinsurance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

906

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

56,093

 

 

The reconciliation for the net incurred and paid loss development tables to the liability for losses and LAE at December 31, 2019 reported in our balance sheet is as follows:

 

 

 

2019

 

Net outstanding liabilities for losses and loss adjustment

   expenses:

 

 

 

 

Medical professional

 

$

56,092,840

 

Liabilities for losses and loss adjustment expenses, net of

   Reinsurance

 

 

56,092,840

 

Reinsurance recoverable on unpaid claims:

 

 

 

 

  Medical professional

 

 

7,515,135

 

Total reinsurance recoverable on unpaid claims

 

 

7,515,135

 

Total gross liability for losses and loss adjustment expenses

 

$

63,607,975

 

 

Investments

Our investments in fixed maturity securities are classified as available for sale and are carried at fair value with unrealized gains and losses, net of taxes, reflected as a component of equity. We also invest in equity securities which are stated at fair value with unrealized gains and losses credited or charged to net income (loss) as incurred.  The goal of our investment activities is to complement and support our overall mission. An important component of our operating results has been the return on invested assets. Our investment objectives are (i) accumulation and preservation of capital, (ii) optimization, within accepted risk levels, of after-tax returns, (iii) assuring proper levels of liquidity, (iv) providing for an acceptable and stable level of current income, (v) managing the maturities of our investment securities to reflect the maturities of our liabilities, and (vi) maintaining a quality, diversified portfolio. See Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”

In addition to any investments prohibited by the insurance laws and regulations of Pennsylvania, our investment policy prohibits the following investments and investing activities:

 

Commodities and futures contracts;

 

Options (except covered call options);

 

Interest-only, principal-only, and residual tranche collateralized mortgage obligations;

 

Foreign currency trading;

 

Venture-capital investments;

 

Securities lending;

 

Portfolio leveraging, i.e., margin transactions; and

 

Short selling.

8


 

The Board of Directors of Positive Insurance Company reviews and approves our investment policy annually.

Our investment portfolio is managed by Positive Insurance Company’s Investment Committee and Wilmington Trust, with the exception of certain direct investments at December 31, 2018, which previously represented approximately 4% of the total portfolio.

 

The following table sets forth information concerning our investment portfolio as of December 31.

 

 

 

2019

 

 

2018

 

 

 

Fair Value

 

 

Percentage

of Total

 

 

Fair Value

 

 

Percentage

of Total

 

Fixed maturity securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  U.S. government

 

$

10,751,562

 

 

 

10.3

%

 

$

12,737,756

 

 

 

13.1

%

  States, territories, and possessions

 

 

1,143,023

 

 

 

1.1

%

 

 

1,125,479

 

 

 

1.2

%

  Subdivisions of states, territories, and possessions

 

 

12,822,865

 

 

 

12.2

%

 

 

13,292,064

 

 

 

13.7

%

  Industrial and miscellaneous

 

 

71,030,592

 

 

 

67.9

%

 

 

58,051,370

 

 

 

59.9

%

Total fixed maturity securities

 

 

95,748,042

 

 

 

91.5

%

 

 

85,206,669

 

 

 

87.9

%

Equity securities

 

 

7,756,966

 

 

 

7.4

%

 

 

7,267,094

 

 

 

7.5

%

Other investments

 

 

-

 

 

 

0.0

%

 

 

4,051,399

 

 

 

4.2

%

Short-term investments

 

 

1,169,472

 

 

 

1.1

%

 

 

373,949

 

 

 

0.4

%

Total investments

 

$

104,674,480

 

 

 

100.0

%

 

$

96,899,111

 

 

 

100.0

%

 

At December 31, 2018, we had ownership interests in limited partnership equity hedge funds.  Our partnership interests were measured at fair value using the funds’ net asset values as a practical expedient.  At December 31, 2018, the fair value and cost basis of these investments were $4,051,399 and $3,547,687, respectively.  During the second half of 2019, we sold our interests in these limited partnership funds and recognized a pre-tax gain of $556,723.

At December 31, 2019, our fixed maturity securities had an overall average credit quality of A.  The following table summarizes the distribution of our fixed maturity investments as a percentage of fair value based on average credit ratings assigned by Standard & Poor’s.

 

 

 

December 31, 2019

 

 

 

Fair Value

 

 

Percentage

of Total

 

U.S. government and AAA

 

$

13,975,988

 

 

 

14.6

%

AA

 

 

14,637,137

 

 

 

15.3

%

A

 

 

35,937,635

 

 

 

37.5

%

BBB

 

 

30,358,520

 

 

 

31.7

%

Below investment grade

 

 

838,762

 

 

 

0.9

%

Total

 

$

95,748,042

 

 

 

100.0

%

 

At December 31, 2019, the average maturity of our fixed maturity investment portfolio was 3.6 years and the average duration was 3.1 years. As a result, the fair value of our investments may fluctuate significantly in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.

Our average cash and invested assets and investment income for 2019 and 2018 were as follows:

 

 

 

Year Ended

December 31,

 

 

 

2019

 

 

2018

 

Average cash and invested assets

 

$

113,232,646

 

 

$

105,921,752

 

Net investment income

 

 

2,960,367

 

 

 

2,568,907

 

Return on average cash and invested assets

 

 

2.61

%

 

 

2.43

%

 

We use quoted values and other data provided by independent pricing services as inputs in our process for determining fair values of our investments. The pricing services cover substantially all of the securities in our portfolio for which publicly quoted values are not available. The pricing services’ evaluations represent an exit price, a good faith opinion as to what a buyer in the marketplace would pay for a security in a current sale. The pricing is based on observable inputs either directly or indirectly, such as

9


 

quoted prices in markets that are active, quoted prices for similar securities at the measurement date, or other inputs that are observable. Additionally, our investments in limited partnership funds were measured at fair value using the funds’ net asset values as a practical expedient.

