BWINB Protective Ins Corp (MM)

Notes to Unaudited Condensed Consolidated Financial Statements

(All dollar amounts presented in these notes are in thousands, except per share data)

(1) Summary of Significant Accounting Policies

Description of Business :  Baldwin & Lyons, Inc. (the "Company"), based in Carmel, Indiana, is a specialty property-casualty insurer providing liability coverage for large to small-sized trucking and public transportation fleets.   The Company operates as one reportable property and casualty insurance segment, offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.

The Company determined that its business constituted one reportable property and casualty insurance segment as of January 1, 2017.  During 2016 and prior years, the Company had two reportable segments – property and casualty insurance and reinsurance.  The Company moved to a single reportable segment based on how its operating results are regularly reviewed by the Company's chief operating decision maker when making decisions about how resources are to be allocated to the segment and assessing its performance.  The prior period segment information throughout this Quarterly Report on Form 10-Q was updated to conform to the current year presentation.

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included.  Interim financial statements should be read in conjunction with the Company's annual audited financial statements and other disclosures included in the Company's most recent Annual Report on Form 10-K.  Operating results for interim periods are not necessarily indicative of results that may be expected for the year ending December 31, 2017 or any other future period.

Investments :  Carrying amounts for fixed maturity securities represent fair value and are based on quoted market prices, where available, or broker/dealer quotes for specific securities where quoted market prices are not available.  Equity securities are carried at quoted market prices (fair value).  The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to record its proportionate share of the limited partnership's net income.  To the extent that the limited partnership investees include both realized and unrealized investment gains or losses in the determination of net income or loss, then the Company would also recognize, through its condensed consolidated statements of operations, its proportionate share of the investee's unrealized, as well as realized, investment gains or losses.

Short-term and other investments are carried at cost, which approximates their fair values.

Realized gains and losses on disposals of investments are recorded on the trade date and are determined by specific identification of cost of investments sold and are included in income.  All fixed maturity and equity securities are considered to be available-for-sale; the related unrealized net gains or losses (net of applicable tax effect) are reflected directly in shareholders' equity.  Included within available for sale fixed maturity securities are convertible debt securities.  A portion of the changes in fair values of convertible debt securities are reflected as a component of net realized gains (losses) on investments.

Notes to Unaudited Condensed Consolidated Financial Statements (continued)

 

In accordance with the Financial Accounting Standards Board's ("FASB") other-than-temporary impairment guidance, if a fixed maturity security is in an unrealized loss position and the Company has the intent to sell the fixed maturity security, or it is more likely than not that the Company will have to sell the fixed maturity security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to net realized losses on investments in the condensed consolidated statements of operations.   For impaired fixed maturity securities that the Company does not intend to sell or in cases where it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in net realized losses on investments in the condensed consolidated statements of operations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity (accumulated other comprehensive income).

The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed maturity security.  The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the appropriate effective interest rate.

The unrealized net gains or losses (net of applicable tax effect) related to equity securities are reflected directly in shareholders' equity, unless a decline in value is determined to be other-than-temporary, in which case the loss is charged to income.  In determining if and when a decline in market value below cost is other-than-temporary, an objective analysis is made of each individual security where current market value is less than cost.   For any equity security where the unrealized loss exceeds 20% of original or adjusted cost, or where that decline has existed for a period of at least one year, the decline is treated as an other-than-temporary impairment.  Additionally, the Company takes into account any known subjective information in evaluating for impairment, separate from consideration of the Company's quantitative criteria defined above, as well as the Company's intent and ability to retain the equity security for a period of time sufficient to allow for such recovery in fair value.

