Presurance Holdings, Inc.: Form 10-Q for the period ended Sep 30, 2023

For the Periods Ended September 30, 2023 and 2022

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements (Unaudited), related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K, filed on March 27, 2023 with the U. S. Securities and Exchange Commission.

Forward-Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q, which are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek” and similar terms and phrases, or the negative thereof, may be used to identify forward-looking statements.

The forward-looking statements contained in this report are based on management’s good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks and uncertainties, many of which are beyond our control, that could cause our actual results to differ materially from those in the forward-looking statements, including those described in our Form 10-K (“Item 1A Risk Factors”) filed with the SEC on March 27, 2023 and subsequent reports filed with or furnished to the SEC. Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified herein. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable laws or regulations.

Recent Developments

Sale of Renewal Rights

In September 2023, the Company sold the renewal rights of one of its insurance programs to another insurer for $2.5 million in cash. The program provided mostly liability insurance to the security guard and alarm installation industries. This program produced $41.0 million of gross earned premiums in 2022 and $41.4 million for the nine months ended September 30, 2023. The buyer began writing new and renewal policies for this program as of September 15, 2023. Under a related 100% quota share reinsurance agreement, the Company also ceded $30.9 million of its gross unearned premium in the program to the buyer on September 30, 2023, net of a 27% ceding commission. The Company retained the $22.6 million of the net cash owed to the buyer under a funds withheld provision within the agreement which increased the funds held under reinsurance agreements on the Consolidated Balance Sheets as of September 30. 2023. The Company incurred $135,000 in expense related to this transaction. As part of this transaction, five claims staff transferred employment to the buyer. The buyer will handle all of the Company’s run-off claims for this program under a related claims administration agreement. The buyer also participated in the Company’s issuance of new public debt by purchasing $5.0 million of the new debt.

The Company recognized a net gain of $2.3 million, which is reflected in Gain from sale of renewal rights on the Consolidated Statements of Operations.

Debt Restructuring

The Company extinguished all of the $24.4 million of public notes that matured on September 30, 2023. The Company funded this through a combination of newly issued public notes as well as exchanging the maturing notes for new notes. The Company also restructured its $10.5 million subordinated under a new amended and restated agreement in which the Company paid down $500,000 of the outstanding debt, changed the priority to a senior secured position, and changed the maturity from September 30, 2038, to September 30, 2028. There is also a new provision requiring $250,000 quarterly principal payments with the remainder due upon maturity and a requirement that net proceeds from any asset sales be applied against the principal balance of the senior secured notes. See Note 8 ~ Debt for further details.

VSRM Transaction

Prior to October 13, 2022, Sycamore owned 50% of Venture Agency Holdings, Inc. ("Venture") and has accounted for its ownership under the equity method of accounting. On October 13, 2022, Sycamore purchased the other 50% of Venture from an individual for $9.7 million. Following this purchase, Sycamore owned 100% of Venture, which was then renamed to

VSRM, Inc. ("VSRM"). VRSM and its two wholly owned subsidiaries, The Roots Insurance Agency, Inc. ("Roots") and Mitzel Insurance Agency, Inc. ("Mitzel") were incorporated into the Company's consolidated financial statements as of the date of the acquisition.

The Company recognized Sycamore's purchase of the individual's shares of VSRM as a step acquisition and revalued all assets and liabilities upon the acquisition date.

On October 14, 2022, VSRM sold all of its security guard and alarm installation insurance brokerage business (the "Security & Alarm Business") to a third party insurance brokerage firm for $38.2 million. As part of the transaction, the individual who previously owned 50% of VSRM transitioned employment to the buyer, along with a team of approximately eight other employees of VSRM. The Company recognized this transaction as the sale of a business.

On December 30, 2022, VSRM contributed its remaining business, including its two wholly owned subsidiaries (Mitzel and Roots) to a new wholly owned subsidiary, Sycamore Specialty Underwriters, LLC ("SSU"). The business contributed to SSU consisted of customer accounts of substantially all of the personal lines business and a small subset of the commercial lines business underwritten by the Insurance Company Subsidiaries, and all of the customer accounts VSRM produced for third-party insurers, other than the security guard and alarm installation brokerage business previously sold.

