(EDGAR Online via COMTEX) -- Item 7. 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 audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Certain restatements have been made to historical information to give effect to the IPO merger, in which ProSight Global Holdings Limited merged with and into the Company, and related transactions. See Note 1 - Background in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those discussed in the section titled "Risk factors" included under Part I, Item 1A and elsewhere in this Annual Report on this Form 10-K. See "Special Note Regarding Forward-Looking Statements."
This section of this Annual Report on Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Annual Report on Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
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 Annual 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 Annual 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;
? our expectations with respect to the ultimate financial obligations to the buyers of our United Kingdom ("U.K.") operations; and
? statements we make relating to the proposed merger.
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
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statements contained in this Annual 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 Annual 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:
risks relating to our ability to obtain regulatory approvals of the proposed ? merger, including the timing, terms and conditions of any such approvals, which could affect our ability to complete the proposed merger;
the occurrence of any event, change or other circumstances that could give rise ? to the termination of the Merger Agreement, including a termination of the Merger Agreement under circumstances that could require us to pay a termination fee;
? the risk that the parties to the proposed merger may not be able to satisfy the conditions of the proposed merger in a timely manner or at all;
? risks related to disruption of management time from ongoing business operations due to the proposed merger;
risk that the proposed merger could have an adverse effect on our ability to ? retain and hire key personnel and maintain relationships with our customers, agents or business counterparties, and on our operating results and businesses generally;
? the outcome of any potential legal proceedings that may be instituted against us;
? the performance of and our relationship with third-party agents and vendors we rely upon to distribute certain business on our behalf;
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;
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? 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" of this 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 Annual Report by these cautionary statements. Except as 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.
On January 15, 2021, we announced that we had entered into an agreement and plan of merger (the "Merger Agreement") with Pedal Parent Inc., a Delaware corporation ("Parent"), owned by affiliates of TowerBrook Capital Partners L.P. and Further Global Capital Management, and Pedal Merger Sub, Inc., pursuant to which, subject to the terms and conditions of the Merger Agreement, Pedal Merger Sub, Inc. would merge with and into the Company (the "proposed merger"), with the Company surviving as a wholly owned subsidiary of Parent. For a further discussion of the proposed merger, see Item 1. "Business" and Note 22. "Subsequent Events" to our consolidated financial statements on this Annual Report.
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:
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that were at one time attractive but may become less so. We are focused on delivering consistent underwriting profitability with low volatility of underwriting results. We market and distribute our insurance product offerings in all 50 states on both an admitted and non-admitted basis.
Initial Public Offering
On July 29, 2019, the Company completed its initial public offering ("IPO") with the sale of 7,857,145 shares of the Company's common stock, including the issuance and sale by the Company of 4,285,715 shares of the Company's common stock and the sale by ProSight Parallel Investment LLC and ProSight Investment LLC ("PI") (collectively, the "GS Investors") and ProSight TPG, L.P., TPG PS 1, L.P., TPG PS 2, L.P., TPG PS 3, L.P. and TPG PS 4, L.P. (collectively the "TPG Investors" and together with the GS Investors, the "Principal Stockholders") of 3,571,430 shares of the Company's common stock.
Shares of the Company's common stock were initially offered to the public by the underwriters in the IPO at a per-share price of $14.00. The Company did not receive any of the proceeds from the sale of the shares of the Company's common stock sold by the Principal Stockholders in the IPO. Following the IPO, the GS Investors held approximately 40.9% of the Company's outstanding common stock and the TPG Investors held approximately 39.4% of the Company's outstanding common stock.
On August 15, 2019 the Principal Stockholders completed the sale of 1,178,570 shares of the Company's common stock at a price of $14.00 per share less the underwriting discount pursuant to the underwriters' exercise of their over-allotment option granted in connection with the IPO. The Company did not receive any of the proceeds from the sale of the shares of common stock of the Company sold by the Principal Stockholders in this offering. Following this offering, the GS Investors held approximately 39.5% of the Company's outstanding common stock and the TPG Investors held approximately 38.0% of the Company's outstanding common stock.
