Presurance Holdings, Inc.: Form 10-Q for the period ended Mar 31, 2024

For the Periods Ended March 31, 2024 and 2023

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 April 1, 2024 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 April 1, 2024 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

Strategic Shift from Premium Revenues to Commission Revenues

In the first quarter of 2024, the Company began a strategic shift that will reduce premiums revenues from underwriting operations and increase commission revenues from policy production within the MGA. The Company began utilizing one third-party insurer for the underwriting capacity in one program, but is expected to see significant expansion of the use of two third-party insurers during the second quarter of 2024. By the third quarter of 2024, we expect that almost all commercial lines business previously underwritten by the Company’s Insurance Company Subsidiaries will be written by third-party insurers. The Company expects to continue to directly write the Midwest and Texas homeowners business.

A.M. Best and Kroll

On March 25, 2024, Kroll downgraded the financial strength ratings of CIC and WPIC. Kroll has given CIC an insurance financial strength rating of BB- with a negative outlook. Kroll has given WPIC an insurance financial strength rating of B with a negative outlook. A BB- and a B rating indicates that the insurer's financial condition is low quality. Concurrently, the Company withdrew its participation in the rating process, and shall be non-rated by Kroll going forward.

On March 14, 2024, A.M. Best downgraded the financial strength ratings of CIC and WPIC to C. A rating of C means A.M. Best considers both companies to have a "weak" ability to meet ongoing financial obligations. Concurrently, the Company withdrew its participation in the rating process, and shall be non-rated by A.M. Best going forward.

Business Overview

We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 44 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 almost 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 MGA, CIS operates through our wholesale agency business segment. Through CIS, we offer commercial and personal lines insurance products for our Insurance Company Subsidiaries as well as third-party insurers. The wholesale agency business segment provides our agents with more insurance product options. We expect the wholesale agency segment to become more prominent going forward as substantially all of our commercial lines business will be produced by our MGA and underwritten by third-party insurers.

An advantage of using these third-party insurers is they will both have a minimum of an A- A.M. Best rating, which greatly improves our competitive edge in the marketplace.

As we transition to more of a MGA operation, more revenues will be derived from commissions while insurance premiums and investment income will diminish over time. Cash flows from written premiums will decline quickly over the next two quarters and will be almost entirely comprised of the homeowners business by the third quarter of 2024. Concurrently, cash flows from commissions revenues will increase. As claims are settled, claim payments will be funded from the sale of investments within the Insurance Company Subsidiaries. Such claims payments will reduce cash flows provided by operating activities and will be offset by an increase in cash flows from investing activities as the investment portfolio is liquidated over time to fund the claim payments. Management may consider the sale of other assets to generate additional cash resources available to the Company.

There will be fewer claim payments as loss reserves run off. Other operating costs and commissions to retail agencies will fluctuate relatively similarly to the premiums produced by the MGA as they did when the premiums were written by the insurance companies. However, certain insurance company specific costs will decrease as the premium volume in the insurance company subsidiaries decreases. We expect that the net revenues generated in the MGA will provide the majority of the cash flows needed to cover operating and debt service costs going forward.

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 three months ended March 31, 2024, 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 April 1, 2024.

Executive Overview

The Company reported $24.3 million of gross written premiums in the first quarter of 2024, representing a 32.9% decrease as compared to the same period in 2023. Our commercial lines gross written premiums decreased by $16.2 million, or 56.0%, to $12.8 million in the first quarter of 2024, compared to $29.0 million for the same period in 2023. Personal lines gross written premiums increased by $4.3 million, or 59.6%, to $11.6 million in the first quarter of 2024, compared to $7.2 million for the same period in 2023.

The Company reported net income allocable to common shareholders of $74,000, or $0.01 per share for the three months ended March 31, 2024. The Company reported net income of $1.0 million, or $0.08 per share, for the three months ended March 31, 2023.

Adjusted operating income per share is a non-GAAP measure that represents net income allocable to common shareholders excluding net realized investment gains or losses, change in fair value of equity securities, and other gains or losses. Adjusted operating income was $188,000, or $0.02 per share, for the three months ended March 31, 2024. Adjusted operating income was $307,000, or $0.03 per share, for the three months ended March 31, 2023.

Our underwriting combined ratio was 96.7% and 99.5% for the three months ended March 31, 2024 and 2023, respectively.