On December 31, 2022, Andrew D. Petcoff purchased 50% of SSU from VSRM, Inc. for $1,000. As a result, SSU and its two wholly owned subsidiaries, Roots and Mitzel, are no longer consolidated in the Company's consolidated financial statements as of December 31, 2022, and VSRM's investment in SSU is accounted for using the equity method.

Loss Portfolio Transfer

On November 1, 2022, the Company entered into a loss portfolio transfer (“LPT”) reinsurance agreement with Fleming Reinsurance Ltd (“Fleming Re”). Under the agreement, Fleming Re covers an aggregate limit of $66.3 million of paid losses on $40.8 million of stated net reserves as of June 30, 2022, relating to accident years 2019 and prior. This covers substantially all of the commercial liability lines underwritten by the Company. Within the aggregate limit, there is a $5.5 million loss corridor in which the Company retains losses in excess of $40.8 million. Fleming Re is then responsible to cover paid losses in excess of $46.3 million up to $66.3 million. Accordingly, there is $20.0 million of adverse development cover for accident years 2019 and prior. Under the agreement, Fleming Re was paid $40.8 million for stated net reserves as of June 30, 2022, plus a one-time risk fee of $5.4 million. Recoverables due to the Company under this agreement are recorded as reinsurance recoverables. The agreement is between CIC and WPIC and Fleming Re.

As of September 30, 2023, the Company has recorded losses through the $5.5 million corridor and $4.5 million into the $20.0 million layer. As of December 31, 2022, the Company recorded losses through the $5.5 million corridor and $644,000 into the $20.0 million layer.

The Company paid $25.0 million in cash on October 14, 2022, which was offset for claims paid through September 30, 2022 and $13.6 million of funds withheld.

A.M. Best

On April 21, 2022, A.M. Best downgraded the Company’s Long-Term Issuer Credit Rating (Long-Term ICR) from “bb” (Fair) to “bb-” (Fair), and downgraded the Company’s insurance subsidiaries Financial Strength Rating from “B++” (Good) to “B+” (Good) and the Long-Term ICR from “bbb” (Good) to “bbb-” (Good). The outlook assigned to all these ratings by A.M. Best was Stable. We do not believe the rating changes will have a material effect on our business.

Business Overview

We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 45 states, including the District of Columbia. We are licensed to write insurance as an admitted carrier in 42 states, including the District of Columbia, and we offer our insurance products in all 50 states.

Our revenues are primarily derived from premiums earned from our insurance operations. We also generate other revenues through investment income and other income which mainly consists of: installment fees and policy issuance fees generally related to the policies we write.

Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions, and other underwriting and administrative expenses. We organize our operations in three insurance businesses: commercial insurance lines, personal lines, and agency business. Together, the commercial and personal lines refer to “underwriting” operations that take insurance risk, and the agency business refers to non-risk insurance business.

Through our commercial insurance lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers’ compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis.

Through our personal insurance lines, we offer homeowners insurance and dwelling fire insurance products to individuals in several states. Our specialty homeowners insurance product line is primarily comprised of low-value dwelling insurance tailored for owners of lower valued homes, which we offer in Illinois, Indiana and Texas.

Through our wholesale agency business segment, we offer commercial and personal lines insurance products for our Insurance Company Subsidiaries as well as a small number of third-party insurers. The wholesale agency business segment provides our agents with more insurance product options.

Critical Accounting Policies and Estimates

In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions periodically on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operations will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. During the nine months ended September 30, 2023, there were no material changes to our critical accounting policies and estimating methodologies, which are disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K filed with the SEC on March 27, 2023.

Executive Overview

The Company reported $38.5 million of gross written premiums in the third quarter of 2023, representing a 16.5% increase as compared to the same period in 2022. Our commercial lines gross written premiums increased by $857,000, or 3.1%, to $28.5 million in the third quarter of 2023, compared to $27.6 million for the same period in 2022. Personal lines gross written premiums increased by $4.6 million, or 84.4%, to $10.1 million in the third quarter of 2023, compared to $5.5 million for the same period in 2022.

The Company reported $119.4 million of gross written premiums for the nine months ended September 30, 2023, compared to $103.5 million for the same period in 2022.

