Attached files

file filename
EX-32 - BALDWIN & LYONS INCexh32.htm
EX-31.2 - BALDWIN & LYONS INCexh312.htm
EX-31.1 - BALDWIN & LYONS INCexh311.htm
EX-24 - BALDWIN & LYONS INCexh24.htm
EX-23 - BALDWIN & LYONS INCexh23.htm
EX-21 - BALDWIN & LYONS INCexh21.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 Commission file number 0-5534
December 31, 2017
BALDWIN & LYONS, INC.
(Exact name of registrant as specified in its charter)
Indiana
(State or other jurisdiction of
Incorporation or organization)
35-0160330
(I.R.S. Employer
Identification No.)
111 Congressional Boulevard, Carmel, Indiana
(Address of principal executive offices)
46032
(Zip Code)
Registrant's telephone number, including area code:  (317) 636-9800
Securities registered pursuant to Section 12(b) of the Act:
                           (Title of class)                                                     Name of Each Exchange on which Registered
             Class A Common Stock, No Par Value                                     The Nasdaq Stock Market, LLC
             Class B Common Stock, No Par Value                                     The Nasdaq Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act:  None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    
Yes -___ No  
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes -___ No  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes -       No ___
Indicate by check mark whether the registrant has submitted electronically 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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes       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.         -   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ____    Accelerated filer         Non-accelerated filer ____    Smaller reporting company____    Emerging growth company ____
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ______
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes -___ No  
The aggregate market value of Class A and Class B Common Stock held by non-affiliates of the Registrant as of June 30, 2017, based on the closing trade prices on that date, was approximately $266,182,000.
The number of shares outstanding of each of the issuer's classes of common stock as of March 1, 2018:
Common Stock, No Par Value:                           Class A (voting)                                                        2,623,109
Class B (nonvoting) 12,387,703
                                                                                   15,010,812
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 8, 2018 are incorporated by reference into Part III of this Annual Report on Form 10-K.
 

FORWARD-LOOKING STATEMENTS

The disclosures in this Form 10-K 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.

Investors are cautioned that such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements, many of which are difficult to predict and generally beyond our control. Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date hereof. Investors are also urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the factors that affect our business, including "Risk Factors" set forth in Part I, Item 1A hereof and our reports filed with the U.S. Securities and Exchange Commission, or SEC, from time to time. Except to the extent otherwise required by federal securities laws, we do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof.

Factors that could contribute to these differences include, among other things:
·
general economic conditions, including weakness of the financial markets, 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;
·
increasing competition in the sale of our insurance products and services resulting from the entrance of new competitors into, or the expansion of the operations of existing competitors in, our markets and our ability to retain existing customers;
·
other changes in the markets for our insurance products;
·
changes in the legal or regulatory environment, which may affect the manner in which claims are adjusted or litigated, including loss and loss adjustment expense;
·
legal or regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements;
·
technology or network security disruptions;
·
adequacy of insurance reserves;
·
availability of reinsurance and ability of reinsurers to pay their obligations;
·
our ability to attract and retain qualified employees;
·
tax law and accounting changes; and
·
legal actions brought against us.
Some of the significant risks and uncertainties that could cause actual results to differ materially from our expectations and projections are described more fully in Item 1A "Risk Factors" of this report.  You should read that information in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this report and our Consolidated Financial Statements and related notes in Part II, Item 8 of this report.


- 2 -

PART I

Item 1.  BUSINESS

Baldwin & Lyons, Inc. (referred to herein as "B&L") was incorporated under the laws of the State of Indiana in 1930.  Through its subsidiaries, B&L engages in marketing and underwriting property, liability and workers' compensation coverage for trucking and public transportation fleets, as well as coverage for trucking industry independent contractors.  In addition, B&L offers workers' compensation coverage for a variety of operations outside the transportation industry.
B&L's principal subsidiaries are:
1.
Protective Insurance Company (referred to herein as "Protective"), which is licensed by insurance authorities in all 50 states, the District of Columbia, all Canadian provinces and Puerto Rico;
2.
Protective Specialty Insurance Company (referred to herein as "Protective Specialty"), which is currently approved for excess and surplus lines business by insurance authorities in 48 states and the District of Columbia and licensed in Indiana;
3.
Sagamore Insurance Company (referred to herein as "Sagamore"), which is licensed by insurance authorities in 49 states and the District of Columbia and approved for excess and surplus lines business in one additional state;
4.
B&L Brokerage Services, Inc. (referred to herein as "BLBS"), an Indiana domiciled insurance broker licensed in all 50 states and the District of Columbia; and
5.
B&L Insurance, Ltd. (referred to herein as "BLI"), which is domiciled and licensed in Bermuda.
Protective, Protective Specialty, Sagamore and BLI are collectively referred to herein as the "Insurance Subsidiaries."  The "Company", "we", "us" and "our", as used herein, refers to B&L and all its subsidiaries unless the context clearly indicates otherwise.

As is a common practice in the property and casualty insurance industry, the Insurance Subsidiaries share or "cede" portions of their gross premiums written with several non-affiliated reinsurers under excess of loss and quota-share treaties covering predetermined groups of risks and by facultative (individual policy-by-policy) placements.  Reinsurance is ceded to spread the risk of loss from individual claims or groups of claims among several reinsurers and is an integral part of the Company's business.
In 2017, the Insurance Subsidiaries primarily served the fleet transportation market, although the Insurance Subsidiaries continue to support previously written policies in specialty markets for which the Company has discontinued operations.  Continuing operations and targeted growth are expected to occur in our core business of fleet transportation and workers' compensation.

The Company determined that its business constituted one reportable property and casualty insurance segment as of January 1, 2017.  During 2016 and prior years, the Company had two reportable segments – property and casualty insurance and reinsurance.  The Company moved to a single reportable segment based on how its operating results are regularly reviewed by the Company's chief operating decision maker when making decisions about how resources are to be allocated to the segment and assessing its performance.  The prior year segment information throughout this Annual Report on Form 10-K was updated to conform to the current year presentation.

Product Lines
Fleet Transportation

The Insurance Subsidiaries provide coverage for larger companies in the motor carrier industry that retain substantial amounts of self-insurance, for independent contractors utilized by trucking companies, for medium-sized and small trucking companies on a first dollar or deductible basis, and for public livery concerns, principally covering fleets of commercial buses and taxis.  This group of products is collectively referred to as fleet transportation.  Large fleet trucking products are marketed both directly to fleet transportation clients and also through relationships with non-affiliated brokers and specialized agents.  Products for small and intermediate fleets and independent contractors are marketed through relationships with non-affiliated brokers and specialized agents.  In some cases, the Insurance Subsidiaries will provide customized product offerings to specific markets through partnerships with brokers or program administrators.  In most cases, the Company's fleet transportation policies are written on an "occurrence" basis (i.e. we may be liable for claims that occurred when our policy was in place with an insured, regardless of when those claims are reported to us; and it may take months or even years for claims to be reported to us).