Results of Operations For The Three Months Ended March 31, 2024 and 2023

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 March 31, 2024 and 2023 (dollars in thousands):

Summary of Premium Revenue

Gross written premiums decreased $11.9 million, or 32.9%, to $24.3 million for the three months ended March 31, 2024, as compared to $36.2 million for the same period in 2023.

Commercial lines gross written premiums decreased $16.2 million, or 56.0%, to $12.8 million in the first quarter of 2024, as compared to $29.0 million for the first quarter of 2023. There was a $13.5 million decrease in premiums due to the sale of the Security Program in September 2023, as well as continued reductions in certain hospitality lines as we exited less profitable states. To a lesser degree, some of the premium reduction was due to our MGA beginning to shift business from our Insurance Company Subsidiaries to the third-party insurers. This impact will be significantly greater in the second and third quarters of 2024.

Personal lines gross written premiums increased $4.3 million, or 59.6%, to $11.6 million in the first quarter of 2024, as compared to $7.2 million for the same period in 2023. The increase was due to the organic growth in the low-value dwelling book of business in Texas and Oklahoma. The Company is expected to discontinue writing in Oklahoma in the second quarter of 2024, while Texas homeowners is expected to continue to grow.

Net written premiums decreased $3.0 million, or 16.1%, to $15.4 million for the three months ended March 31, 2024, as compared to $18.3 million for the same period in 2023. Net written premiums declined as a result of the Company's reduction in gross written premiums during the first quarter of 2024.

Agency Commission Income

Commission income is received by the Company’s insurance agency for writing policies for third-party insurance companies. Agency commission income increased by $3.9 million to $4.3 million during the first quarter of 2024, compared to $430,000 for the same period in 2023. The increase was due to the Company's Security Program transaction in September of 2023. As part of the arrangement with the buyer, our MGA was appointed as the producer for this business, for approximately a two-year transition period. During this time our MGA will receive a commission from the buyer, and pay a sub-producer substantially the same commission. This will result in higher consolidated Agency Commission Income for the Company. Policy acquisition costs will remain substantially the same amount for the period of this agreement. In the first quarter of 2024, the Company recorded $3.6 million of commission revenue and $3.6 million of commission expense as a result of this arrangement. Going forward, as our MGA produces more business for third-party insurers, we expect that commission revenue, net of expense, is to grow significantly.

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 March 31, 2024 and 2023 (dollars in thousands):

Net losses and LAE decreased by $3.2 million, or 23.3%, to $10.5 million during the first quarter of 2024, compared to $13.7 million for the same period in 2023. The decrease was attributable to a $3.9 million decrease in current accident year losses during the first quarter of 2024, compared to the same period in 2023.

The Company’s incurred losses during the three months ended March 31, 2024 included prior-year favorable development of $461,000. Of the $461,000 of favorable development experience during the first quarter of 2024, $508,000 of favorable development was experienced in the Company's personal lines of business, mostly related to accident year 2023. The $508,000 of favorable development in the Company's personal lines was offset by $47,000 of adverse development in the Company's commercial lines of business, mostly related to accident year 2022.

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 2.6% during the first quarter of 2024, compared to the same period in 2023.

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 2.1% during the first quarter of 2024 to 18.7%, compared to 20.8% during the same period in 2023. The decrease was primarily related to the impact from the ceding commissions received from the unearned premium transfer of the Security Program effective September 30, 2023.

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 decreased by 0.5% during the first quarter of 2024 to 16.0%, compared to 16.5% for the same period in 2023. The decrease was primarily due to cost-reducing measures taken by management throughout the year.

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 March 31, 2024 and 2023 (dollars in thousands):

Segment Gain (Loss)

* Elimination amounts are a result of more intercompany commission revenue being generated in the Wholesale Agency, which is recognized when the premiums are written, while the Insurance Company Subsidiaries recognize the intercompany commission expense when the premiums are earned. This timing difference between two consolidating companies is adjusted through Eliminations.

Liquidity and Capital Resources

Sources and Uses of Funds

At March 31, 2024, the Company had $41.0 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.

For the next twelve months, based on the capital structure as of March 31, 2024, the Company will be required to make $1.0 million of principal payments on the senior secured notes, $630,000 of preferred dividend payments and approximately $2.9 million of interest on all of the Company's debt instruments, all of which are paid quarterly.