The offer and sale of all shares sold in the IPO, including those sold in connection with the underwriters' exercise of their over-allotment option, were registered pursuant to a registration statement filed on Form S-1, which the Securities and Exchange Commission ("SEC") declared effective on July 24, 2019. After deducting underwriting discounts and commissions and estimated offering expenses (including expenses related to the offering pursuant to the underwriters' exercise of their overallotment option), the net proceeds to the Company from the IPO were approximately $50.8 million.
We currently write insurance coverage in eight customer segments across a broad range of specialty lines of business. Our customer segments currently include:
The tables below set forth the gross written premiums ("GWP"), gross written commission ratios, and gross loss and allocated loss adjustment expense ("ALAE") ratios by customer segment for the years ended December 31, 2020, 2019, and 2018. We have one reportable segment, Specialty Insurance. "Other" includes GWP from: (i) primary and excess workers' compensation coverage for exited Self-Insured Groups; (ii) niches exited prior to 2018, many with a concentration in commercial auto; (iii) participation in industry pools; and (iv) emerging new business.
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GWP Years Ended December 31 ($ in millions) % Change % Change Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Construction $ 110.0 $ 117.9 $ 101.9 (6.7) % 15.7 % Consumer Services 123.0 133.7 107.1 (8.0) 24.8 Marine and Energy 110.2 94.7 83.1 16.4 14.0 Media and Entertainment 88.8 124.9 119.9 (28.9) 4.2 Professional Services 130.9 119.3 110.5 9.7 8.0 Real Estate 159.2 167.6 132.7 (5.0) 26.3 Sports 23.3 30.1 23.6 (22.6) 27.5 Transportation 64.6 112.2 92.2 (42.4) 21.7 Customer segments subtotal 810.0 900.4 771.0 (10.0) 16.8 Other 7.1 67.6 124.1 (89.5) (45.5) Total $ 817.1 $ 968.0 $ 895.1 (15.6) % 8.1 %
Gross Written Commission Ratio Years Ended December 31 % Change % Change Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Construction 20.2 % 20.3 % 20.7 % (0.1) % (0.4) % Consumer Services 21.5 18.1 17.1 3.4 1.0 Marine and Energy 19.7 18.5 17.9 1.2 0.6 Media and Entertainment 17.4 16.9 16.6 0.5 0.3 Professional Services 23.2 22.9 23.0 0.3 (0.1) Real Estate 20.6 21.2 21.1 (0.6) 0.1 Sports 22.7 23.0 22.7 (0.3) 0.3 Transportation 13.5 14.1 14.5 (0.6) (0.4) All customer segments 20.1 19.1 19.0 1.0 0.1 Other 17.8 16.6 18.1 1.2 (1.5) Total 20.1 % 18.9 % 18.9 % 1.2 % - %
Gross Loss and ALAE Ratio, excluding Unallocated Loss Adjustment Expense ("ULAE") Ratio
Years Ended December 31 % Change % Change Customer Segment 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Construction 58.9 % 58.0 % 56.1 % 0.9 % 1.9 % Consumer Services 77.0 65.5 58.0 11.5 7.5 Marine and Energy 57.4 52.0 32.4 5.4 19.6 Media and Entertainment 38.4 45.8 54.8 (7.4) (9.0) Professional Services 58.0 47.5 37.6 10.5 9.9 Real Estate 104.1 65.2 60.6 38.9 4.6 Sports 55.1 39.0 61.7 16.1 (22.7) Transportation 57.3 69.0 62.9 (11.7) 6.1 All customer segments 67.3 57.2 52.6 10.1 4.6 Other (351.6) 87.9 59.8 (439.5) 28.1 Total 64.9 % 60.4 % 53.6 % 4.5 % 6.8 %
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Components of Our Results of Operations
Gross written and earned 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, and alternative investments. 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 fixed maturity securities recognized in earnings.
Losses and Loss Adjustment Expenses ("LAE")
Losses and 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;
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? 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.
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, as well as taxes we pay to the states in which we write business, generally based on premium volume. 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.
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.
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 (loss) 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, impairment of goodwill and 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.
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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 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 whole account quota share reinsurance agreements (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 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. There were no ceded loss . . .
Feb 23, 2021
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