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EX-31.1 - EXHIBIT 31.1 - National Interstate CORPexhibit311-10k2015.htm
EX-24.1 - EXHIBIT 24.1 - National Interstate CORPexhibit241-10k2015.htm
EX-32.2 - EXHIBIT 32.2 - National Interstate CORPexhibit322-10k2015.htm
EX-32.1 - EXHIBIT 32.1 - National Interstate CORPexhibit321-10k2015.htm
EX-23.1 - EXHIBIT 23.1 - National Interstate CORPexhibit231-10k2015.htm
EX-31.2 - EXHIBIT 31.2 - National Interstate CORPexhibit312-10k2015.htm
EX-21.1 - EXHIBIT 21.1 - National Interstate CORPexhibit211-10k2015.htm

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2015
 
 Commission File No. 000-51130
National Interstate Corporation
(Exact name of registrant as specified in its charter)
Ohio
  
34-1607394
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer
Identification No.)
 
3250 Interstate Drive
Richfield, Ohio 44286-9000
(330) 659-8900
(Address and telephone number of principal executive offices)
 
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class
 
Name of exchange on which registered
Common Shares, $0.01 par value
 
Nasdaq Global Select Market
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  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ¨    No  x
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   x     No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   x     No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filer
 
¨
  
Accelerated filer
 
x
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨    No  x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $202.0 million (based upon non-affiliate holdings of 7,395,196 shares and a market price of $27.32 at June 30, 2015).
As of March 4, 2016 there were 19,924,535 shares of the Registrant’s Common Shares ($0.01 par value) outstanding.
Documents Incorporated by Reference:
Proxy Statement for 2016 Annual Meeting of Shareholders (portions of which are incorporated by reference into Part III hereof).
 

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National Interstate Corporation
Index to Annual Report on Form 10-K
 

 
 
Page
 
 
Item 1   —
 
 
 
 
 
 
 
Item 1A —
Item 1B —
Item 2   —
Item 3   —
Item 4   —
 
 
 
 
 
Item 5   —
Item 6   —
Item 7   —
Item 7A —
Item 8   —
Item 9   —
Item 9A —
Item 9B —
 
 
 
 
 
Item 10 —
Item 11 —
Item 12 —
Item 13 —
Item 14 —
 
 
 
 
 
Item 15 —


2


FORWARD-LOOKING STATEMENTS
The disclosures in this Form 10-K, including information incorporated by reference, contain “forward-looking statements” (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements, trend analyses and other information contained in this Form 10-K relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as “may,” “target,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “project,” and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Factors that could contribute to these differences include, among other things:
general economic conditions, weakness of the financial markets and other factors, including prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value of our investments;
our ability to obtain adequate premium rates and manage our growth strategy;
performance of securities markets;
our ability to attract and retain independent agents and brokers;
customer response to new products and marketing initiatives;
tax law and accounting changes;
increasing competition in the sale of our insurance products and services and the retention of existing customers;
changes in legal environment;
legal actions brought against us;
regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements;
damage to our reputation;
levels of natural catastrophes, terrorist events, incidents of war and other major losses;
technology or network security disruptions;
adequacy of insurance reserves; and
availability of reinsurance and ability of reinsurers to pay their obligations.
The forward-looking statements herein are made only as of the date of this report. We assume no obligation to publicly update any forward-looking statements.

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PART I
 
ITEM 1    Business
 
Introduction
National Interstate Corporation (the “Company”, “we”, “our”, “us”) and its subsidiaries operate as an insurance holding company group that underwrites and sells traditional and alternative property and casualty insurance products primarily to the passenger transportation, trucking and moving and storage industries, general commercial insurance to small businesses in Hawaii and Alaska and personal insurance to owners of recreational vehicles throughout the United States. Our principal executive offices are located at 3250 Interstate Drive, Richfield, Ohio, 44286 and our telephone number is (330) 659-8900. Securities and Exchange Commission (the “SEC”) filings, news releases, our Code of Ethics and Conduct and other information may be accessed free of charge through our website at http://invest.natl.com. Information on the website is not part of this Form 10-K. We make all documents that we file with, or furnish to, the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports, available on our website as soon as reasonably practicable. These reports are also available on the SEC's website at http://www.sec.gov.
Great American Insurance Company (“Great American”), a wholly-owned subsidiary of American Financial Group, Inc. (“AFG”), is our majority shareholder. At December 31, 2015, Great American owned 51.1% of our outstanding shares. Our common shares trade on the Nasdaq Global Select Market under the symbol “NATL.”

Property and Casualty Insurance Operations
We are a specialty property and casualty insurance company with a niche orientation and a focus on the transportation industry. Founded in 1989, we have had an uninterrupted record of profitability in every year since 1990, our first full year of operation. We have also reported an underwriting profit in 22 of the 27 years we have been in business. For the year ended December 31, 2015, we had gross premiums written (direct and assumed) of $727.1 million and net income of $20.8 million.
Our Products
We offer approximately 40 product lines in the specialty property and casualty insurance market, which we group into four general business components (alternative risk transfer (“ART”), transportation, specialty personal lines and Hawaii and Alaska) based on the class of business, insureds’ risk participation or geographic location.
The following table sets forth an analysis of gross premiums written by business component during the years indicated:
 
Year Ended December 31,
 
2015
 
2014
 
2013
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Alternative Risk Transfer
$
412,443

 
56.7
%
 
$
374,152

 
54.3
%
 
$
326,305

 
51.7
%
Transportation
237,271

 
32.6
%
 
245,261

 
35.6
%
 
228,139

 
36.1
%
Specialty Personal Lines
35,295

 
4.9
%
 
35,597

 
5.2
%
 
47,715

 
7.5
%
Hawaii and Alaska
22,284

 
3.1
%
 
21,276

 
3.1
%
 
20,096

 
3.2
%
Other
19,826

 
2.7
%
 
12,717

 
1.8
%
 
9,738

 
1.5
%
Gross premiums written
$
727,119

 
100.0
%
 
$
689,003

 
100.0
%
 
$
631,993

 
100.0
%

The range of in-force premium and annual premium averages at December 31, 2015 for the products we offer for each business component were as follows:
 
Premium Range
 
Annual Averages
 
(Dollars in thousands)
Alternative Risk Transfer
$1,000 - $38,100
 
$9,600
Transportation
$2,900 - $46,400
 
$18,200
Specialty Personal Lines
$3,200 - $29,600
 
$12,100
Hawaii and Alaska
$10,500 - $11,300
 
$10,900

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Alternative Risk Transfer.    We underwrite, market and distribute primarily truck transportation, passenger transportation and moving and storage ART insurance products, also known as captives. ART products function by utilizing insurance or reinsurance companies that are owned or “rented” (as described below) by the participants in the program. Participants may include homogeneous groups of passenger transportation, trucking or moving and storage companies, transportation insurance agencies and individual, larger insureds as single participants in our national account ART products. Program participants share in the underwriting profits or losses and the investment results associated with the risks of being insured through the program. Participants in these programs typically are interested in improved risk control, increased participation in the claims settlement process and asset investment features associated with an ART insurance program.
We support two forms of ART programs – member-owned and rental. In a member-owned ART program, the participants form, capitalize and manage their own reinsurance company. In a rental ART program, the reinsurance company is formed, capitalized and managed by someone other than the participants. The participants in a rental ART program pay a fee to use the reinsurance facility in their ART program; in other words, the participants “rent” it. For both member-owned and rental ART programs, we typically underwrite and price the risk, issue the policies and adjust the claims. A portion of the risk and premium is ceded to the ART insurance program. The ART insurance program serves the same purpose for the participants regardless of whether they own the reinsurance company or rent it. Hudson Indemnity, Ltd. (“HIL”), our consolidated subsidiary, is “rented” to program participants to facilitate the transfer of risk to the participants and the respective program’s results are recorded solely in HIL’s financial statements. Captive reinsurance facilities owned and managed directly by the member-owned program participants are not consolidated in our financial results since they are not variable interest entities.
The revenue we earn, our profit margins and the risks we assume are substantially consistent in member-owned and rental ART programs. The primary differences to us are the expenses associated with these programs and who ultimately bears those expenses. In a member-owned ART program, the participants own and manage their own reinsurance company, which includes general management responsibilities, financial statement preparation, actuarial analysis, investment management, corporate governance, regulatory management and legal affairs. If the actual expenses associated with managing a member-owned ART program exceed the funded projections, the participants pay for these added expenses outside the insurance transaction. In our rental ART programs, we include an expense charge in the program premium that we charge participants to fund expenses related to the managing of HIL. Investment management expenses also are included in the program premium and we cap the participant’s expense contribution regardless of whether or not we collect adequate funds to operate the off-shore reinsurance company.
All other loss, expense and profit margin components are substantially the same for our member-owned or rental ART programs. The advantage of a member-owned ART program to the participants is the ability to change policy issuing companies and service providers without changing the makeup of their group. Rental ART program participants are not obligated to capitalize their own reinsurer. They generally enjoy a slightly lower expense structure and their ART program expenses are fixed for the policy year regardless of the amount of expenses actually incurred to operate the reinsurer and facilitate participant meetings.
The premiums generated by each of the ART insurance programs offered by us are developed in a similar manner. The most important component of the premium charged is the development of the participants’ loss fund. The loss fund represents the amount of premium needed to cover the participants’ expected losses in the layer of risk being ceded to the captive reinsurer. Participants may assume 100% of the losses in the first loss layer or participate in a quota share arrangement, where the losses are shared between the participants and us. The loss layers typically range from $50,000 to $700,000 per occurrence and our members’ participation percentages in quota share arrangements generally range from 30% to 50%. Each participant’s loss fund layer is analyzed quarterly on a policy year basis to determine if the loss fund is sufficient to cover all losses within the layer. If the results in the loss fund layer are unfavorable to expectations an assessment of premium is charged and if results are favorable to expectations a return of premium is credited at the participant or group level. Typically, the premium and losses incurred through the funding of our captive participant’s loss layer are comparable period-over-period. However, increased member participation or assessment premium charged on the loss fund layer through HIL has the potential to unfavorably impact our loss and LAE ratio, and conversely, have a favorable impact on our underwriting expense ratio, when comparing results to a prior period.
Once the participants’ loss fund is established, all other expenses related to the coverages and services being provided are derived by a formula which is agreed to in advance by the ART program participants and the service providers. We provide services, including policy issuance, claims adjusting and insurance coverage in excess of the ART program retention, for our participants utilizing either our rental captive or a member owned captive. Additionally, for rental captive participants we provide loss control services and management of their captive program, whereas for member owned captive participants we coordinate these services with the member owned captive manager. These items, which are included in premiums charged to the insured, range from approximately 30% to 70% of a $1 million policy premium depending on the program structure and the loss layer ceded to the ART program.
Since our first member-owned ART program in the passenger transportation insurance market was established in 1995, we have established additional ART products for passenger and commercial transportation, including but not limited to, rental cars,

5


paratransit operations, taxi cabs, liquefied petroleum gas distributors, waste haulers, buses, crane and rigging operators, trucks and moving and storage companies. As of December 31, 2015, we insured approximately 450 transportation companies in ART programs. For the year ended December 31, 2015, we collectively had two customers that made up 19.0% of the total ART component revenues with one customer that independently accounted for 10.1% of the total ART revenues. Due to this concentration of revenue among a group of customers, if an event were to adversely affect one of these customers, it could have a material impact on our revenues from ART products.
Transportation.    We believe that we are one of the largest writers of insurance for the passenger transportation and moving and storage industries in the United States. In our transportation component, we underwrite commercial auto liability, general liability, physical damage, workers' compensation and motor truck cargo and related coverages for truck and passenger operators. Passenger transportation operators include charter and tour bus companies, municipal transit systems, school transportation contractors, limousine companies, inter-city bus services and community service and paratransit operations. We also provide tailored coverages to the moving and storage industry including, but not limited to, commercial auto liability, physical damage, workers’ compensation, employers’ liability, cargo, commercial umbrella, commercial property, general liability, crime, equipment breakdown, inland marine and movers and warehousemen’s liability. No one customer in our transportation component accounted for 10% or more of the revenues of this component during 2015 or 2014.
Specialty Personal Lines.    We believe our specialty recreational vehicle, or RV insurance program, differs from those offered by traditional personal auto insurers because we offer coverages written specifically for RV owners, including those who live in their RV full-time. We offer coverage for campsite liability, vehicle replacement coverage and coverage for trailers, golf carts and campsite storage facilities. In addition to our RV product, we also offer companion personal auto coverage to RV policyholders covering automobiles owned by our insured RV policyholders. One feature of our companion auto product that we believe is not generally available from other insurers is the application of a single deductible when an insured RV and the insured companion auto being towed are both damaged in an accident. We also assume all of the net risk related to policies for RV risks underwritten by us and issued by Great American. No one customer in our specialty personal lines component accounted for 10% or more of the revenues of this component during 2015 or 2014.