 
- 3 -

The principal types of fleet transportation insurance marketed by the Insurance Subsidiaries are:
-
Commercial motor vehicle liability, physical damage and general liability insurance.
-
Workers' compensation insurance.
-
Specialized accident (medical and indemnity) insurance for independent contractors in the trucking industry.
-
Non-trucking motor vehicle liability insurance for independent contractors.
-
Fidelity and surety bonds.
-
Inland Marine insurance consisting principally of cargo insurance.

The Insurance Subsidiaries also perform a variety of additional services, primarily for the Company's insureds, including risk surveys and analyses, safety program design and monitoring, government compliance assistance, loss control and cost studies and research, development, and consultation in connection with new insurance programs, including development of systems to assist customers in monitoring their accident data.  B&L also provides claims handling services, primarily to excess clients with self-insurance programs.
Workers' Compensation

The Insurance Subsidiaries provide workers' compensation insurance for the fleet transportation industry, primarily to employees of motor carriers or independent contractors providing services in the transportation industry.  In 2017, workers' compensation coverage was marketed beyond fleet transportation clients to a variety of non-transportation operations such as light manufacturing, restaurants, retailers, and professional services on both a first-dollar and deductible basis.  Non-transportation workers' compensation is marketed through relationships with non-affiliated brokers and specialized agents.  In addition, we have developed customized non-transportation workers' compensation programs which are marketed through non-affiliated agent partners.  In most cases, the Company's workers' compensation policies are written on an "occurrence" basis (i.e. we may be liable for claims that occurred when our policy was in place with an insured, regardless of when those claims are reported to us; and it may take months or even years for claims to be reported to us).
Discontinued Products
·
Reinsurance Assumptions

In the first quarter of 2016, the Company discontinued its reinsurance assumed professional liability line of products.  These products are in run-off but continued earning premiums in 2017.  Prior to that, the Company accepted cessions and retrocessions from selected insurance and reinsurance companies, providing reinsurance coverage for both property and casualty events.  Participation in reinsurance markets fluctuated based on market conditions for these products.  The Company's reinsurance assumed policies were written on both an "occurrence" basis and a "claims-made" basis.

·
Professional Liability

In the fourth quarter of 2016, the Company discontinued its professional liability line of products.  Prior to that, the Company marketed a variety of professional liability products through wholesale and retail agents on both an admitted and surplus lines basis throughout the United States, specializing in smaller insureds.  Some professional liability policies renewed in 2017 as required by state regulations and existing policies remained inforce through 2017.  In most cases, the Company's professional liability policies were written on a "claims-made" basis.  Under claims-made policies, the Company was generally only liable for claims when a policy was in place with our insured, however we were potentially liable for claims reported to us, even if the claim event occurred before we had a policy in place with the insured.

- 4 -


Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses incurred on average comprise approximately two-thirds of the Company's operating expenses.

The Company's consolidated balance sheets as of December 31, 2017 and 2016 set forth in Part II, Item 8 of this Annual Report on Form 10-K include the estimated liability for unpaid losses and loss adjustment expenses ("LAE") of the Insurance Subsidiaries before the application of reinsurance credits (gross reserves).  The liabilities for losses and LAE are determined using case basis evaluations and statistical projections and represent estimates of the Company's ultimate exposure for all unpaid losses and LAE incurred through December 31 of each year.  These estimates are subject to the effects of trends in claim severity and frequency and are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary.  Such adjustments, either positive or negative, are reflected in current operations as recorded.
The Company's reserves for losses and loss expenses are determined based on evaluations of individual reported claims and by actuarial estimation processes using historical experience, current economic information and, when necessary, available industry statistics.  "Case basis" loss reserves are evaluated on an individual case-by-case basis by experienced claims adjusters using established Company guidelines and are monitored by claims management.  Additionally, "bulk" reserves are established for (1) those losses which have occurred, but have not yet been reported to the Company ("incurred but not reported" claims), (2) provisions for any possible deficiencies in the case reserving process and (3) the expected external and internal costs to fully settle each claim, also referred to as LAE.  Common actuarial methods are employed in the establishment of bulk reserves using Company historical loss data, consideration of changes in the Company's business and study of current economic trends affecting ultimate claims costs.  Loss adjustment expense reserves include amounts ultimately allocable to individual claims as well as amounts required for the general overhead of the claims handling operation which are not specifically allocable to individual claims.  Historical analyses of the ratio of loss adjusting expenses to losses paid on prior closed claims and study of current economic trends affecting loss settlement costs are used to estimate the loss adjustment reserve needs relative to the established loss reserves.  Each of these reserve categories contain elements of uncertainty which assure variability when compared to the ultimate costs to settle the underlying claims for which the reserves are established.  For a more detailed discussion of the three categories of reserves, see "Loss and Loss Expense Reserves" under the caption, "Critical Accounting Policies" noted in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Annual Report on Form 10-K.

For policies inforce at December 31, 2017, the maximum amount for which the Company insures a fleet transportation risk is $10 million, less applicable self-insured retentions, although for the majority of policies written, the maximum limits provided by the Company are $5 million or less. Occasionally, limits above $10 million required by customers are placed directly by the Company with non-affiliated carriers or written by the Company but 100% reinsured with non-affiliated reinsurers. Certain coverages, such as workers' compensation, do not have policy limits, although the Company protects itself to the extent believed prudent through the purchase of excess reinsurance for these coverages.

After giving effect to treaty and facultative reinsurance arrangements, the Company's maximum exposure to loss from a single occurrence for the vast majority of risks insured (those with policy limits of $5 million or less) is approximately:
·
$0.25 million to $1.3 million for policies written on or after July 3, 2016, and
·
$0.8 million to $4.1 million for policies written on or after July 3, 2017.
However, for certain losses (those with policy limits up to $10 million) the maximum exposure could be as high as:
·
$2.5 million for policies written on or after July 3, 2016, and
·
$8.0 million for policies written on or after July 3, 2017.

 
- 5 -

The change in the Company's single occurrence loss exposure described above (from a range of $0.25 million to $2.5 million in 2016, to a range of $0.8 million to $8.0 million in 2017) is offset by a change in the reinsurance structure for these risks.  As of July 3, 2017, the Company no longer utilizes sliding scale ceding premium provisions in its reinsurance arrangements for these risks, instead utilizing a flat ceding premium percentage.

