(EDGAR Online via COMTEX) -- Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited interim consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this "Quarterly Report"), and in conjunction with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on February 24, 2020, as amended by Amendment No. 1 to Form 10-K filed with the SEC on March 10, 2020 (the "2019 Annual Report").
Certain restatements have been made to historical information to give effect to the merger and related transactions. See Note 1 - Basis of Reporting in the notes to the consolidated financial statements included in Part I, Item 1 of this Quarterly Report.
References to the "Company," "ProSight," "we," "us," and "our" are to ProSight Global, Inc. and its consolidated subsidiaries unless the context otherwise requires. References to "insurance subsidiaries" are to New York Marine and General Insurance Company ("New York Marine"), Gotham Insurance Company ("Gotham") and Southwest Marine and General Insurance Company ("Southwest Marine") unless the context otherwise requires.
Special Note Regarding Forward-Looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of Operations includes certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" in this Quarterly Report. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. Forward-looking statements include statements relating to future developments in our business or expectations for our future financial performance and any statement not involving a historical fact. Forward-looking statements use words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "should," "seek," and other words and terms of similar meaning. Forward-looking statements in this Quarterly Report include, but are not limited to, statements about:
� our strategies to continue our growth trajectory, expand our distribution network and maintain underwriting profitability;
� the impact of coronavirus disease 2019 ("COVID-19") and related economic conditions and governmental actions, including the Company's assessment of the vulnerability of certain categories of investments to the economic disruptions associated with COVID-19;
� future growth in existing niches or by entering into new niches;
� our loss expectations and expectation to decrease our loss ratio; and
� our expectations with respect to the ultimate financial obligations to the buyers of our United Kingdom ("U.K.") operations.
Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance or outcomes and that actual performance and outcomes may differ materially from those made in or suggested by the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market in which we operate, are consistent with the forward-looking statements contained in this Quarterly Report, those results or developments may not be indicative of results or developments in subsequent periods. New factors emerge from time to time that may cause our business not to develop as we expect, and it is not possible for us to predict all of them. Factors that could cause actual results and outcomes to differ from those reflected in forward-looking statements include:
� the performance of and our relationship with third-party agents and vendors we rely upon to distribute certain business on our behalf;
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� the adequacy of our loss reserves, including as a result of changes in the legal, regulatory, and economic environments in which the Company operates or the impacts of COVID-19;
� the direct and indirect impacts of COVID-19 and related risks such as governmental responses and economic contraction, including on the Company's investments and business operations, its distribution or other key partners and its customers;
� the effects of uncertain emerging claim and coverage issues on the Company's business, and court decisions or legislative or regulatory changes that take place after the Company issues its policies, including those taken in response to COVID-19 (such as effectively expanding workers' compensation coverage by instituting presumptions of compensability of claims for certain types of workers or requiring insurers to cover business interruption claims irrespective of terms, exclusions or other conditions included in the policies that would otherwise preclude coverage);
� the effectiveness of our risk management policies and procedures;
� potential technology breaches or failure of our or our business partners' systems;
� adverse changes in the economy which could lower the demand for our insurance products;
� our ability to effectively start up or integrate new product opportunities;
� cyclical changes in the insurance industry;
� the effects of natural and man-made catastrophic events;
� our ability to adequately assess risks and estimate losses;
� the availability and affordability of reinsurance;
� changes in interest rates, government monetary policies, general economic conditions, liquidity and overall market conditions;
� changes in the business, financial condition or results of operations of the entities in which we invest;
� increased costs as a result of operating as a public company, and time our management will be required to devote to new compliance initiatives;
� our ability to protect intellectual property rights;
� the impact of government regulation, including the impact of restrictions on our business activities under the Bank Holding Company ("BHC") Act;
� our status as an emerging growth company;
� the absence of a previous public market for shares of our common stock; and
� potential conflicts of interests with our principal stockholders.
We discuss many of these risks in greater detail under the section titled Item 1A. "Risk Factors." in the Company's 2019 Annual Report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Quarterly Report by these cautionary statements. Except as
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required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.
