UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

For the fiscal year ended December 31, 2019

OR

 

Commission File Number 001-38814

 

POSITIVE PHYSICIANS HOLDINGS, INC.

(Exact name of Registrant as specified in its Charter)

 

 

 

Registrant’s telephone number, including area code: (888) 335-5335

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  YES ☐ NO ☒

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES ☒ NO ☐

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).  YES ☒ NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES ☐ NO ☒

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The NASDAQ Stock Market on June 28, 2019 (the last business day of the Registrant’s most recently completed second quarter) was approximately $50,617,000.

The number of shares of Registrant’s Common Stock outstanding as of May 11, 2020 was 3,615,500 with a par value of $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933.  The listed documents should be clearly described for identification purposes (e.g., annual report to security holders for fiscal year ended December 24, 1980).

 

 

 

 

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Table of Contents

 

 

 

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PART I

Forward-Looking Statements

This report may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 with respect to the Company’s business, financial condition and results of operations and the plans and objectives of its management.  Forward-looking statements can generally be identified by use of forward-looking terminology such as “may,” “will,” “plan,” “expect,” “intend,” “anticipate,” and “believe.”  These forward-looking statements may include estimates, assumptions or projections and are based on currently available financial, industry, competitive and economic data and our current operating plans.  All forward-looking statements are subject to risks and uncertainties, including risks regarding the effects and duration of the COVID-19 pandemic, that could cause actual results to differ materially from those expressed or implied by the forward-looking statements.

The effect of the COVID-19 pandemic on our operations could have a material adverse effect on our business, financial condition, results of operations, or cash flows.  The World Health Organization has declared the outbreak of COVID-19, which began in December 2019, a pandemic and the U.S. federal government has declared it a national emergency. Our business and operations could be materially and adversely affected by the effects of COVID-19. The global spread of COVID-19 has already created significant volatility, uncertainty and economic disruption in the markets in which we operate. Governments, public institutions, and other organizations in countries and localities where cases of COVID-19 have been detected are taking certain emergency measures to mitigate its spread, including implementing travel restrictions and closing factories, schools, public buildings, and businesses. While the full impact of this outbreak is not yet known, we are closely monitoring the spread of COVID-19 and continually assessing its potential effects on our business. 

As a result of current restrictions put in place to address COVID-19 and the related economic downturn, the Company has experienced business disruptions including, but not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force.  The extent to which our results continue to be affected by COVID-19 will largely depend on future developments which cannot be accurately predicted, including the duration and scope of the pandemic, governmental and business responses to the pandemic and the impact on the global economy.  While these factors are uncertain, the COVID-19 pandemic or the perception of its effects could continue to have a material adverse effect on our business, financial condition, results of operations, or cash flows.

Other factors that could cause actual results to differ materially from those in the forward-looking statements, include, but are not limited to:

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Because forward-looking information is subject to various risks and uncertainties, actual results may differ materially from that expressed or implied by the forward-looking information. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. These forward-looking statements speak only as of the date of the report. The Company expressly disclaims any obligation to publicly release any updates or revisions to reflect any change in the Company’s expectations with regard to any change in events, conditions or circumstances on which any such statement is based.

Item 1. Business.

Positive Physicians Holdings, Inc. (the “Company”) is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”).  In connection with the completion of the Company’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies and were merged together to form Positive Physicians Insurance Company (“Positive Insurance Company”), a wholly owned subsidiary of the Company.  The Company’s initial public offering and its acquisition of Positive Insurance Company were completed on March 27, 2019.  Prior to that time, the Company had minimal assets and liabilities and had not engaged in any operations.  References to the Company or Positive Insurance Company financial information in this Annual Report prior to the conversion and merger date is to the financial information of PPIX, PCA, and PIPE on a combined basis.  When used in this Annual Report, “we” and “our” mean PPIX, PCA, and PIPE prior to March 27, 2019, and Positive Insurance Company thereafter.

Positive Insurance Company

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Diversus Management, LLC (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement.  Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement, effective March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based upon a percentage of Positive Insurance Company’s gross written premiums, less return premiums.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued by Positive Insurance Company and for all sales commissions paid to producers.

At December 31, 2019, the Company had total assets of $156,620,361 and shareholders’ equity of $73,193,405. For the year ended December 31, 2019, the Company had total revenues of $27,965,606 and a net loss of $238,951.

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The executive offices of the Company are located at 100 Berwyn Park, 850 Cassatt Road, Suite 220, Berwyn, PA 19312, and its telephone number is 888-335-5335. The Company’s web site address is www.positivephysicians.com. Information contained on such website is not incorporated by reference into this Annual Report on Form 10-K, and such information should not be considered to be part of this Annual Report on Form 10-K.

Option Agreement

Upon completion of the conversions of PPIX, PCA, and PIPE and the securities offering on March 27, 2019, the Company and Diversus entered into an option agreement whereby either party has the option to cause Diversus, subject to shareholder approval, to merge with and become a wholly owned subsidiary of the Company.  Under the terms of the agreement, the option may be exercised by either the Company or Diversus at any time (1) during the period beginning 2 years after completion of the conversions of the exchanges and ending 54 months after the completion of the conversions, or (2) if earlier than 2 years after the completion of the conversions, then such date that the majority stockholder of the Company no longer has the right to appoint a majority of the board of directors of the Company.  In connection with any merger, the common stock shareholders of Diversus will receive either cash, common stock shares of the Company, or some combination thereof for their shares of Diversus’ common stock.  With respect to the preferred stock shares of Diversus, they will either be paid out in cash or converted into common stock shares of Diversus as if such preferred stock shares were converted into Diversus’ common stock shares immediately prior to the effective date of the merger.

Products and Services

Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers.  Medical professional liability insurance (“MPLI”) protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services.  We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Our policies include coverage for the cost of defending claims.  Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage.  We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires.  Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported.  Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.

The Company accounts for its medical professional liability insurance business as a single reporting segment line of business.

Marketing and Distribution

Our marketing philosophy is to sell profitable business in our core states, using a focused, cost-effective distribution system. Our medical professional liability insurance products are currently sold through approximately 93 retail producers in our territories of Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  All of these producers represent multiple insurance companies and are established businesses in the communities in which they operate. While we view our insureds as our primary customer, we view our independent insurance producers as important partners because they are in a position to recommend either our insurance products or those of a competitor to their customers. We consider our relationships with these producers to be good.

We review our producers annually with respect to both premium volume and profitability. Our producers will be monitored and supported primarily by our marketing employees, who have the principal responsibility for recruiting and training new producers. We meet regularly with producers to provide both technical training about our products and sales training about how to effectively market our products.

Producers are compensated through a fixed base commission. Agents receive commission as a percentage of premiums (generally 10% to 12%) as their primary compensation from us. No profit-sharing commissions are paid to agents based upon the profitability of the business they produce.

Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service and claims processing, resulting in a positive experience for producers and policyholders. We believe that these positive experiences result in higher policyholder retention and new business opportunities when communicated by producers and policyholders to potential customers. While we rely on our independent agents for distribution and customer support, underwriting and claim handling responsibilities are retained by us. Many of our agents have had direct relationships with us for a number of years.

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Underwriting, Risk Assessment and Pricing

Although we are willing to consider physicians in most specialties and classifications for insurance coverage, we recognize that certain specialties present a higher exposure to frequency or severity of claims. Although the number of medical malpractice claims filed in Pennsylvania has decreased significantly since 2008, the severity of the claims brought has not decreased. Accordingly, we rely heavily on individual risk characteristics in determining which medical professionals to whom we will offer coverage.

Our underwriting philosophy is aimed at consistently generating profits through sound risk selection and pricing discipline. Through the management and underwriting staff of Diversus Management, we regularly establish rates and rating classifications for our physician and medical group insureds based on loss and loss adjustment expense experience that we have developed over the years and the loss and loss adjustment expense experience for the entire medical professional liability market. We have various rating classifications based on practice location, medical specialty and other liability factors.

The nature of our business requires that we remain sensitive to the marketplace and the pricing strategies of our competitors. Using the market information as our background, we normally set our prices based on our estimated future costs. From time to time, we may reduce or increase our discounts or apply a premium surcharge to achieve an appropriate return. Pricing flexibility allows us to provide a fair rate commensurate with the assumed liability. If our pricing strategy cannot yield sufficient premium to cover our costs on a particular type of risk, we may determine not to underwrite that risk. It is our philosophy not to sacrifice profitability for premium growth.

We also encourage our insureds to adopt and practice loss reduction methods and loss mitigation practices. Our integrated risk management platform can reduce claims occurring from lack of informed consent, surgical complications, or missed diagnoses. Similarly, required educational sessions for doctors and other medical professionals regarding record keeping, patient follow-up and other basic practices can reduce the frequency of claims. Premium credits are provided to physicians in higher risk specialties who take advantage of these loss reduction methods and loss mitigation practices. Medical professionals who do not commit to these practices and methods can be refused coverage.

Our competitive strategy in underwriting is to provide very high-quality service to our producers and insureds by responding quickly and effectively to information requests and policy submissions. Each policy undergoes the entire underwriting process prior to renewal. We maintain information on all aspects of our business, which is regularly reviewed to determine both agency and policyholder profitability. Specific information regarding individual insureds is monitored to assist us in making decisions about policy renewals or modifications.

Claims and Litigation Management

Our policies require us to provide a defense for our insureds in any suit involving a medical incident covered by the policy. The defense costs we incur are in addition to the limit of liability under the policy. Medical professional liability claims often involve the evaluation of highly technical medical issues, severe injuries and conflicting expert opinions.

Our claims management philosophy involves: (i) closure of claims through prompt and thorough investigation of the facts related to the claim; (ii) equitable settlement of meritorious claims; (iii) vigorous defense of unfounded claims as to coverage, liability or the amount claimed; and (iv) the use of mediation and arbitration combined, when appropriate, with agreements with plaintiff’s counsel limiting the range of damage awards. Our claims team supports our underwriting strategy by working to provide a timely, good faith claims handling response to our policyholders. Claims excellence is achieved by timely investigation and handling of claims, settlement of meritorious claims for equitable amounts, maintenance of adequate case reserves, and control of loss adjustment expenses.

Claims on insurance policies are received directly from the insured or through our independent producers. Our claims department supports our producer relationship strategy by working to provide a consistently responsive level of claim service to our policyholders. Positive Insurance Company is required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses for reported claims and for claims incurred but not reported, arising from policies that have been issued. Generally, these laws and regulations require that we provide for the ultimate cost of those claims, subject to our policy limits, without regard to how long it takes to settle them or the time value of money. We are also required to maintain reserves for extended reporting coverage we provide in the event of a physician’s death, disability and retirement, or DDR reserves, which are included in our reserves as a component of unearned premiums. The determination of reserves involves actuarial and statistical projections of what we expect to be the cost of the ultimate settlement and administration of such claims based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and potential changing judicial theories of liability.

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Our actuaries utilize standard actuarial techniques to project ultimate losses based on our paid and incurred loss information, as well as drawing from industry data. These projections are done using actual loss dollars and claim counts. We analyze loss trends and claims frequency and severity to determine our best estimate of the required reserves. We then record this best estimate in Positive Insurance Company’s financial statements. Our reserve methodology is discussed in greater detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.”

We have contracts with Gateway Risk Services, LLC and Andrews Outsource Solutions LLC, both of which are wholly owned subsidiaries of Diversus, under which those companies provide claims processing and risk management services.

Technology

Diversus Management uses commercially available software to provide the information management systems platform that runs its accounting, policy underwriting and issuance, and claims processing functions. These systems permit Diversus Management to integrate the accounting and reporting functions of our insurance operations. We have adopted a disaster recovery plan tailored to meet our needs and geographic location. A portion of the operations of Diversus Management is managed in a cloud environment using an outside service provider.

Reinsurance

Reinsurance Ceded. In accordance with insurance industry practice, we reinsure a portion of our exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by us are reinsured with other insurance companies principally to:

Under Pennsylvania law, each insured must maintain MPLI of at least $1,000,000 for each claim and $3,000,000 of annual aggregate coverage.  We provide primary insurance coverage up to $500,000 per claim and $1,500,000 of annual aggregate coverage. The Pennsylvania Medical Care Availability and Reduction of Error (“MCARE”) Fund provides coverage for any losses above $500,000 per claim up to $1,000,000.  In cases where coverage under the Pennsylvania MCARE Fund does not apply, the primary insurance provides coverage up to $1,000,000 per claim and $3,000,000 of annual aggregate coverage.  We retain the first $300,000 in loss on all Pennsylvania claims and reinsurance covers the excess up to $1,000,000 that is not covered by the Pennsylvania MCARE Fund.  We cede to reinsurers any Pennsylvania claims in excess of $1,000,000.      

Other states in which we write insurance require doctors to maintain certain minimum coverage and provide a fund that provides coverage for losses above a certain amount, but some states do not prescribe insurance requirements for doctors.

We offer primary coverage up to $1,000,000 for each claim and $3,000,000 of annual aggregate coverage in Delaware, Maryland, Michigan, Ohio, New Jersey, and South Carolina.  We retain the first $300,000 in loss for claims from these states, and reinsurance covers the excess up to $1,000,000.  If an insured in New Jersey requests, additional coverage of $1,000,000, each claim, each insured, each policy can be provided and is fully ceded to the reinsurer up to a maximum aggregate liability of $2,000,000 to the reinsurer per the term of the reinsurance agreement.  In South Carolina and Michigan, the insured can elect policy limits of $200,000 per claim and, on these claims, we retain the first $100,000 and the reinsurer covers the next $100,000.  

We also purchase additional reinsurance coverage for clash, losses in excess of policy limits and extra contractual obligation claims.

Our premiums under our current treaty year reinsurance agreement are based on a percentage of our earned premiums during the term of the agreement. The agreement was renewed on April 1, 2020.

Reinsurance does not legally discharge the insurance company issuing the policy from primary liability for the full amount due under the reinsured policies.  A primary factor in the selection of reinsurers from whom we purchase reinsurance is their financial strength. Our reinsurance arrangements are generally renegotiated annually.  The insolvency or inability of any reinsurer to meet its

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obligations to us could have a material adverse effect on our results of operations or financial condition.  Our reinsurance providers, the majority of whom are longstanding partners that understand our business, are all carefully selected with the help of our reinsurance broker.  We monitor the solvency of reinsurers through regular review of their financial statements and, if available, their A.M. Best ratings. Hannover Re, our current reinsurance partner, has an “A+ (Superior)” rating from A.M. Best.  According to A.M. Best, companies with a rating of “A” or better “have an excellent ability to meet their ongoing obligations to policyholders.”

Reinsurance Assumed. We generally do not assume risks from other insurance companies.  However, we could be required by statute to participate in guaranty funds, which are formed to pay claims on policies issued by insolvent property and casualty insurers domiciled in certain states, such as Pennsylvania.  This participation, where applicable, requires us to pay an annual assessment based on our premiums written and determined on a market share basis.  At December 31, 2019, our participation was not material.

Captive Insurance.  On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and is a wholly owned subsidiary of Positive Insurance Company.  PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018.  PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”).  Keystone is owned by an insured of Positive Insurance Company.  Effective October 16, 2018, Positive Insurance Company entered into a reinsurance agreement with Keystone and that agreement was endorsed in 2019 for continuous annual renewal.

Losses and Loss Adjustment Expenses

We are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (“LAE”). These reserves are established for both reported claims and for claims incurred but not reported (“IBNR”), arising from the policies we have issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what we expect to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and potential changing judicial theories of liability.

Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Our reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. We do not discount our reserves to recognize the time value of money. For a more detailed overview of our estimation process for reserves for losses and loss adjustment expenses see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.”

When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of our claims staff. In estimating the appropriate reserve, our claims staff considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss, to the extent determinable at the time. Case reserves are adjusted by our claims staff as more information becomes available and discovery progresses. It is our policy to settle each claim as expeditiously as possible.

We maintain IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating our ultimate net liability for both reported and IBNR claims and then subtracting the case reserves and paid losses and LAE for reported claims.

Each quarter, we compute our estimated ultimate liability using principles and procedures we have developed over several years. However, because the establishment of loss reserves is an inherently uncertain process, we cannot assure you that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made.

The following table provides a reconciliation of beginning and ending unpaid losses and LAE reserve balances of Positive Insurance Company for the years ended December 31, 2019 and 2018, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

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The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or anticipated to be settled for amounts less than originally estimated (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or anticipated to be settled for amounts greater than originally estimated (unfavorable or adverse development).

Reconciliation of Reserves for Losses and Loss Adjustment Expenses

The following tables set forth information about Positive Insurance Company’s incurred and paid loss development at December 31, 2019, net of reinsurance. The information about incurred and paid claims development for the years ended December 31, 2010 to December 31, 2018 is presented as supplementary information.

 

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The reconciliation for the net incurred and paid loss development tables to the liability for losses and LAE at December 31, 2019 reported in our balance sheet is as follows:

 

 

Investments

Our investments in fixed maturity securities are classified as available for sale and are carried at fair value with unrealized gains and losses, net of taxes, reflected as a component of equity. We also invest in equity securities which are stated at fair value with unrealized gains and losses credited or charged to net income (loss) as incurred.  The goal of our investment activities is to complement and support our overall mission. An important component of our operating results has been the return on invested assets. Our investment objectives are (i) accumulation and preservation of capital, (ii) optimization, within accepted risk levels, of after-tax returns, (iii) assuring proper levels of liquidity, (iv) providing for an acceptable and stable level of current income, (v) managing the maturities of our investment securities to reflect the maturities of our liabilities, and (vi) maintaining a quality, diversified portfolio. See Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”

In addition to any investments prohibited by the insurance laws and regulations of Pennsylvania, our investment policy prohibits the following investments and investing activities:

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The Board of Directors of Positive Insurance Company reviews and approves our investment policy annually.

Our investment portfolio is managed by Positive Insurance Company’s Investment Committee and Wilmington Trust, with the exception of certain direct investments at December 31, 2018, which previously represented approximately 4% of the total portfolio.

 

The following table sets forth information concerning our investment portfolio as of December 31.