The Company reported a net loss of $2.7 million, or $0.22 per share, and a net loss of $6.4 million, or $0.53 per share, for the three and nine months ended September 30, 2023, respectively. The Company reported a net loss of $1.5 million, or $0.14 per share, and a net loss of $12.8 million, or $1.26 per share, for the three and nine months ended September 30, 2022, respectively.

Adjusted operating loss per share is a non-GAAP measure that represent net loss allocable to common shareholders excluding net realized investment gains or losses, other gains or losses, and changes in fair value of equity securities; all net of tax. Adjusted operating loss was $5.0 million, or $0.41 per share, for the three months ended September 30, 2023. Adjusted operating loss was $9.4 million, or $0.77 per share, for the nine months ended September 30, 2023. Adjusted operating loss was $1.4 million, or $0.13 per share, for the three months ended September 30, 2022. Adjusted operating loss was $11.8 million, or $1.16 per share for the nine months ended September 30, 2022.

Our underwriting combined ratio was 120.8% and 114.1% for the three and nine months ended September 30, 2023, compared to 106.5% and 116.0% for the three and nine months ended September 30, 2022.

Results of Operations For The Three Months Ended September 30, 2023 and 2022

The following table summarizes our operating results for the periods indicated (dollars in thousands):

Summary of Operating Results

(1) The loss ratio is the ratio, expressed as a percentage, of net losses and loss adjustment expenses to net earned premiums and other income from underwriting operations.

(2) The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and other underwriting expenses to net earned premiums and other income from underwriting operations.

(3) The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.

* Percentage change is not meaningful.

Premiums

Premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. Almost all commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over the terms of the policies.

Our premiums are presented below for the three months ended September 30, 2023 and 2022 (dollars in thousands):

Summary of Premium Revenue

Gross written premiums increased $5.5 million, or 16.5%, to $38.5 million for the three months ended September 30, 2023, as compared to $33.1 million for the same period in 2022.

Commercial lines gross written premiums increased $857,000, or 3.1%, to $28.5 million in the third quarter of 2023, as compared to $27.6 million for the third quarter of 2022. The increased gross written premiums were due to $2.0 million of quarter-over-quarter premium growth in the Company's small business programs. This increase was offset by a $1.1 million quarter-over-quarter decrease in the Company's hospitality programs.

Personal lines gross written premiums increased $4.6 million, or 84.4%, to $10.1 million in the third quarter of 2023, as compared to $5.5 million for the same period in 2022. The increase was due to the organic growth in the low-value dwelling book of business in Texas and Oklahoma.

Net written premiums decreased $18.0 million, or 76.0%, to $5.7 million for the three months ended September 30, 2023, as compared to $23.7 million for the same period in 2022. As part of the renewal rights sale, the Company ceded to the buyer 100% of its gross unearned premium, or $30.9 million, related to its security guard and alarm installation program as of September 30, 2023. There was $12.3 million of previously ceded written premium relating to other reinsurance treaties that was reversed this quarter so that 100% of the unearned premiums could be ceded to the buyer. As a result, the Company's ceded written premiums increased by $18.6 million during the quarter relating to the renewal rights sale.

Net written premiums in commercial lines, before the impact of the renewal rights transaction, was $15.5 million, or a $3.3 million decrease. This decrease was due, in part, to a 50% quota share reinsurance agreement, effective January 1, 2023 that applies to a subset of our commercial business that represents approximately 10.4% of our gross written premiums in the third quarter of 2023. The Company ceded $1.7 million of written premium related to this quota share reinsurance agreement during the third quarter of 2023. Additional reductions in net written premiums were largely due to increases in reinsurance rates in 2023 as compared to 2022.

Net written premiums in personal lines grew commensurate with the gross written premiums, offset by slightly higher reinsurance rates.

Other Income

Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings and policy issuance costs. Commission income is also received by the Company’s insurance agency for writing policies for third-party insurance companies. Other income decreased by $164,000, or 27.2%, to $439,000 for the three months ended September 30, 2023, compared to $603,000 for the same period in 2022. The decrease was due to the Company's Wholesale Agency business revenue decreasing by $204,000, or 25.7%, to $589,000 for three months ended September 30, 2023, compared to $793,000 for the same period in 2022. A majority of the decrease in Wholesale Agency revenue was because of the business contributed to SSU, which was then deconsolidated as of December 31, 2022, and thus not reflected in the Company's consolidated income.