Notes to Unaudited Condensed Consolidated Financial Statements (continued)

Recent Accounting Pronouncements: In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606), as amended by subsequently issued ASUs, to clarify the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, the Company's service and fee income, other than that directly associated with insurance contracts, will be subject to this updated guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to the quarter ending March 31, 2018. The Company has performed an evaluation of the impact this guidance will have on its results of operations, financial position and liquidity as well as a technical assessment of material customer contracts.  The Company will use the modified retrospective method upon adoption in 2018.  The Company does not expect the new standard to have a material impact on its condensed consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 change the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income. Under current guidance, changes in fair value for investments of this nature are recognized in accumulated other comprehensive income as a component of shareholders' equity. Additionally, ASU 2016-01 simplifies the impairment assessment of equity investments without readily determinable fair values; requires entities to use the exit price when estimating the fair value of financial instruments; and modifies various presentation disclosure requirements for financial instruments. ASU 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017.  The effect of this guidance will be dependent on the unrealized gains or losses associated with the Company's equity investments.  Such unrealized gains or losses will be recognized upon adoption as a cumulative-effect adjustment with future unrealized gains or losses recognized in the statement of operations.  Refer to Note 2 for unrealized gains and losses currently recognized in other comprehensive income (loss).

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), or ASU 2016-02. Upon the effective date, ASU 2016-02 will supersede the current lease guidance in ASC Topic 840, Leases. Under the new guidance, lessees will be required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis. Concurrently, lessees will be required to recognize a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018.  Early adoption is permitted, but the Company plans to adopt this ASU on January 1, 2019.  This guidance is required to be applied using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements.  The Company is currently evaluating the effects that adoption of ASU 2016-02 will have on its condensed consolidated financial statements.

 

Notes to Unaudited Condensed Consolidated Financial Statements (continued)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU 2016-13. This update introduces a current expected credit loss model for measuring expected credit losses for certain types of financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. ASU 2016-13 replaces the current incurred loss model for measuring expected credit losses, requires expected losses on available-for-sale debt securities to be recognized through an allowance for credit losses rather than as reductions in the amortized cost of the securities, and provides for additional disclosure requirements. ASU 2016-

13 is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for interim and annual reporting periods beginning after December 15,

2018. The Company is currently evaluating the effects that adoption of ASU 2016-13 will have on its condensed consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, or ASU 2017-04.  This amendment removes Step 2 of the goodwill impairment test under current guidance.  The new guidance requires an impairment charge to be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value.  ASU 2017-04 is effective for interim and annual reporting periods beginning after December 15, 2020, with early adoption permitted.  The Company does not expect the guidance to have a material impact on its condensed consolidated financial statements.

 

 

 

The fair value and the cost or amortized costs of fixed maturity investments at September 30, 2017, by contractual maturity, are shown below.  Actual maturities may ultimately differ from contractual maturities because borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties. Pre-refunded municipal bonds are classified based on their pre-refunded call dates.

Net realized gains activity for investments, as shown in the previous table, are further detailed as follows:

The mark-to-market adjustments in the table above represent the changes in fair value of options embedded in convertible debt securities held by the Company.

Shareholders' equity at September 30, 2017 included approximately $30,293, net of federal income taxes, of reported earnings which remain undistributed by limited partnerships.

Notes to Unaudited Condensed Consolidated Financial Statements (continued)

At September 30, 2017, limited partnership investments included approximately $40,169 invested in two partnerships which are managed by organizations in which certain of the Company's directors are officers, directors, general partners or owners.  Each of these investments contains profit sharing agreements, pursuant to which a portion of the gains will be paid to the affiliated organizations.

The Company's limited partnerships include one investment which primarily invests in public and private equity markets in India.  The limited partnership investment's value as of September 30, 2017 and 2016 was $26,970 and $29,718, respectively.  At September 30, 2017, the Company's estimated ownership interest in this limited partnership investment was approximately 5%.  The Company's share of earnings from this limited partnership investment was $4,817 and $1,448 for the nine months ended September 30, 2017 and 2016, respectively.

The summarized financial information of the partnership in which the Company has invested is as follows:

At September 30, 2017, the Company's invested assets, excluding limited partnership investments, included approximately $24,229 in portfolios managed by organizations in which certain of the Company's directors are officers, directors, general partners or owners.

(3) Reinsurance:

The following table summarizes the Company's transactions with reinsurers for the 2017 and 2016 comparative periods.