 

 

At December 31, 2018, we had ownership interests in limited partnership equity hedge funds.  Our partnership interests were measured at fair value using the funds’ net asset values as a practical expedient.  At December 31, 2018, the fair value and cost basis of these investments were $4,051,399 and $3,547,687, respectively.  During the second half of 2019, we sold our interests in these limited partnership funds and recognized a pre-tax gain of $556,723.

At December 31, 2019, our fixed maturity securities had an overall average credit quality of A.  The following table summarizes the distribution of our fixed maturity investments as a percentage of fair value based on average credit ratings assigned by Standard & Poor’s.

 

 

At December 31, 2019, the average maturity of our fixed maturity investment portfolio was 3.6 years and the average duration was 3.1 years. As a result, the fair value of our investments may fluctuate significantly in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.

Our average cash and invested assets and investment income for 2019 and 2018 were as follows:

 

 

We use quoted values and other data provided by independent pricing services as inputs in our process for determining fair values of our investments. The pricing services cover substantially all of the securities in our portfolio for which publicly quoted values are not available. The pricing services’ evaluations represent an exit price, a good faith opinion as to what a buyer in the marketplace would pay for a security in a current sale. The pricing is based on observable inputs either directly or indirectly, such as

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quoted prices in markets that are active, quoted prices for similar securities at the measurement date, or other inputs that are observable. Additionally, our investments in limited partnership funds were measured at fair value using the funds’ net asset values as a practical expedient.

 

The investment manager provides us with pricing information that we utilize, together with information obtained from independent pricing services, to determine the fair value of our fixed maturity securities.

Competition

The medical professional liability insurance market is highly competitive. We compete with stock and mutual insurance companies, risk retention groups (“RRGs”), reciprocal exchanges, and other underwriting organizations. Our largest competitors in Pennsylvania are PMSLIC/NORCAL Mutual Insurance Company, MedPro Group, Central Pennsylvania Physicians Risk Retention Group, and Medical Mutual of North Carolina. Most of these competitors have substantially greater financial, technical and operating resources than we do and may be able to offer lower rates to policyholders or higher commissions to their producers.

We compete on a number of factors such as pricing, agency relationships, policy support, claim service, and market reputation. Like other writers of MPLI, our policy terms vary from state to state based on the maximum prescribed limits in each state, as established by state law. We believe our company differentiates itself from many larger companies competing for this business by focusing on service and responsiveness.

To compete successfully in the MPLI industry, we rely on our ability to: identify insureds that are most likely to produce an underwriting profit; operate with a disciplined underwriting approach; practice prudent claims management; and provide services and competitive commissions to our independent agents.

Ratings

Demotech, Inc. (“Demotech”), a nationally recognized, independent rating agency, rates the financial strength of Positive Insurance Company.  Ratings are not recommendations to buy the Company’s stock.

Rating agencies rate insurance companies based on financial strength and the ability to pay claims and other factors more relevant to policyholders than investors.  We believe that the rating assigned by Demotech is material to our operations.  We currently only participate in the ratings process of Demotech.  However, we intend to seek participation in the ratings process of A.M. Best Company, Inc. in the future.

The rating scale of Demotech is characterized as follows:

Positive Insurance Company’s financial stability rating of A’ (A Prime), Unsurpassed was affirmed on March 18, 2020.

A downgrade in the Demotech rating of Positive Insurance Company would result in a material loss of business as policyholders would move to other companies with higher financial strength ratings.  Accordingly, such a downgrade would have a material adverse effect on our results of operations, liquidity and capital resources.  This rating is subject to revision or withdrawal at any time by the rating agency, and therefore, no assurance can be given that we or Positive Insurance Company can maintain this rating.

Regulation

General.

We are subject to extensive regulation, particularly at the state level. The method, extent and substance of such regulation varies by state, but generally has its source in statutes that establish standards and requirements for conducting the business of insurance and that delegate regulatory authority to state insurance regulatory agencies who may then promulgate regulations. In general, such regulation is intended for the protection of those who purchase or use insurance products, not the companies that write the policies. These laws and regulations have a significant impact on our business and relate to a wide variety of matters including accounting

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methods, agent and company licensure, claims procedures, corporate governance, examinations, investing practices, policy forms, pricing, trade practices, reserve adequacy and underwriting standards.

State insurance laws and regulations require Positive Insurance Company to file financial statements with state insurance departments everywhere we do business, and the operations of Positive Insurance Company and its respective accounts are subject to examination by those departments at any time. Positive Insurance Company prepares statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by Pennsylvania. Pennsylvania generally conforms to National Association of Insurance Commissioners (“NAIC”) practices and procedures, so its examination reports and other filings generally are accepted by other states.

Premium rate regulation varies greatly among jurisdictions and lines of insurance. In the states in which Positive Insurance Company writes insurance, premium rates for the various lines of insurance are subject to either prior approval or limited review upon implementation. Positive Insurance Company recently applied for a license in the state of Texas, was admitted in November 2019, and is currently in the process of obtaining approval on premium rates before we can begin writing business in Texas.  Positive Insurance Company intends to apply for approval to act as a surplus lines carrier in those states where we believe sufficient business opportunities make providing surplus lines coverage to physicians and other healthcare providers in those states attractive. Positive Insurance Company also intends to apply for approval to act as a reinsurer in those states where we believe sufficient business opportunities exist to provide quota share insurance to RRGs that are attractive acquisition targets.

Examinations.

Examinations are conducted by the Pennsylvania Insurance Department every three to five years. Past examinations, including the most recent exam completed through December 31, 2017, did not result in any adjustments to our financial position. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on our operations.

NAIC Risk-Based Capital Requirements.

Pennsylvania and most other states have adopted the NAIC system of risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business risks and such other relevant risks as are set forth in the risk-based capital instructions. A company’s “total adjusted capital” is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies.

The requirements provide for four different levels of regulatory attention. The “company action level” is triggered if a company’s total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The “regulatory action level” is triggered if a company’s total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The “authorized control level” is triggered if a company’s total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level, the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The “mandatory control level” is triggered if a company’s total adjusted capital is less than 0.7 times its authorized control level; at this level, the regulatory authority is mandated to place the company under its control.  As of December 31, 2019, the total adjusted capital of Positive Insurance Company was 6.3 times its authorized control level.  The capital level of Positive Insurance Company has never triggered any of these regulatory capital levels. We cannot assure you, however, that the capital requirements applicable to Positive Insurance Company will not increase in the future.

NAIC Ratios.

The NAIC also has developed a set of 13 financial ratios referred to as the Insurance Regulatory Information System (IRIS). On the basis of statutory financial statements filed with state insurance regulators, the NAIC annually calculates these IRIS ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. The NAIC has established an acceptable range for each of the IRIS financial ratios. If four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC, an insurance company may receive inquiries from individual state insurance departments.  As of December 31, 2019, Positive Insurance Company only had one IRIS ratio, the two-year overall operating ratio, fall outside the NAIC’s tolerable range, and that was due to operating results which were reported prior to the conversions and merger of PPIX, PCA, and PIPE.

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Enterprise Risk Assessment.

In 2012, the NAIC adopted the NAIC Amendments. The NAIC Amendments, when adopted by the various states, are designed to respond to perceived gaps in the regulation of insurance holding company systems in the United States. One of the major changes is a requirement that an insurance holding company system’s ultimate controlling person submit annually to its lead state insurance regulator an “enterprise risk report” that identifies activities, circumstances or events involving one or more affiliates of an insurer that, if not remedied properly, are likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole. Beginning in 2016, Pennsylvania required insurers domiciled in Pennsylvania to include an enterprise risk assessment in its annual report. Other changes include requiring a controlling person to submit prior notice to its domiciliary insurance regulator of its divestiture of control, having detailed minimum requirements for cost sharing and management agreements between an insurer and its affiliates and expanding of the agreements between an insurer and its affiliates to be filed with its domiciliary insurance regulator. In addition, in 2012 the NAIC adopted the Own Risk Solvency Assessment (ORSA) Model Act. The ORSA Model Act, when adopted by the various states, will require an insurance holding company system’s chief risk officer to submit at least annually to its lead state insurance regulator a confidential internal assessment appropriate to the nature, scale and complexity of an insurer, conducted by that insurer of the material and relevant risks identified by the insurer associated with an insurer’s current business plan and the sufficiency of capital resources to support those risks. Although Positive Insurance Company is exempt from ORSA because of its size, we intend to incorporate those elements of ORSA that we believe constitute “best practices” into our annual internal enterprise risk assessment.

Market Conduct Regulation.

State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations.

Guaranty Fund Laws.

All states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2019 and 2018, we incurred total assessment expense in the amounts of $70,000 and $36,000, respectively, pursuant to state insurance guaranty association laws.

Positive Insurance Company establishes reserves relating to insurance companies that are subject to insolvency proceedings when it is notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on Positive Insurance Company under these laws.

Federal Regulation.

The U.S. federal government generally has not directly regulated the insurance industry except for certain areas of the market, such as insurance for flood, nuclear and terrorism risks. However, the federal government has undertaken initiatives or considered legislation in several areas that may impact the insurance industry, including tort reform, corporate governance and the taxation of reinsurance companies. The Dodd-Frank Act established the Federal Insurance Office which is authorized to study, monitor and report to Congress on the insurance industry and to recommend that the Financial Stability Oversight Council designate an insurer as an entity posing risks to the U.S. financial stability in the event of the insurer’s material financial distress or failure. In December 2013, the Federal Insurance Office issued a report on alternatives to modernize and improve the system of insurance regulation in the United States, including by increasing national uniformity through either a federal charter or effective action by the states. Changes to federal legislation and administrative policies in several areas, including changes in federal taxation, can also significantly impact the insurance industry and us.

We are also subject to the Fair and Accurate Credit Transactions Act of 2003, or FACTA, and the Health Insurance Portability and Accountability Act of 1996, or HIPAA, both of which require us to protect the privacy of our customers’ information, including health and credit information.

Sarbanes-Oxley Act of 2002.

Enacted in 2002, the stated goals of the Sarbanes-Oxley Act of 2002, or SOX, are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. We became subject to most of the provisions of the SOX immediately after completion of our initial public offering.

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The SOX includes very specific disclosure requirements and corporate governance rules and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related regulations.

Privacy.

As mandated by the Gramm-Leach-Bliley Act, states continue to promulgate and refine laws and regulations that require financial institutions, including insurance companies, to take steps to protect the privacy of certain consumer and customer information relating to products or services primarily for personal, family or household purposes. An NAIC initiative that affected the insurance industry was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. We have implemented procedures to comply with the Gramm-Leach-Bliley Act’s related privacy requirements.

OFAC.

The Treasury Department’s Office of Foreign Asset Control (“OFAC”) maintains a list of “Specifically Designated Nationals and Blocked Persons” (the SDN List). The SDN List identifies persons and entities that the government believes are associated with terrorists, rogue nations or drug traffickers. OFAC’s regulations prohibit insurers, among others, from doing business with persons or entities on the SDN List. If the insurer finds and confirms a match, the insurer must take steps to block or reject the transaction, notify the affected person and file a report with OFAC.

JOBS Act.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, such as reduced public company reporting, accounting and corporate governance requirements.

Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards.

We will remain an “emerging growth company” for up to five years following March 27, 2019, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenue exceeds $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.

In addition, as an emerging growth company, we are exempt from Section 14A (a) and (b) of the Exchange Act, which requires shareholder approval of executive compensation and golden parachutes.

Dividends.

Our insurance subsidiary, Positive Insurance Company, is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the holding company.  In considering future dividend policy, Positive Insurance Company will consider, among other things, applicable regulatory constraints.  At December 31, 2019, Positive Insurance Company had statutory surplus of $39,415,264.  

An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by the Company to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of the Company, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.  Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to the Company for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.

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Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department.  This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend.  The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation.  These restrictions or any subsequently imposed restrictions may affect our future liquidity.  No dividends were paid in 2019 and 2018.

Holding Company Laws.

Most states, including Pennsylvania, have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company group that may materially affect the operations, management or financial condition of the insurers within the group. Pursuant to these laws, the Pennsylvania Insurance Department requires disclosure of material transactions involving an insurance company and its affiliates, and requires prior notice and/or approval of certain transactions, such as “extraordinary dividends” distributed by the insurance company. Under these laws, the Pennsylvania Insurance Department will have the right to examine us and Positive Insurance Company at any time.

All transactions within our consolidated group affecting Positive Insurance Company must be fair and equitable. Notice of certain material transactions between Positive Insurance Company and any person or entity in our holding company system will be required to be given to the Pennsylvania Insurance Department. Certain transactions cannot be completed without the prior approval of the Pennsylvania Insurance Department.

Approval of the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In Pennsylvania, the acquisition of 10% or more of the outstanding voting securities of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person or entity from (i) making a tender offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person or entity would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Insurance Department.

Item 1A. Risk Factors.

Not applicable.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

None.

Item 3. Legal Proceedings.

The Company is periodically subject to litigation in the normal course of its business. Based upon information presently available to us, we do not consider any litigation to be material. However, given the uncertainties attendant to litigation, we cannot assure you that our results of operations and financial condition will not be materially adversely affected by any litigation.

Item 4. Mine Safety Disclosures.

Not applicable.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

On March 27, 2019, the Company completed its initial public offering. The Company’s common stock trades on The NASDAQ Stock Market under the symbol “PPHI.” At May 11, 2020, there were 77 registered holders of the Company’s common stock.

The following is information regarding sales prices for our common stock, which commenced trading on April 1, 2019:

 

 

Dividends

Payment of dividends on our common stock is subject to determination and declaration by our Board of Directors. Our dividend policy will depend upon our financial condition, results of operations and future prospects. At present, we have no intention to pay dividends to our shareholders. We cannot assure you that dividends will be paid, or if and when paid, that they will continue to be paid in the future. The order of the Pennsylvania Insurance Department approving the conversions of PPIX, PCA and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by us to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, our two principal stockholders, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.

Unregistered Sales of Equity Securities

The Company, PPIX, PCA, and PIPE entered into a Standby Stock Purchase Agreement, dated June 1, 2018, with Insurance Capital Group, LLC (“ICG”) in connection with the Company’s anticipated initial public offering. Pursuant to the terms of that agreement, ICG agreed to purchase such number of shares in the Company’s initial public offering that would result in at least the minimum number of shares being sold in the offering. ICG subsequently agreed to permit Enstar Holdings (US) LLC to purchase 30% of the shares that ICG would otherwise purchase. Contemporaneously with the completion of the Company’s public offering on March 27, 2019, the Company issued a total of 2,499,500 shares to the standby purchasers at the public offering price of $10.00 per share.

Use of Proceeds from Initial Public Offering of Common Stock

The Registration Statement on Form S-1 (File No. 333-229322) for the initial public offering of our common stock became effective on February 11, 2019. There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC on February 20, 2019, pursuant to Rule 424(b)(4).

Item 6. Selected Financial Data.

Not applicable.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is intended to provide a more comprehensive review of Positive Physicians Holdings, Inc. (“PPHI”) and its wholly owned subsidiary’s (collectively referred to as the “Company,” which also may be referred to as “we” or “us”) operating results and financial condition than can be obtained from reading the Financial Statements alone.  The discussion should be read in conjunction with the audited Consolidated and Combined Financial Statements and the notes thereto included in “Item 8. Financial Statements and Supplementary Data” of the Company.  Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K constitutes forward-looking information that involves risk and uncertainties. Please see “Forward-Looking Statements” in Part I for more information.

OVERVIEW

Positive Physicians Holdings, Inc. is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”).  In connection with the completion of PPHI’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies.  

As part of the conversions, on March 27, 2019, PPIX merged with and into PPIX Conversion Corp., PCA merged with and into PCA Conversion Corp., and PIPE merged with and into PIPE Conversion Corp.  Accordingly, PPIX, PCA, and PIPE no longer exist.  Immediately thereafter, PCA Conversion Corp. and PIPE Conversion Corp. merged with and into PPIX Conversion Corp., which then changed its name to Positive Physicians Insurance Company (“Positive Insurance Company”) and became our single insurance company subsidiary and successor to PPIX, PCA, and PIPE.  PPHI had minimal assets and liabilities and had not engaged in any operations prior to March 27, 2019.

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Diversus Management, LLC (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement.  Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement, effective March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based upon a percentage of Positive Insurance Company’s gross written premiums, less return premiums.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued by Positive Insurance Company and for all sales commissions paid to producers.

Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers.  Medical professional liability insurance (“MPLI”) protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services.  We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Our policies include coverage for the cost of defending claims.  Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage.  We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires.  Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported.  Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.

Overview of PPIX

PPIX was an unincorporated exchange organized on April 20, 2004 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange.  PPIX provided medical professional liability insurance consisting of claims-made, tail, claims made plus, and occurrence policies to its subscribers (policyholders).  On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and became a wholly owned subsidiary of PPIX.  PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018.  PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”).  Keystone is owned by an insured of Positive Insurance Company.

PPIX marketed its medical professional liability insurance policies directly to physicians and through independent producers to doctors and allied healthcare professionals who practice in Pennsylvania, Delaware, Maryland, New Jersey, and Ohio.

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PPIX was managed by Specialty Insurance Services, LLC (“SIS”), a Pennsylvania limited liability company, pursuant to the terms of an Attorney-In-Fact Agreement between the exchange and SIS.  SIS provided underwriting and administrative services to PPIX based on a percentage not to exceed 25% of gross written premiums, less return premiums.  As the attorney-in-fact, SIS had the power to direct the activities of PPIX that most significantly impact PPIX’s economic performance.  Diversus acquired 100% of the ownership interests of SIS on January 1, 2017.  

Overview of PCA

PCA was an unincorporated, reciprocal insurance association organized on April 16, 2003 and formed for the purpose of insuring its subscribers against loss due to the imposition of legal liability.  PCA provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).  

PCA marketed its medical professional liability insurance policies through independent producers, primarily to doctors and allied healthcare providers who practice in Pennsylvania.  In November 2015, PCA was granted a license to write insurance in Michigan and began writing policies in Michigan in the fourth quarter of 2015.