Hawaii and Alaska.    Our Hawaii office provides general commercial and transportation insurance for business owners in both Hawaii and Alaska and has become a leading writer of public and truck transportation in both states. No one customer in our Hawaii and Alaska component accounted for 10% or more of the revenues of this component during 2015 or 2014.
Geographic Concentration
The following table sets forth the geographic distribution of our direct premiums written for the years indicated:
 
 
Year Ended December 31,
 
2015
 
2014
 
Volume
 
Percent of
Total
 
Volume
 
Percent of
Total
 
(Dollars in thousands)
California
$
107,667

 
15.2
%
 
$
102,328

 
15.1
%
Texas
40,926

 
5.8
%
 
33,784

 
5.0
%
New York
40,174

 
5.7
%
 
39,093

 
5.8
%
Florida
33,756

 
4.8
%
 
32,491

 
4.8
%
Missouri
33,689

 
4.8
%
 
27,960

 
4.1
%
New Jersey
31,700

 
4.5
%
 
30,668

 
4.5
%
North Carolina
29,083

 
4.1
%
 
34,183

 
5.1
%
Pennsylvania
28,371

 
4.0
%
 
29,846

 
4.4
%
Illinois
24,644

 
3.5
%
 
21,479

 
3.2
%
All other states
338,480

 
47.6
%
 
324,989

 
48.0
%
Direct premiums written
$
708,490

 
100.0
%
 
$
676,821

 
100.0
%

6


Concentration by Statutory Line of Business
The following table sets forth our direct premiums written by statutory line of business for the years indicated:
 
 
Year Ended December 31,
 
2015
 
2014
 
Volume
 
Percent of
Total
 
Volume
 
Percent of
Total
 
(Dollars in thousands)
Auto and other liability
$
331,451

 
46.8
%
 
$
359,569

 
53.1
%
Workers’ compensation
278,290

 
39.3
%
 
217,455

 
32.1
%
Auto physical damage
81,947

 
11.6
%
 
82,375

 
12.2
%
All other lines
16,802

 
2.3
%
 
17,422

 
2.6
%
Direct premiums written
$
708,490

 
100.0
%
 
$
676,821

 
100.0
%
Product Management Organization
We believe we have a competitive advantage in our major lines of business, in part, as a result of our product management focus. Each of our product lines is headed by a manager who assists in determining and is solely responsible for achieving that product line’s planned results. We believe that the use of a product management organization provides the focus required to successfully offer and manage a diverse set of product lines. We offer our large transportation customers flexibility based on their needs by, for example, designing custom insurance programs, such as unique billing plans and deductibles. Our claims, accounting, information technology and other support functions are organized to align their resources with specific product line initiatives and needs. Our product managers are responsible for the underwriting, pricing and marketing and they are held accountable for underwriting profitability of a specific insurance product. Other required services and support are provided across product lines by functional managers.
Underwriting
We employ a pricing segmentation approach in our underwriting that makes extensive use of proprietary data and pricing methodologies. Our pricing strategy enables our product managers to manage rate structures by evaluating detailed policyholder information, such as loss experience based on driver characteristics, financial responsibility scores (where legally permissible) and the make/model of vehicles. This pricing segmentation approach requires extensive involvement of the product managers, who are responsible for the underwriting profitability of a specific product line with direct oversight of product design and rate level structure by our most senior managers. Individual product managers work closely with our pricing and database managers to generate rate level indications and other relevant data. We use this data coupled with information from the National Council on Compensation Insurance and the actuarial loss costs obtained from the Insurance Services Office, an insurance industry advisory service organization, as a benchmark in pricing our products. We believe the quality of our proprietary data, combined with our rigorous approach, has permitted us to generally respond more quickly than our competitors to adverse trends and to obtain appropriate pricing and risk selection for each individual account.
Risk selection and pricing decisions are discussed regularly by product line underwriters and product managers. We believe this group’s input and deliberation on pricing and risk selection reaffirms our philosophy and underwriting culture and aids in avoiding unknown exposures. Underwriting files at both our regional and corporate offices are audited by senior management on a regular basis for compliance with our price and risk selection criteria. Product managers are responsible for the underwriting profitability resulting from these risk selection and pricing decisions and the incentive-based portion of their compensation is based, in part, on that profitability.
Marketing and Distribution
We offer our products through multiple distribution channels including independent agents and brokers, program administrators, affiliated agencies and agent internet initiatives. During the year ended December 31, 2015, approximately 90% of our gross premiums written were generated by unaffiliated producers (i.e., independent agents, brokers and program administrators) and approximately 10% were generated by our affiliated agencies. Together, our top two unaffiliated producers accounted for an aggregate of 13.5% of our gross premiums written during 2015.

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Reinsurance
We reinsure a portion of our business to other insurance companies, which permits diversification of our risks and limits our maximum loss arising from large or unusually hazardous risks or catastrophic events. We are subject to credit risk with respect to our reinsurers, because the ceding of risk to a reinsurer generally does not relieve us of liability to our insureds until claims are fully settled. To mitigate this credit risk, we cede business only to reinsurers if they meet our credit ratings criteria of an A.M. Best rating of “A-” or better. If a reinsurer is not rated by A.M. Best or their rating falls below “A-”, our contract with them generally requires that they secure outstanding obligations with cash, a trust or a letter of credit that we deem acceptable.
Claims Management and Administration
We believe that effective claims management is critical and has contributed to our success, and that our process is cost efficient, delivers the appropriate level of claims service and produces superior claims results. We are focused on controlling claims from their inception with thorough investigation, accelerated communication to insureds and claimants and compressing the cycle time of claim resolution to control both loss cost and claim handling cost.
Claims arising under our insurance policies are reviewed, supervised and handled by our internal claims department. As of December 31, 2015, our claims organization employed 223 people (31% of our employee group) and operated out of three regional offices. All of our claims employees have been trained to handle claims according to our customer-focused claims management processes and procedures and are subject to periodic audit. We systematically conduct continuing education for our claims staff in the areas of best practices, fraud awareness, legislative changes and litigation management. All large claim reserves are reviewed on a quarterly basis by executive claims management, and adjusters frequently participate in audits and large loss reviews with participating reinsurers. We also employ a formal large loss review methodology that involves senior company management, executive claims management and adjusting staff in a quarterly review of all large loss exposures.
We provide 24-hour, 7 days per week, toll-free service for our policyholders to report claims. When we receive the first notice of loss, our claims personnel open a file and establish appropriate reserving to maximum probable exposure (based on our historical claim settlement experience) as soon as practicable and continually revise case reserves as new information develops. We maintain and implement a fraud awareness program designed to educate our claims employees and others throughout the organization of fraud indicators. Potentially fraudulent claims are referred for special investigation and fraudulent claims are contested.
Our claims department is organized by product and program specific divisions to allow the best understanding of our insured's organizations and particular risks. This structure enables our claims staff to become dedicated experts in particular product areas which enhances communication with our customers and increases cost effectiveness with claims resolution.
Our physical damage claims processes involve the utilization and coordination of internal staff, vendor resources and property specialists. We pay close attention to the vehicle repair process, which we believe reduces the amount we pay for repairs, storage costs and auto rental costs.
We employ highly qualified and experienced liability adjusters who are responsible for overseeing all injury-related losses including those in litigation. We identify and retain specialized outside defense counsel to litigate such matters. We negotiate fee arrangements with retained defense counsel and attempt to limit our litigation costs. The liability focused adjusters manage these claims by placing a priority on detailed file documentation and emphasizing investigation, evaluation and negotiation of liability claims.
Reserves for Unpaid Losses and Loss Adjustment Expenses (“LAE”)
We record our best estimate of liabilities for the costs of losses and LAE for both reported and unreported claims based on historical trends adjusted for changes in loss costs, underwriting standards, policy provisions, product mix and other factors. Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. We monitor factors such as the effect of inflation on medical, hospitalization, material repair and replacement costs, general economic trends and the legal environment. While the ultimate liability may be greater than recorded loss reserves, the reserve tail for transportation coverage is generally shorter than that associated with many other casualty coverages and, therefore, generally can be established with less uncertainty than coverages having longer reserve tails.
We review loss reserve adequacy and claims adjustment effectiveness quarterly. We focus significant management attention on claims reserved above $100,000. Further, our reserves are reviewed quarterly and opined upon annually by accredited actuaries from Great American. Reserves are routinely adjusted as additional information becomes known. Such routine adjustments are reflected in quarterly results in the period of adjustment.

The following tables present the development of our loss reserves, net of reinsurance, on a U.S. generally accepted accounting principles (“GAAP”) basis for the calendar years 2005 through 2015. The top line of each table shows the estimated liability for

8


unpaid losses and LAE recorded at the balance sheet date for the indicated year. The next line, “As re-estimated at December 31, 2015,” shows the re-estimated liability as of December 31, 2015. The remainder of the table presents intervening development from the initially estimated liability. This development results from additional information and experience in subsequent years. The middle line shows a net cumulative redundancy (deficiency) which represents the aggregate percentage change in the liability initially estimated. The lower portion of the table indicates the cumulative amounts paid as of successive periods.
 
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
Net Liability for Unpaid
Losses And LAE:
(Dollars in thousands)
As originally estimated
$
151,444

 
$
181,851

 
$
210,302

 
$
262,440

 
$
276,419

 
$
596,136

 
$
594,448

 
$
607,604

 
$
647,339

 
$
713,635

 
$
796,384

As re-estimated at December 31, 2015
135,599

 
164,932

 
199,011

 
253,812

 
266,998

 
549,520

 
605,462

 
652,198

 
700,418

 
735,060

 
 
Liability re-estimated as of:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year later
143,991

 
176,179

 
209,448

 
261,154

 
269,747

 
583,663

 
578,705

 
609,889

 
677,937

 
735,060

 
 
Two years later
142,929

 
173,860

 
207,281

 
250,185

 
267,995

 
553,526

 
579,048

 
633,458

 
700,418

 
 
 
 
Three years later
139,994

 
169,879

 
199,142

 
248,851

 
266,085

 
538,746

 
592,175

 
652,198

 
 
 
 
 
 
Four years later
138,108

 
166,043

 
198,852

 
248,675

 
263,346

 
543,274

 
605,462

 
 
 
 
 
 
 
 
Five years later
135,635

 
163,855

 
197,482

 
248,903

 
266,482

 
549,520

 
 
 
 
 
 
 
 
 
 
Six years later
134,328

 
163,279

 
196,405

 
251,645

 
266,998

 
 
 
 
 
 
 
 
 
 
 
 
Seven years later
134,686

 
163,055

 
197,774

 
253,812

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Eight years later
134,553

 
164,230

 
199,011

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine years later
135,293

 
164,932

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ten years later
135,599

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net cumulative redundancy (deficiency) [1]
15,845

 
16,919

 
11,291

 
8,628

 
9,421

 
46,616

 
(11,014
)
 
(44,594
)
 
(53,079
)
 
(21,425
)
 
 
Net cumulative redundancy (deficiency)  — %
10.5
%
 
9.3
%
 
5.4
%
 
3.3
%
 
3.4
%
 
7.8
%
 
(1.9
)%
 
(7.3
)%
 
(8.2
)%
 
(3.0
)%
 
 
Cumulative paid as of:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year later
51,901

 
63,314

 
67,673

 
91,615

 
90,410

 
182,652

 
201,717

 
240,981

 
276,653

 
272,712

 
 
Two years later
85,193

 
95,752

 
111,841

 
145,279

 
146,378

 
302,821

 
357,834

 
412,687

 
445,961

 
 
 
 
Three years later
101,340

 
119,984

 
141,484

 
182,163

 
189,177

 
399,997

 
466,486

 
514,939

 
 
 
 
 
 
Four years later
112,474

 
133,976

 
159,410

 
209,272

 
213,198

 
460,765

 
524,730

 
 
 
 
 
 
 
 
Five years later
117,073

 
140,160

 
170,085

 
220,421

 
227,573

 
485,348

 
 
 
 
 
 
 
 
 
 
Six years later
119,461

 
144,133

 
174,896

 
227,565

 
234,863

 
 
 
 
 
 
 
 
 
 
 
 
Seven years later
121,566

 
145,996

 
177,646

 
232,050

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Eight years later
122,205

 
147,134

 
180,025

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine years later
122,768

 
148,351

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ten years later
123,833

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
[1] —
Unfavorable development of $7.0M associated with Vanliner's guaranteed reserves was recorded in 2015. No development associated with Vanliner’s guaranteed reserves was recorded in 2014. Favorable development associated with Vanliner's guaranteed reserves recorded in 2013, 2012, and 2011 were $20.8 million, $19.0 million, and $9.8 million, respectively. Vanliner guaranteed reserve development related to accident years 2010 and prior is required to be reflected in calendar year 2010, which was the year of acquisition. See Note 2 to our consolidated financial statements - "Significant Accounting Policies" for a discussion of the contingent consideration related to the Vanliner guaranty. Excluding the Vanliner guaranty, we recorded unfavorable development of $14.4 million, $30.6 million and $23.1 million, for the years ending December 31, 2015, 2014 and 2013, respectively, in our Consolidated Statements of Income. See Note 12 to our consolidated financial statements - "Unpaid Losses and LAE," for a discussion of the impact on our unpaid losses and LAE.