Losses and Loss Adjustment Expenses

The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the three months ended September 30, 2023 and 2022 (dollars in thousands):

Net losses and LAE increased by $4.2 million, or 25.4%, to $20.9 million during the third quarter of 2023, compared to $16.7 million for the same period in 2022. The increase was attributable to a $3.7 million increase in current accident year losses during the third quarter of 2023, compared to the same period in 2022. There was $2.5 million of additional homeowners loss emergence in the third quarter related to the second quarter storm activity.

The Company’s incurred losses during the three and nine months ended September 30, 2023 included prior-year adverse reserve development of $3.6 million and $2.9 million, respectively. For the quarter, the Company recognized $4.0 million of reserve development in the commercial liability lines of business relating to accident years 2020 through 2022, offset by $414,000 of favorable development in the personal lines segment. For the nine months ended September 30, 2023, the Company recognized $4.1 million of adverse development in the commercial liability lines of business, related to accident years 2020 through 2022, offset by $1.2 million of favorable development in the personal lines segment.

Net losses and LAE were $16.7 million during the third quarter of 2022. Of the $3.1 million of adverse development that occurred for the three months ended September 30, 2022, $2.3 million was related to 2019 and prior accident years and $1.8 million was related to the 2021 accident year. This was offset by $958,000 of favorable development experienced in the 2020 accident year. Of the $3.1 million of adverse development, $2.7 million was related to the commercial lines of business, while $381,000 was related to the personal lines of business.

Expense Ratio

Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses.

The table below provides the expense ratio by major component.

Our expense ratio decreased by 6.0% during the third quarter of 2023, compared to the same period in 2022.

Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceding commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased by 6.4%, from 24.6% in the third quarter of 2022, to 18.2% for the same period in 2023. The decrease was primarily related to additional ceding commissions, which reduces commission expense, as a result of the new quota share reinsurance treaty mentioned above.

Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other underwriting income increased by 0.4% during the third quarter of 2023 to 15.7%, compared to 15.3% for the same period in 2022. The main reason for the increase was due to a combination of some higher non-recurring expenses and lower net earned premiums as a result of the increased reinsurance costs.

Segment Results

We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the three months ended September 30, 2023 and 2022 (dollars in thousands):

Segment Gain (Loss)

32

Results of Operations For The Nine Months Ended September 30, 2023 and 2022

The following table summarizes our operating results for the periods indicated (dollars in thousands):

(1) The loss ratio is the ratio, expressed as a percentage, of net losses and loss adjustment expenses to net earned premiums and other income from underwriting operations.

(2) The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and other underwriting expenses to net earned premiums and other income from underwriting operations.

(3) The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.

* Percentage change is not meaningful.

Premiums

Premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. Almost all commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over the terms of the policies.

Our premiums are presented below for the nine months ended September 30, 2023 and 2022 (dollars in thousands):

Gross written premiums increased $16.0 million, or 15.4%, to $119.4 million for the nine months ended September 30, 2023, as compared to $103.5 million for the same period in 2022.

Commercial lines gross written premiums increased $3.9 million, or 4.5%, to $92.2 million for the nine months ended September 30, 2023, as compared to $88.3 million in the same period of 2022. The increase was due to $8.3 million of premium growth in the Company’s small business programs, partially offset by a $4.4 million reduction of gross written premium in the Company’s hospitality programs.

Personal lines gross written premiums increased $12.0 million, or 79.3%, to $27.2 million for the nine months ended September 30, 2023, as compared to $15.2 million for the same period in 2022. The increased gross written premiums were due to $7.0 million of premium growth in the Company’s low-value dwelling book of business.