PCA was managed by Professional Third Party, LP (“PTP”), a Pennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the association and PTP.  PTP provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PCA, and paid certain expenses on behalf of PCA in exchange for 25% of gross written premium.  As the attorney-in-fact, PTP had the power to direct the activities of PCA that most significantly impact PCA’s economic performance.  Diversus acquired 100% of the ownership interests of PTP on June 4, 2014.  

Overview of PIPE

PIPE was an unincorporated exchange organized on March 14, 2005 and was licensed by the Commonwealth of Pennsylvania as a reciprocal insurance exchange.  PIPE provided medical professional liability insurance consisting of claims-made, tail occurrence, and occurrence policies to its subscribers (policyholders).

PIPE marketed its medical professional liability insurance policies through independent producers to doctors and allied healthcare professionals who practice primarily in Pennsylvania.   PIPE also had a license and wrote business in South Carolina.

PIPE was managed by Physicians’ Insurance Program Management Company (“PIPE Management”), a Pennsylvania corporation, pursuant to the terms of an Attorney-in-Fact Agreement between the exchange and PIPE Management.  PIPE Management provided salaries and benefit expenses of the employees, rent and other occupancy expenses, supplies, and data processing services to PIPE, and paid certain expenses on behalf of PIPE in exchange for 25% of gross written premium.  As the attorney-in-fact, PIPE Management had the power to direct the activities of PIPE that most significantly impact PIPE’s economic performance.  Diversus acquired 100% of the ownership interests of PIPE Management on November 23, 2015.

SIS, PTP, and PIPE Management merged with and into Diversus Management in connection with the conversions on March 27, 2019.

Marketplace Conditions and Trends

The MPLI industry is affected by recurring industry cycles known as “hard” and “soft” markets.  A soft market is characterized by intense competition, resulting in lower pricing in order to compete for business.  A hard market, generally considered a beneficial industry trend, is characterized by reduced competition that results in higher pricing.  From approximately 2001 until approximately 2007, the Pennsylvania MPLI market experienced a hard market cycle.  This resulted in the creation of several alternative MPLI providers, such as PPIX, PCA, and PIPE.  

The MPLI market began to experience a soft market cycle around the second quarter of 2008, due primarily to the large rate increases taken over the previous six years.  The soft market continued and was facilitated by the restructuring of the healthcare industry, partially as a result of the Affordable Care Act.  This resulted in significant price competition, as the number of medical professionals practicing independent of hospitals or large professional groups began to decline.  According to a study prepared by the National Association of Insurance Commissioners, MPLI direct premiums written declined by 24.0% on a national basis from 2006 to 2018 and declined by 14.6% in Pennsylvania and 33.0% in New Jersey during this same time period.  This resulted in lower direct premiums written and lower operating profits for many MPLI carriers.

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The soft market cycle troughed in 2012, and since then, national loss payouts, on average, have steadily increased through 2019.  As a result, underwriting criteria in the MPLI industry has started to become more stringent, with opportunities for improved pricing, and we believe the market cycle is currently transitioning to a hard market.  At Positive Insurance Company, beginning in April 2020 our renewal book of business has begun to experience price increases of 2.5% through reduced credits, a development which we expect to continue and extend through our policy renewals in 2020.  We are also seeing rate increases take place by other carriers in many of the states in which we write business.

In addition to pricing increases, in what we perceive to be the beginnings of a hard market, we intend to achieve further premium growth with our expansion into new states.  Positive Insurance Company is currently in the process of obtaining licenses to write business in the states of California and Florida and was recently admitted into Texas in November 2019.

Effects of COVID-19

Our operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughout the United States.  These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force.  Our management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on our operations and financial position and developing operational and financial plans to address those matters.

As a result of the COVID-19 pandemic, we anticipate that premiums will decrease due to policy endorsements associated with doctors electing to work part time, take a leave of absence or retire.  In addition, our insureds may elect to temporarily change specialties.  For example, a doctor may choose to drop from orthopedic surgery to office-only status due to the lack of elective surgeries.  We have received notification for such requests from our policyholders which will go into effect on June 30, 2020.  

In terms of collections, prior to the pandemic, our policy was to cancel any insurance policies for which premiums had not been received within 60 days subsequent to policy effective date, with notice of intent to cancel sent to the insured after 30 days post-inception date.  As a result of COVID-19, we have updated this policy and suspended cancellations of insurance contracts resulting from non-payment of premium until June 30, 2020 for invoices due after April 1, 2020.  Through May 11, 2020, the amount of premium payment deferrals is about $817,000.  Dependent upon the extent to which our policyholders’ own businesses have been impacted by the pandemic, our collection of premiums against current in-force policies could be significantly impacted.

With respect to claims, our policyholder base mainly consists of physicians, their corporations and medical groups.  During the COVID-19 pandemic, on-site visits to doctors have declined and been replaced by an increase in telehealth/virtual office visits.  Since the COVID-19 pandemic resulted in government-issued work from home orders, we have seen the number of new claims reported begin to decrease.  In general, our expectation is that the frequency of new claims reported during this time period will decrease.  As to actual claims relating to COVID-19 exposures, we anticipate that the number of claims will be minimal.  Unless some unforeseen fact pattern is established, we expect that the difficulty of establishing the source of a COVID-19 exposure, as well as the heroic efforts of healthcare providers, will serve to make such claims unattractive to both patients and their counsel.  We do not anticipate our loss and LAE ratios to be impacted.  However, this view could change in the future depending on the duration of the pandemic and if the lower frequency of new claims reported becomes a trend.

Principal Revenue and Expense Items

Positive Insurance Company derives its revenue primarily from net premiums earned, net investment income, and net realized and unrealized gains (losses) from investments.

Net premiums earned

Gross premiums written is equal to direct and assumed premiums before the effect of ceded reinsurance.  Net premiums written is the difference between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written).

Premiums earned are the earned portion of net premiums written.  Gross premiums written include all premiums recorded by an insurance company during a specified policy period.  Insurance premiums on MPLI policies are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies.  At the end of each accounting period, the portion of the premiums that is not yet earned is included in unearned premiums and recognized as revenue in subsequent periods over the remaining term of the policy.  The policies written by Positive Insurance Company typically have a term of twelve months.  Thus, for example, for a policy that is written on July 1, 2019, one-half of the premiums would be earned in 2019 and the other half would be earned in 2020.

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Net investment income and net realized and unrealized gains (losses) from investments

We invest our surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid loss and loss adjustment expenses) in cash, cash equivalents, short-term investments, and equity and debt securities.  Investment income includes interest and dividends earned.  We recognize realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognize realized losses when investment securities are written down as a result of other-than-temporary-impairment or sold for an amount less than their cost or amortized cost, as applicable.  Realized gains and losses on sales of fixed maturity and equity securities and other investments and unrealized holding gains and losses on equity securities and other investments are included in realized investment gains (losses), net.  Our portfolio of investment securities is managed by our outside investment manager, who has discretion to buy and sell securities in accordance with the investment policy approved by Positive Insurance Company’s Board of Directors.

Losses and loss adjustment expenses

Losses and loss adjustment expenses (“LAE”) represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates for prior periods, and (3) costs associated with investigating, defending and adjusting claims, including legal fees.

Other underwriting expenses

Expenses incurred to underwrite risks include policy acquisition costs and underwriting and administrative expenses.  Policy acquisition costs consist of commission expenses, premium taxes, and certain other underwriting expenses that vary with and are primarily related to the writing and acquisition of new and renewal business.  These policy acquisition costs are deferred and amortized over the effective period of the related insurance policies.  Underwriting and administrative expenses consist of salaries, rent, office supplies, depreciation, and all other operating expenses not otherwise classified separately, and payments to bureaus and assessments of statistical agencies for policy service and administration items such as rating manuals, rating plans and experience data.

Income taxes

We use the asset and liability method of accounting for income taxes.  Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities.  A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.  The effect of a change in tax rates is recognized in the period of the enactment date.

Key Financial Measures

We evaluate our insurance operations by monitoring certain key measures of growth and profitability.  Some of these measurements are “non-GAAP” financial measurements under Securities and Exchange Commission rules and regulations.  We utilize certain non-GAAP financial performance measures that are widely used in the property and casualty insurance industry and that we believe are valuable in managing our business and for comparison to our peers.  These financial performance measures are the loss and LAE ratio, expense ratio, combined ratio, underwriting income (loss), and operating income (loss).  

We measure growth by monitoring changes in gross premiums written and net premiums written, and measure underwriting profitability by examining losses and LAE, underwriting expenses and combined ratios.  We also measure profitability by examining underwriting income (loss) and operating income (loss).

Loss and LAE ratio

The loss and LAE ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned.  Positive Insurance Company measures the loss and LAE ratio on a policy year and calendar year loss basis to measure underwriting profitability.  A policy year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that year.  A calendar year loss and LAE ratio measures losses and loss adjustment expenses for insured events occurring during a particular year and the change in loss reserves from prior policy years as a percentage of premiums earned during that year.

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Expense ratio

The expense ratio is the ratio (expressed as a percentage) of other underwriting expenses (attributable to insurance operations) to premiums earned, and measures our operational efficiency in producing, underwriting and administering the Company’s insurance business.

Combined ratio

The combined ratio is a measure of property and casualty underwriting performance.  The combined ratio computed on a GAAP basis is equal to the sum of losses and loss adjustment expenses and other underwriting expenses, all divided by net premiums earned.  If the combined ratio is below 100%, we are making an underwriting profit.  If our combined ratio is at or above 100%, we are not profitable without investment income and may not be profitable if investment income is insufficient.

Underwriting income (loss)

Underwriting income (loss) measures the pre-tax profitability of insurance operations.  It is derived by subtracting losses and loss adjustment expenses and other underwriting expenses from earned premiums.

Operating income (loss)

Operating income (loss) measures the profitability of business operations.  We define it as GAAP net income (loss) excluding net realized investment gains and losses, net of tax.  Net realized investment activity is excluded because net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business operations.  Operating income is a non-GAAP measure which is important for an understanding of our overall results of operations.  However, it does not replace net income (loss) as the GAAP measure of our consolidated results of operations, nor should it be viewed as a substitute for measures determined in accordance with GAAP.

Critical Accounting Policies

General

The preparation of financial statements in accordance with GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments:

We believe our accounting policies for these items are of critical importance to our consolidated financial statements.  The following discussion provides more information regarding the estimates and assumptions required to arrive at these amounts.

Losses and Loss Adjustment Expenses

We maintain reserves for the payment of claims (indemnity losses) and expenses related to adjusting those claims (loss adjustment expenses). The loss reserves consist of case reserves, which are reserves for claims that have been reported to us, and reserves for claims that have been incurred but have not yet been reported and for the future development of case reserves.

When a claim is reported to us, our claims personnel establish a case reserve for the estimated amount of the ultimate payment to the extent it can be determined or estimated.  The amount of the loss reserve for the reported claim is based primarily upon a claim-by-claim evaluation of coverage, liability, and injury severity, and any other information considered pertinent to estimating the

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exposure presented by the claim.  Each claim is contested or settled individually based upon its merits, and some claims may take years to resolve, especially if legal action is involved.  Case reserves are reviewed on a regular basis and are updated as new information becomes available.

In addition to case reserves, we maintain reserve estimates for those that have been incurred but not reported (“IBNR”).  These reserves include estimates for the future development of case reserves and claims in which case reserves have not yet been established.  Some claims may not be reported for several years.  As a result, the liability for unpaid losses and LAE reserves includes significant estimates for IBNR.

We utilize an independent actuary to assist with the estimation of our losses and LAE reserves on a quarterly basis.  Our independent actuary prepares estimates of the ultimate liability for unpaid losses and LAE based on established actuarial methods described below.  We review these estimates and supplement the actuarial analysis with information not fully incorporated into the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy.  We may adjust the actuarial estimates based on this supplemental information in order to arrive at the amount recorded in the financial statements.

We accrue liabilities for unpaid losses and LAE based upon estimates of the ultimate amount payable. We project our estimate of ultimate losses and LAE by using the following actuarial methodologies:

We estimate IBNR reserves by first deriving an actuarially based estimate of the ultimate cost of total losses and loss adjustment expenses incurred as of the financial statement date.  We then reduce the estimated ultimate losses and LAE by loss and LAE payments and case reserves carried as of the financial statement date.  The actuarially determined estimate is based upon indications from one of the above actuarial methodologies or uses a weighted average of these results.  The specific method used to estimate the ultimate losses will vary depending on the judgment of the actuary as to what is the most appropriate method for the MPLI business.  Finally, we consider other factors that impact reserves that are not fully incorporated in the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy.

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The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Loss reserve estimation is affected by the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. We continually refine our loss reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. We consider all significant facts and circumstances known at the time loss reserves are established.

Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for losses and loss adjustment expense reserves may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. We reflect adjustments to loss reserves in the results of operations in the period the estimates are changed.

Our independent actuary determined a range of reasonable reserve estimates shown in the tables below, which reflect the uncertainty inherent in the loss reserve process.  This range does not represent the range of all possible outcomes.  We believe that the actuarially determined ranges represent reasonably likely changes in the loss and LAE estimates, however, actual results could differ significantly from these estimates.  The range was determined after a review of the output generated by the various actuarial methods utilized.  Our actuary reviewed the variance around the select loss reserve estimates for each of the actuarial methods and selected reasonable low and high estimates based on their knowledge and judgment.  In addition, when selecting these low and high estimates, the actuary considered:

Our actuary is required to exercise a considerable degree of judgment in the evaluation of all of these and other factors in the analysis of losses and loss adjustment expenses, and related range of anticipated losses. Because of the level of uncertainty impacting the estimation process, it is reasonably possible that different actuaries would arrive at different conclusions. The method of determining the reserve range has not changed and the reserve range generated by the actuary is consistent with the observed development of our loss reserves over the last few years.

The width of the range in reserves arises primarily because specific losses may not be known and reported for some time and the ultimate losses and LAE paid and incurred with respect to known losses may be larger or smaller than currently estimated. The ultimate frequency or severity of the claims can be very different than the assumptions used in the estimation of our ultimate reserves for these exposures.

Specifically, the following factors could impact the frequency and severity of claims and, therefore, the ultimate amount of losses and loss adjustment expenses paid:

The estimation process for determining the liability for unpaid losses and LAE inherently results in adjustments each year for claims incurred (but not paid) in preceding years. Negative amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts less than originally estimated or a reduction in the estimate for unpaid losses and loss adjustment expense (favorable development). Positive amounts reported for claims incurred related to prior years are a result of claims being settled or resolved for amounts greater than originally estimated or an increase in the estimate for unpaid losses and loss adjustment expense (unfavorable development).

Positive Insurance Company uses a combination of the Actual versus Expected Method, Bornhuetter-Ferguson Method, Expected Loss Ratio Method, Frequency/Severity Method, and the Incurred Loss Development Method in order to estimate its liability for losses and LAE.  Following the conversions and merger which were completed on March 27, 2019, the Company changed its approach by aggregating its data, previously under PPIX, PCA, and PIPE, and performing a single loss reserve analysis, as opposed to three separate loss reserve analyses.  The Company used combined development patterns based on PPIX, PCA, and PIPE experience for claims-made development factors, but derived occurrence development factors strictly based on former PPIX

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experience.  Tail policy development factors were derived from the occurrence factors.  Management does not believe that the effects of these changes had a material impact on the Company’s estimates.  The year-end loss reserve analysis also assumes that the Company will no longer utilize Andrews Outsource Solutions LLC to provide claims processing and risk management services following 2020, a measure which is expected to reduce the amount of LAE incurred in subsequent periods.  If this action is not taken, then the Company’s reserves for loss adjustment expenses would increase as a result.  There were no other significant changes in the methodologies and assumptions used to develop the liabilities for losses and LAE during the year ended December 31, 2019.

The following tables provide case and IBNR reserves for losses and LAE at December 31, 2019 and 2018 (dollars in thousands).

At December 31, 2019

 

 

At December 31, 2018

 

 

At December 31, 2019 and 2018, Positive Insurance Company’s total liability for losses and LAE was $63,607,975 and $68,392,333, respectively.

The components of our (favorable) unfavorable development of reserves for losses and LAE for prior accident years by accident year were as follows (dollars in thousand):

 

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In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.

During 2018, we experienced unfavorable development primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.

As discussed earlier, the estimation of Positive Insurance Company’s losses and LAE reserves is based on several actuarial methods, each of which incorporates many quantitative assumptions. The judgment of the actuary plays an important role in selecting among various loss development factors and selecting the appropriate method, or combination of methods, to use for a given policy year.

 

 

At December 31, 2019, our carried reserves for losses and loss adjustment expenses, net of reinsurance, reflect an estimate of loss and LAE reserves that is approximately the point estimate of our actuaries’ range of loss reserves.  If the liability for losses and loss adjustment expenses were recorded at the high end of the actuarially determined range, then the liability for losses and loss adjustment expenses would increase, which would result in a higher net loss and lower equity. If the liability for losses and loss adjustment expenses were recorded at the low end of the actuarially determined range, then the liability for losses and loss adjustment expenses would be reduced with a corresponding increase in net income and equity.

Investments

Our investment portfolio is invested primarily in publicly traded, investment grade, fixed maturity securities with an average credit quality of A as rated by nationally recognized credit rating agencies.  The portfolio is externally managed by independent, professional investment managers and is broadly diversified across sectors and issuers.  Exposures are aggregated, monitored, and actively managed by our Investment Committee.  We also have an investment policy statement which requires managers to maintain highly diversified exposures to individual issuers and closely monitor compliance with portfolio guidelines.  Our investment portfolio also includes equity securities.

We have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claims payments.  The fair values of these investments are subject to fluctuation in interest rates.  If we decide or are required in the future to sell securities in a rising interest rate environment, then we would expect to incur losses from such sales.  As of December 31, 2019, the average duration of our fixed maturity security investments that support the insurance reserves was approximately 3.1 years and the duration of our insurance reserves was about 2.6 years.  The difference in the duration of our investments and our insurance reserves reflects our decision to maintain longer asset duration in order to enhance overall yield, while maintaining a high overall credit quality.  We estimate that a 100 basis points (bps) increase in interest rates would reduce the valuation of our fixed maturity portfolio by $3,416,769 at December 31, 2019.