We conduct our business operations primarily through our Insurance Company Subsidiaries and our MGA. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries and MGA to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries and MGA 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. There were no dividends paid from our Insurance Company Subsidiaries for the three months ended March 31, 2024 and 2023, respectively. We do not anticipate any dividends being paid to us from our insurance subsidiaries in the near term. The MGA may pay dividends to the Parent without regulatory restrictions, and we believe is will be utilized as the MGA begins to produce more business for third-party insurers.

Due to significant losses in 2023, much of which was attributable to strengthening reserves and severe storm activity affecting the Oklahoma homeowners business, both Insurance Company Subsidiaries lack sufficient capital to continue to underwrite the volume of business they have historically written. Also, both CIC and WPIC fell below critical statutory capital and surplus minimum requirements including the Risk Based Capital (“RBC”) ratio. CIC’s and WPIC’s RBC ratios at December 31, 2023, were 169% and 142%, respectively. The Insurance Company Subsidiaries submitted an action plan with the state of domicile insurance regulator on April 1, 2024, to remediate certain statutory capital and surplus regulatory deficiencies. As part of the plan, WPIC will no longer write any business after June 30, 2024, and CIC will only write a small amount of commercial business as well as the homeowners business after June 30, 2024. These actions were part of a strategic shift implemented by management to utilize third-party insurers and to mostly rely on commission revenues generated by our MGA to fund operations and service debt, going forward.

With the producer agreements currently executed, the Company expects to be able to generate the needed revenues to meet our obligations as they become due over the next twelve months. Management believes the actions that were executed to implement the planned strategic shift coupled with additional available sources of available liquidity, will be sufficient to enable the Company to meet its obligations for the foreseeable future.

Our outstanding public debt securities are currently trading at a discount to their face amount. In order to reduce future cash interest payments, as well as future amounts due at maturity or upon redemption, we may, from time to time, purchase such debt for cash, in exchange for common stock, or for a combination of cash and common stock, in open market or privately negotiated transactions. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in such transactions, individually or in the aggregate, may be material.

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.

Cash Flows

Operating Activities. Cash provided by operating activities for the three months ended March 31, 2024 was $8.2 million compared to cash used in operating activities of $6.0 million for the same period in 2023. The $14.2 million increase in cash provided by operating activities was primarily due a $12.4 million decrease in total net losses paid and a $4.0 million increase in other income received during the period. These amounts were offset by a $2.4 million increase in acquisition costs paid during the first three months of 2024, compared to the same period in 2023.

Investing Activities. Cash used in investing activities for the three months ended March 31, 2024 was $1.6 million, compared to $468,000 for the same period in 2023. The $1.1 million increase in cash used by investing activities was driven by a $9.3 million decrease in proceeds from sales of investment during the period. This amount was offset by a $7.7 million decrease in purchases of investments during the period.

Financing Activities. Cash used in financing activities for the three months ended March 31, 2024 was $426,000 compared to $0 for the same period in 2023. The $426,000 increase in cash used for financing activities was attributable to $176,000 of preferred stock dividends paid during the first quarter of 2024, and a $250,000 principal payment towards the Company's senior secured notes during the first quarter of 2024. The Company did not have the Senior Secured Notes or the preferred stock in the first quarter of 2023.

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 $34.0 million and $32.8 million at March 31, 2024 and December 31, 2023, 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 and other gains and losses. 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:

* The Company has recorded a full valuation allowance against its deferred tax assets as of March 31, 2024 and March 31, 2023, respectively. As a result, there were no taxable impacts to adjusted operating income from the adjustments to net income (loss) in the table above after taking into account the use of NOLs and the change in the valuation allowance.

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 March 31, 2024. 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 March 31, 2024, the fair value of our investment portfolio, excluding cash and cash equivalents, was $146.6 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 March 31, 2024 and December 31, 2023 was 2.7 and 2.9 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 March 31, 2024. 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 March 31, 2024, the net amount due to the Company from reinsurers, including prepaid reinsurance premiums, was $72.8 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 Chief Executive Officer 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 March 31, 2024. Based on such evaluations, the Executive Officer 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 Company’s Chief Executive Officer 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 March 31, 2024, 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 April 1, 2024.