 

The investment manager provides us with pricing information that we utilize, together with information obtained from independent pricing services, to determine the fair value of our fixed maturity securities.

Competition

The medical professional liability insurance market is highly competitive. We compete with stock and mutual insurance companies, risk retention groups (“RRGs”), reciprocal exchanges, and other underwriting organizations. Our largest competitors in Pennsylvania are PMSLIC/NORCAL Mutual Insurance Company, MedPro Group, Central Pennsylvania Physicians Risk Retention Group, and Medical Mutual of North Carolina. Most of these competitors have substantially greater financial, technical and operating resources than we do and may be able to offer lower rates to policyholders or higher commissions to their producers.

We compete on a number of factors such as pricing, agency relationships, policy support, claim service, and market reputation. Like other writers of MPLI, our policy terms vary from state to state based on the maximum prescribed limits in each state, as established by state law. We believe our company differentiates itself from many larger companies competing for this business by focusing on service and responsiveness.

To compete successfully in the MPLI industry, we rely on our ability to: identify insureds that are most likely to produce an underwriting profit; operate with a disciplined underwriting approach; practice prudent claims management; and provide services and competitive commissions to our independent agents.

Ratings

Demotech, Inc. (“Demotech”), a nationally recognized, independent rating agency, rates the financial strength of Positive Insurance Company.  Ratings are not recommendations to buy the Company’s stock.

Rating agencies rate insurance companies based on financial strength and the ability to pay claims and other factors more relevant to policyholders than investors.  We believe that the rating assigned by Demotech is material to our operations.  We currently only participate in the ratings process of Demotech.  However, we intend to seek participation in the ratings process of A.M. Best Company, Inc. in the future.

The rating scale of Demotech is characterized as follows:

 

A’’ (A Double Prime), Unsurpassed

 

A’ (A Prime), Unsurpassed

 

A, Exceptional

 

S, Substantial

 

M, Moderate  

 

L, Licensed

 

NR, Not Rated

 

N/A, Ineligible

Positive Insurance Company’s financial stability rating of A’ (A Prime), Unsurpassed was affirmed on March 18, 2020.

A downgrade in the Demotech rating of Positive Insurance Company would result in a material loss of business as policyholders would move to other companies with higher financial strength ratings.  Accordingly, such a downgrade would have a material adverse effect on our results of operations, liquidity and capital resources.  This rating is subject to revision or withdrawal at any time by the rating agency, and therefore, no assurance can be given that we or Positive Insurance Company can maintain this rating.

Regulation

General.

We are subject to extensive regulation, particularly at the state level. The method, extent and substance of such regulation varies by state, but generally has its source in statutes that establish standards and requirements for conducting the business of insurance and that delegate regulatory authority to state insurance regulatory agencies who may then promulgate regulations. In general, such regulation is intended for the protection of those who purchase or use insurance products, not the companies that write the policies. These laws and regulations have a significant impact on our business and relate to a wide variety of matters including accounting

10


 

methods, agent and company licensure, claims procedures, corporate governance, examinations, investing practices, policy forms, pricing, trade practices, reserve adequacy and underwriting standards.

State insurance laws and regulations require Positive Insurance Company to file financial statements with state insurance departments everywhere we do business, and the operations of Positive Insurance Company and its respective accounts are subject to examination by those departments at any time. Positive Insurance Company prepares statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by Pennsylvania. Pennsylvania generally conforms to National Association of Insurance Commissioners (“NAIC”) practices and procedures, so its examination reports and other filings generally are accepted by other states.

Premium rate regulation varies greatly among jurisdictions and lines of insurance. In the states in which Positive Insurance Company writes insurance, premium rates for the various lines of insurance are subject to either prior approval or limited review upon implementation. Positive Insurance Company recently applied for a license in the state of Texas, was admitted in November 2019, and is currently in the process of obtaining approval on premium rates before we can begin writing business in Texas.  Positive Insurance Company intends to apply for approval to act as a surplus lines carrier in those states where we believe sufficient business opportunities make providing surplus lines coverage to physicians and other healthcare providers in those states attractive. Positive Insurance Company also intends to apply for approval to act as a reinsurer in those states where we believe sufficient business opportunities exist to provide quota share insurance to RRGs that are attractive acquisition targets.

Examinations.

Examinations are conducted by the Pennsylvania Insurance Department every three to five years. Past examinations, including the most recent exam completed through December 31, 2017, did not result in any adjustments to our financial position. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on our operations.

NAIC Risk-Based Capital Requirements.

Pennsylvania and most other states have adopted the NAIC system of risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business risks and such other relevant risks as are set forth in the risk-based capital instructions. A company’s “total adjusted capital” is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies.

The requirements provide for four different levels of regulatory attention. The “company action level” is triggered if a company’s total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The “regulatory action level” is triggered if a company’s total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The “authorized control level” is triggered if a company’s total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level, the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The “mandatory control level” is triggered if a company’s total adjusted capital is less than 0.7 times its authorized control level; at this level, the regulatory authority is mandated to place the company under its control.  As of December 31, 2019, the total adjusted capital of Positive Insurance Company was 6.3 times its authorized control level.  The capital level of Positive Insurance Company has never triggered any of these regulatory capital levels. We cannot assure you, however, that the capital requirements applicable to Positive Insurance Company will not increase in the future.