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Our investments at December 31 were as follows:

 

Our investment portfolio is comprised of mostly investment grade fixed maturity securities and equity securities, all of which are publicly traded.  We believe the portfolio is sufficiently diversified because it does not contain any significant concentrations in single issuers other than U.S. government obligations.  Our largest exposure to a single corporate issuer is $1,743,740, or less than 2% of total invested assets.  In addition, we do not have a significant concentration of our investments in any single industry segment other than finance companies, which comprised approximately 22% of invested assets at December 31, 2019.  Included in this industry segment are diverse financial institutions, including banks (11%) and financial service (9%) and insurance (2%) companies, with no single issuer exceeding 2% of the total investment portfolio.  During the first quarter of 2020, we reduced our exposure to this industry segment by about 3%.  All of our investments as of December 31, 2019 are dollar denominated.

At December 31, 2019, our fixed maturity securities had an overall average credit quality of A.  The credit quality of our fixed maturity securities at the end of the year was broken down as follows:

 

 

Ratings as assigned by Standard and Poor’s.  Such ratings are generally assigned at the time of the issuance of the securities, subject to revision on the basis of ongoing evaluations.

At December 31, 2019, all but 17 of the publicly traded securities in our fixed maturity portfolio were of investment grade credit quality.  The 17 below investment grade securities had an aggregate fair value of $838,762 and a net unrealized loss of $(3,761).

Investments in fixed maturity securities are classified as available-for-sale and are stated at fair value. Unrealized holding gains and losses, net of related tax effects, on available-for-sale fixed maturity securities are recorded directly to accumulated other comprehensive income (loss).  Investments in equity securities are stated at fair value and unrealized holding gains and losses are credited or charged to net income (loss) as incurred.  During 2019 and 2018, we had ownership interests in limited partnership equity hedge funds which were sold in 2019.  The partnership interests were measured at fair value using the funds’ net asset values as a practical expedient.  Unrealized holding gains and losses on partnership interests were credited or charged to net income (loss) as incurred.  Realized gains and losses on sales of equity and fixed maturity securities as well as other investments are recognized into income based upon the specific identification method.  Interest and dividends are recognized as earned. We regularly evaluate all of our investments based on current economic conditions, credit loss experience, and other specific developments.  If there is a decline in a security’s net realizable value that is other than temporary, it is considered as a realized loss and the cost basis in the security is reduced to its estimated fair value.

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The following table shows the fair value and amortized cost/cost of our available-for-sale fixed maturity securities:

 

 

 

The fair value of these securities increased $10,541,373 during 2019, primarily due to the investing of net proceeds from the initial public offering stock issuance and unrealized appreciation driven by declining interest rates.  The net unrealized gain on these securities at December 31, 2019 was $2,075,598 or more than 2% of the amortized cost or cost basis.  The net unrealized gain included gross unrealized gains of $2,127,857 and gross unrealized losses of $52,259.

For 2019, our investment portfolio experienced a gain in the net change in unrealized gains/losses of $5,088,803, with gains occurring in fixed maturity securities and equity securities.

 

 

The fair value and unrealized losses of our securities that were temporarily impaired at December 31, 2019 and 2018 are as follows:

 

 

 

At December 31, 2019, we had gross unrealized losses on fixed maturity securities of $52,259, compared to gross unrealized losses of $1,778,831 at December 31, 2018.  Most of these unrealized losses were attributable to fluctuations in interest rates. We have not observed any evidence which would lead us to believe that the entire amortized cost basis will not be recovered.

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Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions.

We evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. We found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed. Our fixed maturity portfolio is managed by our investment committee in concert with an outside investment manager for investment grade bond investments. By agreement, the investment manager cannot sell any security without the consent of our investment committee if such sale will result in a net realized loss.

We monitor our investment portfolio and review securities that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. When assessing whether the amortized cost basis of the security will be recovered, we compare the present value of the cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as the “credit loss.” If there is a credit loss, the impairment is considered to be other-than-temporary. If we identify that an other-than-temporary impairment loss has occurred, we then determine whether we intend to sell the security, or if it is more likely than not that we will be required to sell the security prior to recovering the amortized cost basis less any current-period credit losses. If we determine that we do not intend to sell, and it is not more likely than not that we will be required to sell the security, the amount of the impairment loss related to the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of tax. If we determine that we intend to sell the security, or that it is more likely than not that we will be required to sell the security prior to recovering its amortized cost basis less any current-period credit losses, the full amount of the other-than-temporary impairment will be recognized in earnings.

For 2019 and 2018, we determined that none of our securities were other-than-temporarily impaired. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Fixed maturity available-for-sale securities and equity securities are recorded at fair value on a recurring basis. FASB ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”), establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

Under ASC Topic 820, we base fair values of assets on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of the consolidated and combined financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

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We obtain one price for each security primarily from a third-party pricing service (“pricing service”), which generally uses quoted prices or other observable inputs for the determination of fair value.  The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information.  For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds.

In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest-level input that is significant to the fair value measurement in its entirety.  Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

The table below presents the level within the fair value hierarchy generally utilized to estimate the fair value of assets disclosed on a recurring basis at December 31, 2019 and 2018:

 

 

 

Investment Portfolio Update

Our investment portfolio has experienced significant fluctuations in fair value as a result of the market volatility due to the COVID-19 pandemic.  The following tables reflect the changes in our investment portfolio since December 31, 2019.

 

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Deferred Acquisition Costs

Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the successful production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned. The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred acquisition costs. If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, they would be written off.

Reinsurance Recoverable

We cede reinsurance risk to other insurance companies. This arrangement allows us to reduce the net loss potential arising from large risks. Reinsurance contracts do not relieve us of our obligation to our policyholders. Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract.

Our reinsurance recoverable balance at December 31, 2019 was $7,850,409, which we anticipate will be fully collectible.  Although the contractual obligation of individual reinsurers to pay their reinsurance obligations is determinable from specific contract provisions, the collectability of such amounts requires estimation by management.  Many years may pass between the occurrence of a claim, when it is reported to us and when we ultimately settle and pay the claim.  As a result, it can be several years before a reinsurer has to actually remit amounts to us.  Over this period of time, economic conditions and operational performance of a particular reinsurer may impact their ability to meet these obligations and while they may still acknowledge their contractual obligation to do so, they may not have the financial resources to fully meet their obligation to us.  If this occurs, we may have to write down a reinsurance recoverable to its then determined net realizable value and reflect that write-down in earnings in the period such determination is made.  We attempt to limit any such exposure to uncollectible reinsurance recoverable by assessing the creditworthiness of our reinsurers.  In addition, we require collateral, such as assets held in trust or letters of credit, for certain reinsurance recoverable balances.  However, if our future estimate of uncollectible recoverable exceeds our current expectations, we may need to record an allowance for uncollectible reinsurance recoverable.  This allowance would result in a charge to earnings in the period recorded.  Accordingly, any related charge could have a material adverse effect on our financial condition, results of operations and liquidity.

At December 31, 2019, the amount of our reinsurance recoverable which was uncollateralized was $1,799,409.  This uncollateralized balance was recoverable from reinsurers rated “A” or better by A.M. Best.

Income Taxes

We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of its assets and liabilities. The effect of a change in tax rates is recognized in the period of the enactment date.

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At December 31, 2019, we had a net deferred tax asset of $891,584, resulting from $2,362,499 of gross deferred tax assets reduced by $1,470,915 of deferred tax liabilities.  In establishing the appropriate value of this asset, management must make judgments about our ability to utilize the net tax benefit from the reversal of temporary differences and the utilization of operating loss carryforwards that will begin to expire in 2038.

We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets.

CARES Act

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) into law. The CARES Act includes certain income tax-related law changes that we believe will have a material effect on our deferred income taxes in 2020. The most significant effect on our deferred income taxes is expected to be due to changes in the Federal net operating loss (“NOL”) carryback provisions which will allow us to carryback NOLs originating in 2018 and 2019 to prior tax years with corporate income tax rates of 34% (as opposed to forward to future tax years with corporate income tax rates of 21%). We estimate that this change will result in additional Federal income tax refunds of approximately $1.1 million during 2020 and will reduce our NOL by about $3.1 million, or about $650,000 tax-effected.

Results of Operations

Our results of operations are influenced by factors affecting the MPLI industry, in general.  The operating results of the United States MPLI industry are subject to significant variations due to competition, changes in regulation, rising medical expenses, judicial trends, fluctuations in interest rates, and other changes in the investment environment.

Our premium levels and underwriting results have been, and continue to be, influenced by market conditions.  Pricing in the MPLI industry historically has been cyclical.  During a soft market cycle, price competition is more significant than during a hard market cycle which makes it difficult to attract and retain properly priced MPLI business.  As previously discussed, the markets in which we operate, and the national MPLI markets, have been in a prolonged period of a soft market cycle.  However, we have started to see price increases with our policy renewals in 2020 and we believe the market is beginning to harden.  Therefore, it is generally likely that insurers will be able to increase their rates or profit margins, as market conditions continue to improve.  A hard market typically has a positive effect on premium growth, which can include absolute increases in premiums written.

In 2019, we had a net loss of $(238,951), compared to a net loss of $(5,371,516) in 2018.  We also reported operating losses of $(1,269,329) and $(4,160,239) in 2019 and 2018, respectively.  

Total revenues for 2019 were $27,965,606, compared to $24,623,479 for 2018.  The increase in revenues for 2019, compared to prior year, primarily reflects unrealized gains on equity securities recognized in 2019 in contrast to unrealized losses recorded in 2018.  To a lesser extent, the increase in revenues also reflects realized gains on sales of other investments in 2019 and higher net investment income reported in current year.  Net premiums earned increased modestly in 2019, compared to 2018.

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The major components of consolidated revenues and pre-tax loss for 2019 and major components of combined revenues and pre-tax loss for 2018 are as follows:

 

 

Premiums Written and Premiums Earned

The comparative changes in premiums written and premiums earned for 2019 and 2018 are reflected in the table below.  The increases in direct and net premiums written are primarily due to new business written during 2019, while premiums earned remained relatively consistent year-over-year.

 

 

Net Investment Income

The following table sets forth our average cash and invested assets and investment income for 2019 and 2018:

 

 

Net investment income for 2019 was $2,960,367, compared to $2,568,907 for 2018. The average monthly net investment income increased from $214,000 during 2018 to $247,000 during 2019.  

The increase in net investment income primarily reflects the increase in our cash and invested asset positions, due to proceeds from the initial public offering stock issuance in 2019.

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Realized Investment Gains (Losses), Net

Realized net investment gains (losses) for 2019 and 2018 are as follows:

 

 

The total gain on sales of investments in 2019 includes a realized gain of $556,723 related to sales of our interests in limited partnership equity hedge funds.  Our fixed maturity investments and equity investments are available-for-sale because we may, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies.

Losses and Loss Adjustment Expenses

The components of the GAAP combined ratios were as follows:

 

 

The improved loss and LAE ratio for 2019 reflects lower adverse loss reserve development in prior accident years.  During 2019, we recorded unfavorable prior year loss reserve development of $136,271, compared to unfavorable prior year development of $4,057,821 in 2018.

In 2019, the unfavorable development related to reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.

During 2018, we experienced unfavorable development primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.

The MPLI line of business is prone to variability in the loss reserving process due to the extended period of time during which claims can be made and the subsequent time required to settle those claims.  Adjustments to our original estimates resulting from claims are not made until the period in which there is reasonable evidence that an adjustment to the reserve is appropriate.

Other Underwriting Expenses

Other underwriting expenses, including changes in deferred acquisition costs, were $12,619,517 for 2019, compared to $12,340,647 for 2018.  The amount for 2019 includes expenses incurred by the holding company which did not exist in prior year.  Positive Insurance Company pays a management fee to Diversus Management which is equal to a percentage of premiums written.  This percentage was 25% in 2018 and was reduced to 12%, effective March 27, 2019.  The reduction in the management fee is largely offset by the increase due to holding company expenses in 2019.  Positive Insurance Company also had $371,000 and $532,000 in initial public offering and conversion costs that were expensed during 2019 and 2018, respectively, and are included in other underwriting expenses.  

We are required to participate in the Pennsylvania Property and Casualty Insurance Guaranty Association (“PIGA”), which was formed to pay claims on policies issued by insolvent Pennsylvania domiciled property and casualty insurers.  Each Pennsylvania domiciled property and casualty insurer pays PIGA an annual assessment based on its premiums written in Pennsylvania.

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Income Tax Expense (Benefit)

The provision for income taxes for 2019 and 2018 resulted in an income tax expense (benefit) of $6,986 and $(1,935,328), respectively.  The Company’s effective tax rate for 2019 and 2018 was 21%.

Liquidity and Capital Resources

Liquidity is a measure of an entity’s ability to secure sufficient cash to meet its contractual obligations and operating needs.  Our insurance operations generate cash by writing policies and collecting premiums.  The cash generated is used to pay losses and LAE as well as other underwriting expenses.  Any excess cash is invested and earns investment income.  

We maintained investment and reinsurance programs that are intended to provide sufficient funds to meet our obligations without forced sales of investments.  As such, our investment portfolio contains a high degree of liquidity, with relatively short-term and highly liquid assets, to ensure the availability of funds and to meet the demands of claim settlements and operating expenses. We also have an Investment Committee which meets regularly to discuss cash flow projections and our short-term cash needs as well as asset allocation within our investment portfolio.

Furthermore, liquidity requirements are met primarily through operating cash flows and by maintaining a portfolio with maturities that reflect our estimates of future cash flow requirements.  Our investment strategy includes setting guidelines for asset quality standards, allocating assets among investment types and issuers, and other relevant criteria for our portfolio.  In addition, invested asset cash flows, which include both current interest income received and investment maturities, are structured to consider projected liability cash flows of loss reserve payouts that are based on actuarial models.  Property and casualty claim demands are somewhat unpredictable in nature and require liquidity from the underlying invested assets.  Our invested assets are structured to emphasize current investment income while maintaining appropriate portfolio quality and diversity.

Cash flows for 2019 and 2018 were as follows:

 

 

Cash flows used in operating activities increased during 2019, compared to prior year, primarily attributable to the current year payment of the $10,000,000 prepaid management fee to Diversus.  Cash flows from investing activities decreased in 2019, compared to 2018, mainly due to additional purchases of fixed maturity securities.  The increase in cash flows from financing activities reflects the initial public offering stock issuance of $33,574,401 in March 2019.

At the holding company level, our primary sources of liquidity are dividends and tax payments received from Positive Insurance Company and capital raising activities.  We utilize cash to pay debt obligations, taxes to the federal government, and corporate expenses.  At December 31, 2019, we had $16,843,126 of cash and short-term investments at our holding company which we believe, combined with our other capital sources, will continue to provide us with sufficient funds to meet our foreseeable ongoing expenses and other obligations.

Our insurance subsidiary, Positive Insurance Company, is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the holding company.  In considering future dividend policy, Positive Insurance Company will consider, among other things, applicable regulatory constraints.  At December 31, 2019, Positive Insurance Company had statutory surplus of $39,415,264.  

An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by PPHI to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of PPHI, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.  Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to PPHI for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.

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Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department.  This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend.  The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation.  These restrictions or any subsequently imposed restrictions may affect our future liquidity.

Upon completion of the offering on March 27, 2019, the Company is a public company and is subject to the proxy solicitation, periodic reporting, insider trading and other requirements of the Exchange Act and to most of the provisions of the Sarbanes-Oxley Act of 2002.  As a result, the Company anticipates incurring significant increases in expenses related to accounting and legal services that will be necessary to comply with such requirements.  We estimate that the cost of initial compliance with the requirements of the Sarbanes-Oxley Act will be approximately $350,000 and that compliance with the ongoing requirements of the Exchange Act and the Sarbanes-Oxley Act will result in an increase of approximately $200,000 in annual operating expenses.

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital reserves.

Other Matters

Comparison of SAP and GAAP Results

Results presented in accordance with GAAP vary in certain respects from results presented in accordance with statutory accounting practices prescribed or permitted by the Pennsylvania Insurance Department (collectively “SAP”).  Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners publications.  Permitted SAP encompasses all accounting practices that are not prescribed.  Our domestic insurance subsidiary uses SAP to prepare various financial reports for use by insurance regulators.

Recent Accounting Guidance

For a discussion of recent accounting guidance, see Note 4 to the Consolidated and Combined Financial Statements in “Item 8. Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Market Risk

Market risk is the risk that a company will incur losses due to adverse changes in the fair value of financial instruments. We have exposure to three principal types of market risk through our investment activities: interest rate risk, credit risk and equity risk. Our primary market risk exposure is changes in interest rates. We have not entered, and do not plan to enter, into any derivative financial instruments for hedging, trading or speculative purposes.

Interest Rate Risk

Interest rate risk is the risk that a company will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the fair value of these securities.

The average duration of the fixed maturity securities in our investment portfolio at December 31, 2019 was 3.1 years.  Our fixed maturity investments include U.S. government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, and corporate bonds, most of which are exposed to changes in prevailing interest rates and which may experience moderate fluctuations in fair value resulting from changes in interest rates. We hold these investments as available for sale. This allows us to manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by management, our investment adviser and our board of directors.

Fluctuations in near-term interest rates could impact our results of operations and operating cash flows. Certain of these securities may have call features. In a declining interest rate environment these securities may be called by their issuer and replaced with securities bearing lower interest rates. If we are required to sell these securities in a rising interest rate environment, then we may recognize losses.

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As a general matter, we attempt to match the durations of our assets with the durations of our liabilities. Our investment objectives include maintaining adequate liquidity to meet our operational needs and optimizing our after-tax investment income and our after-tax total return, all of which are subject to our tolerance for risk.

The table below shows the interest rate sensitivity on our fixed maturity investments measured in terms of fair value (which is equal to the carrying value for all of our investment securities that are subject to interest rate changes) at December 31, 2019:

 

 

Credit Risk

Credit risk is the potential economic loss principally arising from adverse changes in the financial condition of a specific debt issuer. We address this risk by investing primarily in fixed maturity securities that are rated at least “A” by Moody’s or an equivalent rating quality. We also independently, and through our outside investment manager, monitor the financial condition of all the issuers of fixed maturity securities in our portfolio. To limit our exposure to risk, we employ diversification rules that limit the credit exposure to any single issuer or asset class.