9


The following is a reconciliation of our net liability to the gross liability for unpaid losses and LAE:
 
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
 
(Dollars in thousands)
As originally estimated:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net liability shown above
$
151,444

 
$
181,851

 
$
210,302

 
$
262,440

 
$
276,419

 
$
596,136

 
$
594,448

 
$
607,604

 
$
647,339

 
$
713,635

 
$
796,384

Add reinsurance recoverables
71,763

 
84,115

 
91,786

 
137,561

 
140,841

 
202,509

 
182,128

 
167,701

 
156,443

 
169,443

 
217,811

Gross liability
$
223,207

 
$
265,966

 
$
302,088

 
$
400,001

 
$
417,260

 
$
798,645

 
$
776,576

 
$
775,305

 
$
803,782

 
$
883,078

 
$
1,014,195

As re-estimated at December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net liability shown above
$
135,599

 
$
164,932

 
$
199,011

 
$
253,812

 
$
266,998

 
$
549,520

 
$
605,462

 
$
652,198

 
$
700,418

 
$
735,060

 
N/A

Add reinsurance recoverables re-estimated
61,510

 
59,962

 
55,530

 
105,369

 
83,996

 
138,692

 
165,629

 
179,328

 
187,453

 
196,905

 
N/A

Gross liability
$
197,109

 
$
224,894

 
$
254,541

 
$
359,181

 
$
350,994

 
$
688,212

 
$
771,091

 
$
831,526

 
$
887,871

 
$
931,965

 
N/A

Gross cumulative (deficiency) redundancy
$
26,098

 
$
41,072

 
$
47,547

 
$
40,820

 
$
66,266

 
$
110,433

 
$
5,485

 
$
(56,221
)
 
$
(84,089
)
 
$
(48,887
)
 
N/A

Gross cumulative (deficiency) redundancy — %
11.7
%
 
15.4
%
 
15.7
%
 
10.2
%
 
15.9
%
 
13.8
%
 
0.7
%
 
(7.3
)%
 
(10.5
)%
 
(5.5
)%
 
N/A


These tables do not present accident or policy year development data. Furthermore, in evaluating the re-estimated liability and cumulative (deficiency) redundancy, we note that each amount includes the effects of changes in amounts for prior periods. Conditions and trends that affected development of the liability in the past may not necessarily exist in the future. Accordingly, extrapolating redundancies and or deficiencies based on this table is inherently uncertain.

The preceding tables show our calendar year development for each of the last ten years resulting from reevaluating the original estimate of the loss and LAE liability on both a net and gross basis. Gross reserves are liabilities for direct and assumed losses and LAE before a reduction for amounts ceded. At December 31, 2015, our liability on a gross basis was $1.0 billion and our asset for ceded reserves was $217.8 million. The difference between gross development and net development is ceded loss and LAE reserve development. The range of dollar limits ceded by us is much greater and therefore more volatile than the range of dollar limits we retain, which could cause more volatility in estimates for ceded losses. Therefore, ceded reserves are more susceptible to development than net reserves. Net calendar year reserve development affects our income for the year while ceded reserve development or savings affects the income of reinsurers.

Investments
General
We approach investment and capital management with the intention of supporting insurance operations by providing a stable source of income to supplement underwriting income. We strive to protect capital while optimizing investment income, capital appreciation and maintaining appropriate liquidity. Our Board of Directors has approved investment guidelines established by management and reviews the portfolio performance at least quarterly for compliance with the established guidelines.

During 2015, we reinvested cash flows from sold and matured investments into primarily asset backed securities, which are categorized as other debt obligations, as these securities generally offered the best combination of yield, duration, and credit risk when considering other market opportunities and our existing holdings.


10


The following table presents the percentage distribution of our investment portfolio for the dates given based upon fair value:
 
 
At December 31,
 
2015
 
2014
Fixed maturities:
 
 
 
State and local government obligations
26.8
%
 
30.9
%
Other debt obligations
17.4
%
 
9.6
%
Corporate obligations
17.1
%
 
18.0
%
Residential mortgage-backed securities
13.3
%
 
17.4
%
U.S. Government and government agency obligations
12.8
%
 
10.3
%
Commercial mortgage-backed securities
1.2
%
 
1.5
%
Redeemable preferred stock
0.4
%
 
0.4
%
Total fixed maturities
89.0
%
 
88.1
%
Equity securities:
 
 
 
Common stocks
4.8
%
 
5.7
%
Nonredeemable preferred stocks
2.1
%
 
2.0
%
Total equity securities
6.9
%
 
7.7
%
Other invested assets
4.1
%
 
4.2
%
Total
100.0
%
 
100.0
%
The following table presents the yields of our investment portfolio exclusive of changes in unrealized gains and losses:
 
 
Year Ended December 31,
 
2015
 
2014
 
2013
Yield on fixed maturities:
 
 
 
 
 
Excluding realized gains and losses
3.6
 %
 
3.5
%
 
3.5
%
Including realized gains and losses
3.4
 %
 
3.6
%
 
3.8
%
Yield on equity securities:
 
 
 
 
 
Excluding realized gains and losses
5.2
 %
 
4.2
%
 
4.1
%
Including realized gains and losses
5.4
 %
 
7.2
%
 
8.5
%
Yield on other invested assets:
 
 
 
 
 
Excluding realized gains and losses
0.0
 %
 
0.0
%
 
0.0
%
Including realized gains and losses
(3.5
)%
 
7.6
%
 
3.9
%
Yield on all investments:
 
 
 
 
 
Excluding realized gains and losses
3.6
 %
 
3.4
%
 
3.4
%
Including realized gains and losses
3.3
 %
 
4.1
%
 
4.0
%


11


The table below compares total returns on our fixed maturities and equity securities to comparable public indices. We benchmark our fixed maturity portfolio, excluding redeemable preferred stock, to the Barclays Intermediate Aggregate Index because we believe it best matches our investment strategy and the resulting composition of our portfolio. For similar reasons we benchmark our equity securities, including other invested assets, against the Standard & Poor’s (“S&P”) 500 Index. Both our performance and the indices include investment income, realized gains and losses and changes in unrealized gains and losses.
 
Year Ended December 31,
 
2015
 
2014
 
2013
Fixed maturities:
 
 
 
 
 
National Interstate Total Return on Fixed Maturities
2.4
 %
 
5.3
%
 
1.6
 %
Barclays Intermediate Aggregate Index
1.2
 %
 
4.1
%
 
(1.0
)%
Equity securities:
 
 
 
 
 
National Interstate Total Return on Equity Securities
(4.3
)%
 
6.9
%
 
15.1
 %
S&P 500 Index
1.4
 %
 
13.7
%
 
32.4
 %
Fixed Maturity Investments
Our fixed maturity portfolio is primarily invested in investment grade securities. The following table shows our fixed maturity securities by S&P or comparable rating as of December 31, 2015:
 
S&P or Comparable Rating
 
Amortized Cost
 
Fair Value
 
% of Total
 
 
(Dollars in thousands)
AAA, AA, A
 
$
812,263

 
$
825,128

 
78.5
%
BBB
 
134,334

 
133,744

 
12.7
%
Total Investment Grade
 
946,597

 
958,872

 
91.2
%
BB
 
23,733

 
21,969

 
2.1
%
B
 
9,802

 
8,347

 
0.8
%
CCC
 
19,026

 
20,529

 
2.0
%
CC, C, D
 
39,072

 
41,271

 
3.9
%
Total Non-Investment Grade
 
91,633

 
92,116

 
8.8
%
Total
 
$
1,038,230

 
$
1,050,988

 
100.0
%

At December 31, 2015, approximately 67% of our mortgage-backed securities (“MBS”), having a fair value of $114.6 million, were rated investment grade (BBB or better) by major rating firms. The National Association of Insurance Commissioners (“NAIC”) retained a third-party investment management firm to assist in the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At December 31, 2015, 98.9% (based on statutory carrying value of $166.9 million) of our MBS had an NAIC designation of 1 or 2 (the highest of the six designations).

12


The table below sets forth the scheduled maturities of available for sale fixed maturity securities at December 31, 2015, based on their fair values. Other debt obligations, which are primarily comprised of asset-backed securities other than those related to mortgages and other securities with sinking funds, are categorized based on their average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.

 
December 31, 2015
 
Fair Value
 
% of Total
 
(Dollars in thousands)
One year or less
$
36,226

 
3.5
%
More than one year to five years
375,561

 
35.7
%
More than five years to ten years
387,039

 
36.8
%
More than ten years
80,391

 
7.7
%
 
879,217

 
83.7
%
Mortgage-backed securities
171,771

 
16.3
%
Total fixed maturities
$
1,050,988

 
100.0
%

Fixed maturity investments are generally invested in securities with intermediate-term maturities with an objective of optimizing total return, including investment income, while allowing flexibility to react to changes in market conditions and maintaining sufficient liquidity to meet policyholder obligations. At December 31, 2015, the weighted average effective duration (adjusted for call provisions) was approximately 4 years and the weighted average maturity was 5.9 years. The concept of weighted average effective duration takes into consideration the probability of the exercise of the various call features associated with many of the fixed maturity securities we hold. Fixed maturity securities are frequently issued with call provisions that provide the issuer the option of accelerating the maturity of the security.

Competition
The commercial transportation insurance industry is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. We compete with numerous insurance companies and reinsurers, including large national underwriters and smaller niche insurance companies. We believe that our primary competitors in the commercial specialty insurance market include, among others, Lancer Insurance Company, RLI Corporation, Great West Casualty Company (a subsidiary of Old Republic International Corporation), Northland Insurance Company (a subsidiary of the Travelers Companies, Inc.), Sentry Insurance, Liberty Mutual Insurance Company, Baldwin & Lyons, Inc., ProSight Specialty Insurance Group, Inc., AmTrust Financial Services, Inc. and American International Group, Inc. In the specialty personal lines market, our primary competitors are Progressive Corporation, Nationwide Insurance Company and National General Insurance, and in our Hawaii and Alaska markets, our primary competitors are Island Insurance Company, Liberty Mutual Insurance Company, First Insurance, Dongbu Insurance Company, DTRIC Insurance Company, Alaska National Insurance Company, Berkshire Hathaway, Umialik Insurance Company and Zurich Insurance Company. In the moving and storage market we compete against, among others, American International Group, Inc., Travelers Company, Inc., AmTrust Financial Services, Inc., ProSight Specialty Insurance Group, Inc. and Transguard Insurance Company of America.
We compete in the property and casualty insurance marketplace with other insurers on the basis of price, coverages offered, product and program design, claims handling, customer service quality, agent commissions where applicable, geographic coverage, reputation and financial strength ratings by independent rating agencies. We compete by developing product lines to satisfy specific market needs and by maintaining relationships with our independent agents and customers who rely on our expertise. This expertise, along with our experience in offering specialty underwriting products, is our principal means of distinguishing ourselves from our competitors.
We believe we have a competitive advantage in our major lines of business as a result of the extensive experience of our management, our superior service and products, our willingness to design custom insurance programs for our large transportation customers and the extensive use of current technology with respect to our insureds and independent agent force. However, we are not “top-line” oriented and are willing to sacrifice premium volume during periods that we believe exhibit unrealistic rate competition. Accordingly, should competitors determine to “buy” market share with unprofitable rates, our insurance subsidiaries could experience limited growth or a decline in business until market pricing returns to what we view as profitable levels.

Ratings
A.M. Best assigned a current group rating of “A” (Excellent) to our domestic insurance companies. According to A.M. Best, “A” ratings are assigned to insurers that have, on balance, excellent balance sheet strength, operating performance and business profile

13


when compared to the standards established by A.M. Best and, in A.M. Best’s opinion, have a strong ability to meet their ongoing obligations to policyholders. The objective of A.M. Best’s rating system is to provide potential policyholders and other interested parties an opinion of an insurer’s financial strength and ability to meet ongoing obligations, including paying claims. This rating reflects A.M. Best’s analysis of our balance sheet, financial position, capitalization and management. This rating is subject to periodic review and may be revised downward, upward or revoked at the sole discretion of A.M. Best. Any changes in our rating category could affect our competitive position.