We are an entrepreneurial specialty insurance company that since our founding in 2009 has built products, services and solutions with the goal of significantly improving the experience and value proposition for our customers. We write property and casualty insurance with a focus on underwriting specialty risks by partnering with a select number of distributors, often on an exclusive basis. We currently write insurance coverage in eight customer segments across a broad range of specialty lines of business. Our customer segments currently include:
Components of Our Results of Operations
Gross Written and Earned Premiums
Gross written premiums ("GWP") are the amounts received or to be received for insurance policies written by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our GWP in any given period is generally influenced by:
� Expansion or retraction of business within existing niches;
� Entrance into new customer segments or niches;
� Exit from customer segments or niches;
� Average size and premium rate of newly issued and renewed policies; and
� The amount of policy endorsements, audit premiums, and cancellations.
We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our GWP, less that portion of our GWP that is earned and ceded to third-party reinsurers under our reinsurance agreements.
Ceded Written and Earned Premiums
Ceded written premiums are the amount of GWP ceded to reinsurers. We actively use ceded reinsurance across our book of business to reduce our overall risk position and to protect our capital. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered and the underlying policies. The volume of our ceded written premiums is impacted by the level of our GWP and any decision we make to increase or decrease retention levels.
Net Investment Income
We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of debt securities, and may also include cash and cash equivalents, short-term investments, non-
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redeemable preferred stock securities, and limited partnerships. Our limited partnerships are not accounted for on a lag and thus reflect the current period fair value adjustments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value, such as changes in interest rates and credit spreads), the size of our investment portfolio is mainly a function of our invested equity capital along with premiums we receive from our insureds less payments on policyholder claims and operating expenses.
Realized Investment Gains and Losses
Realized investment gains and losses are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost, as well as any change in current expected credit loss allowance for available-for-sale investments recognized in earnings.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses ("LAE") are a function of the amount and type of insurance contracts we write, the loss experience associated with the underlying coverage, and the expenses incurred in the handling of the losses. In general, our losses and LAE are affected by:
� Frequency of claims associated with the particular types of insurance contracts that we write;
� Trends in the average size of losses incurred on a particular type of business;
� Mix of business written by us;
� Changes in the legal or regulatory environment related to the business we write;
� Trends in legal defense costs;
� Wage inflation; and
� Inflation in medical costs.
Losses and LAE are based on an actuarial analysis of the paid and estimated outstanding losses, including losses incurred during the period and changes in estimates from prior periods. Losses and LAE may be paid out over a number of years.
Within Losses and LAE, we report catastrophe losses separately. Catastrophe losses are unusual in nature and do not reflect upon the normal loss results of our underlying business. We define catastrophe losses as any one claim, or group of claims, with an accumulation of paid and estimated outstanding losses equal to or greater than $1.0 million related to a single, natural or man-made loss event as designated by Property Claims Services ("PCS").
Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our distribution partners and ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs that are directly related to the successful acquisition of those policies are deferred. The amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the policy life. Other underwriting expenses represent the general and administrative expenses of our insurance business including employment costs, telecommunication and technology costs, the costs of our leases, and legal and auditing fees.
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Income Tax Expense
Substantially all of our income tax expense relates to U.S. federal income taxes. Our insurance companies are generally not subject to income taxes in the states in which they operate; however, our non-insurance subsidiaries are subject to state income taxes. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect. Our income tax expense for periods beginning in 2018 is based on the U.S. federal corporate income tax rate of 21%.
We discuss certain key metrics, described below, which provide useful information about our business and the operational factors underlying our financial performance.
Net income is the amount of profit or loss remaining after deducting all incurred expenses, including income taxes, from the total earned revenues for an accounting period.
Underwriting income is calculated by subtracting losses and LAE and underwriting, acquisition and insurance expenses from net earned premiums.
Adjusted operating income is net income excluding net realized investment gains and losses, expenses relating to various transactions that we consider to be unique and non-recurring in nature (net of estimated tax impact).
Loss and LAE ratio, expressed as a percentage, is the ratio of losses and LAE, allocated and unallocated, to net earned premiums, net of the effects of reinsurance.
Expense ratio, expressed as a percentage, is the ratio of underwriting, acquisition and insurance expenses to net earned premiums.