Net written premiums decreased $15.6 million, or 22.6%, to $53.4 million for the nine months ended September 30, 2023, as compared to $69.0 million for the same period in 2022. The Company's gross unearned premium related to its security guard and alarm program was $30.9 million as of September 30, 2023. As part of the Core Specialty transaction, the Company ceded 100% of its gross unearned premium related to its security guard and alarm book of business to Core Specialty as of September 30, 2023. This increased the Company's net ceded written premium by $18.6 million in its commercial lines of business for the nine months ended September 30, 2023. Commercial lines net written premiums further decreased due to more ceded premiums as a result of a higher reinsurance cost and the Company entered into a new quota share reinsurance agreement, effective January 1, 2023. The new 50% quota share treaty applies to a subset of our commercial business that represents approximately 11.0% of our gross written premiums for the nine months ended September 30, 2023. The Company ceded $8.7 million of written premium related to this quota share reinsurance agreement for the nine months ended September 30, 2023.

Other Income

Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings and policy issuance costs. Commission income is also received by the Company’s insurance agency for writing policies for third-party insurance companies. Other income decreased by $501,000, or 25.5%, to $1.5 million, for the nine months ended September 30, 2023, compared to $2.0 million for the same period in 2022. The decrease was due to the Company's Wholesale Agency business revenue decreasing by $907,000, or 30.6%, to $2.1 million for the nine months ended September 30, 2023, compared to $3.0 million for the same period in 2022. A majority of the decrease in Wholesale Agency revenue was because of the business contributed to SSU, which was then deconsolidated as of December 31, 2022, and thus not reflected in the Company's consolidated income.

Losses and Loss Adjustment Expenses

The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the nine months ended September 30, 2023 and 2022(dollars in thousands).

Net losses and LAE decreased by $3.0 million, or 5.3%, to $53.9 million for the nine months ended September 30, 2023, compared to $56.9 million for the same period in 2022. The decrease in losses was driven by a $15.2 million decrease in adverse development quarter-over-quarter. This decrease was partially offset by a $12.2 million increase in current accident year losses, driven by the storm losses described above.

For the nine months ended September 30, 2023, the Company recognized $4.1 million of adverse development in the commercial liability lines of business, related to accident years 2020 through 2022, offset by $1.2 million of favorable development in the personal lines segment.

Of the $18.2 million of adverse development experienced in the first nine months of 2022, $14.3 million was related to 2019 and prior accident years, $2.2 million was related to the 2020 accident year, and $1.7 million was related to the 2021 accident year. Substantially all of the $18.2 million of adverse development was related to the Company’s commercial lines of business.

Expense Ratio

Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses.

The table below provides the expense ratio by major component.

Our expense ratio decreased 2.5% during the first nine months of 2023, compared to the same period in 2022.

Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased by 4.1%, from 23.4% in the first nine months of 2022, to 19.3% for the same period in 2023. The decrease was primarily related to additional ceding commissions, which reduces commission expense, as a result of the new quota share reinsurance treaty mentioned above.

Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other underwriting income increased by 1.6% to 17.0% for the nine months ended September 30, 2023, as compared to 15.4% for the same period in 2022. The operating expense ratios are higher primarily due to increased reinsurance costs which have lowered net earned premiums.

Segment Results

We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the nine months ended September 30, 2023 and 2022 (dollars in thousands):

Liquidity and Capital Resources

Sources and Uses of Funds

At September 30, 2023, the Company had $54.9 million in cash, cash equivalents and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturities and sales of invested assets and installment fees. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt.

We believe that our existing cash, cash equivalents, short-term investments and investment securities balances will be adequate to meet our capital and liquidity needs and the needs of our subsidiaries on a short-term and long-term basis.

We conduct our business operations primarily through our Insurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the Parent Company. Secondarily, the Parent Company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the holding company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the Parent Company. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10% of statutory surplus at the end of the preceding year. No dividends were paid from our Insurance Company Subsidiaries during the nine months ended September 30, 2023 and 2022.

On November 2, 2023, CIC purchased $4.0 million of the Company’s new public notes providing another means in which the holding company can source cash. This will be not be reflected as outstanding debt on a consolidated basis.

In September 2023, the Company repaid its $24.4 million of senior public debt and funded it, in part, with issuing new public debt in the amount of $17.9 million with a 9.75% interest rate, or three percentage points higher than the old public notes. This new public debt has a five year term and all other terms and conditions are substantially the same as the old public debt. The Company also refinanced its subordinated debt into a senior secured note, paying down $500,000 of the debt resulting in a remaining $10.0 million of a senior secured note outstanding with a 12.5% interest rate. This rate is five percentage points higher than the historical rate on the subordinated debt of 7.5%. The maturity of the new senior secured note was shortened to five years (maturing on September 30, 2028) from 15 years (maturing on September 30, 2038) and there are now required quarterly principal payments of $250,000 with the balance due at maturity.