NAIC Ratios.

The NAIC also has developed a set of 13 financial ratios referred to as the Insurance Regulatory Information System (IRIS). On the basis of statutory financial statements filed with state insurance regulators, the NAIC annually calculates these IRIS ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. The NAIC has established an acceptable range for each of the IRIS financial ratios. If four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC, an insurance company may receive inquiries from individual state insurance departments.  As of December 31, 2019, Positive Insurance Company only had one IRIS ratio, the two-year overall operating ratio, fall outside the NAIC’s tolerable range, and that was due to operating results which were reported prior to the conversions and merger of PPIX, PCA, and PIPE.

11


 

Enterprise Risk Assessment.

In 2012, the NAIC adopted the NAIC Amendments. The NAIC Amendments, when adopted by the various states, are designed to respond to perceived gaps in the regulation of insurance holding company systems in the United States. One of the major changes is a requirement that an insurance holding company system’s ultimate controlling person submit annually to its lead state insurance regulator an “enterprise risk report” that identifies activities, circumstances or events involving one or more affiliates of an insurer that, if not remedied properly, are likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole. Beginning in 2016, Pennsylvania required insurers domiciled in Pennsylvania to include an enterprise risk assessment in its annual report. Other changes include requiring a controlling person to submit prior notice to its domiciliary insurance regulator of its divestiture of control, having detailed minimum requirements for cost sharing and management agreements between an insurer and its affiliates and expanding of the agreements between an insurer and its affiliates to be filed with its domiciliary insurance regulator. In addition, in 2012 the NAIC adopted the Own Risk Solvency Assessment (ORSA) Model Act. The ORSA Model Act, when adopted by the various states, will require an insurance holding company system’s chief risk officer to submit at least annually to its lead state insurance regulator a confidential internal assessment appropriate to the nature, scale and complexity of an insurer, conducted by that insurer of the material and relevant risks identified by the insurer associated with an insurer’s current business plan and the sufficiency of capital resources to support those risks. Although Positive Insurance Company is exempt from ORSA because of its size, we intend to incorporate those elements of ORSA that we believe constitute “best practices” into our annual internal enterprise risk assessment.

Market Conduct Regulation.

State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations.

Guaranty Fund Laws.

All states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2019 and 2018, we incurred total assessment expense in the amounts of $70,000 and $36,000, respectively, pursuant to state insurance guaranty association laws.

Positive Insurance Company establishes reserves relating to insurance companies that are subject to insolvency proceedings when it is notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on Positive Insurance Company under these laws.

Federal Regulation.

The U.S. federal government generally has not directly regulated the insurance industry except for certain areas of the market, such as insurance for flood, nuclear and terrorism risks. However, the federal government has undertaken initiatives or considered legislation in several areas that may impact the insurance industry, including tort reform, corporate governance and the taxation of reinsurance companies. The Dodd-Frank Act established the Federal Insurance Office which is authorized to study, monitor and report to Congress on the insurance industry and to recommend that the Financial Stability Oversight Council designate an insurer as an entity posing risks to the U.S. financial stability in the event of the insurer’s material financial distress or failure. In December 2013, the Federal Insurance Office issued a report on alternatives to modernize and improve the system of insurance regulation in the United States, including by increasing national uniformity through either a federal charter or effective action by the states. Changes to federal legislation and administrative policies in several areas, including changes in federal taxation, can also significantly impact the insurance industry and us.

We are also subject to the Fair and Accurate Credit Transactions Act of 2003, or FACTA, and the Health Insurance Portability and Accountability Act of 1996, or HIPAA, both of which require us to protect the privacy of our customers’ information, including health and credit information.

Sarbanes-Oxley Act of 2002.

Enacted in 2002, the stated goals of the Sarbanes-Oxley Act of 2002, or SOX, are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. We became subject to most of the provisions of the SOX immediately after completion of our initial public offering.

12


 

The SOX includes very specific disclosure requirements and corporate governance rules and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related regulations.

Privacy.

As mandated by the Gramm-Leach-Bliley Act, states continue to promulgate and refine laws and regulations that require financial institutions, including insurance companies, to take steps to protect the privacy of certain consumer and customer information relating to products or services primarily for personal, family or household purposes. An NAIC initiative that affected the insurance industry was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. We have implemented procedures to comply with the Gramm-Leach-Bliley Act’s related privacy requirements.

OFAC.

The Treasury Department’s Office of Foreign Asset Control (“OFAC”) maintains a list of “Specifically Designated Nationals and Blocked Persons” (the SDN List). The SDN List identifies persons and entities that the government believes are associated with terrorists, rogue nations or drug traffickers. OFAC’s regulations prohibit insurers, among others, from doing business with persons or entities on the SDN List. If the insurer finds and confirms a match, the insurer must take steps to block or reject the transaction, notify the affected person and file a report with OFAC.

JOBS Act.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, such as reduced public company reporting, accounting and corporate governance requirements.

Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards.

We will remain an “emerging growth company” for up to five years following March 27, 2019, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenue exceeds $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.

In addition, as an emerging growth company, we are exempt from Section 14A (a) and (b) of the Exchange Act, which requires shareholder approval of executive compensation and golden parachutes.

Dividends.