Equity Risk

Equity price risk is the risk that we will incur economic losses on our equity securities due to adverse changes in equity prices.

Impact of Inflation

Increases in the cost of medical procedures and related services can affect the losses that we may incur in connection with resolving claims under policies that we issue. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We, like all insurance companies, establish insurance premium levels before the amount of losses and loss adjustment expenses, or the extent to which inflation may impact these expenses, are known. Therefore, we attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, our financial results have not been significantly affected by it.

 

 

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Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the shareholders and the board of directors of Positive Physicians Holdings, Inc.:

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Positive Physicians Holdings, Inc (the "Company") as of December 31, 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders' equity, and cash flows, for the year ended December 31, 2019, and the combined balance sheet as of December 31, 2018, the related combined statements of operations, comprehensive income (loss), stockholders' equity, and cash flows, for the year ended December 31, 2018, and the related notes and financial statement schedules I and V (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Baker Tilly Virchow Krause, LLP

 

We have served as the Company's auditor since 2018.

 

Philadelphia, Pennsylvania

May 14, 2020

 

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Positive Physicians Holdings, Inc.

Consolidated and Combined Balance Sheets

December 31, 2019 and 2018

 

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

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Positive Physicians Holdings, Inc.

Consolidated and Combined Statements of Operations

Years Ended December 31, 2019 and 2018

 

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

 

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Positive Physicians Holdings, Inc.

Consolidated and Combined Statements of Comprehensive Income (Loss)

Years Ended December 31, 2019 and 2018

 

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

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Positive Physicians Holdings, Inc.

Consolidated and Combined Statements of Stockholders’ Equity

Years Ended December 31, 2019 and 2018

 

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

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Positive Physicians Holdings, Inc.

Consolidated and Combined Statements of Cash Flows

Years Ended December 31, 2019 and 2018

 

 

The accompanying notes are an integral part of these consolidated and combined financial statements.

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Positive Physicians Holdings, Inc.

Notes to Consolidated and Combined Financial Statements

The accompanying consolidated financial statements include the accounts of Positive Physicians Holdings, Inc. and its wholly owned subsidiary (collectively referred to as the “Company”).  Positive Physicians Holdings, Inc. is a Pennsylvania domiciled holding company, which was incorporated on May 1, 2018 for the purpose of acquiring three Pennsylvania based reciprocal insurance exchanges: Positive Physicians Insurance Exchange (“PPIX”), Professional Casualty Association (“PCA”), and Physicians’ Insurance Program Exchange (“PIPE”).  In connection with the completion of the Company’s initial public offering, PPIX, PCA, and PIPE converted from reciprocal insurance exchanges into stock insurance companies and were merged together to form Positive Physicians Insurance Company (“Positive Insurance Company”), a wholly owned subsidiary of the Company.  The Company’s initial public offering and its acquisition of Positive Insurance Company were completed on March 27, 2019.  Prior to that time, the Company had minimal assets and liabilities and had not engaged in any operations.  References to the Company or Positive Insurance Company financial information in this Annual Report prior to the conversion and merger date is to the financial information of PPIX, PCA, and PIPE on a combined basis.  When used in this Annual Report, “we” and “our” mean PPIX, PCA, and PIPE prior to March 27, 2019, and Positive Insurance Company thereafter.

Positive Insurance Company

Positive Insurance Company writes medical malpractice insurance for healthcare providers practicing in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Diversus Management, LLC (“Diversus Management”) manages and administers essentially all of the operations of Positive Insurance Company under the terms of a management agreement.  Diversus Management is a wholly owned subsidiary of Diversus, Inc. (“Diversus”).  Pursuant to the terms of the agreement, effective March 27, 2019, Diversus Management provides such administrative services to Positive Insurance Company in exchange for fees based upon a percentage of Positive Insurance Company’s gross written premiums, less return premiums.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.  Positive Insurance Company remains responsible for all underwriting decisions and the payment of all claims and claims related expenses incurred under policies issued by Positive Insurance Company and for all sales commissions paid to producers.

Products and Services

Positive Insurance Company underwrites medical professional liability coverage for physicians, their corporations, medical groups, clinics and allied healthcare providers.  Medical professional liability insurance (“MPLI”) protects physicians and other health care providers against liabilities arising from the rendering of, or failure to render, professional medical services.  We offer claims-made coverage, claims-made plus, and occurrence-based policies as well as tail coverage in Pennsylvania, New Jersey, Ohio, Delaware, Maryland, South Carolina, and Michigan.  Our policies include coverage for the cost of defending claims.  Claims-made policies provide coverage to the policyholder for claims reported during the period of coverage.  We offer extended reporting endorsements, or tails, to cover claims reported after the policy expires.  Occurrence-based policies provide coverage to the policyholders for all losses incurred during the policy coverage year regardless of when the claims are reported.  Although we generate a majority of our premiums from individual and small group practices, we also insure several major physician groups.

The Company accounts for its medical professional liability insurance business as a single reporting segment line of business.

Option Agreement

Upon completion of the conversions of PPIX, PCA, and PIPE and the securities offering on March 27, 2019, the Company and Diversus entered into an option agreement whereby either party has the option to cause Diversus, subject to shareholder approval, to merge with and become a wholly owned subsidiary of the Company.  Under the terms of the agreement, the option may be exercised by either the Company or Diversus at any time (1) during the period beginning 2 years after completion of the conversions of the exchanges and ending 54 months after the completion of the conversions, or (2) if earlier than 2 years after the completion of the conversions, then such date that the majority stockholder of the Company no longer has the right to appoint a majority of the board of directors of the Company.  In connection with any merger, the common stock shareholders of Diversus will receive either cash, common stock shares of the Company, or some combination thereof for their shares of Diversus’ common stock.  With respect to the preferred stock shares of Diversus, they will either be paid out in cash or converted into common stock shares of Diversus as if such preferred stock shares were converted into Diversus’ common stock shares immediately prior to the effective date of the merger.

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The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  Positive Physicians Holdings, Inc. was formed on May 1, 2018.  The accompanying financial statements for 2018 have been prepared on a combined basis and reflect our historical financial information and results of operations of PPIX, PCA, and PIPE as if the conversions and merger took place as of January 1, 2018.  Prior to the completion of the initial public offering, the Company, PPIX, PCA, and PIPE were under the common control of Diversus.  Additionally, prior to March 27, 2019, the Company did not engage in substantive pre-combination activities, and accordingly, is not considered the acquirer of the net assets of Positive Insurance Company.  The acquirer of these net assets is the majority stockholder of the Company.  Accordingly, the accompanying financial statements do not reflect any adjustments to fair value as might have been determined had the Company accounted for the acquisition of Positive Insurance Company’s net assets as a business combination.  

Our consolidated financial statements include our accounts and those of our wholly owned subsidiary.  We have eliminated all inter-company accounts and transactions in consolidation.  

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and notes.  Actual results could differ from these estimates and such differences could be material.  The Company’s principal estimates include the liability for losses and loss adjustment expenses, deferred acquisition costs, other-than-temporary impairments of investments, and valuation of deferred tax assets.

Cash and Cash Equivalents

The Company considers cash and cash equivalents to be cash on hand and depository bank accounts with original maturities of three months or less, are readily convertible to known amounts of cash, and present insignificant risk of changes in value due to changing interest rates.

Investments

Investments in fixed maturity securities are classified as available-for-sale and are stated at fair value. Unrealized holding gains and losses, net of related tax effects, on available-for-sale fixed maturity securities are recorded directly to accumulated other comprehensive income (loss).  Investments in equity securities are stated at fair value and unrealized holding gains and losses are credited or charged to net income (loss) as incurred and are included in realized investment (losses) gains, net in the accompanying consolidated and combined statements of operations.

In 2018, the Company had ownership interests in limited partnership equity hedge funds, which are reported as other investments in the accompanying combined balance sheet.  The partnership interests were measured at fair value using the funds’ net asset values as a practical expedient.  Unrealized holding gains and losses on partnership interests were credited or charged to net income (loss) as incurred and are included in realized investment gains (losses), net in the accompanying combined statement of operations. The Company sold these partnership interests during the second half of 2019.

Realized gains and losses on sales of equity and fixed maturity securities as well as other investments are recognized into income based upon the specific identification method.  Interest and dividends are recognized as earned.  Short-term investments are considered to be short-term, highly liquid investments that are less than one year in term to the dates of maturity at the purchase dates, and they present insignificant risk of changes in value due to changing interest rates.

The Company regularly evaluates all of its investments based on current economic conditions, credit loss experience, and other specific developments.  If there is a decline in a security’s net realizable value that is other than temporary, it is considered as a realized loss and the cost basis in the security is reduced to its estimated fair value.

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A fixed maturity security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) we intend to sell the security, 2) it is more likely than not that we will be required to sell the security before recovery of the security’s amortized cost basis, or 3) we believe we will be unable to recover the entire amortized cost basis of the security (i.e., credit loss has occurred).  Other-than-temporary-impairments (“OTTI”) of fixed maturity securities are separated into credit and noncredit-related amounts when there are credit-related losses associated with the impaired fixed maturity security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  The amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors is recorded in other comprehensive income (loss).  A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered, by comparing the present value of cash flows expected to be collected from the security, computed using original yield as the discount rate, to the amortized cost basis of the security.  The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.”

Deferred Acquisition Costs

Certain direct acquisition costs consisting of commissions, premium taxes and certain other direct underwriting expenses that vary with and are primarily related to the successful production of business are deferred and amortized over the effective period of the related insurance policies as the underlying policy premiums are earned.  The method followed in computing deferred acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned.  Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred acquisition costs.  If the estimation of net realizable value indicates that the deferred acquisition costs are not recoverable, then they would be written off.

Prepaid Management Fee

Prepaid management fee comprises costs incurred by the Company to execute a new management agreement with Diversus Management and is amortized on a straight-line basis over the seven-year useful life of the agreement.

Liability for Losses and Loss Adjustment Expenses

Liability for losses and loss adjustment expenses include an amount determined from individual case estimates and loss reports and an amount, based on prior experience, actuarial assumptions and management judgments for losses incurred but not reported. Such liabilities are necessarily based on assumptions and estimates, and while management believes the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided.  The methods for making such estimates for establishing the resulting liabilities are continually reviewed.  Estimating the ultimate cost of future losses and loss adjustment expenses is an uncertain and complex process.  This estimation process is based upon the assumption that past developments are an appropriate indicator of future events and involves a variety of actuarial techniques that analyze experience, trends, and other relevant factors.  The uncertainties involved with the reserving process include internal factors, such as changes in claims handling procedure, as well as external factors, such as economic trends and changes in the concepts of legal liability and damage awards.  Accordingly, final loss settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.  Adjustments to previously established reserves are reflected in the operating results of the period in which the adjustment is determined to be necessary.  Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.      

We also offer extended reporting coverage at no additional charge in the event of disability, death or retirement after a policyholder reaches the age of 55 and has been a mature-claims policyholder with Positive Insurance Company for at least one year.  An extended reporting endorsement policy reserve is required to assure that premiums are not earned prematurely.  This reserve is actuarially determined, and the balance is included in unearned premiums in the consolidated and combined balance sheets.

Premium Deficiency Reserves

Premium deficiency reserves and the related expenses are recognized when it is probable that expected future benefit payments, loss adjustment expenses, direct administration costs, and an allocation of indirect administration costs under a group of existing contracts will exceed anticipated future premiums and reinsurance recoveries considered over the remaining lives of the contracts, and are recorded as a component of deferred acquisition costs in the accompanying consolidated and combined balance sheets. The Company does not consider anticipated investment income when calculating premium deficiency reserves.  As of December 31, 2019 and 2018, the Company did not have any premium deficiency reserves.

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Reinsurance

The Company cedes insurance risk to other insurance companies. This arrangement allows us to minimize the net loss potential arising from large risks.  Reinsurance contracts do not relieve the Company of its obligation to its policyholders. Reinsurance premiums, losses, and loss adjustment expenses are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract.

Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments, non-U.S. government bonds, premiums receivable, and balances recoverable from reinsurers.  Non-U.S. government bonds are diversified, and no one investment accounts for greater than 5% of our invested assets.  Cash and cash equivalents are deposited with financial institutions with balances that fluctuate in excess of federally insured limits.  If the financial institutions were not to honor their contractual liability to us, we could incur losses.  We are of the opinion that there is low risk because of the financial strength of the respective financial institutions.  We are also subject to concentrations of credit risk through short-term money market investments.  The credit risk related to short-term money market investments is minimized by our investing in money market funds or repurchase agreements, both secured by U.S. government securities.  

No one insured accounted for over 10% of premiums receivable at December 31, 2019 and December 31, 2018 or gross written premium for the years ended December 31, 2019 and 2018.  We have reinsurance contracts with various reinsurers all of whom have A.M. Best ratings of A or better or have provided collateral to secure their obligations.

Revenue Recognition

Premiums are earned on a daily pro rata basis over the terms of the insurance policies.  Unearned premium reserves are established to cover the unexpired portion of the policies in force less amounts ceded to reinsurers.  For consideration received for policies with effective dates subsequent to the reporting period, the Company records an advance premium liability in lieu of written premium.

Premiums associated with tails are generally earned as written, except for the afore-mentioned extended reporting coverage in the event of disability, death or retirement.  Other forms of tails, in which premiums are earned as written, include the following: 1) An insured who terminates a claims-made policy with their prior carrier, and who purchases tail coverage (extended reporting coverage) from their old carrier or obtains retroactive (prior-acts) coverage from a new carrier, or 2) Stand-alone tail coverage in which an insured is offered a tail policy by their prior carrier but seeks a competitive quote from a different carrier.  Both types of tail coverage insure against claims reported after the end of the original policy period for incidents that occurred while that policy was in effect.  

Comprehensive Income (Loss)

Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale fixed maturity securities and unrealized losses related to factors other than credit on fixed maturity securities, are reported as a separate component in the equity section in the accompanying consolidated and combined balance sheets.  Such items, along with net income (loss), are components of comprehensive income (loss), and are reflected in the accompanying consolidated and combined statements of comprehensive income (loss).  Reclassifications of realized gains and losses on sales of investments out of accumulated other comprehensive income (loss) are recorded in realized investment (losses) gains, net in the accompanying consolidated and combined statements of operations.

Income Taxes

The Company accounts for income taxes under the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated and combined financial statements.  Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated and combined financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized.  In making such determination, we consider all available positive and negative evidence, including future reversal of existing taxable temporary differences, tax planning strategies, projected future taxable income, and recent financial operations.

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Prior to March 27, 2019, PPIX, PCA, and PIPE filed separate federal income tax returns.  The Company did not recognize any interest and penalties in the accompanying consolidated statement of operations for the year ended December 31, 2019 and the combined statement of operations for the year ended December 31, 2018.  PPIX, PCA, and PIPE remain subject to examination by the Internal Revenue Service for tax years 2016 through 2018 and the short stub period in 2019.  Beginning with 2019 tax year, the Company will file a consolidated federal income tax return.

Conversion Costs

PPIX, PCA, and PIPE incurred direct consulting and other costs related to the conversions from reciprocal insurance exchanges to stock forms of ownership and as part of offering securities during the initial public offering which took place on March 27, 2019.   Conversion and securities offering costs that were not expected to be reimbursed from the gross proceeds of the offering were expensed as incurred and included in other underwriting expenses in the accompanying consolidated and combined statements of operations.

As an emerging growth company, we have elected to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.  The following discussion includes effective dates for both public business entities and emerging growth companies, as well as whether specific guidance may be adopted early.

Recently Adopted Accounting Pronouncements

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-01 for the year ended December 31, 2018.  

The amendments in this ASU:

With the adoption of ASU 2016-01, a cumulative effect of unrealized holding gains and losses on previously classified available-for-sale equity securities included in accumulated other comprehensive income at January 1, 2018 are to be reclassified to retained earnings.  At January 1, 2018, unrealized holding gains in equity securities, net of tax effect, of $1,387,895 were reclassified from accumulated other comprehensive income to retained earnings for the year ended December 31, 2018.

In February 2016, the FASB issued guidance that requires lessees to recognize leases, including operating leases, on the lessee’s balance sheet, unless a lease is considered a short-term lease.  This guidance also requires entities to make new judgments to identify leases.  The guidance was effective for annual and interim reporting periods beginning after December 15, 2018 and permitted early adoption.  The Company’s adoption of this guidance on January 1, 2019 did not have a significant impact on our financial condition, results of operations or cash flows.

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Recently Issued Accounting Pronouncements

New accounting rules and disclosure requirements can impact the results and the comparability of the Company’s consolidated and combined financial statements. The following recently issued accounting pronouncements are relevant to the Company’s consolidated and combined financial statements:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.  The amendments in this Update require a new topic to be added (Topic 326) to the Accounting Standards Codification ("ASC") and removes the thresholds that entities apply to measure credit losses on financial instruments measured at amortized cost, such as loans, trade receivables, reinsurance recoverables, off-balance-sheet credit exposures, and held-to-maturity securities.  Under current GAAP, entities generally recognize credit losses when it is probable that the loss has been incurred.  The guidance under ASU 2016-13 will remove all current recognition thresholds and will require entities under the new current expected credit loss ("CECL") model to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that an entity expects to collect over the instrument's contractual life.   The new CECL model is based upon expected losses rather than incurred losses.  Additionally, the credit loss recognition guidance for available-for-sale securities is amended and will require that credit losses on such debt securities should be recognized as an allowance for credit losses rather than a direct write-down of amortized cost balance.  The ASU was effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years.  In November 2019, the FASB issued ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which extended the effective date of adopting ASU 2016-13.  Under ASU 2019-10, ASU 2016-13 will be effective for Public Business Entities that are SEC filers, excluding smaller reporting companies such as the Company, for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years.  For all other entities, including smaller reporting companies like the Company, ASU 2016-13 will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.  For all entities, early adoption will continue to be permitted; that is, early adoption is allowed for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (that is, effective January 1, 2019, for calendar year-end companies).  The Company is currently a smaller reporting company, so once the ASU becomes effective, the Company’s expected adoption date for ASU 2016-13 would change from fiscal years beginning after December 15, 2019 to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.  At this time, we are evaluating the potential impact of ASU 2016-13 in the Company’s consolidated financial statements.