The changes to the debt structure will result in $1.0 million per year of principal to be paid on the senior secured debt that previously was not required. And the first year interest payments will be approximately $400,000 greater than with the subordinated debt. The interest payments on the public debt will be approximately $100,000 greater going forward. Management believes that there will be continued sufficient cash flow to the Parent Company to service these additional interest and principal payments.

Parent Company is required to pay certain intercompany obligations before December 31, 2023. Management believes that the Parent Company will have adequate cash flow to fund operations and service debt going forward. However, there is a current potential short fall over the next several months. To alleviate any concern as to whether the Company will have enough funds to satisfy its near term obligations, a member of the Company’s board of directors has pledged to fund up to $6.0 million in capital, by December 15, 2023, which could be used to fund these obligations or other cash needs. The member’s funding was conditioned on 1) the contribution would be in the form of a preferred stock with a dividend equal to the prime rate plus 2%, and is redeemable at the option of the company in 24 months with a redemption premium of $1.5 million. If the preferred is not redeemed, the preferred will convert into common stock at a price of $1.25 per share. And, 2) the member would have the right to nominate an additional board member.

Cash Flows

Operating Activities. Cash used in operating activities for the nine months ended September 30, 2023 was $729,000 compared to $14.1 million for the same period in 2022. The $13.5 million decrease in cash used in operating activities was primarily due a $9.3 million decrease in paid losses, a $6.0 million decrease in acquisition costs paid, and a $15.4 million increase in the funds held under reinsurance agreements liability account during the period. These amounts were offset by a $16.1 million decrease in net premiums collected for the first nine months of 2023, compared to the same period in 2022.

Investing Activities. Cash used in investing activities for the nine months ended September 30, 2023 was $4.0 million, compared to $20.1 million of cash provided by investing activities for the same period in 2022. The $24.3 million decrease in cash provided by investing activities was driven by a $78.0 million decrease in proceeds from sales of investments. This was partially offset by $62.5 million decrease in purchases of investments during the first nine months of 2023.

Financing Activities. Cash used in financing activities for the nine months ended September 30, 2023 was $8.9 million compared to $19.5 million of cash provided by financing activities in the same period of 2022. The $28.4 million decrease in cash provided by financing activities was mostly attributable to the Company paying down $13.7 million of its long-term debt during the third quarter of 2023, and the Company borrowing $14.5 million from the Federal Home Loan Bank of Indianapolis during the first nine months of 2022.

Statutory Capital and Surplus

Our Insurance Company Subsidiaries are required to file quarterly and annual financial reports with state insurance regulators. These financial reports are prepared using statutory accounting practices promulgated by the Insurance Company

Subsidiaries’ state of domiciliary, rather than GAAP. The Insurance Company Subsidiaries’ aggregate statutory capital and surplus (which is a statutory measure of equity) was $53.2 million and $59.9 million at September 30, 2023 and December 31, 2022, respectively.

Non-GAAP Financial Measures

Adjusted Operating Income and Adjusted Operating Income Per Share

Adjusted operating income and adjusted operating income per share are non-GAAP measures that represent net income allocable to common shareholders excluding net realized investment gains or losses, changes in fair value of equity securities, the gain from the sale of the renewal rights business, and other gains and losses; all net of tax. The most directly comparable financial GAAP measures to adjusted operating income and adjusted operating income per share are net income and net income per share, respectively. Adjusted operating income and adjusted operating income per share are intended as supplemental information and are not meant to replace net income or net income per share. Adjusted operating income and adjusted operating income per share should be read in conjunction with the GAAP financial results. Our definition of adjusted operating income may be different from that used by other companies. The following is a reconciliation of net income (loss) to adjusted operating income (loss) (dollars in thousands), as well as net income (loss) per share to adjusted operating income (loss) per share:

We use adjusted operating income and adjusted operating income per share to assess our performance and to evaluate the results of our overall business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized gains and losses as a result of our market risk sensitive instruments, which primarily relate to debt securities that are available for sale and not held for trading purposes. The change in fair value of equity securities and realized gains and losses may vary significantly between periods and are generally driven by external economic developments, such as capital market conditions. Accordingly, adjusted operating income excludes the effect of items that tend to be highly variable from period to period and highlights the results from our ongoing business operations and the underlying results of our business. We believe that it is useful for investors to evaluate adjusted operating income and adjusted operating income per share, along with net income and net income per share, when reviewing and evaluating our performance.