Our insurance subsidiary, Positive Insurance Company, is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the holding company.  In considering future dividend policy, Positive Insurance Company will consider, among other things, applicable regulatory constraints.  At December 31, 2019, Positive Insurance Company had statutory surplus of $39,415,264.  

An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by the Company to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of the Company, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.  Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to the Company for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.

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Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department.  This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend.  The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation.  These restrictions or any subsequently imposed restrictions may affect our future liquidity.  No dividends were paid in 2019 and 2018.

Holding Company Laws.

Most states, including Pennsylvania, have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company group that may materially affect the operations, management or financial condition of the insurers within the group. Pursuant to these laws, the Pennsylvania Insurance Department requires disclosure of material transactions involving an insurance company and its affiliates, and requires prior notice and/or approval of certain transactions, such as “extraordinary dividends” distributed by the insurance company. Under these laws, the Pennsylvania Insurance Department will have the right to examine us and Positive Insurance Company at any time.

All transactions within our consolidated group affecting Positive Insurance Company must be fair and equitable. Notice of certain material transactions between Positive Insurance Company and any person or entity in our holding company system will be required to be given to the Pennsylvania Insurance Department. Certain transactions cannot be completed without the prior approval of the Pennsylvania Insurance Department.

Approval of the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In Pennsylvania, the acquisition of 10% or more of the outstanding voting securities of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person or entity from (i) making a tender offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person or entity would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Insurance Department.

Item 1A. Risk Factors.

Not applicable.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

None.

Item 3. Legal Proceedings.

The Company is periodically subject to litigation in the normal course of its business. Based upon information presently available to us, we do not consider any litigation to be material. However, given the uncertainties attendant to litigation, we cannot assure you that our results of operations and financial condition will not be materially adversely affected by any litigation.

Item 4. Mine Safety Disclosures.

Not applicable.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

On March 27, 2019, the Company completed its initial public offering. The Company’s common stock trades on The NASDAQ Stock Market under the symbol “PPHI.” At May 11, 2020, there were 77 registered holders of the Company’s common stock.

The following is information regarding sales prices for our common stock, which commenced trading on April 1, 2019:

 

 

 

Second

 

Third

 

Fourth

 

 

Quarter

 

Quarter

 

Quarter

PPHI common stock prices:

 

 

 

 

 

 

 

 

 

High

 

$

14.50

 

$

14.00

 

$

13.02

Low

 

$

10.80

 

$

12.01

 

$

11.40

Close

 

$

14.00

 

$

12.02

 

$

11.40

 

Dividends

Payment of dividends on our common stock is subject to determination and declaration by our Board of Directors. Our dividend policy will depend upon our financial condition, results of operations and future prospects. At present, we have no intention to pay dividends to our shareholders. We cannot assure you that dividends will be paid, or if and when paid, that they will continue to be paid in the future. The order of the Pennsylvania Insurance Department approving the conversions of PPIX, PCA and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by us to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, our two principal stockholders, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.

Unregistered Sales of Equity Securities

The Company, PPIX, PCA, and PIPE entered into a Standby Stock Purchase Agreement, dated June 1, 2018, with Insurance Capital Group, LLC (“ICG”) in connection with the Company’s anticipated initial public offering. Pursuant to the terms of that agreement, ICG agreed to purchase such number of shares in the Company’s initial public offering that would result in at least the minimum number of shares being sold in the offering. ICG subsequently agreed to permit Enstar Holdings (US) LLC to purchase 30% of the shares that ICG would otherwise purchase. Contemporaneously with the completion of the Company’s public offering on March 27, 2019, the Company issued a total of 2,499,500 shares to the standby purchasers at the public offering price of $10.00 per share.

Use of Proceeds from Initial Public Offering of Common Stock

The Registration Statement on Form S-1 (File No. 333-229322) for the initial public offering of our common stock became effective on February 11, 2019. There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC on February 20, 2019, pursuant to Rule 424(b)(4).

Item 6. Selected Financial Data.

Not applicable.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is intended to provide a more comprehensive review of Positive Physicians Holdings, Inc. (“PPHI”) and its wholly owned subsidiary’s (collectively referred to as the “Company,” which also may be referred to as “we” or “us”) operating results and financial condition than can be obtained from reading the Financial Statements alone.  The discussion should be read in conjunction with the audited Consolidated and Combined Financial Statements and the notes thereto included in “Item 8. Financial Statements and Supplementary Data” of the Company.  Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K constitutes forward-looking information that involves risk and uncertainties. Please see “Forward-Looking Statements” in Part I for more information.

OVERVIEW

Positive Physicians Holdings, Inc. is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”).  In connection with the completion of PPHI’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies.  

As part of the conversions, on March 27, 2019, PPIX merged with and into PPIX Conversion Corp., PCA merged with and into PCA Conversion Corp., and PIPE merged with and into PIPE Conversion Corp.  Accordingly, PPIX, PCA, and PIPE no longer exist.  Immediately thereafter, PCA Conversion Corp. and PIPE Conversion Corp. merged with and into PPIX Conversion Corp., which then changed its name to Positive Physicians Insurance Company (“Positive Insurance Company”) and became our single insurance company subsidiary and successor to PPIX, PCA, and PIPE.  PPHI had minimal assets and liabilities and had not engaged in any operations prior to March 27, 2019.

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Diversus Management, LLC (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement.  Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement, effective March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based upon a percentage of Positive Insurance Company’s gross written premiums, less return premiums.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued by Positive Insurance Company and for all sales commissions paid to producers.

Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers.  Medical professional liability insurance (“MPLI”) protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services.  We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Our policies include coverage for the cost of defending claims.  Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage.  We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires.  Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported.  Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.

Overview of PPIX

PPIX was an unincorporated exchange organized on April 20, 2004 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange.  PPIX provided medical professional liability insurance consisting of claims-made, tail, claims made plus, and occurrence policies to its subscribers (policyholders).  On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and became a wholly owned subsidiary of PPIX.  PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018.  PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”).  Keystone is owned by an insured of Positive Insurance Company.

PPIX marketed its medical professional liability insurance policies directly to physicians and through independent producers to doctors and allied healthcare professionals who practice in Pennsylvania, Delaware, Maryland, New Jersey, and Ohio.

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PPIX was managed by Specialty Insurance Services, LLC (“SIS”), a Pennsylvania limited liability company, pursuant to the terms of an Attorney-In-Fact Agreement between the exchange and SIS.  SIS provided underwriting and administrative services to PPIX based on a percentage not to exceed 25% of gross written premiums, less return premiums.  As the attorney-in-fact, SIS had the power to direct the activities of PPIX that most significantly impact PPIX’s economic performance.  Diversus acquired 100% of the ownership interests of SIS on January 1, 2017.  

Overview of PCA

PCA was an unincorporated, reciprocal insurance association organized on April 16, 2003 and formed for the purpose of insuring its subscribers against loss due to the imposition of legal liability.  PCA provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).  

PCA marketed its medical professional liability insurance policies through independent producers, primarily to doctors and allied healthcare providers who practice in Pennsylvania.  In November 2015, PCA was granted a license to write insurance in Michigan and began writing policies in Michigan in the fourth quarter of 2015.

PCA was managed by Professional Third Party, LP (“PTP”), a Pennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the association and PTP.  PTP provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PCA, and paid certain expenses on behalf of PCA in exchange for 25% of gross written premium.  As the attorney-in-fact, PTP had the power to direct the activities of PCA that most significantly impact PCA’s economic performance.  Diversus acquired 100% of the ownership interests of PTP on June 4, 2014.  

Overview of PIPE

PIPE was an unincorporated exchange organized on March 14, 2005 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange.  PIPE provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).

PIPE marketed its medical professional liability insurance policies through independent producers to doctors and allied healthcare professionals who practice primarily in Pennsylvania.   PIPE also had a license and wrote business in South Carolina.

PIPE was managed by Physicians’ Insurance Program Management Company (“PIPE Management”), a Pennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the exchange and PIPE Management.  PIPE Management provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PIPE, and paid certain expenses on behalf of PIPE in exchange for 25% of gross written premium.  As the attorney-in-fact, PIPE Management had the power to direct the activities of PIPE that most significantly impact PIPE’s economic performance.  Diversus acquired 100% of the ownership interests of PIPE Management on November 23, 2015.

SIS, PTP, and PIPE Management merged with and into Diversus Management in connection with the conversions on March 27, 2019.

Marketplace Conditions and Trends

The MPLI industry is affected by recurring industry cycles known as “hard” and “soft” markets.  A soft market is characterized by intense competition, resulting in lower pricing in order to compete for business.  A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing.  From approximately 2001 until approximately 2007, the Pennsylvania MPLI market experienced a hard market cycle.  This resulted in the creation of several alternative MPLI providers, such as PPIX, PCA, and PIPE.  

The MPLI market began to experience a soft market cycle around the second quarter of 2008, due primarily to the large rate increases taken over the previous six years.  The soft market continued and was facilitated by the restructuring of the healthcare industry, partially as a result of the Affordable Care Act.  This resulted in significant price competition, as the number of medical professionals practicing independent of hospitals or large professional groups began to decline.  According to a study prepared by the National Association of Insurance Commissioners, MPLI direct premiums written declined by 24.0% on a national basis from 2006 to 2018 and declined by 14.6% in Pennsylvania and 33.0% in New Jersey during this same time period.  This resulted in lower direct premiums written and lower operating profits for many MPLI carriers.

17


 

The soft market cycle troughed in 2012, and since then, national loss payouts, on average, have steadily increased through 2019.  As a result, underwriting criteria in the MPLI industry has started to become more stringent, with opportunities for improved pricing, and we believe the market cycle is currently transitioning to a hard market.  At Positive Insurance Company, beginning in April 2020 our renewal book of business has begun to experience price increases of 2.5% through reduced credits, a development which we expect to continue and extend through our policy renewals in 2020.  We are also seeing rate increases take place by other carriers in many of the states in which we write business.

In addition to pricing increases, in what we perceive to be the beginnings of a hard market, we intend to achieve further premium growth with our expansion into new states.  Positive Insurance Company is currently in the process of obtaining licenses to write business in the states of California and Florida and was recently admitted into Texas in November 2019.

Effects of COVID-19

Our operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughout the United States.  These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force.  Our management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on our operations and financial position and developing operational and financial plans to address those matters.

As a result of the COVID-19 pandemic, we anticipate that premiums will decrease due to policy endorsements associated with doctors electing to work part time, take a leave of absence or retire.  In addition, our insureds may elect to temporarily change specialties.  For example, a doctor may choose to drop from orthopedic surgery to office-only status due to the lack of elective surgeries.  We have received notification for such requests from our policyholders which will go into effect on June 30, 2020.  