Combined ratio is the sum of the loss and LAE ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
Adjusted loss and LAE ratio is the loss and LAE ratio excluding the effects of the whole account quota share reinsurance agreement ("WAQS") (as defined below).
Adjusted expense ratio is the expense ratio excluding the effects of the WAQS.
Adjusted combined ratio is the combined ratio excluding the effects of the WAQS.
Return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
Adjusted operating return on equity is adjusted operating income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
Net retention ratio is the ratio of net written premiums to GWP.
Underwriting income, adjusted operating income, adjusted loss and LAE ratio, adjusted expense ratio, adjusted combined ratio and adjusted operating return on equity are non-generally accepted accounting principles ("GAAP") financial measures. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income and adjusted operating income. See "Factors Affecting Our Results of Operations-The WAQS" for additional detail on the impact of the WAQS on our results of operations.
Factors Affecting Our Results of Operations
In connection with the divestment of our U.K. business, New York Marine as reinsured entered into the WAQS with third party reinsurers to maintain reasonable underwriting leverage within New York Marine and its subsidiary insurance companies during a transition period following the U.K. divestment. The effective date of the WAQS was April
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1, 2017. The reinsurers' ceding participation is an aggregate 26.0%. A provisional ceding commission of 30.0% to 30.5% is received as a reduction in the amount of ceded premium. Subject to limits, these ceding commissions will vary in subsequent periods based on contractual ultimate loss ratios. During 2018 and following the transition of the U.S. business back to New York Marine, the WAQS were terminated. Previously ceded written and unearned premium, net of the ceding commission, was reversed. Loss reserves on premium earned prior to the cut-off termination remain ceded loss reserves. Loss reserve development on the reserves ceded under the WAQS is included in continuing operations. Effective January 1, 2020, the WAQS was commuted at an amount equal to ceded reserves.
The effect of the WAQS on our results of operations is primarily reflected in our ceded written premiums, losses and LAE, as well as our underwriting, acquisition and insurance expenses. For the three months ended March 31, 2020 and 2019, respectively, there was no impact of WAQS on underwriting results or ratios.
The following tables summarize the effect of the WAQS on our underwriting income for the three months ended March 31, 2020 and 2019:
Three Months Ended March 31, 2020 Three Months Ended March 31, 2019 Including Effect of Excluding Including Effect of Excluding ($ in thousands) WAQS WAQS WAQS WAQS WAQS WAQS GWP $ 213,784 $ - $ 213,784 $ 255,838 $ - $ 255,838 Ceded written premiums (23,601) - (23,601) (45,936) - (45,936) Net written premiums $ 190,183 $ - $ 190,183 $ 209,902 $ - $ 209,902 Net retention (1) 89.0% - 89.0% 82.0% - 82.0% Net earned premiums $ 205,662 $ - $ 205,662 $ 195,608 $ - $ 195,608 Net losses and LAE incurred 127,557 - 127,557 118,333 - 118,333 Underwriting, acquisition and insurance expenses 73,623 - 73,623 73,767 - 73,767 Underwriting income (2) $ 4,482 $ - $ 4,482 $ 3,508 $ - $ 3,508 Loss and LAE ratio 62.0 % - - 60.5 % - - Expense ratio 35.8 % - - 37.7 % - - Combined ratio 97.8 % - - 98.2 % - - Adjusted loss and LAE ratio (3) - - 62.0 % - - 60.5 % Adjusted expense ratio (3) - - 35.8 % - - 37.7 % Adjusted combined ratio (3) - - 97.8 % - - 98.2 %
(1) Net retention is a non-GAAP measure. We define net retention as the ratio of net written premiums to GWP.
(2) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income to underwriting income.
(3) Adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined ratio are non-GAAP financial measures. We define adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined ratio as the corresponding ratio excluding the effects of the WAQS. We use these adjusted ratios as internal performance measures in the management of our operations because we believe they give our management and other users of our financial information useful insight into our results of operations and our underlying business performance. Our adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined ratio should not be viewed as substitutes for our loss and LAE ratio, expense ratio and combined ratio, respectively.