Regulation
State Regulation
General
Our insurance subsidiaries are subject to regulation in all 50 states, Washington D.C. and the Cayman Islands. The extent of regulation varies by jurisdiction and generally derives from statutes that delegate regulatory, supervisory and administrative authority to a department of insurance in each jurisdiction in which the companies transact insurance business. These statutes and regulations generally require each of our insurance subsidiaries to register with the insurance department where the Company is domiciled and to furnish annually financial and other information about the operations of the Company. Certain transactions and other activities by our insurance companies must be approved by Ohio, Missouri or Cayman Islands regulatory authorities, where our active insurance company subsidiaries are domiciled, before the transaction takes place.
The regulation, supervision and administration also relate to statutory capital and reserve requirements and standards of solvency that must be met and maintained, the payment of dividends, changes of control of insurance companies, the licensing of insurers and their agents, the types of insurance that may be written, the regulation of market conduct, including underwriting and claims practices, provisions for unearned premiums, losses, LAE and other obligations, the ability to enter and exit certain insurance markets, the nature of and limitations on investments, premium rates or restrictions on the size of risks that may be insured under a single policy, privacy practices, deposits of securities for the benefit of policyholders, payment of sales compensation to third parties and the approval of policy forms and guaranty funds.
State insurance departments also conduct periodic examinations of the business affairs of our insurance companies and require us to file annual financial and other reports, prepared under statutory accounting principles, relating to the financial condition of companies and other matters. These insurance departments conduct periodic examinations of the books and records, financial reporting, policy filings and market conduct of our insurance companies doing business in their states, generally once every three to five years, although target financial, market conduct and other examinations may take place at any time. These examinations are generally carried out in cooperation with the insurance departments of other states in which our insurance companies transact insurance business under guidelines promulgated by the NAIC. Any adverse findings by insurance departments could result in significant fines and penalties, negatively affecting our profitability.
Generally, state regulators require that all material transactions among affiliated companies in our holding company system to which any of our insurance subsidiaries is a party, including sales, loans, reinsurance agreements, management agreements and service agreements, must be fair and reasonable. In addition, if the transaction is material or of a specified category, prior notice and approval (or absence of disapproval within a specified time limit) by the insurance department where the subsidiary is domiciled is required.
Statutory Accounting Principles (“SAP”)
SAP is a basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. One of the primary goals is to measure an insurer’s statutory surplus. Accordingly, statutory accounting focuses on valuing assets and liabilities of our insurance subsidiaries at financial reporting dates in accordance with appropriate insurance laws and regulatory provisions applicable in each insurer’s domiciliary jurisdiction. Insurance departments utilize SAP to help determine whether our insurance companies will have sufficient funds to timely pay all the claims of our policyholders and creditors. GAAP gives more consideration to matching of revenue and expenses than SAP. As a result, assets and liabilities will differ in financial statements prepared in accordance with GAAP as compared to SAP. Major differences for SAP include, but are not limited to, charging policy acquisition costs to expense as incurred rather than spreading the costs over the periods covered by the policies; reporting investment grade bonds and redeemable preferred stocks at amortized cost rather than fair value; netting of reinsurance recoverables and prepaid reinsurance premiums against the corresponding liabilities rather than reporting such items separately; and charging to surplus certain GAAP assets, such as furniture and fixtures and agents’ balances over 90 days old.
SAP, as established by the NAIC and adopted, for the most part, by the various state insurance regulators to determine, among other things, the amount of statutory surplus and net income of our insurance subsidiaries and thus determine, in part, the amount of funds they have available to pay as dividends to us.

14


Restrictions on Paying Dividends
State insurance laws restrict the ability of our insurance subsidiaries to declare shareholder dividends and require our insurance companies to maintain specified levels of statutory capital and surplus. The amount of an insurer’s surplus following payment of any dividends must be reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial needs. Limitations on dividends are generally based on net income or statutory capital and surplus. In 2016, the maximum amount of dividends that our insurance companies can pay to us without seeking regulatory approval is $29.6 million. National Interstate Insurance Company (NIIC) did not pay dividends in 2015 and paid $10.0 million in both 2014 and 2013 without the need for regulatory approval. 

Assessments and Fees Payable

Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by insureds as a result of the insolvency of other insurers or other miscellaneous state assessments. Significant assessments could limit the ability of our insurance subsidiaries to recover such assessments through tax credits or other means. We paid assessments of $4.4 million, $6.9 million and $4.2 million in the years ended December 31, 2015, 2014 and 2013, respectively. Our estimated liability for anticipated assessments was $5.0 million and $4.6 million at December 31, 2015 and 2014, respectively.

NAIC Risk-Based Capital (“RBC”) Requirements
In order to enhance the regulation of insurer solvency, the NAIC established RBC requirements for insurance companies that are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policy holders. These requirements measure three major areas of risk facing property and casualty insurers: (i) underwriting risks, which encompass the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; and (iii) other business risks from investments. Insurers having less statutory surplus than required will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. At December 31, 2015, the capital and surplus of all of our insurance companies, which have been prepared in accordance with NAIC statutory accounting principles, substantially exceeded the RBC requirements.
Insurance Regulatory Information System (“IRIS”) Ratios
The NAIC IRIS was developed by a committee of state insurance regulators and is intended primarily to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies 13 industry ratios and specifies “usual values” for each ratio. Departure from the usual values of the IRIS ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business. Our insurance subsidiaries have consistently met the IRIS ratios.
Restrictions on Cancellation, Non-Renewal or Withdrawal
Many states in which we conduct business have laws and regulations that limit the ability of our insurance companies licensed in that state to exit a market, cancel policies or not renew policies. Some states prohibit us from withdrawing one or more lines of business from the state, except pursuant to a plan approved by the state insurance regulator, which may disapprove a plan that may lead to market disruption.
Federal Regulation
General
The federal government generally does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas, including age and sex discrimination, consumer privacy, terrorism, federal taxation and motor-carrier safety, do affect our insurance business. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), among other things, established a Federal Insurance Office (“FIO”) within the U.S. Treasury. Regulations will need to be created for the FIO to carry out its mandate to focus on systemic risk oversight. The FIO has limited regulatory authority and is empowered to gather information regarding the insurance industry and insurers. In December 2013, the FIO submitted a report to Congress recommending ways to modernize and improve the system of insurance regulation in the United States. The report concluded that a hybrid approach to regulation, involving a combination of state and federal government action, could improve the U.S. insurance system by attaining uniformity, efficiency and consistency, particularly with respect to solvency and market conduct regulation. It is not clear to what extent, if any, the report will lead to changes to the current state-based system of insurance industry regulation or how such changes would ultimately impact our operations.


15


The Terrorism Risk Insurance Act (“the Act”)
The Terrorism Risk Insurance Program Reauthorization Act of 2015 extended the Federal program that provides for a transparent system of shared public and private compensation for insured losses resulting from certified acts of terrorism through December 31, 2020. The Act requires commercial insurers to make terrorism coverage available for commercial property/casualty losses, including workers' compensation. Commercial auto, burglary/theft, surety, professional liability and farmowners multiple-peril are not included in the program. The "event trigger" under the Act provides that in the case of a certified act of terrorism, no federal compensation shall be paid by the Secretary of the Treasury unless aggregate industry losses exceed $100 million. This will increase to $120 million in 2016 and increase annually thereafter by $20 million per year until the level of insured losses required to trigger coverage reaches $200 million in 2020. The federal government will pay 85% of covered terrorism losses that exceed the insurer deductibles, in excess of the event trigger. Beginning on January 1, 2016, the federal government’s reimbursement obligation will be reduced to 84% and will decrease annually thereafter by 1% per year until the level of reimbursement is reduced to 80%.
We are continuing to take the steps necessary to comply with the Act, as well as the state regulations implementing its provisions, by providing required notices to commercial policyholders describing coverage provided for certified acts of terrorism (as defined by the Act). We do not anticipate terrorism losses to have a material impact on our results of operations. It is possible that future legislation could modify or eliminate the program, which could adversely affect our property and casualty business through increased exposure to a catastrophic level of terrorism losses.
To our knowledge and based on our internal review and control process for compliance, we believe we have been in compliance in all material respects with the laws, rules and regulations described above.
Employees
At December 31, 2015, we employed 715 people, of which 704 are full-time employees. None of our employees are covered by collective bargaining arrangements.

ITEM 1A    Risk Factors
All material risks and uncertainties currently known regarding our business operations are included in this section. If any of the following risks, or other risks and uncertainties that we have not yet identified or that we currently consider not to be material, actually occur, our business, prospects, financial condition, results of operations and cash flows could be materially and adversely affected.
Your interests as a holder of our common shares may be different than the interests of our majority shareholder, Great American, and its parent company, American Financial Group, Inc.
The interests of Great American and AFG may differ from the interests of our other shareholders. Current and former senior executives of AFG and Great American hold five out of eleven seats on our Board. As a result, AFG has the ability to exert significant influence over our policies and affairs including the power to affect the election of our Directors, appointment of our management and the approval of any action requiring a shareholder vote, such as amendments to our Amended and Restated Articles of Incorporation or Code of Regulations, transactions with affiliates, mergers or asset sales.
Subject to the terms of our right of first refusal to purchase its shares in certain circumstances, AFG may be able to influence or control matters requiring approval by our shareholders, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. AFG may also have interests that differ from those of our other shareholders and may vote in a way with which our other shareholders disagree and which may be adverse to their interests. AFG’s majority ownership may have the effect of delaying, preventing or deterring a change of control of the Company, could deprive our shareholders of an opportunity to receive a premium for their common stock as part of a sale of the Company and might ultimately affect the market price of our common stock.
Provisions in our organizational documents, Ohio corporate law and the insurance laws of Ohio and Missouri, among other states, could impede an attempt to replace or remove our management or Directors or prevent or delay a merger or sale, which could diminish the value of our common shares.
Our Amended and Restated Articles of Incorporation and Code of Regulations, the corporate laws of Ohio and the insurance laws of various states contain provisions that could impede an attempt to replace or remove our management or Directors or prevent the sale of our Company that shareholders might consider to be in their best interests. These provisions include, among others:
a classified Board of Directors consisting of eleven Directors divided into two classes;

16


the inability of our shareholders to remove a Director from the Board without “cause;”
requiring a vote of holders of 50% of the common shares to call a special meeting of the shareholders;
requiring a two-thirds vote to amend the shareholder protection provisions of our Code of Regulations and to amend the Amended and Restated Articles of Incorporation;
requiring the affirmative vote of a majority of the voting power of our shares represented at a special meeting of shareholders;
excluding the voting power of interested shares to approve a “control share acquisition” under Ohio law; and
prohibiting a merger, consolidation, combination or majority share acquisition between us and an interested shareholder or an affiliate of an interested shareholder for a period of three years from the date on which the shareholder first became an interested shareholder, unless previously approved by our Board.
These provisions may prevent shareholders from receiving the benefit of any premium over the market price of our common shares offered by a bidder in a potential takeover. In addition, the existence of these provisions may adversely affect the prevailing market price of our common shares if they are viewed as discouraging takeover attempts.
The insurance laws of most states require prior notice or regulatory approval of changes in control of an insurance company or its holding company. The insurance laws of the States of Ohio and Missouri, where our U.S. insurance companies are domiciled, provide that no corporation or other person may acquire control of a domestic insurance or reinsurance company unless it has given notice to such insurance or reinsurance company and obtained prior written approval of the relevant insurance regulatory authorities. Any purchaser of 10% or more of our aggregate outstanding voting power could become subject to these regulations and could be required to file notices and reports with the applicable regulatory authorities prior to such acquisition. In addition, the existence of these provisions may adversely affect the prevailing market price of our common shares if they are viewed as discouraging takeover attempts. For further discussion of insurance laws, see the subsection of “Business” entitled “Regulation.”
We may have conflicts of interest with our majority shareholder, Great American, and its parent company, American Financial Group, Inc., which we would be unable to resolve in our favor.
As of December 31, 2015, AFG, through its wholly-owned subsidiary Great American, owns 51.1% of our outstanding common shares. From time to time, Great American and its affiliated companies engage in underwriting activities and enter into transactions or agreements with us or in competition with us, which may give rise to conflicts of interest. We do not have any agreement or understanding with any of these parties regarding the resolution of potential conflicts of interest. In addition, we may not be in a position to influence any party’s decision not to engage in activities that would give rise to a conflict of interest. These parties may take actions that are not in the best interests of our other shareholders.
We rely on services provided by Great American, and if Great American no longer controlled a majority of our shares, our operating expenses could increase significantly.
We rely on Great American to provide certain services to us without charge including actuarial and consultative services for legal, accounting and internal audit and other support services. If Great American no longer controlled a majority of our shares, it is possible that many of these services would cease or, alternatively, be provided at an increased cost to us. This could impact our personnel resources, require us to hire additional professional staff and generally increase our operating expenses.
Because we are primarily a transportation insurer, conditions in that industry could adversely affect our business.
Approximately 90% of our gross premiums written for the years ended December 31, 2015 and 2014 were generated from transportation insurance policies, including ART programs for transportation companies. Adverse developments in the market for transportation insurance, including those which could result from potential declines in commercial and economic activity, could cause our results of operations to suffer. The transportation insurance industry is cyclical. Historically, the industry has been characterized by periods of price competition and excess capacity followed by periods of high premium rates and shortages of underwriting capacity. These downward fluctuations in the business cycle have and could continue to negatively impact our revenues.
Additionally, our results may be affected by risks that impact the transportation industry related to severe weather conditions, as well as explosions, terrorist attacks and riots. Our transportation insurance business also may be affected by cost trends that negatively impact profitability, such as an economic downturn, inflation in vehicle repair costs, vehicle replacement parts costs, used vehicle prices, fuel costs and medical care costs. Increased costs related to the handling and litigation of claims may also negatively impact our profitability.