The Company uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures.  Fixed maturity available-for-sale securities and equity securities are recorded at fair value on a recurring basis.  FASB ASC Topic 820 “Fair Value Measurements and Disclosures” establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value.  The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

Under ASC Topic 820, we base fair values of assets on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820. Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon our or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Management uses its best judgment in estimating the fair value of financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts we could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period end and have not been re-evaluated or updated for purposes of the consolidated and combined financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. Additionally, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

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We obtain one price for each security primarily from a third-party pricing service (“pricing service”), which generally uses quoted prices or other observable inputs for the determination of fair value.  The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information.  For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates, and prepayment speeds.

In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest-level input that is significant to the fair value measurement in its entirety.  Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

Amortized cost/cost, gross unrealized gains, gross unrealized losses, and fair value of fixed maturity securities by major security type for the results at December 31, 2019 and 2018 are as follows:

 

 

 

The table below sets forth the contractual maturity profile of our investments in fixed maturity securities at December 31, 2019 and 2018.  Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

 

 

Realized gains and losses are determined using the specific identification method. During the years ended December 31, 2019 and 2018, proceeds from maturities and sales and gross realized gains and losses on securities and other investments are as follows:

 

 

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The components of net realized investment gains (losses) for the years ended December 31, 2019 and 2018 are as follows:

 

 

The components of net investment income for the years ended December 31, 2019 and 2018 are as follows:

 

 

The following table shows fair value and gross unrealized losses of our fixed maturity investments with unrealized losses that are not deemed to be other-than temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019:

 

 

At December 31, 2019, we had 47 fixed maturity securities in unrealized loss positions of less than 12 months with a combined gross unrealized loss of $14,161 and 40 securities in unrealized loss positions of 12 months or longer with a combined gross unrealized loss of $38,098.

The following table shows fair value and gross unrealized losses of our fixed maturity investments with unrealized losses that are not deemed to be other-than temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2018:

 

 

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At December 31, 2018, we had 210 fixed maturity securities in unrealized loss positions of less than 12 months with a combined gross unrealized loss of $581,464 and 243 fixed maturity securities in unrealized loss positions of 12 months or longer with a combined gross unrealized loss of $1,197,367.

Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates, which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments.  The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions.

We evaluated each security and took into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts.  We found that the declines in fair value are most likely attributable to increases in interest rates, and there is no evidence that the likelihood of not receiving all of the contractual cash flows as expected has changed.  Our fixed maturity portfolio is managed by our investment committee in concert with an outside investment manager for investment grade bond investments.  By agreement, the investment manager cannot sell any security without the consent of our investment committee if such sale will result in a net realized loss.

We monitor our investment portfolio and review securities that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary.  When assessing whether the amortized cost basis of the security will be recovered, we compare the present value of the cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the amortized cost basis of the security.  The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as the “credit loss.”  If there is a credit loss, the impairment is considered to be other-than-temporary.  If we identify that an other-than-temporary impairment loss has occurred, we then determine whether we intend to sell the security, or if it is more likely than not that we will be required to sell the security prior to recovering the amortized cost basis less any current-period credit losses.  If we determine that we do not intend to sell, and it is more likely than not that we won’t be required to sell the security, then the amount of the impairment loss related to the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of tax.  If we determine that we intend to sell the security, or that it is more likely than not that we will be required to sell the security prior to recovering its amortized cost basis less any current-period credit losses, then the full amount of the other-than-temporary impairment will be recognized in earnings.

For the years ended December 31, 2019 and 2018, we determined that none of our fixed maturity securities were other-than-temporarily impaired.  Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.

The table below presents the level within the fair value hierarchy generally utilized by us to estimate the fair value of assets disclosed on a recurring basis at December 31, 2019:

 

 

The table below presents the level within the fair value hierarchy generally utilized by us to estimate the fair value of assets disclosed on a recurring basis at December 31, 2018:

 

 

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At December 31, 2018, we had ownership interests in limited partnership equity hedge funds.  Our partnership interests were measured at fair value using the funds’ net asset values as a practical expedient and are excluded from the fair value hierarchy tables above.  At December 31, 2018, the fair value and cost basis of these investments were $4,051,399 and $3,547,687, respectively.  During the second half of 2019, we sold our interests in these limited partnership funds and recognized a pre-tax gain of $556,723.  There were no sales of these investments in 2018.

The following table summarizes the movements in deferred acquisition costs for the years ended December 31, 2019 and 2018:

 

 

Effective as of March 27, 2019, Positive Insurance Company entered into a new policy reinsurance agreement.  Under the new agreement, the Company retains a portion of its exposure and pays to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by us are reinsured with other insurance companies principally to:

Under Pennsylvania law, each insured must maintain MPLI of at least $1,000,000 for each claim and $3,000,000 of annual aggregate coverage.  The Company provides primary insurance coverage up to $500,000 per claim and $1,500,000 of annual aggregate coverage. The Pennsylvania Medical Care Availability and Reduction of Error (“MCARE”) Fund provides coverage for any losses above $500,000 per claim up to $1,000,000.  In cases where coverage under the Pennsylvania MCARE Fund does not apply, the primary insurance provides coverage up to $1,000,000 per claim and $3,000,000 of annual aggregate coverage.  The Company retains the first $300,000 in loss on all Pennsylvania claims and reinsurance covers the excess up to $1,000,000 that is not covered by the Pennsylvania MCARE Fund.  We cede to reinsurers any Pennsylvania claims in excess of $1,000,000.      

Other states in which we write insurance require doctors to maintain certain minimum coverage and provide a fund that provides coverage for losses above a certain amount, but some states do not prescribe insurance requirements for doctors.

We offer primary coverage up to $1,000,000 for each claim and $3,000,000 of annual aggregate coverage in Delaware, Maryland, Michigan, Ohio, New Jersey, and South Carolina.  We retain the first $300,000 in loss for claims from these states, and reinsurance covers the excess up to $1,000,000.  If an insured in New Jersey requests, additional coverage of $1,000,000, each claim, each insured, each policy can be provided and is fully ceded to the reinsurer up to a maximum aggregate liability of $2,000,000 to the reinsurer per the term of the reinsurance agreement.  In South Carolina and Michigan, the insured can elect policy limits of $200,000 per claim and, on these claims, we retain the first $100,000 and the reinsurer covers the next $100,000.  

We also purchase additional reinsurance coverage for clash, losses in excess of policy limits and extra contractual obligation claims.

Our premiums under the new reinsurance agreement are based on a percentage of our earned premiums during the term of the agreement.  The agreement was renewed on April 1, 2020.

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Reinsurance does not legally discharge the insurance company issuing the policy from primary liability for the full amount due under the reinsured policies.  A primary factor in the selection of reinsurers from whom we purchase reinsurance is their financial strength. Our reinsurance arrangements are generally renegotiated annually.  The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition.  Our reinsurance providers, the majority of whom are longstanding partners that understand our business, are all carefully selected with the help of our reinsurance broker.  We monitor the solvency of reinsurers through regular review of their financial statements and, if available, their A.M. Best ratings. Hannover Re, our current reinsurance partner, has an “A+ (Superior)” rating from A.M. Best.  According to A.M. Best, companies with a rating of “A” or better “have an excellent ability to meet their ongoing obligations to policyholders.”

As of December 31, 2019, the Company’s reinsurance recoverable of $7,850,409 was supported by $6,051,000 of collateral.  The uncollateralized portion of this balance was recoverable from reinsurers rated “A” or better by A.M. Best.

As of December 31, 2019, the Company had reinsurance recoverable balances due from the following unaffiliated reinsurer in excess of 5% of shareholders’ equity:

 

We generally do not assume risks from other insurance companies.  However, we could be required by statute to participate in guaranty funds, which are formed to pay claims on policies issued by insolvent property and casualty insurers domiciled in certain states, such as Pennsylvania.  This participation, where applicable, requires us to pay an annual assessment based on our premiums written and determined on a market share basis.  At December 31, 2019, our participation was not material.

On October 9, 2018, Positive Physicians Captive Insurance Company (“PPCIC”), a sponsored captive insurance company, was incorporated in the State of New Jersey and is a wholly owned subsidiary of Positive Insurance Company.  PPCIC was licensed under the New Jersey Captive Insurance Act on October 16, 2018.  PPCIC has one protected unincorporated cell, Keystone Captive Group (“Keystone”).  Keystone is owned by an insured of Positive Insurance Company.  Effective October 16, 2018, the Company entered into a reinsurance agreement with Keystone and that agreement was endorsed in 2019 for continuous annual renewal.

The effect of reinsurance on premiums written, amounts earned, and losses incurred for the years ended December 31, 2019 and 2018 is as follows:

 

 

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The following table provides a reconciliation of our beginning and ending unpaid loss and loss adjustment expense (“LAE”) reserve balances for the years ended December 31, 2019 and 2018.

 

 

The liability for losses and LAE at December 31, 2019 and 2018 was $63,607,975 and $68,392,333, respectively.  For the years ended December 31, 2019 and 2018, $18,588,912 and $19,412,215, respectively, has been paid for incurred claims attributable to insured events of prior years.  Original estimates are increased or decreased, as additional information becomes known regarding individual claims.  The Company recorded unfavorable development of $136,271 on its prior period reserves for the year ended December 31, 2019. The adverse development consisted of reserve strengthening in the 2018 report year for claims-made policies and, to a lesser extent, the 2012 and 2016 accident years for occurrence policies, but was largely offset by favorable development in the 2015 report year for claims-made policies and 2017 accident year for occurrence policies.  For the year ended December 31, 2018, the Company experienced unfavorable development of $4,057,821 primarily related to significant reserve strengthening in the 2016 and 2017 accident years for both claims-made and occurrence policies.  

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Incurred and Paid Loss Development Information

The following information is presented about incurred and paid loss development at December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities, plus expected development on reported claims included within the net incurred claims amounts.

The information about incurred and paid claims development for the years ended December 31, 2010 to December 31, 2018 is presented as supplementary information and is unaudited.

 

 

 

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Reconciliation

The reconciliation for the net incurred and paid loss development tables to the liability for losses and LAE at December 31, 2019 in the accompanying balance sheet is as follows:

 

Losses Duration Information

The following is supplemental information about average historical claims duration at December 31, 2019:

 

 

 

Positive Insurance Company uses a combination of the Actual versus Expected Method, Bornhuetter-Ferguson Method, Expected Loss Ratio Method, Frequency/Severity Method, and the Incurred Loss Development Method in order to estimate its liability for losses and LAE.  Following the conversions and merger which were completed on March 27, 2019, the Company changed its approach by aggregating its data, previously under PPIX, PCA, and PIPE, and performing a single loss reserve analysis, as opposed to three separate loss reserve analyses.  The Company used combined development patterns based on PPIX, PCA, and PIPE experience for claims-made development factors, but derived occurrence development factors strictly based on former PPIX experience.  Tail policy development factors were derived from the occurrence factors.  Management does not believe that the effects of these changes had a material impact on the Company’s estimates.  The year-end loss reserve analysis also assumes that the Company will no longer utilize Andrews Outsource Solutions LLC to provide claims processing and risk management services following 2020, a measure which is expected to reduce the amount of LAE incurred in subsequent periods.  If this action is not taken, then the Company’s reserves for loss adjustment expenses would increase as a result.  There were no other significant changes in the methodologies and assumptions used to develop the liabilities for losses and LAE during the year ended December 31, 2019.

On December 12, 2014, PPIX entered into a loan agreement with a financial institution with proceeds totaling $300,000 to finance the development of a new policy system.  The loan is secured by the equipment purchased with the proceeds received.  The loan is being repaid on a monthly basis from January 2016 through December 2020 with interest calculated on the unpaid principal balance at a rate of 4% per annum.   At December 31, 2019 and 2018, the balance of the note payable was $64,858 and $127,327, respectively, and the Company remains compliant with all loan covenants.

The components of the Company’s income tax provision for the years ended December 31, 2019 and 2018 are as follows:

 

 

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The Company’s U.S. federal statutory income tax rate applicable to ordinary income was 21% for the years ended December 31, 2019 and 2018. The income tax provision differs from that computed by applying federal statutory rate to loss before income taxes for the years ended December 31, 2019 and 2018; those income tax rate differences are summarized as follows:

 

 

Deferred income taxes are provided for temporary differences between the consolidated and combined financial statements and the tax basis of the Company’s assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. At December 31, 2019 and 2018, the Company’s deferred income taxes consisted of the following:

 

 

At December 31, 2019 and 2018, the Company had unused net operating loss (“NOL”) carryforwards of $3,600,298 and $3,865,253, respectively, which will begin to expire in 2038, if unused.  At the time of the conversions and merger, the Company had unused NOLs of $4,313,198, which are subject to limitations under Section 382 of the Internal Revenue Code and are limited in the amount that can be utilized in any one year.  The Company also has AMT credits of $14,754, which are expected to be fully utilized by 2021.  Refer to Note 16, Subsequent Events, for the effects on the NOL carryforwards resulting from the Coronavirus Aid, Relief, and Economic Security Act.

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax planning strategies in making this assessment. At December 31, 2019 and 2018, management determined that it is more likely than not that all of the deferred tax assets will be realized by the Company in future years. Accordingly, the Company did not record a valuation allowance against its deferred tax assets at December 31, 2019 and 2018.

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The Company has applied the provisions of ASC 740, Income Taxes, for the years ended December 31, 2019 and 2018. ASC 740 prescribes a recognition threshold and measurement attribute with respect to uncertainty in income tax positions. In applying ASC 740, the Company has evaluated its various tax positions taken during the years ended December 31, 2019 and 2018. The Company has determined that based solely on the technical merits, each tax position on a current and deferred basis has a more-likely-than-not probability that the tax position will be sustained by taxing authorities. The Company is not presently under audit by any taxing authority and there are no other uncertainties and events that are reasonably possible in the next year that would cause a significant change in the amount of unrecognized tax benefits.

The Company did not recognize any interest and penalties in the accompanying consolidated and combined statements of operations for the years ended December 31, 2019 and 2018, respectively.               

Additionally, as part of the enactment of the Tax Cuts and Jobs Act (“TCJA”) on December 22, 2017, property and casualty insurance companies are required to use Internal Revenue Service (“IRS”) prescribed factors to determine the loss discount. From the date of the passage of the new law, the IRS is using a corporate bond yield curve to determine the discount factors and property and casualty insurance companies are no longer allowed to use their own historical payment patterns to determine their discount factors. Transition rules require that property and casualty insurance companies recalculate the 2017 reserve discount as if the 2018 tax reform rules had been in effect at the time of the passage of the new law, compare it to the actual 2017 reserve discount, and amortize the difference into taxable income over eight years beginning in 2018. As a result of this comparison, the Company recorded as a component of deferred income taxes at December 31, 2017 a resulting tax-effected difference amount of $201,439, for which the pre-tax amount of $959,235 is being amortized into taxable income beginning in 2018. During 2019, the IRS issued additional regulations related to the 2017 reserve discount resulting in an adjusted pre-tax amount of $1,249,684.   At December 31, 2019 and 2018, the deferred tax liability related to the TCJA transitional adjustment was $224,943 and $314,446, respectively, and is included as a component of deferred income taxes.

Positive Insurance Company is managed by Diversus Management.  Prior to March 27, 2019, Diversus Management, through former attorneys-in-fact of PPIX, PCA, and PIPE, earned management fees at 25% of gross written premiums of the exchanges.  Concurrent with the acquisition of PPIX, PCA, and PIPE and the initial public offering on March 27, 2019, Positive Insurance Company and Diversus Management entered into a new management agreement, effective March 27, 2019, whereby Diversus Management provides administrative services to Positive Insurance Company in exchange for fees based on a percentage of Positive Insurance Company’s gross written premium, less return premium.  Under the new agreement, Diversus Management earns management fees at 12%.  Diversus Management may also earn quarterly performance management fees based on Positive Insurance Company’s combined ratio and net earned premiums.   No quarterly performance fees were payable under the terms of the agreement at December 31, 2019.   

Management fees for 2019 and 2018 are recorded in other underwriting expenses in the consolidated and combined statements of operations, respectively.  Positive Insurance Company incurred management fees for the respective periods, as follows:

 

 

In connection with the execution of the new management agreement with Diversus Management, the Company paid Diversus $10,000,000 to execute the agreement.  Such payment is presented as “Prepaid management fee” in the accompany consolidated balance sheet at December 31, 2019 and is amortized on a straight-line basis over a period of seven years.  During the year ended December 31, 2019, the Company incurred amortization expense of $1,071,429, which is recorded in other underwriting expenses in the consolidated statement of operations.

 

Positive Insurance Company has contracts with Gateway Risk Services, LLC and Andrews Outsource Solutions LLC, both of which are wholly owned subsidiaries of Diversus, under which those companies provide claims processing and risk management services. Fees incurred by Positive Insurance Company under these contracts for 2019 and 2018 were recorded in other underwriting expenses in the consolidated and combined statements of operations, respectively, as follows:

 

 

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Additionally, the former attorney-in-fact of PCA earned commissions related to our gross written premium and other accounts.  Beginning March 27, 2019, these commissions were paid to Specialty Insurance Agency, LLC, a wholly owned subsidiary of Diversus. These commissions for 2019 and 2018 are recorded in other underwriting expenses in the consolidated and combined statements of operations, respectively.  Positive Insurance Company incurred related commission expenses for the respective periods, as follows:  

 

 

The Company and Diversus entered into a loan agreement dated March 27, 2019 to provide a $6,000,000 credit facility to Diversus for working capital purposes.  Diversus may borrow in one or more advances up to $5,500,000 under a term loan and up to $500,000 under a revolving loan.  Outstanding borrowings under the credit facility will bear interest at 8%, will be unsecured, and will be subordinate to the existing senior debt and other commercial loan obligations of Diversus.  The loan is convertible into common stock shares of Diversus at a price of $1 per share at the option of the Company.  At December 31, 2019, there was no outstanding balance on the credit facility.