The economic exposure from a single claim occurrence remains relatively consistent year over year; however, under the current flat ceding premium provision, more of the economic exposure will flow through loss expense moving forward, whereas in prior periods, utilizing the sliding scale ceding premium provisions, more of the economic exposure was reflected in lower net premiums earned.  For both periods discussed above, the Company's has limited economic exposure for losses occurring in treaty years that have loss and allocated loss adjustment expense ratios greater than approximately 86.5%.

The Company is a cedent under numerous reinsurance treaties covering its product lines.  Treaties are typically written on an annual basis, each with its own renewal date.  However, treaty terms may occasionally be agreed to for periods beyond one year.  Treaty renewals are expected to largely continue to occur annually in the foreseeable future.  Because losses from certain of the Company's products can experience delays in being reported and can take years to settle, losses reported to the Company in the current year may be covered by a number of older reinsurance treaties with higher or lower net loss exposures than those provided by current treaty provisions.

The table below sets forth a reconciliation of beginning and ending loss and LAE liability balances for 2017, 2016 and 2015.  This table includes reserves, net of reinsurance recoverable, to correspond with our income statement presentation, but also includes a reconciliation of beginning and ending loss and LAE liability, gross of reinsurance recoverable, as presented in the balance sheet.  All amounts are shown net of reinsurance, unless otherwise indicated.

   
2017
   
2016
   
2015
 
Reserves, gross of reinsurance
                 
    recoverable, at the beginning of the year
 
$
576,330
   
$
513,596
   
$
506,102
 
Reinsurance recoverable on unpaid losses at the beginning of the year
   
251,563
     
211,843
     
210,519
 
Reserves at the beginning of the year
   
324,767
     
301,753
     
295,583
 
                         
Provision for losses and loss expenses:
                       
   Claims occurring during the current year
   
228,303
     
172,645
     
165,812
 
   Claims occurring during prior years
   
19,215
     
13,836
     
(10,062
)
   Total incurred losses and loss expenses
   
247,518
     
186,481
     
155,750
 
                         
Loss and loss expense payments:
                       
   Claims occurring during the current year
   
67,234
     
54,239
     
56,710
 
   Claims occurring during prior years
   
132,920
     
109,228
     
92,870
 
   Total paid
   
200,154
     
163,467
     
149,580
 
Reserves at the end of the year
   
372,131
     
324,767
     
301,753
 
                         
Reinsurance recoverable on unpaid losses at the end of the year
   
308,143
     
251,563
     
211,843
 
Reserves, gross of reinsurance
                       
    recoverable, at the end of the year
 
$
680,274
   
$
576,330
   
$
513,596
 


The reconciliation above shows the Company's estimate of net losses on 2016 and prior accidents is approximately $19.2 million higher at December 31, 2017 than was provided in loss reserves at December 31, 2016 (referred to as a "reserve deficiency").  This compares to a $13.8 million reserve deficiency on prior accident years in 2016 and a $10.0 million reserve savings reported in 2015 related to prior accident years.


- 6 -


The following table is a summary of the 2017 calendar year reserve deficiency by accident year (dollars in thousands):


Years in Which Losses Were Incurred
 
Reserve at December 31, 2016
   
(Savings) Deficiency Recorded During 2017 1
   
% (Savings) Deficiency
 
             
2016
 
$
118,406
   
$
(8,561
)
   
(7.2
%)
2015
   
69,463
     
(3,863
)
   
(5.6
%)
2014
   
50,739
     
3,688
     
7.3
%
2013
   
22,186
     
17,418
     
78.5
%
2012
   
16,414
     
6,234
     
38.0
%
2011 & Prior
   
47,559
     
4,299
     
9.0
%
                         
   
$
324,767
   
$
19,215
     
5.9
%

1 Consist of development on cases known at December 31, 2016, losses reported which were previously unknown at December 31, 2016 (incurred but not reported), unallocated loss expense paid related to accident years 2016 and prior changes in the reserves for incurred but not reported losses and loss expenses.
The savings shown in accident years 2015 and 2016 in the table above reflect favorable loss development in both short-tail lines of business, such as physical damage, and the Company's independent contractor products (including non-trucking liability, occupational accident and workers' compensation).  The deficiencies in accident years 2014 and prior are largely the result of discontinued lines (professional liability and general property based in Florida) and several infrequent, but severe, transportation losses.  The Company took action in all accident years to reflect new trends in loss development for commercial auto products that have emerged over the last two years.  These actions included case reserving reviews, as well as actuarial product reviews, and resulted in the reserve strengthening noted during 2017.
Bulk loss reserves are established to provide for potential future adverse development on cases known to the Company and for cases unknown at the reserve date.  Changes in the reserves for incurred but not reported losses and loss expenses occur based upon information received on known and newly reported cases during the current year and the effect of that development on the application of standard actuarial methods used by the Company.
The Company continues to incorporate more recent loss development data into its loss reserving formulae; however, the dynamic nature of losses associated with the fleet transportation business, as well as the timing of settlement of large claims, increases the likelihood of variability in loss developments from period to period.  As discussed elsewhere, the Company has historically experienced savings in its loss developments owing to, among other things, its long-standing policy of reserving for the ultimate value of losses quickly and realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures.  While the Company's basic assumptions have remained consistent, we continue to update loss data to reflect changing trends which can be expected to result in fluctuations in loss developments over time.

Management's goal is to produce an overall estimate of reserves which is sufficient and as close to expected ultimate losses as possible.  The $19.2 million in net deficiency developed during 2017 represents 5.9% of December 31, 2016 net loss and LAE reserves, which is within an acceptable range of variation for the Company's diverse and complex book of business.  2017 was the first calendar year in which reserve deficiencies were more than 5% of the prior year's loss position since 1985.  The Company constantly monitors changes in trends related to the numbers of claims incurred relative to correlative variances with premium volume, average settlement amounts, numbers of claims outstanding at period ends and the average value per claim outstanding and adjusts actuarial assumptions as necessary to accommodate observed trends.

- 7 -

Ten Year Historical Development Tables:
The table below presents the development of U.S. generally accepted accounting principles ("GAAP") balance sheet insurance reserves for each year-end from 2007 through 2016, as of December 31, 2017, net of all reinsurance credits.


ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS
 
(Dollars in thousands)
 
                                                                   
Year Ended December 31
 
2007
   
2008
   
2009
   
2010
   
2011
   
2012
   
2013
   
2014
   
2015
   
2016
   
2017
 
                                                                   
Liability for Unpaid Losses
                                                                 
  and Loss Adjustment
                                                                 
  Expenses 1
 
$
244,500
   
$
231,633
   
$
203,253
   
$
218,629
   
$
290,092
   
$
289,236
   
$
288,088
   
$
295,583
   
$
301,753
   
$
324,767
   
$
372,131
 
                                                                                         
Liability Reestimated
                                                                                       
   as of: 2
                                                                                       
  One Year Later
   
227,423
     
222,049
     
194,430
     
208,933
     
280,217
     
283,673
     
277,734
     
285,521
     
315,589
     
343,982
         
  Two Years Later
   
216,730
     
208,702
     
198,220
     
201,745
     
272,285
     
282,381
     
268,757
     
303,540
     
340,361
                 
  Three Years Later
   
206,445
     
210,562
     
188,110
     
204,243
     
276,525
     
279,685
     
288,862
     
332,175
                         
  Four Years Later
   
210,170
     
205,519
     
192,195
     
202,078
     
268,299
     
291,332
     
313,909
                                 
  Five Years Later
   
208,132
     
208,398
     
187,792
     
198,518
     
275,517
     
298,861
                                         
  Six Years Later
   
210,446
     
205,986
     
181,547
     
200,922
     
276,812
                                                 
  Seven Years Later
   
209,288
     
200,460
     
181,998
     
203,692
                                                         
  Eight Years Later
   
205,179
     
200,808
     
184,122
                                                                 
  Nine Years Later
   
205,248
     
202,565
                                                                         
  Ten Years Later
   
205,784
                                                                                 
                                                                                         
                                                                                         
Cumulative Redundancy (Deficiency) 3
 
$
38,716
   
$
29,068
   
$
19,131
   
$
14,937
   
$
13,280
   
$
(9,625
)
 
$
(25,821
)
 
$
(36,592
)
 
$
(38,608
)
 
$
(19,215
)
       
                                                                                         
Cumulative Amount of
                                                                                       
 Liability Paid
                                                                                       
 Through: 4
                                                                                       
  One Year Later
 
$
76,970
   
$
84,777
   
$
74,182
   
$
72,393
   
$
94,003
   
$
103,941
   
$
92,275
   
$
92,870
   
$
109,228
   
$
132,920
         
  Two Years Later
   
124,870
     
120,628
     
107,413
     
109,382
     
156,271
     
162,087
     
159,282
     
166,642
     
195,951
                 
  Three Years Later
   
145,857
     
142,731
     
125,038
     
133,507
     
193,566
     
205,452
     
166,642
     
222,295
                         
  Four Years Later
   
157,724
     
152,679
     
137,460
     
147,462
     
214,873
     
202,803
     
234,158
                                 
  Five Years Later
   
164,877
     
161,834
     
143,461
     
158,172
     
227,359
     
241,533
                                         
  Six Years Later
   
170,554
     
166,290
     
148,101
     
166,112
     
234,578
                                                 
  Seven Years Later
   
174,190
     
170,126
     
152,375
     
168,524
                                                         
  Eight Years Later
   
177,275
     
173,867
     
153,999
                                                                 
  Nine Years Later
   
180,569
     
174,902
                                                                         
  Ten Years Later
   
180,701
                                                                                 


1 Represents the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years.  This liability represents the estimated amount of losses and LAE for claims arising in all prior years that were unpaid at the respective balance sheet date, including incurred but not reported ("IBNR") losses, to the Company.

2 Represents the re-estimated amount of the previously recorded liability based on additional information available to the Company as of the end of each succeeding year.  The estimate is increased or decreased as more information becomes known about the frequency and severity of individual claims and as claims are settled and paid.
3 Represents the aggregate change in the estimates of each calendar year-end reserve through December 31, 2017.
4 Represents the cumulative amount paid with respect to the previously recorded calendar year-end liability as of the end of each succeeding year.  The payment patterns shown in this table demonstrate the "long-tail" nature of much of the Company's business, whereby portions of claims, principally in workers compensation coverages, do not fully pay out for more than ten years.
 
- 8 -

Historically, the Company's net loss developments have been favorable.  Reserve developments for all years ended in the period 1985 through 2011 have produced redundancies as of December 31, 2017, with deficiencies developing for periods from 2012 forward.  The $19.2 million deficiency developed through one year on the 2016 reserve position reflects action taken by management to respond to higher than expected adverse case development, as previously noted.  The deficiencies that have developed in the chart from 2012 through 2017 have been largely attributable to two main themes: (1) The Company engaged in new markets between 2008-2013 including professional liability and property coverages concentrated in the state of Florida.  These products (now discontinued) experienced significant adverse loss development in calendar years 2016 and 2017 as more information emerged and was therefore considered in the reserving process.  (2) The Company has experienced some infrequent but severe loss developments in its transportation offerings, a market that was also entered into during the 2008-2013 strategic period.  The Company is currently addressing the rate adequacy and customer segmentation practices of this product in response to the most recent adverse loss development.
Readers should note the table above does not present accident or policy year development data, which they may be more accustomed to analyzing.  Rather, this table is intended to present an evaluation of the Company's ability to establish its liability for losses and loss expenses at a given balance sheet date.  In reviewing this information, it is important to understand that this method of presentation causes some development experience to be duplicated.  For example, the amount of any redundancy or deficiency related to losses settled in 2010, but incurred in 2007, will be included in the cumulative development amount for each of the years ending December 31, 2007, 2008, and 2009.  It is also important to note that conditions and trends that have affected development of the liability in the past may not necessarily occur in the future.  Accordingly, it would not be appropriate to extrapolate future redundancies or deficiencies based on this table.
The table presented below presents loss development data on a gross (before consideration of reinsurance) basis for the same ten year period December 31, 2007 through December 31, 2016, as of December 31, 2017, with a reconciliation of the data to the net amounts shown in the table above.

ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS
 
(Dollars in thousands)
 
                                                                   
Year Ended December 31
 
2007
   
2008
   
2009
   
2010
   
2011
   
2012
   
2013
   
2014
   
2015
   
2016
   
2017
 
                                                                   
Direct and Assumed:
                                                                 
Liability for Unpaid Losses and Loss
                                                                 
  Adjustment Expenses
 
$
378,616
   
$
389,558
   
$
359,030
   
$
344,520
   
$
421,556
   
$
455,454
   
$
474,470
   
$
506,102
   
$
513,596
   
$
576,330
   
$
680,274
 
                                                                                         
Liability Reestimated as of
                                                                                       
  December 31, 2017
   
316,914
     
311,512
     
303,058
     
322,142
     
414,550
     
476,593
     
532,456
     
590,685
     
608,357
     
601,543
         
                                                                                         
Cumulative Redundancy (Deficiency)
 
$
61,702
   
$
78,046
   
$
55,972
   
$
22,378
   
$
7,006
   
$
(21,139
)
 
$
(57,986
)
 
$
(84,583
)
 
$
(94,761
)
 