17


If our claims payments and related expenses exceed our reserves, our financial condition and results of operations could be adversely affected.
Our success depends upon our ability to accurately assess and price the risks covered by the insurance policies that we write. We establish reserves to cover our estimated liability for the payment of all losses and LAE incurred with respect to premiums earned on the insurance policies that we write. Reserves do not represent an exact calculation of liability. Rather, reserves are estimates of our expectations regarding the ultimate cost of resolution and administration of claims under the insurance policies that we write. These estimates are based upon multiple factors including, but not limited to, actuarial and statistical projections, assessments of currently available data, historical claims information, as well as estimates and assumptions regarding future trends in claims severity and frequency, judicial theories of liability and other factors. We continually refine our reserve estimates in an ongoing process as experience develops and claims are reported and settled. Each year, our reserves are certified by an accredited actuary from Great American.
Establishing an appropriate level of reserves is an inherently uncertain process. The following factors may have a substantial impact on our future actual losses and LAE experience:
the amount of claims payments;
the expenses that we incur in resolving claims;
legislative and judicial developments; and
changes in economic conditions, including the effect of inflation.
Unfavorable development in any of these factors could cause our level of reserves to be inadequate. To the extent that actual losses and LAE exceed expectations and the reserves reflected on our financial statements, we will be required to immediately reflect those changes by increasing reserves. When we increase reserves, the pre-tax income for the period in which we do so will decrease by a corresponding amount. In addition to having a negative effect on pre-tax income, increasing or “strengthening” reserves causes a reduction in our insurance companies’ surplus and could cause a downgrading of the rating of our insurance company subsidiaries. Such a downgrade could, in turn, adversely affect our ability to sell insurance policies.
If we expand our operations too rapidly and do not manage that expansion effectively, our financial performance and stock price could be adversely affected.
We intend to grow by developing new products, expanding into new product lines and expanding our insurance distribution network. Continued growth could impose significant demands on our management, including the need to identify, recruit, maintain and integrate additional employees. Our historical growth rates may not accurately reflect our future growth rates or our growth potential. We may experience higher than anticipated indemnity losses arising from new and expanded insurance products. In addition, our systems, procedures and internal controls may not be adequate to support our operations as they expand.
In addition to these organic growth strategies, we regularly explore opportunities to acquire other companies or selected books of business. Upon the announcement of an acquisition, our stock price may fall depending on the size of the acquisition, the purchase price and the potential dilution to existing shareholders depending upon the financial structure of the acquisition. It is also possible that an acquisition could dilute earnings per share.
If we grow through acquisitions, we could have difficulty in integrating an acquired company, which may cause us not to realize expected revenue increases, cost savings, increases in geographic or product presence, and other projected benefits from the acquisition. The integration could result in the loss of key employees, disruption of our business or the business of the acquired company, or otherwise harm our ability to retain customers and employees or achieve the anticipated benefits of the acquisition. Time and resources spent on integration may also impair our ability to grow our existing businesses. Also, the negative effect of any financial commitments required by regulatory authorities or rating agencies in acquisitions or business combinations may be greater than expected.
Any failure by us to manage our growth effectively could have a material adverse effect on our business, financial condition or results of operations.

18


If we are not able to attract and retain independent agents and brokers, our revenues could be negatively affected.
We compete with other insurance carriers to attract and retain business from independent agents and brokers. Some of our competitors offer independent agents and brokers a larger variety of products, lower prices for insurance coverage or higher commissions than we offer. Our top ten independent agents/brokers accounted for an aggregate of 30.1% of our gross premiums written, and our top two independent agents/brokers accounted for an aggregate of 13.5% of our gross premiums written during the year ended December 31, 2015. If we are unable to attract and retain independent agents/brokers to sell our products, our ability to compete and attract new customers and our revenues would suffer.
Our growth strategy includes expanding into product lines in which we have limited experience.
We are continually evaluating new products to add to our business mix. In some instances, we have limited experience with marketing and managing these new products and insuring the types of risks involved. Our failure to effectively analyze new underwriting risks, set adequate premium rates and establish reserves for these new products or efficiently adjust claims arising from these new products could have a material adverse effect on our business, financial condition or results of operations. During the start up period for new products, we generally set more conservative loss reserves in recognition of the inherent risk. This could adversely affect our statutory capital, net income and ability to pay dividends.
We are currently rated “A” (Excellent) by A.M. Best, which is its third highest rating out of 16 rating categories. A decline in our rating below “A-” could adversely affect our position in the insurance market, make it more difficult to market our insurance products and cause our premiums and earnings to decrease.
Financial ratings are an important factor influencing the competitive position of insurance companies. A.M. Best ratings, which are commonly used in the insurance industry, currently range from “A++” (Superior) to “F” (In Liquidation). The objective of A.M. Best’s rating system is to provide potential policyholders and other interested parties an opinion of an insurer’s financial strength and ability to meet ongoing obligations, including paying claims. This rating reflects A.M. Best’s analysis of our balance sheet, financial position, capitalization and management. It is not an evaluation of an investment in our common shares, nor is it directed to investors in our common shares and is not a recommendation to buy, sell or hold our common shares. This rating is subject to periodic review and may be revised downward, upward or revoked at the sole discretion of A.M. Best.
If our rating is reduced by A.M. Best below an “A-”, we believe that our competitive position in the insurance industry could suffer, and it could be more difficult for us to market our insurance products. A downgrade could result in a significant reduction in the number of insurance contracts we write and in a substantial loss of business to other competitors with higher ratings, causing premiums and earnings to decrease.
We may experience difficulties with technology or network security, which could have an adverse effect on our financial condition or reputation.
We rely on computer systems to process, transmit, store, retrieve and evaluate company and customer data and information. Systems failures, outages or breaches could compromise our ability to perform business functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with business partners and customers. In the event of a natural disaster, a computer virus, a terrorist attack, war or other disruption inside or outside the United States, our systems may be inaccessible to employees, customers or business partners for an extended period of time. Even if our employees are able to work, they may be unable to perform their duties if our data or systems are disabled or destroyed.
Despite our security measures, our information technology and infrastructure are vulnerable to security breaches such as cyber-attacks, viruses, malware, hackers and other external hazards, equipment and system failures, employee misconduct, as well as inadvertent errors. Our administrative and technical controls, as well as other preventative actions to reduce the risk of such incidents and protect our information, may be insufficient to detect or prevent unauthorized access, other physical and electronic break-ins, cyber-attacks or other security breaches to our computer systems or those of third parties with whom we do business.
The increased risk identified above could expose us to data loss, disruption of service, monetary and reputational damage and significant increases in compliance costs and costs to improve the security and resiliency of our computer systems. The compromise of personal, confidential or proprietary information could also subject us to legal liability or regulatory action under evolving cyber-security, data protection and privacy laws and regulations enacted by the U.S. federal and state governments or other jurisdictions or by various regulatory organizations or exchanges. As a result, our ability to conduct our business and our results of operations might be materially and adversely affected.


19


Market fluctuations, changes in interest rates or a need to generate liquidity can have significant and negative effects on our investment portfolio.
Our results of operations depend in part on the performance of our invested assets. As of December 31, 2015, 89.0% of our investment portfolio (excluding cash and cash equivalents) was invested in fixed maturities, 6.9% was invested in equity securities and 4.1% was invested in other invested assets. As of December 31, 2015, approximately 30.1% of our fixed maturity portfolio was invested in state and local government obligations and approximately 91.2% of our fixed maturities were rated “investment grade” (credit rating of AAA to BBB-) by S&P or another nationally recognized rating agency.
Investment returns are an important part of our overall profitability. We cannot predict which industry sectors in which we maintain investments may suffer losses as a result of potential declines in commercial and economic activity, or how any such decline might impact the ability of companies within the affected industry sectors to pay interest or principal on their securities and we cannot predict how or to what extent the value of any underlying collateral might be affected. During 2015, higher interest rates and wider credit spreads in the financial markets caused a decrease in the fair value of our holdings. Adverse fluctuations in the fixed income or equity markets could adversely impact our profitability, financial condition or cash flows.
Historically, we have not had the need to sell our investments to generate liquidity. If we were forced to sell portfolio securities that have unrealized losses for liquidity purposes rather than holding them to maturity or recovery, we would recognize investment losses on those securities when that determination was made.
Future sales of our common shares may affect the trading price of our common shares.
We cannot predict what effect, if any, future sales of our common shares or the availability of common shares for future sale will have on the trading price of our common shares. Sales of substantial amounts of our common shares in the public market by Great American or our other shareholders, or the possibility or perception that such sales could occur, could adversely affect prevailing market prices for our common shares. If such sales reduce the market price of our common shares, our ability to raise additional capital in the equity markets may be adversely affected.
In 2005, we filed a registration statement on Form S-8 under the Securities Act to register 1,338,800 common shares issued or reserved for issuance for awards granted under our Long Term Incentive Plan ("LTIP"). In 2013, we registered an additional 500,000 common shares issued or reserved for issuance for awards granted under our LTIP on registration statement Form S-8. Shares registered under the registration statement on Form S-8 also could be sold into the public markets, subject to applicable vesting provisions and any volume limitations and other restrictions applicable to our officers and Directors selling shares under Rule 144. The sale of the shares under these registration statements in the public market, or the possibility or perception that such sales could occur, could adversely affect prevailing market prices for our common shares.
We may not be successful in reducing our risk and increasing our underwriting capacity through reinsurance arrangements, which could adversely affect our business, financial condition and results of operations.
In order to reduce our underwriting risk, primarily for our excess coverage and catastrophic exposures, we transfer portions of our insurance risk to other insurers through reinsurance contracts. Ceded premiums written amounted to 16.5% of our gross premiums written for both the years ended December 31, 2015 and 2014. The availability, cost and structure of reinsurance protection are subject to prevailing market conditions that are outside of our control and may affect our level of business and profitability. We continually assess our own risk retention, and may increase or decrease our reinsurance participation based on availability and cost. In order for these contracts to qualify for reinsurance accounting and to provide the additional underwriting capacity that we desire, the reinsurer must assume appropriate risk and have a reasonable possibility of experiencing a significant loss. Our reinsurance facilities are subject to ongoing review and most have annual renewal terms. At times, we may be unable to maintain our current reinsurance facilities or obtain reinsurance facilities in adequate amounts and at competitive rates. If we are unable to renew our expiring facilities or obtain new reinsurance facilities, either our net exposure to risk would increase or, if we are unwilling to bear an increase in net risk exposures, we would have to reduce the amount of risk we underwrite which could adversely impact our results of operations.

20


As a holding company, we are dependent on the results of operations of our insurance company subsidiaries to meet our obligations and pay future dividends.
We are a holding company and a legal entity separate and distinct from our insurance company subsidiaries. As a holding company without significant operations of our own, one of our sources of funds are dividends and other distributions from our insurance company subsidiaries. As discussed under the subsection of “Business” entitled “Regulation,” statutory and regulatory restrictions limit the aggregate amount of dividends or other distributions that our insurance subsidiaries may declare or pay within any twelve-month period without advance regulatory approval and require insurance companies to maintain specified levels of statutory capital and surplus. Insurance regulators have broad powers to prevent reduction of statutory capital and surplus to inadequate levels and could refuse to permit the payment of dividends calculated under any applicable formula. As a result, we may not be able to receive dividends from our insurance subsidiaries at times and in amounts necessary to meet our operating needs, to pay dividends to our shareholders or to pay corporate expenses.
We are subject to credit risk with respect to the obligations of our reinsurers and certain of our insureds. The inability of our risk sharing partners to meet their obligations could adversely affect our profitability.
Although the reinsurer is liable to us to the extent of risk ceded by us, we remain ultimately liable to the policyholder on all risks, even those reinsured. As a result, ceded reinsurance arrangements do not limit our ultimate obligations to policyholders to pay claims. We are subject to credit risks with respect to the financial strength of our reinsurers. We are also subject to the risk that our reinsurers may dispute their obligations to pay our claims. As a result, we may not recover sufficient amounts for claims that we submit to our reinsurers in a timely manner, if at all. As of December 31, 2015, we had a total of $152.7 million of unsecured reinsurance recoverables. In addition, our reinsurance agreements are subject to specified limits and we would not have reinsurance coverage to the extent that we exceed those limits.
With respect to our insurance programs, we are subject to credit risk with regards to the payment of claims and on the portion of risk exposure either ceded to the ART participants or retained by our clients. The credit worthiness of prospective risk sharing partners is a factor we consider when entering into or renewing these ART programs. We typically collateralize balances due through funds withheld, letters of credit or trust agreements. To date, we have not, in the aggregate, experienced material difficulties in collecting balances from our risk sharing partners. These entities may be unable to meet their obligations in the future. The inability of our risk sharing partners to meet their obligations could adversely affect our profitability.
We may not have access to capital in the future due to an economic downturn.
We may need new or additional financing in the future to conduct our operations, expand our business or refinance existing indebtedness. Any sustained weakness in the general economic conditions and/or financial markets in the United States or globally could adversely affect our ability to raise capital on favorable terms or at all. We may rely in the future, on access to financial markets as a source of liquidity for operations, acquisitions and general corporate purposes. Our continued access to funds under our $100 million unsecured Credit Agreement (“Credit Agreement”) is dependent in part on the ability of the financial institutions that are parties to the facility to meet their funding commitments. Those financial institutions may not be able to meet their funding commitments if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing requests within a short period of time.
New claim and coverage issues are continually emerging in the insurance industry and these new issues could negatively impact our revenues, our business operations or our reputation.
As insurance industry practices and regulatory, judicial and industry conditions change, unexpected and unintended issues related to pricing, claims, coverage and business practices may emerge. Plaintiffs often target property and casualty insurers in purported class action litigation relating to claims handling and insurance sales practices. The resolution and implications of new underwriting, claims and coverage issues could have a negative effect on our insurance business by extending coverage beyond our underwriting intent, increasing the size of claims or otherwise requiring us to change our business practices. The effects of unforeseen emerging claim and coverage issues could negatively impact our revenues, results of operations and our reputation.
The effects of litigation on our business are uncertain.
The outcome of any litigation is inherently uncertain. We may become subject to material litigation in the future, or any litigation may damage our reputation, which could have a negative impact on our business.