The Company is authorized to issue 10,000,000 shares of $0.01 par value common stock.  At December 31, 2018, there were no shares of common stock issued and outstanding.  In connection with the completion of the initial public offering on March 27, 2019, 3,615,500 shares of the Company’s common stock were issued.  At December 31, 2019, 3,615,500 shares of common stock remain issued and outstanding.  

On September 27, 2019, the Company granted its Chief Executive Officer options to purchase 216,930 shares of common stock at an exercise price of $12.01 per share, which was the closing sale price of the Company’s common stock on the date the options were granted.  Of the total options, 108,465 shares will vest in equal monthly installments over a three-and-one-half year period following September 27, 2019, and the remaining 108,465 shares will vest upon the achievement by the Company of certain milestones.  All vested option shares shall be exercisable for eight years from the date of vesting.  The stock-based compensation expense incurred by the Company during the year ended December 31, 2019 was not significant.     

The holding company has cash and other liquid assets aggregating $16,843,126 at December 31, 2019.  The holding company’s principal source of future liquidity will be dividend payments from Positive Insurance Company, which is restricted by the insurance laws and regulations of the Commonwealth of Pennsylvania as to the amount of dividends or other distributions it may pay to the Company.  

An order by the Pennsylvania Insurance Department approving the conversions of PPIX, PCA, and PIPE prohibits the declaration or payment of any dividend, return of capital, or other distribution by the Company to Insurance Capital Group, LLC and Enstar Holdings (US) LLC, the two principal stockholders of the Company, or any other shareholder without the prior approval of the Pennsylvania Insurance Department, for a period of three years following the effective date of the conversions.  Additionally, by the order of the Pennsylvania Insurance Department, Positive Insurance Company cannot pay a dividend to the Company for a period of three years following the effective date of the conversions without the approval of the Pennsylvania Insurance Department.

Prior to its payment of any dividend, Positive Insurance Company will be required to provide notice of the dividend to the Pennsylvania Insurance Department. This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The Pennsylvania Insurance Department has the power to limit or prohibit dividends if Positive Insurance Company is in violation of any law or regulation.

As discussed in Note 1, the conversions of PPIX, PCA, and PIPE to stock insurance companies and the simultaneous acquisition of these companies resulted in the issuance of the Company’s common stock at March 27, 2019.  The weighted average number of common shares outstanding was 3,615,500 for the year ended December 31, 2019.  For the period prior to the date of the conversions, the net common shares issued in the initial public offering were assumed to be outstanding since January 1, 2019.

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The following table presents a reconciliation of the numerators and denominators that were used in the basic and diluted per share computations for the Company’s common stock:

 

 

In the event a property and casualty insurer operating in a jurisdiction where Positive Insurance Company also operates becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer.  Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction.  The Company receives such assessments from the Pennsylvania Property and Casualty Insurance Guaranty Association for which it accrued liabilities of $194,715 and $171,550 at December 31, 2019 and 2018, respectively.  These accruals are included in accounts payable, accrued expenses, and other liabilities in the accompanying consolidated and combined balance sheets. Positive Insurance Company has not recorded applicable premium tax credits at December 31, 2019 and 2018 related to guaranty assessments. Total guaranty fund expense, net of prior years’ refunds and premium tax credits, for the years ended December 31, 2019 and 2018 was $70,076 and $35,623, respectively.

                   

The Pennsylvania MCARE Fund is a special fund established by the Commonwealth of Pennsylvania to ensure reasonable compensation for persons injured due to medical negligence. Healthcare providers who render 50% or more of his or her healthcare business or practice within Pennsylvania are required to obtain statutory excess professional liability coverage with MCARE by paying a certain percentage (assessment) of the prevailing primary premium charged by the Pennsylvania Professional Liability Joint Underwriting Association to MCARE. Positive Insurance Company assesses its policyholders as required by MCARE in addition to collecting the premium assessed. The assessments collected from policyholders are included in accounts payable, accrued expenses, and other liabilities in the accompanying consolidated and combined balance sheets, and no income is recognized by Positive Insurance Company. At December 31, 2019 and 2018, Positive Insurance Company had liabilities of $340,851 and $678,236, respectively, for amounts collected on behalf of MCARE.

The New Jersey Property-Liability Insurance Guaranty Association (“NJPIGA”) was created by the State of New Jersey to provide a safety net for policyholders and claimants of insolvent property-casualty insurance companies. Positive Insurance Company assesses its policyholders as required by NJPIGA in addition to collecting the premium assessed. The assessments collected from policyholders are included in accounts payable, accrued expenses, and other liabilities in the accompanying consolidated and combined balance sheets, and no income is recognized by Positive Insurance Company. At December 31, 2019 and 2018, Positive Insurance Company had liabilities of $40,301 and $36,777, respectively, for amounts collected on behalf of NJPIGA.

Accounting principles used to prepare statutory financial statements differ from those used to prepare these consolidated financial statements under GAAP. Prescribed statutory accounting practices (“SAP”) include state laws, regulations, and general administration rules, as well as a variety of publications from the National Association of Insurance Commissioners (“NAIC”). The statutory financial statements of Positive Insurance Company are prepared in accordance with SAP prescribed by the Pennsylvania Insurance Department.

Financial statements prepared under SAP focus on solvency of the insurer and generally provide a more conservative approach than under GAAP. These accounting practices differ significantly in the following respects from GAAP: (1) assets must be included in the statutory balance sheet at “admitted asset value,” whereas GAAP requires historical cost or, in certain instances, fair value; (2) “non-admitted assets” must be excluded through a charge to surplus, while on a GAAP basis “non-admitted assets” are included in the balance sheet net of any valuation allowance; (3) acquisition costs, such as commissions, management fees, premium taxes, and other items, have been charged to operations when incurred, whereas GAAP requires capitalization of these expenses, which are amortized over the term of the policies; (4) the carrying value of fixed maturity securities are based on NAIC ratings, whereas GAAP requires fixed maturity securities to be valued based on whether management intends to hold the securities to maturity; (5) changes in deferred income taxes are reported directly to surplus, whereas changes to deferred income taxes are reflected in the statement of income for GAAP; (6) deferred tax assets, net of any valuation allowance, are subject to an admissibility calculation, whereas under GAAP, no such calculation exists; and (7) ceded reinsurance amounts (unearned premiums and estimated unpaid loss recoverables) are shown net of the related liability, whereas they are presented on a gross basis and reflected as an asset for GAAP.

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The Pennsylvania Insurance Department.has adopted certain prescribed accounting practices that differ from those found in NAIC SAP.  Specifically, the Pennsylvania Insurance Department permits the deduction of management fees related to unearned premiums from unearned premiums reserve and charging operations on a pro-rata basis over the period covered by these policies; whereas under NAIC SAP, the unearned premiums would not be reduced by the management fees paid related to unearned premiums reserve.  With the conversions of PPIX, PCA, and PIPE from reciprocal insurance exchanges into stock insurance companies as of March 27, 2019, the prescribed practice of deducting management fees related to unearned premiums from unearned premiums reserve is no longer applicable to Positive Insurance Company.

Statutory net income (loss) and surplus and other funds as determined in accordance with SAP prescribed or permitted by the Pennsylvania Insurance Department for the years ended December 31, 2019 and 2018 are as follows:

 

 

A reconciliation of statutory surplus and other funds between NAIC SAP and practices prescribed by the Pennsylvania Insurance Department for the years ended December 31, 2019 and 2018 are as follows:

 

 

Positive Insurance Company is subject to minimum risk-based capital (“RBC”) requirements that were developed by the NAIC.  The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances and various levels of risk activity.  Regulatory compliance is determined by a ratio of Positive Insurance Company’s total adjusted capital, as defined by the NAIC, to its authorized control level RBC. At December 31, 2019 and 2018, our RBC exceeded minimum RBC requirements.

Subsequent events have been evaluated through May 14, 2020, which is the date the consolidated and combined financial statements were available to be issued.

Subsequent events impacting the Company include the following:

Effects of COVID-19

The Company’s operations and business have experienced disruptions due to the conditions surrounding the COVID-19 pandemic spreading throughout the United States.  These disruptions include, but are not limited to, office closures and difficulties in maintaining operational continuance during remote operations required by illness, social quarantining, and work from home orders currently in force.  The Company’s management has devoted substantial time and attention to assessing the potential impact of COVID-19 and those events on the Company’s operations and financial position and developing operational and financial plans to address those matters.

As a result of the COVID-19 pandemic, the Company anticipates that premiums will decrease due to policy endorsements associated with doctors electing to work part time, take a leave of absence or retire.  In addition, our insureds may elect to temporarily change specialties.  For example, a doctor may choose to drop from orthopedic surgery to office-only status due to the lack of elective surgeries.  The Company has received notification for such requests from our policyholders which will go into effect on June 30, 2020.  

In terms of collections, prior to the pandemic, the Company’s policy was to cancel any insurance policies for which premiums had not been received within 60 days subsequent to policy effective date, with notice of intent to cancel sent to the insured after 30 days post-inception date.  As a result of COVID-19, the Company has updated this policy and suspended cancellations of insurance

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contracts resulting from non-payment of premium until June 30, 2020 for invoices due after April 1, 2020.  Through May 11, 2020, the amount of premium payment deferrals is about $817,000.  

With respect to claims, Positive Insurance Company’s policyholder base mainly consists of physicians, their corporations and medical groups.  During the COVID-19 pandemic, on-site visits to doctors have declined and been replaced by an increase in telehealth/virtual office visits.  Since the COVID-19 pandemic resulted in government-issued work from home orders, the Company has seen the number of new claims reported begin to decrease.  

 

Investments

The Company’s investment portfolio has experienced significant fluctuations in fair value as a result of the market volatility due to the COVID-19 pandemic.  The following tables reflect the changes in our investment portfolio since December 31, 2019.

 

 

 

CARES Act

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) into law.  The CARES Act includes certain income tax-related law changes that the Company believes will have a material effect on its deferred income taxes in 2020.  The most significant effect on the Company’s deferred income taxes is expected to be due to changes in the Federal net operating loss carryback provisions which will allow the Company to carryback NOLs originating in 2018 and 2019 to prior tax years with corporate income tax rates of 34% (as opposed to forward to future tax years with corporate income tax rates of 21%).  The Company estimates that this change will result in additional Federal income tax refunds of approximately $1.1 million during 2020 and will reduce the Company’s NOL by about $3.1 million, or about $650,000 tax-effected.

 

 

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), that are designed to ensure that required information is recorded, processed, summarized and reported within the required timeframe as specified in the SEC’s rules and forms of the SEC.  Our disclosure controls and procedures are also designed to ensure that information required to be disclosed is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

In connection with the preparation of this Annual Report on Form 10-K, we carried out an evaluation under the supervision of and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, as of December 31, 2019, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that as of December 31, 2019, our disclosure controls and procedures were effective and timely at the reasonable assurance level.

Management’s Report on Internal Control Over Financial Reporting

This Annual Report does not include a report of management’s assessment regarding internal control over financial reporting due to a transition period rule of the SEC for newly public companies.

Attestation Report of the Registered Public Accounting Firm

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting as required by Section 404(b) of the Sarbanes Oxley Act of 2002. Because we qualify as an emerging growth company under the JOBS Act, management’s report was not subject to attestation by our independent registered public accounting firm.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) identified during 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information.

None.

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PART III

Item 10. Directors, Executive Officers and Corporate Governance.

Directors and Officers

Our Board of Directors consists of Paul M. J. Brockman, William E. Hitselberger, Stephen J. Johnson, Duncan McLaughlin, Scott C. Penwell, Matthew T. Popoli, Lewis S. Sharps, M.D., and Jack Sun, each of whom also serves as a director of Positive Insurance Company. Each of the directors serves a term of one year, is elected annually, and will hold office until his successor has been elected and qualified or until his earlier death, resignation or removal. Annually, the director nominees are reviewed and proposed by the nominating/governance committee and are selected by the Board of Directors. Insurance Capital Group LLC (“ICG”) and Enstar Holdings (US) LLC have entered into an agreement that, among other things, affects the nomination and election of our directors. See “Board Governance” below.

Our Executive Officers are elected annually and, subject to the terms of their respective employment agreements, will hold office until their respective successors have been elected and qualified or until death, resignation or removal by the Board of Directors.

The following table sets forth certain information regarding our current directors.

 

 

The business experience of each nonemployee director for at least the past five years is set forth below.

Lewis S. Sharps, M. D.

Dr. Sharps founded Positive Physicians Insurance Exchange in 2002 and has served as the CEO and President since its inception. In 2017, he became the CEO and President of Diversus, Inc. Dr. Sharps attended medical school and completed his orthopaedic residency training at Thomas Jefferson University. He is a Fellow of The American Orthopaedic Society and The American Orthopaedic Association. He founded and managed multiple health care related companies and developed numerous instrument patents for minimally invasive spine surgery. Dr. Sharps served as President of the Pennsylvania Orthopaedic Society (POS) from 1999 to 2000. He was also instrumental in the creation of the Political Action Committee (PAC) of POS and was Chairman of the PAC from 1993 to 2011. During that time, the POS PAC became a major factor in Pennsylvania politics, protecting the long-term needs of the medical and orthopaedic communities. His experience and insights as a spine surgeon have greatly benefitted our risk management and claim management platform. He is a strong advocate of “integrated risk management,” whereby the medical malpractice insurer partners with the insureds and trains their in-house staff as to the benefits of notifying Positive Insurance Company of any unforeseen events and then working aggressively to resolve the issue.

Dr. Sharps has also been instrumental in developing technologies that promote patient safety in the operating room and continues to stress the need for integrated risk management in the freestanding outpatient office environment.

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Scott C. Penwell

Scott C. Penwell, Esq., is an attorney who has practiced corporate, securities and insurance law for 35 years and has been a member of the law firm of Penwell, Bowman + Curran LLC since 2017. Prior to that, Mr. Penwell was an associate and partner at Duane Morris LLP from 1981 to 2004, a partner at Stevens & Lee, PC, from 2004 to 2012, and a partner at Rhoads & Sinon, LLP from 2012 to 2017. In addition to practicing law, he has served on the boards of directors of numerous companies including banks, mutual funds and technology companies. He also founded and has served as a director and corporate officer of two insurance companies. From 1987 until its sale in 2014, he was a director and corporate secretary of Eastern Alliance Insurance Company, a publicly traded, national insurance company, and from 2010 until its sale in 2017, he was a director and Chairman of the Board of Directors of Great Falls Insurance Company, a regional insurance company that writes insurance in the northeastern United States. Mr. Penwell has been Chairman of the Business Law Section of the Pennsylvania Bar Association and a member of the attorney advisory committees of both the Pennsylvania Corporation Bureau and the Pennsylvania Securities Commission. Mr. Penwell received his BA from Rutgers University, his MA from Villanova University and his JD from Temple Law School, where he was Editor-in-Chief of Temple Law Review.

Stephen J. Johnson

Stephen J. Johnson is an Insurance Financial and Regulatory Specialist with the law firm of Stradley Ronon Stevens & Young, LLP. Prior to joining Stradley Ronon in 2016, Mr. Johnson served as Deputy Insurance Commissioner for the Pennsylvania Insurance Department’s Office of Corporate and Financial Regulation from 1998-2015, where he oversaw the Bureau of Company Licensing and Financial Analysis and the Bureau of Financial Examinations. Before that, Mr. Johnson served as Director of the Bureau of Financial Examinations where he oversaw a team of examiners and exam managers who conducted on-site reviews of the financial health of nearly 300 insurance companies in Pennsylvania, as well as continuing care retirement communities. Mr. Johnson also worked as Chief of the Financial Analysis Division in the Office of Corporate and Financial Regulation, supervising the department’s financial analysts and overseeing the analysis and review of financial statements filed by Pennsylvania’s licensed insurance companies. Before joining the Pennsylvania Insurance Department, Mr. Johnson worked at the Pennsylvania Securities Commission as Chief Analyst and at the Department of Auditor General as a Field Auditor. He also worked as an Audit Supervisor for the accounting firm Laventhol and Horwath. Mr. Johnson has been involved with numerous committees, task forces and financial working groups of the National Association of Insurance Commissioners (NAIC), including the Statutory Accounting Principles Working Group, which he has been involved with since its founding in 1994, and the Financial Analysis Working Group, of which he was appointed Chair in 2011. Mr. Johnson has 30 years of experience in the insurance industry and is a Certified Public Accountant.

William E. Hitselberger

William E. Hitselberger is the Chief Financial Officer of Sutton National Insurance Company, a property and casualty insurance company formed in 2019. Prior thereto, Mr. Hitselberger was the Treasurer of Castlepoint National Insurance Company from July 2016 through December 2018 and the Chief Financial Officer and Executive Vice President of Tower Group International, Ltd. (formerly, Tower Group Inc.) since March 15, 2010 and served as its Principal Accounting Officer during that time. Mr. Hitselberger joined the Tower Group International on December 8, 2009 as Senior Vice President. Mr. Hitselberger served as Executive Vice President of PMA Companies, Inc. (formerly, PMA Capital Corporation) from April 2004 to December 8, 2009. He served as Senior Vice President, Chief Financial Officer, and Treasurer of PMA Companies, Inc. from June 2002 to December 8, 2009. Mr. Hitselberger is a Certified Public Accountant and Chartered Financial Analyst. Mr. Hitselberger graduated from the University of Pennsylvania, where he received a B.S. in Economics in 1980.

Matthew T. Popoli

Matthew T. Popoli is the Managing Partner and Chief Executive Officer of Insurance Capital Group, with 20 years of insurance industry experience with a specialized focus on sponsored demutualizations and similar complex conversion transactions. Prior to founding Insurance Capital Group, Mr. Popoli was a Partner and Senior Managing Director at Reservoir Capital Group, which he joined in 2005, and led its financial services investing activities until he left Reservoir in May 2018 to found ICG. Previously, Mr. Popoli was a Principal at Capital Z Partners and began his career as an investment banker in the insurance group at Morgan Stanley & Co. Mr. Popoli is a graduate of Amherst College, where he received a B.A. in Economics.