$
(25,213
)
       
                                                                                         
                                                                                         
Ceded:
                                                                                       
Liability for Unpaid Losses and Loss
                                                                                       
  Adjustment Expenses
 
$
134,116
   
$
157,925
   
$
155,777
   
$
125,891
   
$
131,464
   
$
166,218
   
$
186,382
   
$
210,519
   
$
211,843
   
$
251,563
   
$
308,143
 
                                                                                         
Liability Reestimated as of
                                                                                       
  December 31, 2017
   
111,130
     
108,947
     
118,936
     
118,450
     
137,738
     
177,732
     
218,547
     
258,510
     
267,996
     
257,561
         
                                                                                         
Cumulative Redundancy (Deficiency)
 
$
22,986
   
$
48,978
   
$
36,841
   
$
7,441
   
$
(6,274
)
 
$
(11,514
)
 
$
(32,165
)
 
$
(47,991
)
 
$
(56,153
)
 
$
(5,998
)
       
                                                                                         
Net:
                                                                                       
Liability for Unpaid Losses and Loss
                                                                                       
  Adjustment Expenses
 
$
244,500
   
$
231,633
   
$
203,253
   
$
218,629
   
$
290,092
   
$
289,236
   
$
288,088
   
$
295,583
   
$
301,753
   
$
324,767
   
$
372,131
 
                                                                                         
Liability Reestimated as of
                                                                                       
  December 31, 2017
   
205,784
     
202,565
     
184,122
     
203,692
     
276,812
     
298,861
     
313,909
     
332,175
     
340,361
     
343,982
         
                                                                                         
Cumulative Redundancy (Deficiency)
 
$
38,716
   
$
29,068
   
$
19,131
   
$
14,937
   
$
13,280
   
$
(9,625
)
 
$
(25,821
)
 
$
(36,592
)
 
$
(38,608
)
 
$
(19,215
)
       

Readers are reminded the gross data presented above requires significantly more subjectivity in the estimation of IBNR and loss expense reserves because of the high limits provided by the Company to its fleet transportation and workers' compensation customers, some of which has been covered by excess of loss and facultative reinsurance.  This is particularly true of excess of loss treaties where the Company retains risk in only the lower, more predictable, layers of coverage.  Accordingly, one would generally expect more variability in development on a gross basis than on a net basis.  The Company's consolidated financial statements reflect our financial results net of reinsurance.

- 9 -

Environmental Matters:
Given that one of the Company's core businesses is insuring fleet transportation companies, on occasion claims involving a commercial automobile accident which has resulted in the spill of a pollutant are made.  Certain of the Company's policies may cover these situations on the basis that they were caused by an accident that resulted in the immediate and isolated spill of a pollutant.  These claims are typically reported, evaluated and fully resolved within a short period of time.
In general, establishing reserves for environmental claims, other than those associated with "sudden and accidental" losses, is subject to uncertainties that are greater than those represented by other types of claims.  Factors contributing to those uncertainties include a lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability.  Courts have reached different and sometimes inconsistent conclusions as to when the loss occurred and what policies provide coverage, what claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether cleanup costs represent insured property damage.
Very few environmental claims have historically been reported to the Company.  In addition, a review of the businesses of our past and current insureds indicates that exposure to claims of an environmental nature is limited because the vast majority of the Company's accounts are not currently, and have not in the past been, involved in the hauling of hazardous substances.  Also, the revision of the pollution exclusion in the Company's policies since 1986 has, and is expected to, further limit exposure to such claims from that point forward.
The Company does not expect to have any significant environmental claims relating to asbestos exposure.
The Company's reserves for unpaid losses and loss expenses at December 31, 2017 did not include significant amounts for liability related to environmental damage claims.  The Company does not foresee significant future exposure to environmental damage claims and accordingly has established no reserve for IBNR environmental losses at December 31, 2017.


Marketing

Historically, the Insurance Subsidiaries have primarily focused their fleet transportation marketing efforts on large and medium trucking fleets, with their biggest market share in larger trucking fleets (over 150 power units).  The largest of these fleets (over 250 power units) generally self-insure a significant portion of their risk, and self-insured retention plans are a specialty of the Company.  The indemnity contract provided to such customers is designed to cover all aspects of fleet transportation liability, including third party liability, property damage, physical damage and cargo, arising from vehicular accident or other casualty loss.  The self-insured program is supplemented with large deductible workers' compensation policies in states which do not allow for self-insurance of this coverage.  Fleets with fewer than 250 power units typically purchase full insurance coverage or retain deductibles on each claim.  The Company's fleet transportation offerings also include public livery risks, principally large and medium-sized operators of bus fleets and taxis, work-related accident insurance, on a group or individual basis, to independent contractors under contract to a fleet sponsor, as well as workers' compensation coverage to employees of independent contractor fleet owners.  Large fleet trucking products are marketed both directly to fleet transportation clients and also through relationships with non-affiliated brokers and specialized independent agents.
In addition, the Company offers a program of coverages for "small fleet" trucking concerns (owner-operators generally with one to six power units) and "medium fleet" trucking concerns (7-150 power units). Products for small and medium fleets, independent contractors, and non-trucking entities are marketed through relationships with non-affiliated brokers and specialized agents.
 
- 10 -

In some cases, the Company will provide specific product offerings to specialized markets through partnerships with brokers and program administrators.  As we grow, our distribution strategy has moved toward utilization of non-affiliated agents and brokers to place new business for small and intermediate fleet transportation (including independent contractor products) and non-transportation workers' compensation.  In addition, we have developed customized commercial auto liability and workers' compensation programs which are marketed through non-affiliated agent partners.   These customized programs can include a suite of products selected for our targeted customer base, including commercial auto liability, general liability, non-trucking liability, cargo, occupational accident, or workers' compensation coverages.
 