21


Our inability to retain our senior executives and other key personnel could adversely affect our business.
Our success depends, in part, upon the ability of our executive management and other key personnel to implement our business strategy and on our ability to attract and retain qualified employees. On December 21, 2015 we announced that our Board of Directors appointed Anthony (Tony) J. Mercurio, currently our President and Chief Operating Officer, as President and Chief Executive Officer, effective May 5, 2016 (the “Transition Date”). Mr. Mercurio will succeed David W. Michelson, who has served as our Chief Executive Officer since January 1, 2008. Effective as of the Transition Date, Mr. Michelson will retire from his position as Chief Executive Officer and will become a Senior Advisor to the Company to ensure an orderly transition of the Company’s management team. Our inability to effectuate a successful transition, the loss of other senior executives or our failure to attract and develop talented new executives and managers could adversely affect our business and the market price for our common shares.
We are subject to comprehensive regulation and our ability to earn profits may be restricted by these regulations.
We are subject to comprehensive regulation by government agencies in the states and foreign jurisdictions where our active insurance company subsidiaries are domiciled and, to a lesser degree, where these subsidiaries issue policies and handle claims. Failure by one of our insurance company subsidiaries to meet regulatory requirements could subject us to regulatory action. The regulations and associated examinations may have the effect of limiting our liquidity and may adversely affect results of operations.
In addition, state insurance department examiners perform periodic financial, market conduct and other examinations of insurance companies. Compliance with applicable laws and regulations is time consuming and personnel-intensive. In addition to financial examinations, we are subject to market conduct examinations of our claims and underwriting practices. Any adverse findings by insurance departments could result in significant fines and penalties, negatively affecting our profitability.
The federal government generally does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas, including age and sex discrimination, consumer privacy, terrorism, federal taxation and motor-carrier safety, do affect our insurance business. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), among other things, established a Federal Insurance Office (“FIO”) within the U.S. Treasury. Regulations will need to be created for the FIO to carry out its mandate to focus on systemic risk oversight. The FIO has limited regulatory authority and is empowered to gather information regarding the insurance industry and insurers. In December 2013, the FIO submitted a report to Congress recommending ways to modernize and improve the system of insurance regulation in the United States. The report concluded that a hybrid approach to regulation, involving a combination of state and federal government action, could improve the U.S. insurance system by attaining uniformity, efficiency and consistency, particularly with respect to solvency and market conduct regulation. It is not clear to what extent, if any, the report will lead to changes to the current state-based system of insurance industry regulation or how such changes would ultimately impact our operations.
Existing insurance-related laws and regulations may become more restrictive in the future or new or more restrictive regulation, including changes in current tax or other regulatory interpretations affecting the ART insurance model, could make it more expensive for us to conduct our business, restrict the premiums we are able to charge or otherwise change the way we do business. For a further discussion of the regulatory framework in which we operate, see the subsection of “Business” entitled “Regulation.”
We face competition from companies with greater financial resources, broader product lines, higher ratings and stronger financial performance than us, which may impair our ability to retain existing customers, attract new customers and maintain our profitability and financial strength.
The commercial transportation insurance business is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. Many of our competitors are substantially larger and may enjoy better name recognition, substantially greater financial resources, higher ratings by rating agencies, broader and more diversified product lines and more widespread agency relationships than we do. We compete with large national underwriters and smaller niche insurance companies. In particular, in the commercial specialty insurance market we compete against, among others, Lancer Insurance Company, RLI Corporation, Great West Casualty Company (a subsidiary of Old Republic International Corporation), Northland Insurance Company (a subsidiary of the Travelers Companies, Inc.), Sentry Insurance, Liberty Mutual Insurance Company and American International Group, Inc. In our specialty personal lines our primary competitors are Progressive Corporation, Nationwide Insurance Company, and National General Insurance, and in our Hawaii and Alaska markets, our primary competitors are Island Insurance Company, Liberty Mutual Insurance Company, First Insurance, Dongbu Insurance Company, DTRIC Insurance Company, Alaska National Insurance Company, Berkshire Hathaway, Umialik Insurance Company and Zurich Insurance Company. In the moving and storage market we compete against, among others, American International Group, Inc., Travelers Company, Inc., AmTrust Financial Services, Inc. and Transguard Insurance Company of America. Our underwriting profits could be adversely impacted if new entrants or existing competitors try to compete with our products, services and programs or offer similar or better products at or below our prices.

22


We have continued to develop ART programs, attracting new customers as well as transitioning existing traditional customers into these programs. Our ART component constituted approximately 56.7% of our gross premiums written for the year ended December 31, 2015 and 54.3% of our gross written premiums for the same period in 2014. We are subject to ongoing competition for both the individual customers and entire programs. The departure of an entire program due to competition could adversely affect our results.
Changing climate conditions, including legal, regulatory and social responses thereto, may have a negative effect on our business.
Various scientists, environmentalists, international organizations, regulators and other commentators believe that global climate change has added, and will continue to add, to the unpredictability, frequency and severity of natural disasters (including, but not limited to, hurricanes, tornadoes, freezes, large or significant storms and fires) in certain parts of the world. In response, a number of legal and regulatory measures and social initiatives have been introduced in an effort to reduce greenhouse gas and other carbon emissions that may be chief contributors to global climate change.
We cannot predict the impact that changing climate conditions, if any, will have on us or our customers. However, it is possible that the legal, regulatory and social responses to climate change could have a negative effect on our results of operations or our financial condition.

ITEM 1B    Unresolved Staff Comments
None.

ITEM 2    Properties
We own two adjacent buildings that house our corporate headquarters and the surrounding real estate located in Richfield, Ohio. The buildings consist of approximately 164,000 square feet of rentable office space on 17.5 acres. We occupy approximately 143,000 square feet and lease the remainder to unaffiliated tenants.
We lease office space in Fenton, Missouri and Kapolei, Hawaii. The leases account for approximately 47,000 square feet of office space. These leases expire within thirty-one months. The monthly rents, exclusive of operating expenses, to lease these facilities currently total approximately $84,000. We believe that these leases could be renewed or replaced at commercially reasonable rates without material disruption to our business.

ITEM 3    Legal Proceedings
We are subject at times to various claims, lawsuits and legal proceedings arising in the ordinary course of business. All legal actions relating to claims made under insurance policies are considered in the establishment of our loss and LAE reserves. In addition, regulatory bodies, such as state insurance departments, the SEC, the Department of Labor and other regulatory bodies may make inquiries and conduct examinations or investigations concerning our compliance with insurance laws, securities laws, labor laws and the Employee Retirement Income Security Act of 1974, as amended.
Our insurance companies also have lawsuits pending in which the plaintiff seeks extra-contractual damages from us in addition to damages claimed or in excess of the available limits under an insurance policy. These lawsuits, which are in various stages, generally mirror similar lawsuits filed against other carriers in the industry. Although we are vigorously defending these lawsuits, the outcomes of these cases cannot be determined at this time. We have established loss and LAE reserves for lawsuits as to which we have determined that a loss is both probable and estimable. In addition to these case reserves, we also establish reserves for claims incurred but not reported to cover unknown exposures and adverse development on known exposures. Based on currently available information, we believe that our reserves for these lawsuits are reasonable and that the amounts reserved did not have a material effect on our financial condition or results of operations. However, if any one or more of these cases results in a judgment against or settlement by us for an amount that is significantly greater than the amount so reserved, the resulting liability could have a material effect on our financial condition, cash flows and results of operations.

ITEM 4    Mine Safety Disclosures
None.


23



PART II
 
ITEM 5    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common shares are listed and traded on the Nasdaq Global Select Market under the symbol “NATL.” The information presented in the table below represents the high and low sales prices per share reported on the NASDAQ for the periods indicated.
 
 
2015
 
2014
 
High
 
Low
 
High
 
Low
First Quarter
$
30.49

 
$
24.60

 
$
32.66

 
$
21.18

Second Quarter
29.25

 
25.20

 
29.25

 
26.52

Third Quarter
28.60

 
24.78

 
28.85

 
25.60

Fourth Quarter
30.40

 
25.99

 
30.54

 
26.49

There were approximately 65 shareholders of record of our common shares on March 4, 2016.
Dividend Policy
The Board has instituted a policy authorizing us to pay quarterly dividends on our common shares in an amount to be determined at each quarterly Board of Directors meeting. The Board recently announced its intention to increase the quarterly dividend to $0.14 per share for 2016. The Board intends to continue to review our dividend policy annually during each regularly scheduled first quarter meeting, with the anticipation of considering annual dividend increases. We declared and paid quarterly dividends of $0.13 and $0.12 per common share in 2015 and 2014, respectively.
The declaration and payment of dividends remains subject to the discretion of the Board, and will depend on, among other things, our financial condition, results of operations, capital and cash requirements, future prospects, regulatory and contractual restrictions on the payment of dividends by insurance company subsidiaries and other factors deemed relevant by the Board. In addition, our ability to pay dividends would be restricted in the event of a default on our unsecured Credit Agreement, our failure to make payment obligations with respect to such agreement or our election to defer interest payments on the agreement.
We are a holding company without significant operations of our own. Our principal sources of funds are dividends and other distributions from our subsidiaries including our insurance company subsidiaries. Our ability to receive dividends from our insurance company subsidiaries is also subject to limits under applicable state insurance laws.

24


Performance Graph
The following graph shows the percentage change in cumulative total shareholder return on our common shares measured by dividing (i) the sum of (A) the cumulative amount of dividends, assuming dividend reinvestment during the periods presented and (B) the difference between our share price at the end and the beginning of the periods presented by (ii) the share price at the beginning of the periods presented. The graph demonstrates our cumulative five-year total returns compared to those of the Center for Research in Security Prices (“CRSP”) Total Return Index for Nasdaq and the CRSP Total Return Index for Nasdaq Insurance Stocks assuming a $100 investment at the close of trading on the last trading day preceding the first day of the fifth preceding fiscal year, or December 31, 2010 ($21.41) through December 31, 2015 ($26.70).

 Cumulative 5-Year Total Return as of December 31, 2015
(Assumes a $100 investment at the close of trading on December 31, 2010)
 
Company/Index
2010
 
2011
 
2012
 
2013
 
2014
 
2015
NATL Common Stock
$
100

 
$
117

 
$
150

 
$
122

 
$
160

 
$
146

Nasdaq Insurance Stocks
100

 
91

 
108

 
153

 
174

 
173

Nasdaq Index
100

 
100

 
117

 
156

 
175

 
176



25


ITEM 6     Selected Financial Data
The following table sets forth selected consolidated financial information for the periods ended and as of the dates indicated. These historical results are not necessarily indicative of the results to be expected from any future period. You should read this selected consolidated financial data together with our consolidated financial statements and the related notes and the section of this Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
 
At and for the Year Ended December 31,
 
2015
 
2014
 
2013
 
2012
 
2011
 
(Dollars in thousands, except per share data)
Operating Data:
 
 
 
 
 
 
 
 
 
Gross premiums written(1)
$
727,119

 
$
689,003

 
$
631,993

 
$
573,470

 
$
526,313

Net premiums written(2)
$
607,426

 
$
575,574

 
$
537,604

 
$
492,215

 
$
442,200

Premiums earned
$
585,787

 
$
557,267

 
$
525,710

 
$
458,049

 
$
429,946

Net investment income
39,739

 
35,517

 
33,377

 
34,927

 
30,554

Net realized (losses) gains on investments
(3,278
)
 
6,758

 
6,536

 
6,219

 
4,477

Other
3,477

 
3,399

 
3,303

 
3,278

 
3,541

Total revenues
625,725

 
602,941

 
568,926

 
502,473

 
468,518

Losses and loss adjustment expenses
471,940

 
466,998

 
429,556

 
341,008

 
308,357

Commissions and other underwriting expenses
94,075

 
94,430

 
92,193

 
89,917

 
87,860

Other operating and general expenses
25,569

 
20,955

 
19,722

 
19,151

 
17,432

Transaction expenses

 
2,163

 

 

 

Expense on amounts withheld(3)
6,458

 
6,410

 
5,057

 
3,953

 
3,910

Interest expense
199

 
220

 
706

 
615

 
298

  Total expenses
598,241

 
591,176

 
547,234

 
454,644

 
417,857

Income before income taxes
27,484

 
11,765

 
21,692

 
47,829

 
50,661

Provision for income taxes
6,637

 
739

 
4,119

 
13,535

 
15,113

Net income
$
20,847

 
$
11,026

 
$
17,573

 
$
34,294

 
$
35,548

Selected GAAP Ratios:
 
 
 
 
 
 
 
 
 