 

 

The table above shows a roll-forward of loss and loss expense reserves from the prior year end to the current balance sheet date with comparable prior year information.  Losses incurred from claims occurring during prior years reflects the development from prior accident years, composed of individual claim savings and deficiencies which, in the aggregate, have resulted from the settlement of claims at amounts higher or lower than previously reserved and from changes in estimates of losses incurred but not reported.

The $16,480 prior accident year deficiency that developed during the first nine months of 2017 was largely due to infrequent, but severe, transportation losses that occurred primarily during the first six months of 2017.  This 2017 deficiency compares to a deficiency of $8,712 for the first nine months of 2016 that arose due mostly to management's review of reserve positions related to discontinued lines.

 

Notes to Unaudited Condensed Consolidated Financial Statements (continued)

(5) Segment Information :

The Company has one reportable business segment in its operations: Property and Casualty Insurance.  The property and casualty insurance segment provides multiple lines of insurance coverage primarily to fleet transportation companies as well as to independent contractors who contract with fleet transportation companies.  In addition, the Company provides workers' compensation coverage for a variety of classes outside the transportation industry.

The following table summarizes segment revenues for the three and nine months ended September 30, 2017 and 2016:

(6) Debt :

The Company maintains a revolving line of credit with a $40,000 limit and an expiration date of September 23, 2018.  Interest on this line of credit is referenced to LIBOR and can be fixed for periods of up to one year at the Company's option.  Outstanding drawings on this line of credit were $20,000 as of both September 30, 2017 and December 31, 2016.  At September 30, 2017, the effective interest rate was 2.34%.  The Company has $20,000 remaining and unused under the line of credit at September 30, 2017.  The current outstanding borrowings were used for general corporate purposes. 

(7) Taxes:

As of September 30, 2017, the Company's calendar years 2016, 2015 and 2014 remain subject to examination by the Internal Revenue Service.

The effective federal tax rate on consolidated income for the third quarter of 2017 was 30.0% compared to 29.0% for the 2016 third quarter.  The effective federal income tax rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.

The effective federal tax rate on consolidated income (loss) for the first nine months of 2017 was 581.0% compared to 33.1% for the 2016 period.  The significant difference between the effective rate and the normal statutory rate was the result of the Company's operating loss through the first nine months of 2017.

Level inputs, as defined by the FASB guidance, are as follows:

 

Quoted market prices are obtained whenever possible.  Where quoted market prices are not available, fair values are estimated using present value or other valuation techniques.  These techniques are significantly affected by the Company's assumptions, including discount rates and estimates of future cash flows.  Potential taxes and other transaction costs have not been considered in estimating fair values.

Transfers between levels, if any, are recorded as of the beginning of the reporting period.  There were no material transfers of assets between Level 1 and Level 2 during the nine months ended September 30, 2017 and 2016.  The transfers out of Level 3 during the third quarter of 2017 consisted mainly of bank loans, asset-backed securities and certain mortgage-backed securities and corporate securities, which were based on quoted market prices of similar securities and other observable inputs.

In addition to the preceding disclosures on assets recorded at fair value in the condensed consolidated balance sheets, FASB guidance also requires the disclosure of fair values for certain other financial instruments for which it is practicable to estimate fair value, whether or not such values are recognized in the condensed consolidated balance sheets.

Non-financial instruments such as real estate, property and equipment, other assets, deferred income taxes and intangible assets, and certain financial instruments such as policy reserve liabilities are excluded from the fair value disclosures.  Therefore, the fair value amounts cannot be aggregated to determine the underlying economic value of the Company.  The following methods, assumptions and inputs were used to estimate the fair value of limited partnerships and short-term borrowings.

Limited partnerships: The Company accounts for investments in limited partnerships using the equity method of accounting, which requires an investor in a limited partnership to carry the investment at its proportionate share of the limited partnership's equity.   The underlying assets of the Company's investments in limited partnerships are carried primarily at fair value, and, therefore, the Company's carrying value of limited partnerships approximates fair value.  As these investments are not actively traded and the corresponding inputs are based on data provided by the investees, they are classified as Level 3.