Investments
The Company's investment portfolio is notionally divided between (1) funds which are considered necessary to support insurance underwriting activities and (2) excess capital funds.  Management believes the funds invested in fixed maturity and short-term securities are more than sufficient to cover underwriting operations while equity securities and limited partnerships are utilized to invest excess capital funds to achieve higher long-term returns.  The following discussion will concentrate on the different investment strategies for these two major categories.
At December 31, 2017 the market value of the Company's consolidated investment portfolio was approximately $854.6 million, consisting of fixed maturities, equity securities, limited partnership and short-term and other investments and includes $59.2 million of short-term funds classified as cash equivalents.
A comparison of the allocation of assets within the Company's consolidated investment portfolio, using market value as a basis, is as follows as of December 31:

   
2017
   
2016
 
             
Fixed maturities:
           
   Agency collateralized mortgage obligations
   
1.9
%
   
0.8
%
   Agency mortgage-backed securities
   
3.2
     
0.6
 
   Asset-backed securities
   
5.1
     
6.0
 
   Bank loans
   
2.3
     
1.4
 
   Certificates of deposit
   
0.4
     
0.4
 
   Collateralized mortgage obligations
   
0.8
     
1.2
 
   Corporate securities
   
23.2
     
19.0
 
   Mortgage-backed securities
   
2.8
     
3.3
 
   Municipal obligations
   
11.3
     
17.3
 
   Non-U.S. government obligations
   
4.4
     
3.3
 
   U.S. government obligations
   
5.7
     
12.3
 
      Total fixed maturities
   
61.1
     
65.6
 
                 
Short-term
   
0.1
     
0.2
 
Cash equivalents
   
6.9
     
8.0
 
Total fixed maturities and short-term
   
68.1
     
73.8
 
                 
Limited partnerships (equity basis)
   
8.3
     
10.2
 
 
               
Equity securities:
               
   Consumer
   
5.5
     
4.3
 
   Energy
   
1.2
     
1.7
 
   Financial
   
5.3
     
4.2
 
   Industrial
   
3.0
     
2.8
 
   Technology
   
1.5
     
1.2
 
   Funds (e.g. mutual funds, closed end funds, ETFs)
   
5.9
     
0.9
 
   Other
   
1.2
     
0.9
 
      Total equity securities
   
23.6
     
16.0
 
     
100.0
%
   
100.0
%

 
- 11 -

Fixed Maturity and Short-Term Investments

Fixed maturity and short-term securities comprised 68.1% of the market value of the Company's consolidated investment portfolio of $854.6 million at December 31, 2017.  The fixed maturity portfolio is widely diversified with no concentrations in any single industry, geographic location or municipality.  The largest amount invested in any single issuer was $7.5 million (0.9% of the Company's consolidated investment portfolio).  The Company's fixed maturity portfolio has a short duration compared to the duration of its insurance liabilities and, accordingly, the Company does not actively trade fixed maturity securities but typically holds such investments until maturity.  Exceptions exist in instances where the underlying credit for a specific issue is deemed to be diminished.  In such cases, the security will be considered for disposal prior to maturity.  In addition, fixed maturity securities may be sold when realignment of the portfolio is considered beneficial (e.g., moving from taxable to non-taxable issues) or when valuations are considered excessive compared to alternative investments.

The following comparison of the Company's fixed maturity and short-term investment portfolios, using par value as a basis, shows the changes in contractual maturities in the portfolio during 2017.  Note that the expected average maturity of the portfolio is less than the contractual maturity average life shown below because the Company has, in some cases, the right to put obligations and borrowers have, in some cases, the right to call or prepay obligations with or without call or prepayment penalties.

   
2017
   
2016
 
Less than one year
   
19.5
%
   
27.7
%
1 to 5 years
   
53.4
     
52.7
 
5 to 10 years
   
13.0
     
9.7
 
More than 10 years
   
14.1
     
9.9
 
     
100.0
%
   
100.0
%
                 
Average contractual life of portfolio (years)
   
4.9
     
4.5
 

Approximately $71.9 million of our fixed maturity investments (8.4% of the Company's consolidated investment portfolio) consisted of non-rated bonds and bonds rated as less than investment grade by the National Association of Insurance Commissioners ("NAIC") at year end.  These investments included a diversified portfolio of over 40 issuances and had a $1.6 million aggregate net unrealized gain position at December 31, 2017.
The market value of the consolidated fixed maturity portfolio included $0.8 million of net unrealized gains at December 31, 2017 compared to $2.7 million of net unrealized losses at December 31, 2016.  The Company analyzes fixed maturity securities for other-than-temporary impairment ("OTTI") in accordance with the Financial Accounting Standards Board ("FASB") OTTI guidance.  As has been the Company's consistent policy, OTTI is considered for any individual issue which has sustained a decline in current market value of at least 20% below original or adjusted cost, and the decline is ongoing for more than six months, regardless of the evaluation of the creditworthiness of the issuer or the specific issue.  Additionally, the Company takes into account any known subjective information in evaluating for impairment without consideration of the Company's 20% threshold.  The current net unrealized gain on fixed maturity securities consists of $5.7 million of gross unrealized gains and $4.8 million of gross unrealized losses.  The gross unrealized losses equal approximately 0.9% of the cost of all fixed maturity securities.  See also "Critical Accounting Policies" in Part II, Item 7 of this Annual Report on Form 10-K for additional details of our investment valuation.

Equity Securities
Because of the large amount of high quality fixed maturity investments owned, relative to the Company's loss and loss expense reserves (net of reinsurance recoverables) and other liabilities, amounts invested in equity securities are not needed to fund current operations and, accordingly, can be committed for longer periods of time.  Equity securities comprised 23.6% of the market value of the Company's consolidated investment portfolio of $854.6 million at December 31, 2017.  The Company's equity securities portfolio consists of various securities with diversification from large to small capitalization issuers and among several industries.  The largest single equity issue owned had a market value of $6.8 million at December 31, 2017 (0.8% of the Company's consolidated investment portfolio).
 
- 12 -

The Company maintains a buy-and-hold philosophy with respect to equity securities.  Many current holdings have been continuously owned for more than ten years.  An individual equity security will be disposed of when it is determined by the Company's external investment managers or the Board of Director's Investment Committee that there is little potential for future appreciation.  All equity securities are considered to be available for sale, although portfolio turnover has historically been very low.  Securities are disposed of only when market conditions dictate, regardless of the impact, positively or negatively, on current period earnings.  In addition, equity securities may be sold when realignment of the portfolio is considered beneficial or when valuations are considered excessive compared to alternative investments.  Sales of equity securities during 2017 generated both gains and losses but netted to a realized gain of $8.1 million before taxes.
The Company's policy for OTTI is to impair equity securities where the current market value is at least 20% below original or adjusted cost and the decline was ongoing for more than six months at the date of write-down, regardless of the evaluation of the issuer or the potential for recovery.  Additionally, for any equity security where the decline has existed for a period of at least one year, the decline is treated as an other-than-temporary impairment, regardless of the percentage decline.  Further, the Company takes into account any known subjective information in evaluating for impairment without consideration of the Company's 20% threshold.  Net unrealized gains on the equity security portfolio were $71.0 million before taxes at December 31, 2017 compared to $55.0 million at December 31, 2016.  The current net unrealized gain consists of $73.2 million of gross unrealized gains and $2.2 million of gross unrealized losses.