Losses and loss adjustment expense ratio(4)
80.6
%
 
83.8
%
 
81.7
%
 
74.4
%
 
71.7
%
Underwriting expense ratio(5)
19.8
%
 
20.1
%
 
20.7
%
 
23.1
%
 
23.7
%
Combined ratio(6)
100.4
%
 
103.9
%
 
102.4
%
 
97.5
%
 
95.4
%
Return on equity(7)
5.8
%
 
3.1
%
 
5.0
%
 
9.8
%
 
10.8
%
Per Share Data:
 
 
 
 
 
 
 
 
 
Earnings per common share, basic
$
1.05

 
$
0.56

 
$
0.89

 
$
1.76

 
$
1.84

Earnings per common share, assuming dilution
1.05

 
0.56

 
0.89

 
1.75

 
1.82

Book value per common share, basic (at year end)(8)
$
18.03

 
$
18.29

 
$
17.92

 
$
18.07

 
$
17.99

Weighted average number of common shares outstanding, basic
19,862

 
19,755

 
19,645

 
19,446

 
19,371

Weighted average number of common shares outstanding, diluted
19,910

 
19,833

 
19,768

 
19,579

 
19,491

Common shares outstanding (at year end)
19,909

 
19,793

 
19,661

 
19,591

 
19,398

Cash dividends per common share
$
0.52

 
$
0.48

 
$
0.44

 
$
2.40

 
$
0.36


26


 
At December 31,
 
2015
 
2014
 
2013
 
2012
 
2011
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and investments
$
1,252,452

 
$
1,160,343

 
$
1,075,428

 
$
1,054,792

 
$
1,021,104

Reinsurance recoverables
230,346

 
180,332

 
169,210

 
174,345

 
199,081

Total assets
1,935,882

 
1,754,733

 
1,623,827

 
1,570,224

 
1,523,378

Unpaid losses and loss adjustment expenses
1,014,195

 
883,078

 
803,782

 
775,305

 
776,576

Long-term debt
12,000

 
12,000

 
12,000

 
12,000

 
22,000

Total shareholders’ equity
358,897

 
362,089

 
352,284

 
353,948

 
348,899

 
 
 
 
 
 
 
 
 
 
 
At and for the Year Ended December 31,
 
2015
 
2014
 
2013
 
2012
 
2011
Selected Statutory Data(9):
 
 
 
 
 
 
 
 
 
Policyholder surplus(10)
$
295,596

 
$
284,680

 
$
283,419

 
$
269,696

 
$
293,614

Combined ratio(11)
102.6
%
 
104.9
%
 
99.4
%
 
92.6
%
 
94.7
%
 
 
(1)
The sum of premiums written on insurance policies issued by us and premiums assumed by us on policies written by other insurance companies.
(2)
Gross premiums written less premiums ceded to reinsurance companies.
(3)
We invest funds in the participant loss layer for several of the ART programs. We receive investment income and generate realized gains or losses, and incur an equal expense on the amounts owed to ART participants. “Expense on amounts withheld” represents both investment income and realized gains or losses that we remit back to ART participants. The related investment income and realized gains or losses are included in our “Net investment income” and "Net realized (losses) gains on investments" lines, respectively, on our Consolidated Statements of Income.
(4)
The ratio of losses and LAE to premiums earned.
(5)
The ratio of the net of the sum of commissions and other underwriting expenses, other operating and general expenses less other income to premiums earned.
(6)
The sum of the loss and LAE ratio and the underwriting expense ratio.
(7)
The ratio of net income to the average of the shareholders’ equity at the beginning and end of the year.
(8)
Book value per common share is computed using only unrestricted outstanding common shares. As of December 31, 2015 and 2014 total unrestricted common shares were 19,909,000 and 19,793,000, respectively.
(9)
While financial data is reported in accordance with U.S. generally accepted accounting principles ("GAAP") for shareholder and other investment purposes, it is reported on a statutory basis for insurance regulatory purposes. Certain statutory expenses differ from amounts reported under GAAP. Specifically, under GAAP, premium taxes and other variable costs incurred in connection with writing new and renewal business are capitalized and amortized on a pro rata basis over the period in which the related premiums are earned. On a statutory basis, these items are expensed as incurred. In addition, certain other expenses, such as those related to the expensing or amortization of computer software, are accounted for differently for statutory purposes than the treatment accorded under GAAP.
(10)
The statutory policyholder surplus of National Interstate Insurance Company ("NIIC"), which includes the statutory policyholder surplus of its subsidiaries, Vanliner Insurance Company, National Interstate Insurance Company of Hawaii, Inc. and Triumphe Casualty Company.
(11)
Statutory combined ratio of NIIC represents the sum of the following ratios: (1) losses and LAE incurred as a percentage of net earned premium and (2) underwriting expenses incurred as a percentage of net written premiums.



27


ITEM 7    Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our historical consolidated financial statements should be read in conjunction with our audited consolidated financial statements and the related notes included in this Form 10-K.

Overview
We are a holding company with operations being conducted by our subsidiaries.
Our specialty property and casualty insurance companies are licensed in all 50 states, the District of Columbia and the Cayman Islands. Our goal is to generate underwriting profits by providing what we view as specialty insurance products, services and programs not generally available in the marketplace. While many companies write property and casualty insurance for transportation companies, we believe that few write passenger transportation coverage nationwide and very few write coverage for several of the classes of passenger transportation insurance written by our subsidiaries. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. These niche markets typically possess what we view as barriers to entry, such as being too small, too remote or too difficult to attract or sustain most competitors. Examples of products that we write for these markets include captive programs for transportation companies that we refer to as our alternative risk transfer (“ART”) programs (56.7% of 2015 gross premiums written), property and casualty insurance for transportation companies (32.6%), specialty personal lines, primarily recreational vehicle (4.9%) and transportation and general commercial insurance in Hawaii and Alaska (3.1%). We strive to become a market leader in the specialty markets that we choose and serve by offering what we believe are specialized products, excellent customer service and superior claims response.
We write commercial insurance for various sizes of transportation fleets. Because of the number of smaller fleets nationwide, we have more opportunities to write smaller risks than larger ones. When general economic conditions improve, entrepreneurs are encouraged to start new transportation companies, which typically commence operations as a smaller risk and a potential traditional insurance customer for us. During periods of economic downturn, smaller risks are more prone to failure due to a decrease in leisure travel and consolidation in the industry. An increase in the number of larger risks results in more prospective ART insurance customers. We generally do not believe that smaller fleets that generate annual premiums of less than $75 thousand are large enough to retain the risks associated with participation in one of the ART programs we currently offer.
By offering insurance products to all sizes of risks, we believe we have hedged against the possibility that there will be a reduction in demand for the products we offer. We believe that we will continue to have opportunities to grow and profit with both traditional and ART customers based on our assumptions regarding future economic and competitive conditions. We generally incur low start-up costs when we enter new product niches, typically less than $0.5 million incurred over several quarters. We believe our flexible processes and scalable systems, along with controlled increase of businesses, allow us to manage costs and match them with the revenue flow.
The factors that impact our growth rate are consistent across all products. However, the trends impacting each of these factors may vary for individual products. Those factors are as follows:
Submissions
The increase or decrease in the number of new applications we receive. This is influenced by the effectiveness of our marketing activities compared to the marketing activities of our competitors in each market.
The change in the number of current policyholders that are available for a renewal quote. The number of policyholders available for renewal changes based upon the economic conditions impacting our customer groups and the extent of consolidation that may be taking place within the industries we support.

Quotes
The change in the percentage of the new applications received that do not receive a quote from us. We do not quote risks that do not meet our risk selection criteria or for which we have not been provided complete application data. We refer to this ratio as the “declination ratio” and an increasing declination ratio usually results in reduced opportunities to write new business.
Sales
The change in percentage of the quotes we issue that are actually sold. We refer to this ratio as the “hit ratio.” Hit ratios are affected by the number of competitors, the prices quoted by these competitors and the degree of difference between the competitors’ pricing, terms and conditions and ours.

28


Rates
The change in our rate structure from period to period. The rates we file and quote are impacted by several factors including: the cost and extent of the reinsurance we purchase; our operating efficiencies; our average loss costs, which reflect the effectiveness of our underwriting; our underwriting profit expectations; and our claims adjusting processes. The difference between our rates and the rates of our competitors is a primary factor impacting the revenue growth of our established product lines.
Product Offerings and Distribution
We operate in multiple markets with multiple distribution approaches to attempt to reduce the probability that an adverse competitive response in any single market will have a significant impact on our overall business. We also attempt to maintain several new products, product line extensions or product distribution approaches in active development status so we are able to take advantage of market opportunities. We select from potential new product ideas based on our stated new business criteria and the anticipated competitive response.

Industry and Trends
The property/casualty (“P/C”) insurance industry is cyclical, with periods of rising premium rates and shortages of underwriting capacity (“hard market”) followed by periods of substantial price competition and excess capacity (“soft market”). Despite several years of sustained improvement in premiums written, the P/C insurance industry experienced a slower pace of premium growth in 2015 as market competition continues to place downward pressure on rates, specifically for high quality large commercial accounts. According to A.M. Best, the P/C insurance industry is expected to report its third consecutive year of underwriting profit in 2015 as lower catastrophic events have contributed positively to this segment's sustained profitability. These results are despite deterioration in the overall industry combined ratio as rate increases continue to moderate and the level of favorable development of prior years' loss reserves decline. While remaining profitable, overall operating results for the P/C insurance industry are also expected to reflect lower investment yields. However, the industry's invested asset base continues to grow and slightly offsets the impact of lower reinvestment yields. The industry is also experiencing lower realized capital gains, especially in the fourth quarter, in light of poor performance in the equity markets late in 2015.
The industry's commercial auto liability line of business continued to have unfavorable results compared to the P/C insurance industry as a whole. Contributing to these results are increased levels of loss frequency and severity, as well as adverse prior year reserve development. Loss cost trends have also increased due in part to accelerating medical inflation, fraudulent activity, litigation costs and a shortage of qualified drivers coupled with an aging workforce. However, in contrast to most other commercial lines, commercial auto rates increased during 2015 as a result of recent negative loss trends. The outlook for the industry's commercial auto liability line of business continues to face several unfavorable trends in the coming years such as, but not limited to, continued competitive market conditions, a moderation in price increases on renewal business, loss ratios that are expected to remain elevated due to increased frequency and severity, potential unfavorable development on prior year loss and LAE reserves and the effect of industry consolidation on this line of business.
The workers’ compensation line of business has also lagged the P/C insurance industry as a whole despite improved performance in 2014 and 2015. The industry expects deterioration in this line of business as competition has put pressure on rate levels, which have decelerated in recent periods and have mostly offset exposure growth, and loss cost trends have continued to increase and outpace inflation. Additionally, according to A.M Best, the workers’ compensation line of business is estimated to have the largest reserve deficiency amongst all lines in the P/C industry in 2015.  The outlook for the workers’ compensation line of business is that of continuing negative trends including, but not limited to, downward pressure on pricing due to competition, increasing claims costs and unfavorable development on prior years’ loss and LAE reserves.
Since our inception in 1989, we have placed a consistent emphasis on underwriting profit. In 2014 and 2015 our results did not meet our expectations and were impacted by commercial auto liability industry trends. Our five-year average GAAP combined ratio of 99.9% has been consistently better than or in line with industry results, and we believe the following factors contribute to our performance:
Our pricing model, which is continually monitored and adjusted based on specific market conditions, and bottom line orientation, have resulted in disciplined and consistent risk assessment and pricing adequacy of new and renewal business.
Our ability to attract and retain some of the best transportation companies in the industries we serve - both from a financial stability and risk perspective - and to insure them directly or through our ART programs.