Recently Issued Accounting Pronouncements

Refer to Note 1 ~ Summary of Significant Accounting Policies – Recently Issued Accounting Guidance of the Notes to the Consolidated Financial Statements for detailed information regarding recently issued accounting pronouncements.

Market risk is the risk of loss arising from adverse changes in market rates and prices such as interest rates, other relevant market rates or price changes. The volatility and liquidity in the markets in which the underlying assets are traded directly influence market risk. The following is a discussion of our primary market risk exposures and how those exposures are currently managed as of September 30, 2023. Our market risk sensitive instruments are primarily related to fixed income securities, which are available-for-sale and not held for trading purposes.

Interest Rate Risk

At September 30, 2023, the fair value of our investment portfolio, excluding cash and cash equivalents, was $144.6 million. Our investment portfolio consists principally of investment-grade, fixed-income securities, all of which are classified as available for sale. Accordingly, the primary market risk exposure to our debt securities is interest rate risk. In general, the fair market value of a portfolio of debt securities increases or decreases inversely with changes in market interest rates, while net investment income realized from future investments in debt securities increases or decreases along with interest rates. We attempt to mitigate interest rate risks by investing in securities with varied maturity dates and by managing the duration of our investment portfolio to a defined range of three to four years. The effective duration of our portfolio as of September 30, 2023 and December 31, 2022 was 2.8 and 3.5 years, respectively.

The table below illustrates the sensitivity of the fair value of our debt investments, classified as debt securities and short-term investments, to selected hypothetical changes in interest rates as of September 30, 2023. The selected scenarios are not predictions of future events, but rather illustrate the effect that events may have on the fair value of the debt portfolio and shareholders’ equity (dollars in thousands).

Credit Risk

An additional exposure to our debt securities portfolio is credit risk. We manage our credit risk by investing only in investment-grade securities. In addition, we comply with applicable statutory requirements, which limit the portion of our total investment portfolio that we can invest in any one security.

We are subject to credit risks with respect to our reinsurers. Although a reinsurer is liable for losses to the extent of the coverage which it assumes, our reinsurance contracts do not discharge our insurance companies from primary liability to each policyholder for the full amount of the applicable policy, and consequently our insurance companies remain obligated to pay claims in accordance with the terms of the policies regardless of whether a reinsurer fulfills or defaults on its obligations under the related reinsurance agreement. To mitigate our credit risk to reinsurance companies, we attempt to select financially strong reinsurers with an A.M. Best rating of “A-” or better and continue to evaluate their financial condition throughout the duration of our agreements.

At September 30, 2023, the net amount due to the Company from reinsurers, including prepaid reinsurance premiums, was $92.1 million. We believe all amounts recorded as due from reinsurers are recoverable.

Effects of Inflation

We do not believe that inflation has a material effect on our results of operations, except for the effect that inflation may have on interest rates and claims costs. We consider the effects of inflation in pricing and estimating reserves for unpaid losses and LAE. The actual effects of inflation on our results are not known until claims are ultimately settled. In addition to general price inflation, we are exposed to a long-term upward trend in the cost of judicial awards for damages.

Disclosure Controls and Procedures

The Company’s management, including its Co-Chief Executive Officers and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of September 30, 2023. Based on such evaluations, the Co-Chief Executive Officers and Chief Financial Officer have concluded the Company’s disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, and that information is accumulated and communicated to the Company’s management, including the Co-Company’s Chief Executive Officers and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

For the three months ended September 30, 2023, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect the Company's internal control over financial reporting.

There were no material changes to the risk factors disclosed in our Annual Report on Form 10-K (“Item 1A Risk Factors”) filed with the SEC on March 27, 2023.