Limited Partnerships
The Company invests in various limited partnerships engaged in long-short equities, private equity, country focused funds and real estate development as an alternative to direct equity investments.  The funds used for these investments are part of the Company's excess capital strategy.  At December 31, 2017, the aggregate carrying value was $70.8 million, comprising 8.3% of the market value of the Company's consolidated investment portfolio.
As a group, these investments increased in value during 2017, with the aggregate of the Company's share of such gains reported by the limited partnerships totaling approximately $12.5 million.
The Company follows the equity method of accounting for its limited partnership investments and, accordingly, records the total change in value as a component of net gains or losses on investments.  Readers are cautioned that reported increases in equity value can be subsequently reduced or eliminated quickly by volatile market conditions.  Limited partnerships also are highly illiquid investments, and the Company's ability to withdraw funds is generally subject to significant restrictions.

Investment Yields
Interest rates, particularly those on the short end of the yield curve where the vast majority of the Company's fixed maturity investments are maintained, remained at historically low levels during 2017.  Pre-tax net investment income increased $3.6 million, or 25%, during 2017, reflecting higher interest rates for shorter duration securities, increased dividends and increased invested assets from continuing positive cash flow from operations.  A comparison of consolidated investment yields, before consideration of investment management expenses, is as follows:

   
2017
   
2016
 
Before federal tax:
           
     Investment income
   
3.2
%
   
2.9
%
     Investment income plus investment gains
   
6.2
     
6.8
 
                 
After federal tax:
               
     Investment income
   
2.3
     
2.2
 
     Investment income plus investment gains
   
5.4
     
6.1
 

See also "Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K for additional details of our investment operations.
 
- 13 -

Regulatory Framework
The Insurance Subsidiaries are currently subject to insurance industry regulation by each of the jurisdictions in which they are licensed.  In addition, minor portions of the Insurance Subsidiaries' business are subject to regulation by Bermudian and Canadian federal and provincial authorities.  As an insurance holding company, B&L is also subject to oversight from the Indiana Department of Insurance.  There can be no assurance that laws and regulations will not be changed by one or more of these regulatory bodies in ways that will require the Company to modify its business models and objectives.  In particular, the United States federal government continuously reviews the regulation and supervision of financial institutions, including insurance companies, as well as tax laws and regulation, which could impact the Company's operations and performance.  The Company will also be impacted from changes to state and federal tax laws, including the U.S. Tax Cuts and Jobs Act of 2017 (the "U.S. Tax Act").
Additionally, changes in laws and regulations governing the insurance industry could have an impact on the Company's ability to generate historical levels of income from its insurance operations.  We are obligated to comply with numerous complex and varied governmental regulations in order to maintain its authority to write insurance business.  While the Company has continuously maintained each of its licenses without exception, failure to maintain compliance could result in governmental regulators temporarily preventing the Company from writing new business, thus having a detrimental effect on the Company.  Also, the ability of the Insurance Subsidiaries to modify insurance rates is heavily regulated for significant portions of our business, and such rate increases are often denied or delayed for substantial periods by regulators.
Investments made by the Company's domestic Insurance Subsidiaries are regulated by guidelines promulgated by the NAIC, which are designed to provide protection for both policyholders and shareholders.  The statutory capital of each of the Insurance Subsidiaries substantially exceeds the minimum risk- based capital requirements set by the NAIC.  State regulatory authorities prescribe calculations of the minimum amount of statutory capital and surplus necessary for each insurance company to remain authorized.  These computations are referred to as Risk Based Capital ("RBC") requirements and are based on a number of complex factors, taking into consideration the quality and nature of assets, the historical adequacy of recorded liabilities and the specific nature of business conducted.  At December 31, 2017, the minimum statutory capital and surplus requirements of the Insurance Subsidiaries was $104,913.  Actual consolidated statutory capital and surplus at December 31, 2017 exceeded this requirement by $316,750.

Employees
As of December 31, 2017, the Company had 528 employees, an increase of 73 employees from the prior year end.

Revenue Concentration
The Company derives a significant percentage of its direct premium volume from certain FedEx subsidiaries and operating companies ("FedEx"), and from insurance coverage provided to FedEx's contracted service providers.  FedEx represented approximately $18.5 million, $18.3 million and $17.8 million of the Company's consolidated gross premiums written in 2017, 2016 and 2015, respectively.  An additional $189.4 million, $202.2 million and $209.4 million in 2017, 2016 and 2015, respectively, was placed with the Company by a non-affiliated broker on behalf of contracted service providers of FedEx, but this additional business was not dependent upon the Company's direct business with FedEx.

Competition
Insurance underwriting is highly competitive.  The Insurance Subsidiaries compete with other stock and mutual companies and inter-insurance exchanges (reciprocals).  There are numerous insurance companies offering the lines of insurance which are currently written or may in the future be written by the Insurance Subsidiaries.  Many of these companies have been in business for longer periods of time, have significantly larger volumes of business, offer more diversified lines of insurance coverage and have significantly greater financial resources than the Company.  In many cases, competitors are willing to provide coverage for rates lower than those charged by the Insurance Subsidiaries.  Many potential clients self-insure workers' compensation and other risks for which the Company offers coverage, and some have organized "captive" insurance companies as subsidiaries through which they insure their own operations.  Some states have workers' compensation funds that preclude private companies from writing this business in those states.  Federal law also authorizes the creation of "Risk Retention Groups," which may write insurance coverages similar to those offered by the Company.
 
- 14 -

The Company believes it has a competitive advantage in its major lines of business as the result of its management and staff, its service and products, its willingness to custom build insurance programs for its customers, its centralized location with ready access to skilled employees, its extensive proprietary databases and the use of technology with respect to its insureds and independent agent force.  However, the Company is not "top-line" oriented and will readily sacrifice premium volume during periods of unrealistic rate competition.  Accordingly, should competitors determine to "buy" market share with unprofitable rates, the Insurance Subsidiaries will generally experience a decline in business until pricing returns to profitable levels.
Availability of Documents
The Company is an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is required, pursuant to Item 101 of Regulation S-K, to provide certain information regarding its website and the availability of certain documents filed with or furnished to the U.S. Securities and Exchange Commission (the "SEC"). The Company's Internet website is www.baldwinandlyons.com. The Company has included its Internet website address throughout this Annual Report on Form 10-K as a textual reference only. The information contained on, or accessible through, the Company's Internet website is not incorporated by reference into this Annual Report on Form 10-K.

The Company makes available, free of charge, by mail or through its Internet website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after it electronically files such material with or furnishes it to the SEC. The Company also includes on its Internet website its Code of Business Conduct and the charter of each standing committee of its Board of Directors (the "Board"). In addition, the Company intends to disclose on its Internet website any amendments to, or waivers from, its Code of Business Conduct that are required to be publicly disclosed pursuant to rules of the SEC and the Nasdaq Stock Market, LLC ("Nasdaq").