29


Our stable operating expenses (which include both “Commissions and other underwriting expenses” and “Other operating and general expenses” on our Consolidated Statements of Income) have historically been at or below the revenue growth rate.
The P/C insurance industry had its third consecutive year of relatively low catastrophe losses in 2015. For weather-related events such as hurricanes, tornados, and hailstorms, we conduct an analysis at least annually pursuant to which we input our in-force exposures (vehicle values in all states and property limits in Hawaii) into an independent catastrophe model that predicts our probable maximum loss at various statistical confidence levels. Our estimated probable maximum loss is impacted by changes in our in-force exposures as well as changes in the assumptions inherent in the catastrophe model. Hurricane and other weather-related events have not had a material adverse impact on our past or current results.
Our transportation insurance business, in particular, is also affected by loss cost trends that negatively impact profitability such as inflation in vehicle repair costs, vehicle replacement parts costs, used vehicle prices, fuel costs and medical care costs. We routinely obtain independent data for vehicle repair inflation, vehicle replacement parts costs, used vehicle prices, fuel costs and medical care costs and adjust our pricing routines to project more accurately the future costs associated with insurance claims. We would expect a negative impact on our future results if we fail to account adequately for and project for these inflationary trends. Increased litigation of claims may also negatively impact our profitability.
As described below, the average revenue dollar per personal lines policy is significantly lower than typical commercial policies. Profitability in the specialty personal lines component is dependent on proper pricing and the efficiency of underwriting and policy administration. We have continued to monitor rate levels and have adjusted them during 2015, as warranted. We continuously strive to improve our underwriting and policy issuance functions to keep this cost element as low as possible by utilizing current technological advances.
To succeed as a transportation and personal lines underwriter, we must understand and be able to quantify the different characteristics of the risks we consider quoting. Certain coverages are more stable and predictable than others, and we must recognize the various components of the risks we assume when we write any specific class of insurance business. Examples of trends that can change and, therefore, impact our profitability are loss frequency, loss severity, geographic loss cost differentials, societal and legal factors impacting loss costs (such as tort reform, punitive damage inflation and increasing jury awards) and changes in regulation impacting the insurance relationship. Any changes in these factors that are not recognized and priced for accordingly will affect our future profitability.
Revenues
We derive our revenues primarily from premiums from our insurance policies and income from our investment portfolio. Our underwriting approach is to price our products to achieve an underwriting profit even if it requires us to forgo volume. As with all P/C insurance companies, the impact of price changes is reflected in our financial results over time. Price changes on our in-force policies occur as they are renewed, which generally takes twelve months for our entire book of business and up to an additional twelve months to earn a full year of premium at the average renewal rate. Insurance rates charged on renewing policies reflected an approximate average increase of 5% in 2015 and 7% in 2014.
There are distinct differences in the timing of premiums written in traditional transportation insurance compared to the majority of our ART insurance component. We write traditional transportation insurance policies throughout all twelve months of the year and commence new annual policies at the expiration of the old policy. Under most ART programs, all members of the group share a common renewal date. These common renewal dates are scheduled throughout the calendar year. Any new ART program participant that joins after the common date will be written for other than a full annual term so its next renewal date coincides with the common expiration date of the program it has joined. Several of our larger group programs have common renewal dates during the first six months of the year, but as we have added new ART programs in recent years, we now experience renewal dates that occur throughout the calendar year. The ART component of our business accounted for 56.7% of total gross premiums written during 2015 as compared to 54.3% in 2014.
The projected profitability from traditional transportation accounts and transportation ART programs are substantially comparable. Increased investment income opportunities generally are available with traditional insurance, but the lower acquisition expenses and persistence of the ART programs generally provide for lower operating expenses from these programs. The lower expenses associated with our ART programs generally offset the projected reductions in investment income potential. From a projected profitability perspective, we are ambivalent as to whether a transportation operator elects to purchase traditional insurance or one of our ART program options.
All of our transportation products, traditional or ART, are priced to achieve targeted underwriting margins. Because traditional insurance tends to have a higher operating expense structure, the portion of the premiums available to pay losses tends to be lower

30


for a traditional insurance quote versus an ART insurance quote. We use a cost plus pricing approach that projects future losses based upon the insured’s historic losses and other factors. Operating expenses, premium taxes and a profit margin are then added to the projected loss component to achieve the total premium to be quoted. The lower the projected losses, expenses and taxes, the lower the total quoted premiums regardless of whether it is a traditional or ART program quotation. Quoted premiums are computed in accordance with our approved insurance department filings in each state.
Our specialty personal lines products are also priced to achieve targeted underwriting margins. The average premium per policy for this business component is significantly less than transportation lines.
We approach investment and capital management with the intention of supporting insurance operations by providing a stable source of income to supplement underwriting income and mitigate underwriting losses. The goals of our investment policy are to protect capital, optimize investment income and capital appreciation and to maintain appropriate liquidity. We follow a formal investment policy and the Board reviews the portfolio performance at least quarterly for compliance with the established guidelines. In 2015, market interest rates increased and credit spreads widened, which contributed to an overall decrease in the fair value of our holdings. We recorded a $3.3 million pre-tax net realized loss on investments in 2015 as compared to a pre-tax net realized gain of $6.8 million in 2014. Included in these pre-tax net realized losses and gains are other-than-temporary impairment charges of $7.8 million and $2.0 million, respectively.
Expenses
Losses and loss adjustment expenses (“LAE”) are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We record losses and LAE based on management's best estimate of losses we expect to be reported on policies written. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to estimate losses and LAE accurately at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and LAE in any period includes payments in the period net of the change in the value of the reserves for unpaid losses and LAE between the beginning and the end of the period.
Commissions and other underwriting expenses consist principally of brokerage and agent commissions and to a lesser extent premium taxes and assessments. The brokerage and agent commissions are reduced by ceding commissions received from assuming reinsurers that represent a percentage of the premiums on insurance policies and reinsurance contracts written and vary depending upon the amount and types of contracts written.
Other operating and general expenses consist primarily of personnel expenses (including salaries, benefits and certain costs associated with awards under our equity compensation plans, such as stock compensation expense) and other general operating expenses. Our personnel expenses are primarily fixed in nature and do not vary with the amount of premiums written. Interest expenses associated with outstanding debt and “Expense on amounts withheld” are disclosed separately from operating and general expenses. We invest funds in the participant loss layer for several of our ART programs. We receive investment income and generate gains or losses and incur an equal expense on the amounts owed to ART participants. “Expense on amounts withheld” represents investment income and net realized gains that we remit back to ART participants. The related investment income and net realized gains are included in the “Net investment income” and "Net realized (losses) gains on investments" lines on our Consolidated Statements of Income.
Our 2014 results include transaction expenses we incurred related to the February 5, 2014 Great American unsolicited tender offer to acquire all of our remaining outstanding common shares not already owned by Great American. Transaction expenses primarily consisted of financial advisory and legal services incurred in connection with the tender offer and related litigation. Great American withdrew the tender offer on March 16, 2014.


31


Results of Operations
Overview
Our net income, determined in accordance with U.S. generally accepted accounting principles ("GAAP"), includes items that may not be indicative of our ongoing operations. The following table identifies such items and reconciles net income to net income from operations, a non-GAAP financial measure that we believe is a useful tool for investors and analysts in analyzing ongoing operating trends.
 
 
Year Ended December 31,
 
2015
 
2014
 
2013
 
Amount
 
Per Share
 
Amount
 
Per Share
 
Amount
 
Per Share
 
(Dollars in thousands, except per share data)
Net income from operations
$
22,978

 
$
1.16

 
$
8,039

 
$
0.41

 
$
13,325

 
$
0.67

After-tax net realized (losses) gains from investments
(2,131
)
 
(0.11
)
 
4,393

 
0.22

 
4,248

 
0.22

After-tax impact from transaction expense

 

 
(1,406
)
 
(0.07
)
 

 

Net income
$
20,847

 
$
1.05

 
$
11,026

 
$
0.56

 
$
17,573

 
$
0.89

 
 
 
 
 
Our net income for 2015 was $20.8 million ($1.05 per share diluted) compared to $11.0 million ($0.56 per share diluted) in 2014. The increase in net income during the current year reflects an improvement in the loss and LAE ratio to 80.6% compared to 83.8% last year. The 2015 loss and LAE ratio, while improved compared to the prior year, was elevated due to the impact of prior year development, including reserve strengthening, on the commercial auto liability line of business related to the 2012 and 2013 accident years. The 2014 loss and LAE ratio was also primarily attributable to unfavorable development from prior years’ loss reserves including $20.0 million of reserve strengthening recorded in the second quarter of 2014, primarily for accident years 2011, 2012 and 2013. The majority of such strengthening was concentrated in our commercial auto liability lines of business. Also contributing to the improvement in net income over the prior year was increased net investment income due primarily to higher average investment balances in the current year compared to last year. Additionally, 2014 net income was adversely impacted by after-tax transaction expenses related to the Great American tender offer. Partially offsetting these increases to net income was after-tax net realized losses of $2.1 million ($0.11 per share diluted) in 2015 compared to after-tax net realized gains of $4.4 million ($0.22 per share diluted) in 2014. Such losses in 2015 were attributable to other-than-temporary impairment charges primarily from securities related to the energy and financial services sectors. The declines in these sectors and equity markets in general also impacted our other invested assets which produced net realized losses during 2015 compared to net realized gains in the prior year.
Our net income from operations for 2015 was $23.0 million ($1.16 per share diluted) compared to $8.0 million ($0.41 per share diluted) in 2014. The primary drivers for the period-over-period fluctuations are the same as those discussed above for the change in net income for the respective periods.
Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following table sets forth an analysis of gross premiums written by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:
 
 
Year Ended December 31,
 
2015
 
2014
 
2013
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Alternative Risk Transfer
$
412,443

 
56.7
%
 
$
374,152

 
54.3
%
 
$
326,305

 
51.7
%
Transportation
237,271

 
32.6
%
 
245,261

 
35.6
%
 
228,139

 
36.1
%
Specialty Personal Lines
35,295

 
4.9
%
 
35,597

 
5.2
%
 
47,715

 
7.5
%
Hawaii and Alaska
22,284

 
3.1
%
 
21,276

 
3.1
%
 
20,096

 
3.2
%
Other
19,826

 
2.7
%
 
12,717

 
1.8
%
 
9,738

 
1.5
%
Gross premiums written
$
727,119

 
100.0
%
 
$
689,003

 
100.0
%
 
$
631,993

 
100.0
%

32


Gross premiums written includes both direct premium and assumed premium. During 2015, our gross premiums written increased $38.1 million, or 5.5%, compared to 2014, primarily attributable to growth in our ART component. Gross premiums written in our ART component increased $38.3 million, or 10.2%, during 2015 compared to 2014 and was primarily due to growth within our national account ART product's workers' compensation line of business. Additionally, our ART business achieved average rate increases on renewed business of approximately 5% and benefited from increased exposures and high renewal retention amongst our group ART programs. Partially offsetting such growth was the loss of several insureds resulting from rate actions taken within our group captive and national account ART products, as well as the loss of one national account insured to aggressive competition. Gross premiums written in our transportation component decreased $8.0 million, or 3.3%, due primarily to lower renewals from rate actions taken on underperforming accounts within our traditional trucking, tow and waste operations products. These decreases were partially offset by average rate increases of approximately 6% on renewed business, as well as new business written on our expanded limits coverage offered to trucking customers and our traditional crane and heavy haul insurance products. The other component, which is comprised of premium from assigned risk policies that we receive from involuntary state insurance plans from the states in which our insurance company subsidiaries operate and over which we have no control, increased $7.1 million, or 55.9%, compared to 2014.
Our ART programs, which focus on specialty or niche businesses, provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention and reinsurance placement, along with providing various types of property and casualty insurance coverage. Insurance coverage is provided primarily to companies with similar risk profiles and to specified classes of business of our agent partners.
As part of our ART programs, we analyze, on a quarterly basis, members’ loss performance on a policy year basis to determine if there would be an assessment premium (loss results are unfavorable to expectations) or if there would be a return of premium (loss results are favorable to expectations) to participants. Assessment premium and return of premium are recorded as adjustments to premiums written (assessments increase premiums written; returns of premium reduce premiums written). For the years ended 2015 and 2014, we recorded net premium assessments of $7.7 million and $12.1 million, respectively.
Premiums Earned
2015 compared to 2014. We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following table shows premiums earned for the years ended December 31, 2015 and 2014 summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:
 
 
Year Ended December 31,
 
Change
 
2015
 
2014
 
Amount
 
Percent
 
(Dollars in thousands)
Premiums earned:
 
 
 
 
 
 
 
Alternative Risk Transfer
$
321,262

 
$
300,922

 
$
20,340

 
6.8
 %
Transportation
195,960

 
191,482

 
4,478

 
2.3
 %
Specialty Personal Lines
30,718

 
35,086

 
(4,368
)
 
(12.4
)%
Hawaii and Alaska
19,602

 
18,009

 
1,593

 
8.8
 %
Other
18,245

 
11,768

 
6,477

 
55.0
 %
Total premiums earned
$
585,787

 
$
557,267

 
$
28,520

 
5.1
 %

During 2015, our premiums earned increased $28.5 million, or 5.1%, to $585.8 million compared to $557.3 million for the year ended December 31, 2014. The increase is primarily attributable to our ART component, which grew $20.3 million, or 6.8%. Our ART component growth was due to the addition of one large insured to our national account ART product, as well as rate and exposure increases on renewed business in our group ART programs. Growth in our transportation component of $4.5 million, or 2.3%, was primarily due to rate increases on renewed business, as well as new business premium from several of our recently introduced traditional program offerings including our home delivery, ambulance and crane and heavy haul insurance products. Partially offsetting this component's growth has been rate actions and non-renewals of underperforming accounts within our traditional trucking and tow products. The decrease in our specialty personal lines component was primarily due to the continued impact of our decision to stop selling our commercial vehicle product during the third quarter of 2013. The slight increase in our Hawaii and Alaska component was due primarily to rate increases on renewed business, high renewal retention and new business premium. The growth in the other component is due to an increase in premiums from assigned risk policies that we receive from

33


involuntary state insurance plans from the states in which our insurance company subsidiaries operate and over which we have no control.
2014 compared to 2013. The following table shows premiums earned for the years ended December 31, 2014 and 2013 summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services:
 
 
Year Ended December 31,

Change
 
2014

2013

Amount

Percent
 
(Dollars in thousands)
Premiums earned:







Alternative Risk Transfer
$
300,922


$
283,725


$
17,197


6.1
 %
Transportation
191,482


172,367


19,115


11.1
 %
Specialty Personal Lines
35,086


45,311


(10,225
)

(22.6
)%
Hawaii and Alaska
18,009


15,357


2,652


17.3
 %
Other
11,768