In terms of collections, prior to the pandemic, our policy was to cancel any insurance policies for which premiums had not been received within 60 days subsequent to policy effective date, with notice of intent to cancel sent to the insured after 30 days post-inception date.  As a result of COVID-19, we have updated this policy and suspended cancellations of insurance contracts resulting from non-payment of premium until June 30, 2020 for invoices due after April 1, 2020.  Through May 11, 2020, the amount of premium payment deferrals is about $817,000.  Dependent upon the extent to which our policyholders’ own businesses have been impacted by the pandemic, our collection of premiums against current in-force policies could be significantly impacted.

With respect to claims, our policyholder base mainly consists of physicians, their corporations and medical groups.  During the COVID-19 pandemic, on-site visits to doctors have declined and been replaced by an increase in telehealth/virtual office visits.  Since the COVID-19 pandemic resulted in government-issued work from home orders, we have seen the number of new claims reported begin to decrease.  In general, our expectation is that the frequency of new claims reported during this time period will decrease.  As to actual claims relating to COVID-19 exposures, we anticipate that the number of claims will be minimal.  Unless some unforeseen fact pattern is established, we expect that the difficulty of establishing the source of a COVID-19 exposure, as well as the heroic efforts of healthcare providers, will serve to make such claims unattractive to both patients and their counsel.  We do not anticipate our loss and LAE ratios to be impacted.  However, this view could change in the future depending on the duration of the pandemic and if the lower frequency of new claims reported becomes a trend.

Principal Revenue and Expense Items

Positive Insurance Company derives its revenue primarily from net premiums earned, net investment income, and net realized and unrealized gains (losses) from investments.

Net premiums earned

Gross premiums written is equal to direct and assumed premiums before the effect of ceded reinsurance.  Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written).

Premiums earned are the earned portion of net premiums written.  Gross premiums written include all premiums recorded by an insurance company during a specified policy period.  Insurance premiums on MPLI policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies.  At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and recognized as revenue in subsequent periods over the remaining term of the policy.  The policies written by Positive Insurance Company typically have a term of twelve months.  Thus, for example, for a policy that is written on July 1, 2019, one-half of the premiums would be earned in 2019 and the other half would be earned in 2020.

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Net investment income and net realized and unrealized gains (losses) from investments

We invest our surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expenses) in cash, cash equivalents, short-term investments, and equity and debt securities.  Investment income includes interest and dividends earned.  We recognize realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognize realized losses when investment securities are written down as a result of other-than-temporary-impairment or sold for an amount less than their cost or amortized cost, as applicable.  Realized gains and losses on sales of fixed maturity and equity securities and other investments and unrealized holding gains and losses on equity securities and other investments are included in realized investment gains (losses), net.  Our portfolio of investment securities is managed by our outside investment manager, who has discretion to buy and sell securities in accordance with the investment policy approved by Positive Insurance Company’s Board of Directors.

Losses and loss adjustment expenses

Losses and loss adjustment expenses (“LAE”) represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims, including legal fees.

Other underwriting expenses

Expenses incurred to underwrite risks include policy acquisition costs and underwriting and administrative expenses.  Policy acquisition costs consist of commission expenses, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business.  These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies.  Underwriting and administrative expenses consist of salaries, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately, and payments to bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data.

Income taxes

We use the asset and liability method of accounting for income taxes.  Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities.  A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.  The effect of a change in tax rates is recognized in the period of the enactment date.

Key Financial Measures

We evaluate our insurance operations by monitoring certain key measures of growth and profitability.  Some of these measurements are “non-GAAP” financial measurements under Securities and Exchange Commission rules and regulations.  We utilize certain non-GAAP financial performance measures that are widely used in the property and casualty insurance industry and that we believe are valuable in managing our business and for comparison to our peers.  These financial performance measures are the loss and LAE ratio, expense ratio, combined ratio, underwriting income (loss), and operating income (loss).  

We measure growth by monitoring changes in gross premiums written and net premiums written, and measure underwriting profitability by examining losses and LAE, underwriting expenses and combined ratios.  We also measure profitability by examining underwriting income (loss) and operating income (loss).

Loss and LAE ratio

The loss and LAE ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned.  Positive Insurance Company measures the loss and LAE ratio on a policy year and calendar year loss basis to measure underwriting profitability.  A policy year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that year.  A calendar year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior policy years as a percentage of premiums earned during that year.

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Expense ratio

The expense ratio is the ratio (expressed as a percentage) of other underwriting expenses (attributable to insurance operations) to premiums earned, and measures our operational efficiency in producing, underwriting and administering the Company’s insurance business.

Combined ratio

The combined ratio is a measure of property and casualty underwriting performance.  The combined ratio computed on a GAAP basis is equal to the sum of losses and loss adjustment expenses and other underwriting expenses, all divided by net premiums earned.  If the combined ratio is below 100%, we are making an underwriting profit.  If our combined ratio is at or above 100%, we are not profitable without investment income and may not be profitable if investment income is insufficient.

Underwriting income (loss)

Underwriting income (loss) measures the pre-tax profitability of insurance operations.  It is derived by subtracting losses and loss adjustment expenses and other underwriting expenses from earned premiums.

Operating income (loss)

Operating income (loss) measures the profitability of business operations.  We define it as GAAP net income (loss) excluding net realized investment gains and losses, net of tax.  Net realized investment activity is excluded because net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business operations.  Operating income is a non-GAAP measure which is important for an understanding of our overall results of operations.  However, it does not replace net income (loss) as the GAAP measure of our consolidated results of operations, nor should it be viewed as a substitute for measures determined in accordance with GAAP.