Our results of operations may be difficult to compare from year to year due to the origination and termination of the WAQS. In light of the impact of the WAQS on our results of operations, we internally evaluated our financial performance both including and excluding the effect of the WAQS.
As the coronavirus (COVID-19) pandemic continues to impact individuals and businesses worldwide, we are focused on the health and safety of our employees while fulfilling our obligations to our customers and distribution partners. Through the investments we have made in our technology infrastructure over time, we were able to seamlessly transition to a remote work model while maintaining the service and support levels that our customers expect. We are fully operational, and we believe we are in a good position to continue working remotely for as long as necessary.
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There was no significant impact on our premiums and losses in the first quarter relating to the pandemic. It is too early to determine the ultimate effect of the economic shut-down as a result of the pandemic on our revenues, however, assuming a sluggish economic recovery that begins to take hold in the third quarter of 2020, we estimate that this event could have a negative impact on GWP for the remainder of the year, with the most significant impact expected in the second quarter. Additionally, we may have a modest decline in yield with respect to our fixed maturity portfolio for 2020, with potential volatility in net investment income for the remainder of the year due to our limited partnership investments. Also, we may see an increase in claims activity and expense due to the pandemic, and potentially higher expense costs due to bad debt provisioning related to regulatory actions taken in response to COVID-19 to provide premium refunds, grant extended grace periods for premium payments, and provide extended time to pay past due premiums.
Our investment portfolio incurred significant valuation adjustments in the first quarter as credit spreads widened and liquidity contracted; this was reflected in first quarter financial results and while we have seen an improvement in unrealized investment positions as of the end of April, we expect there could be continued volatility in the unrealized position and uncertainty for the remainder of the year.
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Results of Operations Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019 The following table summarizes the results of continuing operations for the three months ended March 31, 2020 and 2019: Three Months Ended March 31 Change ($ in thousands) 2020 2019 $ Percent GWP $ 213,784 $ 255,838 $ (42,054) (16.4) % Ceded written premiums (23,601) (45,936) 22,335 (48.6) Net written premiums $ 190,183 $ 209,902 $ (19,719) (9.4) Net earned premiums $ 205,662 $ 195,608 $ 10,054 5.1 Net losses and LAE incurred: 127,557 118,333 9,224 7.8 Underwriting, acquisition and insurance expenses 73,623 73,767 (144) (0.2) Underwriting income (1) 4,482 3,508 974 27.8 Interest and other expenses, net 4,730 3,269 1,461 44.7 Net investment income 8,815 17,158 (8,343) (48.6) Realized investment gains, net 232 113 119 105.3 Income before taxes 8,799 17,510 (8,711) (49.7) Income tax expense 1,988 3,815 (1,827) (47.9) Net income from continuing operations $ 6,811 $ 13,695 $ (6,884) (50.3) Adjusted operating income (1) $ 7,976 $ 13,582 $ (5,606) (41.3) % Adjusted operating return on equity (1) 6.2 % 13.3 % Return on equity 5.3 % 13.4 % Loss and LAE ratio: 62.0 % 60.5 % Loss and LAE ratio - excluding catastrophe 62.0 % 60.5 % Loss and LAE ratio - catastrophe losses - - Expense ratio 35.8 % 37.7 % Combined ratio 97.8 % 98.2 % Adjusted loss and LAE ratio (2) 62.0 % 60.5 % Adjusted loss and LAE ratio - excluding catastrophe 62.0 % 60.5 % Adjusted loss and LAE ratio - catastrophe losses - - Adjusted expense ratio (2) 35.8 % 37.7 % Adjusted combined ratio (2) 97.8 % 98.2 %
(1) Underwriting income, adjusted operating income and adjusted operating return on equity are non-GAAP financial measures. See "-Reconciliation of Non-GAAP Financial Measures" for reconciliations of net income in accordance with GAAP to underwriting income and adjusted operating income.
(2) Adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined ratio are non-GAAP financial measures. We define adjusted loss and LAE ratio, adjusted expense ratio and adjusted combined ratio as the corresponding ratio excluding the effects of the WAQS. For additional detail on the impact of the WAQS on our results of operations see "-Factors Affecting Our Results of Operations-The WAQS."
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May 12, 2020
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