Jack Sun

Jack Sun is a Vice President of Insurance Capital Group, which he joined in 2018.  Previously, he was a Vice President at Reservoir Capital Group, which he joined in 2016 and where he was a member of the investment team.  Prior to that, Mr. Sun was an investment professional at Centerbridge Partners, where he focused on the firm’s distressed credit and private equity opportunities.  

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He began his career at Lazard in the Restructuring Group.  Mr. Sun received an A.B. in Economics with a secondary in Statistics from Harvard College.

Paul M. J. Brockman

Paul M. J. Brockman was appointed President & Chief Executive Officer of Enstar (US) Inc. in 2016 and continues to serve as its President. He served as Chief Operating Officer of Enstar (US) Inc. from 2014-2016. Enstar is a Bermuda based company that specializes in the acquisition and run-off of insurance policy portfolios that had approximately $15.2 billion in assets at June 30, 2018. From 2012-2014, he served as Senior Vice President, Head of Commutations in the US. Before joining Enstar, he worked as Head of Reinsurance for Resolute Management Services UK Ltd. and prior to that at Equitas.

Duncan McLaughlin

Duncan McLaughlin has been a Director of Cranmore (EU) Ltd, a United Kingdom affiliate of Enstar, since relocating back from the United States in 2018. Cranmore is a specialist insurance and reinsurance audit and consultancy firm with six worldwide offices. From 2012 to 2018, Mr. McLaughlin was a Senior Vice President of Enstar (US) Inc. in the United States, and prior to that, he was a Director of Enstar (EU) Limited in the United Kingdom. Mr. McLaughlin joined Enstar Group in 2000 and has over 25 years of experience in the reinsurance business.

Board Governance

ICG and Enstar have agreed that the number of members of the Board of Directors of the Company shall be nine, and that six of such members shall be designated by ICG and two of such members shall be designated by Enstar. They have also agreed that one of the directors designated by ICG shall be elected as the Chairman of the Board, one of the directors designated by Enstar shall be elected as the Vice Chairman, and that the Chief Executive Officer of the Company will be a member of the Board of Directors.  The agreement also provides that at least five directors must be present at any meeting to constitute a quorum.

On March 25, 2020, the Company’s Board of Directors accepted the resignations of Craig A. Huff and James L. Zech and appointed Jack Sun as a member of the Board, effective immediately.  As a result of these changes, the size of the Company’s Board was decreased from nine to eight members.  This represents a deviation from the agreement described above.

The agreement between ICG and Enstar provides that any of the following actions by the Company or any of its subsidiaries must be approved in writing by both ICG and Enstar:

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ICG and Enstar have also agreed that for so long as Enstar continues to own the shares of Company common stock purchased in the offering, ICG will use commercially reasonable efforts to cause the Company to consider a proposal from Enstar with respect to any reinsurance proposed to be purchased by the Company or any of its subsidiaries.  In connection with this agreement, Enstar agreed to dismiss litigation brought by Enstar against Diversus and its directors that sought to enjoin Diversus from entering into the transaction with ICG contemplated by the standby stock purchase agreement.

Executive Management

The Company is an insurance holding company and currently has three employees, including Lewis S. Sharps, M.D. and Donovan C. Augustin. The Company entered into a management services agreement with Diversus Management that became effective upon completion of the Company’s initial public offering. Pursuant to the management services agreement, officers of Diversus Management are responsible for the day to day management of the Company and provide such management, financial accounting, and other services as the Company may require. Such services include preparing all annual, quarterly and current reports required to be filed with the SEC and all annual, quarterly and other reports required to be filed with the Pennsylvania Insurance Department and any other regulatory agencies. Daniel Payne is an officer of Diversus Management who was identified in the management services agreement as an officer who is responsible for providing such services to the Company and who serves as an executive officer of the Company.

Officers

Lewis S. Sharps, M.D. is the President and Chief Executive Officer of Diversus, Inc. and the President and Chief Executive Officer of the Company.

Donovan C. Augustin, age 44, recently joined the Company and Positive Insurance Company as Chief Financial Officer in October 2019. He has over 20 years of experience in the (re)insurance industry.  Prior to joining the Company, he served as Financial Controller and Senior Vice President at JLT Re (North America), Inc. from April 2017 to October 2019 where he was responsible for financial reporting to JLT Re Group and JLT Group Finance in the UK, financial planning and analysis and overseeing related processes with the company’s onshore and offshore support functions.  Prior to JLT Re, Mr. Augustin was with PricewaterhouseCoopers, serving domestic and multi-national insurance clients in both the audit and tax practices during two separate stints with the firm from 2003 to 2005 and July 2013 to April 2017, respectively.  Mr. Augustin was also an Assistant Controller with PMA Companies, Inc. (formerly, PMA Capital Corporation) where he managed the SEC reporting process from 2005 to 2010 and served as Tax Manager, following Old Republic’s acquisition of PMA in 2010, prior to rejoining PwC in 2013.  Mr. Augustin is a Certified Public Accountant and received an MBA from Villanova University and a B.S. in Accounting from Susquehanna University.

Daniel Payne, age 51, has been the Treasurer and Vice President of Diversus, Inc. since November 2017 and the Treasurer of the Company and Positive Insurance Company since March 2019.  He has also been the Chief Financial Officer and Treasurer of Diversus Management since March 2019 and the Treasurer of Specialty Insurance Agency LLC since February 2019, Andrews Outsource Solutions LLC since December 2017 and Gateway Risk Services LLC since January 2019, which are all subsidiaries of Diversus, Inc.  Mr. Payne was previously the Chief Financial Officer of Positive Physicians Insurance Exchange, Professional Casualty Association and Physicians’ Insurance Program Exchange (“PIPE”) and their respective Attorneys-In-Fact, prior to their respective mergers into Positive Insurance Company and Diversus Management in March 2019.  He is a veteran of the U.S. Air Force and has over 20 years of experience in the insurance industry as an agent, external auditor, consultant and employee.  Mr. Payne has done consulting work for several risk retention groups and began working with PIPE at its inception in 2005.  As a former partner in the CPA firm, Read Martin & Slickman, CPAs, Mr. Payne worked in a variety of business environments, including insurance, governmental, aviation, banking, nonprofit, manufacturing, and wholesale and retail entities.  Mr. Payne also provided individual, trust and corporate tax services for clients along with investment management and insurance services.  He remains a registered investment adviser representative and insurance agent for property, casualty and life.  He is a Certified Public Accountant (Georgia) and a Certified Financial Planner.

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Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s directors, executive officers and beneficial owners of more than 10 percent of the common stock of the Company to file reports of ownership and changes in ownership with the SEC and NASDAQ. Copies of these reports must also be furnished to the Company. 

In connection with the completion of the initial public offering on March 27, 2019, the Company issued 3,615,500 shares of common stock.  There were no directors or executive officers with more than 10 percent ownership of the common stock of the Company during the year ended December 31, 2019.  However, both ICG (63.0%) and Enstar Holdings (US) LLC (27.0%) have filed the appropriate reports, reflecting their beneficial ownership in the Company.

Code of Ethics and Business Conduct

The Company has adopted a Code of Ethics and Business Conduct, which is designed to help directors, officers and employees maintain ethical behavior and resolve ethical issues in an increasingly complex global business environment. The Code of Ethics and Business Conduct applies to all directors, officers and employees, including the Chief Executive Officer, the Chief Financial Officer, and any other employee. The Code of Conduct covers topics including, but not limited to, ethical behavior, conflicts of interest, corporate opportunities, confidentiality of information and compliance with laws and regulations. A copy of our Code of Ethics and Business Conduct is available at the Company’s website under the “Resources” section at www.positivephysicians.com. Any amendments to the Code of Ethics and Business Conduct will be posted on the website, and any waiver that applies to a director or executive officer will be disclosed in accordance with the rules of the SEC and NASDAQ.

Audit Committee. The Company has a standing Audit Committee composed exclusively of independent directors. The members of the Audit Committee are William E. Hitselberger (Chair), Stephen Johnson and Scott C. Penwell. The Company’s Board of Directors has determined that Mr. Hitselberger is an audit committee financial expert within the meaning of SEC regulations. Under the independence criteria utilized by the NASDAQ listing rules, the Audit Committee members must meet additional criteria to be deemed independent. An Audit Committee member may not, other than in his or her capacity as a member of the Committee, the Board of Directors, or any other Board of Directors’ Committee (i) accept directly or indirectly any consulting, advisory, or other compensatory fee from the Company other than the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the Company (provided such compensation is not contingent in any way on continued service); or (ii) be an affiliated person of the Company as defined in Exchange Act Rule 10A-3(e)(1).

The Audit Committee is responsible for:

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Item 11. Executive Compensation.

Compensation Committee Report

Our Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management and, based on such review and discussion, our Compensation Committee recommended to our Board of Directors that the Compensation Discussion and Analysis be included in this Form 10-K.

Compensation Committee:

Scott C. Penwell (Chair)

William E. Hitselberger

Stephen J. Johnson

Executive Compensation

Summary Compensation Table

The following table sets forth information regarding the total annual compensation received by our named executive officers from the Company for each of the fiscal years ended December 31, 2019 and 2018.

 

 

 

Compensation Discussion and Analysis

The officers of the Company did not receive any compensation for their services as officers of the Company, PPIX, PCA, or PIPE during 2018. Effective March 27, 2019, the Company agreed to pay Lewis S. Sharps, M.D. an annual salary of $135,000 for his services as President and Chief Executive Officer of the Company. Dr. Sharps is also entitled to receive an annual cash bonus equal to the sum of 2.5% of the after-tax statutory net income of Positive Insurance Company, plus 2.5% of all dividends paid by the Company to its shareholders.

In addition, on September 27, 2019, the Company granted Dr. Sharps options to purchase 216,930 shares of common stock at an exercise price of $12.01 per share, which was the closing sale price of the Company’s common stock on the date the options were granted.  Of the total options, 108,465 shares will vest in equal monthly installments over a three-and-one-half year period following September 27, 2019, and the remaining 108,465 shares will vest upon the achievement by the Company of certain milestones, as noted below.  All vested option shares shall be exercisable for eight years from the date of vesting.

One third of 108,465 options will vest upon achievement of each of the following milestones: (i) Positive Insurance Company attaining an “A-” rating from A.M. Best, (ii) the completion of acquisitions by the Company, Positive Insurance Company, or any other subsidiary of the Company of risk bearing entities, including risk retention groups, stock and mutual insurance companies, reciprocal insurance exchanges, and reinsurance transactions and loss portfolio transfers with total acquired statutory surplus of $50 million or more, and (iii) purchasers of shares in the offering who continue to hold such shares achieving a 300% return on their investment (including all dividends and proceeds from sales of shares of Company common stock and any other distributions to shareholders of the Company).  Upon the sale by Dr. Sharps of any shares of common stock underlying such stock options, the

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Company will pay to Dr. Sharps in cash the amount equal to the number of shares sold and the amount by which the exercise price for the applicable stock options exceeds $10.00 per share.

On October 11, 2019, the Company appointed Donovan C. Augustin as its Chief Financial Officer and agreed to pay him an annual salary of $180,000 for his services, approximately half of which is allocated to and paid by Diversus Management.  Mr. Augustin also received a signing bonus of $25,000 from the Company upon commencement of his employment, which is subject to repayment should he voluntarily terminate his employment with the Company or be terminated “for cause” prior to October 11, 2020.  Mr. Augustin is also entitled to receive an annual cash bonus at the discretion of the Company’s Board of Directors.

The Company intends to adopt an equity incentive plan that will permit the Company to issue stock options and shares of restricted stock in an aggregate amount equal to ten percent of the number of shares of the Company that were outstanding immediately after completion of the offering, or 361,550 shares. The stock options granted to Dr. Sharps will be counted towards the number of shares restricted stock and stock options that can be granted under such plan.

Director Compensation

The directors of the Company did not receive any compensation for their service as directors during 2018. Effective March 27, 2019, the Company agreed to pay Messrs. Johnson, Hitselberger, Penwell, and Zech a flat annual fee of $25,000 for Board of Directors’ meeting attendance in person or participation by telephone, regardless of the number of such meetings, which annual fee was prorated for fiscal year 2019. No additional compensation is paid for attending committee meetings. Each director is entitled to be reimbursed for all reasonable out-of-pocket expenses incurred in connection with attending meetings of the Board of Directors and of any committees of which such director is a member.

The following table sets forth information regarding the total annual compensation paid by the Company during the fiscal year ended December 31, 2019 to the nonemployee directors who serve as directors of the Company.  No such compensation was paid during 2018.

 

 

 

 

 

 

 

 

 

 

 

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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The table below sets forth information regarding the beneficial ownership of our common shares at May 11, 2020 by:

Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment power with respect to the securities. In computing the number of common shares beneficially owned by a person and the percentage ownership of that person, we deemed outstanding common shares subject to options or other convertible or exercisable securities held by that person that are currently exercisable or convertible or exercisable or convertible within 60 days of May 11, 2020. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. The percentage of beneficial ownership is based on 3,615,500 common shares outstanding.

Except as indicated by footnote, and subject to applicable community property laws, the persons named in the table below have sole voting and investment power with respect to all common shares shown as beneficially owned by them. Unless otherwise indicated, the address of each of the individuals and entities named below is c/o Positive Physicians Holdings, Inc., 100 Berwyn Park, Suite 220, 850 Cassatt Road, Berwyn, Pennsylvania 19312.

 

 

Principal Shareholders

Based on filings made under Section 13(d) and Section 13(g) of the Securities Exchange Act of 1934, at May 11, 2020, the only persons known by us to be beneficial owners of five percent or more of the outstanding shares of our common stock were as follows:

 

 

 

 

 

 

 

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Item 13. Certain Relationships and Related Transactions, and Director Independence.

We have not engaged in any transactions with, loaned money to or incurred any indebtedness to, or otherwise proposed to engage in transactions with, loan money to or incur any indebtedness to, any related person, promoter or control person in an amount that in the aggregate exceeds $120,000.

We maintain a written policy which discourages our officers and directors from having a financial interest in any transaction between the Company or any of its subsidiaries and a third party. When we engage in transactions involving our officers, directors or employees, their immediate family members, or affiliates of these parties, our officers, directors and employees are required to give notice to us of their interest in such a transaction and refrain from participating in material negotiations or decisions with respect to that transaction.

Directors with an interest in such a transaction are expected to disqualify themselves from any vote by the Board of Directors regarding the transaction.

When considering whether we should engage in a transaction in which our officers, directors or employees, their immediate family members, or affiliates of these parties, may have a financial interest, our Board of Directors considers the following factors:

Director Independence

In order to determine which of our directors are independent, we have elected to utilize the standards for independence established under the NASDAQ listing standards. Under this standard, an independent director is a person other than an executive officer or employee of the Company or one of its subsidiaries or any other individual having a relationship which, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The following persons will not be considered independent:

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Under these criteria, all directors, except Lewis S. Sharps, M.D., are independent.  Pennsylvania insurance law requires that one-third of the members of each committee of the board be independent, except for the audit, nominating, and compensation committees, which may only include independent directors.

Item 14. Principal Accounting Fees and Services.

Under the Audit Committee’s charter, the Committee is responsible for the selection of the Company’s independent registered public accounting firm. The Committee also evaluates and monitors the auditors’ qualifications, performance and independence. This evaluation includes a review and evaluation of the lead partner of the independent registered public accounting firm. The Committee also takes into account the opinion of the Company’s management.  More can be learned about the Committee’s responsibility with respect to the independent registered public accounting firm in the Committee’s charter, which is available on the Company’s website at www.positivephysicians.com under the heading “Committee Charters” on the “Investor Relations” page.  Charters to the Company’s Nominating/Governance and Compensation Committees are also available, here, on our website.

The Audit Committee unanimously selected Baker Tilly Virchow Krause, LLP as the Company’s independent registered public accounting firm for 2018 and 2019.

Audit Fees

Fees pertaining to services rendered to the Company and its subsidiaries, PPIX, PCA, and PIPE by Baker Tilly Virchow Krause, LLP during the years ended December 31, 2019 and 2018 were as follows:

 

 

The audit fees shown above for 2018 include the fees of Baker Tilly Virchow Krause, LLP related to the audits of PPIX, PCA and PIPE for the December 31, 2018 stand-alone statutory financial statements.  All other fees presented above include fees from the Company’s Form S-1 filing, consents and comfort letters.

The Audit Committee maintains a policy requiring that it pre-approves all audit and permitted non-audit services provided by Baker Tilly Virchow Krause, LLP.  The non-audit services provided in 2019 were pre-approved by the Audit Committee.  However, none of the non-audit services provided in 2018 were pre-approved by the Audit Committee because the Committee did not exist prior to March 27, 2019.  The Audit Committee has considered whether, and determined that, the provision of the non-audit services reflected above is compatible with maintaining Baker Tilly Virchow Krause, LLP’s independence.

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PART IV

Item 15. Exhibits, Financial Statement Schedules.

FINANCIAL STATEMENTS AND SCHEDULES

 

 

All other schedules specified by Article 7 of Regulation S-X are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted.

Item 16. Form 10-K Summary

None.

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Exhibit Index

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

 

 

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Positive Physicians Holdings, Inc.

Index to Financial Statement Schedules

 

 

Certain financial statement schedules have been omitted because they are either not applicable or the required financial information is contained in the Company’s 2019 Consolidated Financial Statements and notes thereto.

 

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Positive Physicians Holdings, Inc.

Schedule I – Registrant Only Financial Statements

Balance Sheets

(Parent Company Only)

 

 

These financial statements should be read in conjunction with the

Consolidated Financial Statements and the notes thereto.

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Positive Physicians Holdings, Inc.

Schedule I – Registrant Only Financial Statements

Statements of Operations

(Parent Company Only)

 

 

These financial statements should be read in conjunction with the

Consolidated Financial Statements and the notes thereto.

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Positive Physicians Holdings, Inc.

Schedule I – Registrant Only Financial Statements

Statements of Cash Flows

(Parent Company Only)

 

 

These financial statements should be read in conjunction with the

Consolidated Financial Statements and the notes thereto.

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Positive Physicians Holdings, Inc.

Schedule V – Supplemental Information Concerning

Property and Casualty Operations

 

 

 

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