Critical Accounting Policies

General

The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments:

 

losses and loss adjustment expenses;

 

the valuation of our investment portfolio and assessment of other-than-temporary impairments (“OTTI”);

 

deferred acquisition costs;

 

reinsurance recoverable; and

 

valuation of deferred tax assets.

We believe our accounting policies for these items are of critical importance to our consolidated financial statements.  The following discussion provides more information regarding the estimates and assumptions required to arrive at these amounts.

Losses and Loss Adjustment Expenses

We maintain reserves for the payment of claims (indemnity losses) and expenses related to adjusting those claims (loss adjustment expenses). The loss reserves consist of case reserves, which are reserves for claims that have been reported to us, and reserves for claims that have been incurred but have not yet been reported and for the future development of case reserves.

When a claim is reported to us, our claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated.  The amount of the loss reserve for the reported claim is based primarily upon a claim-by-claim evaluation of coverage, liability, and injury severity, and any other information considered pertinent to estimating the

20


 

exposure presented by the claim.  Each claim is contested or settled individually based upon its merits, and some claims may take years to resolve, especially if legal action is involved.  Case reserves are reviewed on a regular basis and are updated as new information becomes available.

In addition to case reserves, we maintain reserve estimates for those that have been incurred but not reported (“IBNR”).  These reserves include estimates for the future development of case reserves and claims in which case reserves have not yet been established.  Some claims may not be reported for several years.  As a result, the liability for unpaid losses and LAE reserves includes significant estimates for IBNR.

We utilize an independent actuary to assist with the estimation of our losses and LAE reserves on a quarterly basis.  Our independent actuary prepares estimates of the ultimate liability for unpaid losses and LAE based on established actuarial methods described below.  We review these estimates and supplement the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy.  We may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the financial statements.

We accrue liabilities for unpaid losses and LAE based upon estimates of the ultimate amount payable. We project our estimate of ultimate losses and LAE by using the following actuarial methodologies:

 

Actual versus Expected Model - The Actual versus Expected Model utilizes the actuarial point ultimate loss and defense containment cost (“DCC”) estimates as of the prior reserve review which are adjusted based on the difference between actual and expected loss development between the prior reserve review and the current evaluation to arrive at an updated actuarial point ultimate loss and DCC estimate. The method is dependent on the loss development factors used to determine the expected losses.

 

Bornhuetter-Ferguson Method (Paid and Incurred) - The Bornhuetter-Ferguson Method is a blended method that explicitly takes into account both actual loss development to date and expected future loss emergence. This method is applied on both a paid loss development basis and an incurred loss development basis. This method uses the selected loss development patterns from each of the two loss development methods to calculate the expected percentage of loss unpaid or unreported, as applicable. The expected future loss component of the method is calculated by multiplying earned premium for the given exposure period by a selected a priori (i.e. deductive) loss ratio. The resulting dollars are then multiplied by the expected percentage of unpaid (or unreported) loss described above. This provides an estimate of future paid (or reported) losses that is then added to actual paid (or incurred) loss data to produce estimated ultimate loss.

 

Expected Loss Ratio Method - The Expected Loss Ratio Method utilizes some measure of anticipated losses and does not consider actual losses. An expected loss ratio, a ratio of anticipated losses relative to some measure of exposure, is applied to that measure of exposure to determine estimated ultimate losses for each year. This method provides stability over time because the ultimate loss estimates do not change unless the exposure measure changes. This is offset by a lack of responsiveness to actual loss experience.

 

Frequency/Severity Method - The Frequency/Severity Method estimates ultimate losses by estimating a frequency and a severity component. For each year, the actuary estimates ultimate claim counts and an ultimate average severity. The actuary then multiplies these two estimates together. The method is useful when the claim count development pattern is more stable than the loss development pattern.

 

Incurred Loss Development Method - The Incurred Loss Development Method utilizes historical incurred loss (the sum of cumulative historical loss payments plus outstanding case reserves) patterns to estimate future losses. This method is often preferred over the paid method as it includes the additional information provided by the aggregation of individual case reserves. The resulting loss development factors (LDFs) tend to be lower and more stable than those of the paid development method. However, the incurred development method may be affected by changes in case reserving practices and any unusually large individual claims. The actuaries produce and review several indications of ultimate loss using this method based on various LDF selections.

We estimate IBNR reserves by first deriving an actuarially based estimate of the ultimate cost of total losses and loss adjustment expenses incurred as of the financial statement date.  We then reduce the estimated ultimate losses and LAE by loss and LAE payments and case reserves carried as of the financial statement date.  The actuarially determined estimate is based upon indications from one of the above actuarial methodologies or uses a weighted average of these results.  The specific method used to estimate the ultimate losses will vary depending on the judgment of the actuary as to what is the most appropriate method for the MPLI business.  Finally, we consider other factors that impact reserves that are not fully incorporated in the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy.

21


 

The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Loss reserve estimation is affected by the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. We continually refine our loss reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. We consider all significant facts and circumstances known at the time loss reserves are established.

Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for losses and loss adjustment expense reserves may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. We reflect adjustments to loss reserves in the results of operations in the period the estimates are changed.

Our independent actuary determined a range of reasonable reserve estimates shown in the tables below, which reflect the uncertainty inherent in the loss reserve process.  This range does not represent the range of all possible outcomes.  We believe that the actuarially determined ranges represent reasonably likely changes in the loss and LAE estimates, however, actual results could differ significantly from these estimates.  The range was determined after a review of the output generated by the various actuarial methods utilized.  Our actuary reviewed the variance around the select loss reserve estimates for each of the actuarial methods and selected reasonable low and high estimates based on their knowledge and judgment.  In addition, when selecting these low and high estimates, the actuary considered:

 

Historical industry development experience in MPLI;

 

Historical company development experience;

 

Changes in the company’s internal claims processing policies and procedures; and

 

Trends and risks in claim costs, such as risk that medical cost inflation could increase.

Our actuary is required to exercise a considerable degree of judgment in the evaluation of all of these and other factors in the analysis of losses and loss adjustment expenses, and related range of anticipated losses. Because of the level of uncertainty impacting the estimation process, it is reasonably possible that different actuaries would arrive at different conclusions. The method of determining the reserve range has not changed and the reserve range generated by the actuary is consistent with the observed development of our loss reserves over the last few years.

The width of the range in reserves arises primarily because specific losses may not be known and reported for some time and the ultimate losses and LAE paid and incurred with respect to known losses may be larger or smaller than currently estimated. The ultimate frequency or severity of the claims can be very different than the assumptions used in the estimation of our ultimate reserves for these exposures.

Specifically, the following factors could impact the frequency and severity of claims and, therefore, the ultimate amount of losses and loss adjustment expenses paid:

 

The rate of increase in medical costs that underlie insured risks; and

 

Impact of changes in laws or regulations.

The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts less than originally estimated or a reduction in the estimate for unpaid losses and loss adjustment expense (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts greater than originally estimated or an increase in the estimate for unpaid losses and loss adjustment expense (unfavorable development).

Positive Insurance Company uses a combination of the Actual versus Expected Method, Bornhuetter-Ferguson Method, Expected Loss Ratio Method, Frequency/Severity Method, and the Incurred Loss Development Method in order to estimate its liability for losses and LAE.  Following the conversions and merger which were completed on March 27, 2019, the Company changed its approach by aggregating its data, previously under PPIX, PCA, and PIPE, and performing a single loss reserve analysis, as opposed to three separate loss reserve analyses.  The Company used combined development patterns based on PPIX, PCA, and PIPE experience for claims-made development factors, but derived occurrence development factors strictly based on former PPIX

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experience.  Tail policy development factors were derived from the occurrence factors.  Management does not believe that the effects of these changes had a material impact on the Company’s estimates.  The year-end loss reserve analysis also assumes that the Company will no longer utilize Andrews Outsource Solutions LLC to provide claims processing and risk management services following 2020, a measure which is expected to reduce the amount of LAE incurred in subsequent periods.  If this action is not taken, then the Company’s reserves for loss adjustment expenses would increase as a result.  There were no other significant changes in the methodologies and assumptions used to develop the liabilities for losses and LAE during the year ended December 31, 2019.

The following tables provide case and IBNR reserves for losses and LAE at December 31, 2019 and 2018 (dollars in thousands).

At December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2019

 

Case

Reserves

 

 

IBNR

Reserves

 

 

Total

Reserves

 

Medical professional liability

 

$

30,127

 

 

$

25,966

 

 

$

56,093

 

Total net reserves

 

 

30,127

 

 

 

25,966

 

 

 

56,093

 

Reinsurance recoverable on unpaid claims

 

 

1,895

 

 

 

5,620

 

 

 

7,515

 

Gross reserves

 

$

32,022

 

 

$

31,586

 

 

$

63,608

 

 

At December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2018

 

Case

Reserves

 

 

IBNR

Reserves

 

 

Total

Reserves

 

Medical professional liability

 

$

30,741

 

 

$

29,701

 

 

$

60,442

 

Total net reserves

 

 

30,741

 

 

 

29,701

 

 

 

60,442

 

Reinsurance recoverable on unpaid claims

 

 

1,614

 

 

 

6,336

 

 

 

7,950

 

Gross reserves

 

$

32,355

 

 

$

36,037

 

 

$

68,392

 

 

At December 31, 2019 and 2018, Positive Insurance Company’s total liability for losses and LAE was $63,607,975 and $68,392,333, respectively.

The components of our (favorable) unfavorable development of reserves for losses and LAE for prior accident years by accident year were as follows (dollars in thousand):

 

Accident Year

 

2019

 

 

2018

 

2009 and prior

 

$

(185

)

 

$

455

 

2010

 

 

(158

)

 

 

(755

)

2011

 

 

(151

)

 

 

(988

)

2012

 

 

956

 

 

 

(152

)

2013

 

 

(148

)

 

 

575

 

2014

 

 

135

 

 

 

(25

)

2015

 

 

(1,056

)

 

 

(121

)

2016

 

 

647

 

 

 

2,515

 

2017

 

 

(1,279

)

 

 

2,554

 

2018

 

 

1,375

 

 

 

 

Total net (favorable) unfavorable development

 

$

136

 

 

$

4,058

 

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In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.

During 2018, we experienced unfavorable development primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.

As discussed earlier, the estimation of Positive Insurance Company’s losses and LAE reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given policy year.

 

 

 

Recent Variabilities of the Liability for

 

 

 

Unpaid Losses and Loss Adjustment Expenses, Net of Reinsurance Recoverables

 

Dollars in thousands

 

2015

 

 

2016

 

 

2017

 

2018

 

 

2019

 

As originally estimated

 

$

70,514

 

 

$

63,288

 

 

$

61,046

 

$

60,442

 

 

$

56,093

 

As estimated at December 31, 2019

 

 

60,874

 

 

 

65,035