Shareholders may obtain, without charge, a copy of this Annual Report on Form 10-K, including the consolidated financial statements and schedules thereto, without the accompanying exhibits, upon written request to Baldwin & Lyons, Inc., 111 Congressional Boulevard, Carmel, Indiana 46032, Attention:  Investor Relations. A list of exhibits is included in this Annual Report on Form 10-K, and exhibits are available from the Company upon payment to the Company of the cost of furnishing the exhibits.
 

Item 1A.  RISK FACTORS

The following is a description of the risk factors that could cause the Company's actual results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time.  Such factors may have a material adverse effect on the Company's business, financial condition and results of operations, and you should carefully consider them before deciding to invest in, or retain, shares of the Company's common stock.  These risk factors do not identify all risks that the Company faces; its operations could also be affected by factors that are not presently known to the Company or that the Company currently considers to be immaterial to its operations. Due to risks and uncertainties, known and unknown, the Company's past financial results may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. 

- 15 -

We compete with a large number of companies in the insurance industry for underwriting revenues.
We compete with a large number of other companies in our selected lines of business. During periods of intense competition for premium, we are vulnerable to the actions of other companies who may seek to write business without what we believe to be an appropriate regard for ultimate profitability. During these times, it is very difficult to grow or maintain premium volume without sacrificing underwriting discipline and income.
Insurance underwriting is highly competitive.  We compete with other stock and mutual companies and inter-insurance exchanges (reciprocals).  There are numerous insurance companies offering the lines of insurance which are currently written or may in the future be written by us.  Many of these companies have been in business for longer periods of time, have significantly larger volumes of business, offer more diversified lines of insurance coverage and have significantly greater financial resources than us.  In many cases, competitors are willing to provide coverage for rates lower than those charged by us.  Many potential clients self-insure workers' compensation and other risks for which we offer coverage, and some have organized "captive" insurance companies as subsidiaries through which they insure their own operations.  Some states have workers' compensation funds that preclude private companies from writing this business in those states.  Federal law also authorizes the creation of "Risk Retention Groups," which may write insurance coverages similar to those offered by us.
We may incur increased costs in competing for underwriting revenues as we expand our business.  Increased costs associated with attracting and writing new clients may negatively impact underwriting revenue.  If we are unable to compete effectively, our underwriting revenues may decline, as well as our overall business results.
New competition could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our coverages at attractive rates and thereby adversely affect our underwriting results.

Changes in laws and regulations governing the insurance industry could have a negative impact on our ability to generate income from our insurance operations.
One or more of our Insurance Subsidiaries are regulated and/or licensed in all 50 of the United States, the District of Columbia, all Canadian provinces, Puerto Rico and Bermuda.  We are obligated to comply with numerous complex and varied governmental regulations in order to maintain our authority to write insurance business.  Failure to maintain compliance could result in governmental regulators preventing us from writing new business, which would have a material adverse impact on us, our results of operations and our financial condition.  Further, the ability for our Insurance Subsidiaries to adjust insurance rates and other product offerings is regulated for significant portions of our business and needed rate adjustments can be denied or delayed for substantial periods by regulators.

A material decline in our financial strength rating could adversely affect our position in the insurance market and cause a significant reduction in our premiums and earnings.
Our main insurance subsidiary, Protective, currently has a financial strength rating of "A+" (Superior) by A.M. Best.    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 with an expert independent opinion of an insurer's financial strength and ability to meet ongoing obligations, including paying claims.  This rating is subject to periodic review and may be revised downward, upward or revoked at the sole discretion of A.M. Best.  A downgrade in rating could result in the loss of a number of insurance contracts we write and in a substantial loss of business to other competitors, which would have a material adverse effect on our results of operations.

We have two classes of common stock with unequal voting rights and are effectively controlled by our principal shareholders and management, which limits other shareholders' ability to influence our operations.
Our principal shareholders, directors and executive officers and their affiliates control approximately 50% of the outstanding shares of voting Class A common stock and approximately 23% of the outstanding shares of non-voting Class B common stock.  These parties effectively control us, direct our affairs, and exert significant influence in the election of directors and approval of significant corporate transactions.  The interests of these shareholders may conflict with those of other shareholders, and this concentration of voting power may limit the marketability of our stock and has the potential to delay, defer or prevent a change in control that other shareholders may believe to be in their best interests.

- 16 -


We are subject to credit risk relating to our ability to recover amounts due from reinsurers.
We limit our risk of loss from policies of insurance issued by our Insurance Subsidiaries through the purchase of reinsurance coverage from other insurance companies.  Such reinsurance does not relieve us of our responsibility to policyholders should the reinsurers be unable to meet their obligations to us under the terms of the underlying reinsurance agreements.  While we have not experienced any significant reinsurance losses for over 25 years, in the past a small number of our less significant reinsurance carriers have experienced deteriorating financial conditions or have been downgraded by rating agencies, and provisions for potential uncollectible balances from these reinsurers have been established.  If we are unable to collect the amounts due to us from reinsurers, any unreserved credit losses could adversely affect our results of operations, equity, business and insurer financial strength rating.

We may incur additional losses if our loss reserves are inadequate.
A large portion of our provision for losses recorded is composed of estimates of future loss payments to be made.  Such estimates of future loss payments may prove to be inadequate.  Loss and loss expense reserves represent our best estimate at a given point in time but are not an exact calculation of ultimate liability.  Rather, they are complex estimates derived by utilizing a variety of reserve estimation techniques from numerous assumptions and expectations about future events, many of which are highly uncertain, such as estimates of claims severity, frequency of claims, inflation, claims handling, case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time of its ultimate settlement.  Many of these uncertainties are not precisely quantifiable and require significant judgment on our part.  As trends in underlying claims develop, particularly in so-called "long tail" lines where the adjudication of claims can take many years, management is sometimes required to revise reserves.  This results in a charge to our earnings in the amount of the adjusted reserves, recorded in the period the change in estimate is made.  These charges can be substantial and can potentially have a material impact, either positively or negatively, on results of operations and shareholders' equity.

The loss of our major customer could severely impact our revenue and earnings potential and A.M. Best rating.
We derive a significant percentage of our direct premium volume from certain FedEx subsidiaries and related entities, and from insurance coverage provided to FedEx's contracted service providers.  The loss of this major customer would likely materially adversely impact our revenue and earnings potential, as well as our A.M. Best rating.  Insurance programs provided to FedEx and programs provided to the contracted service providers are not necessarily dependent upon one another, and therefore can be viewed as separate entities.

Our collateral held may prove to be insufficient.
We require collateral from our large insureds covering the insureds' obligations for self-insured retentions or deductibles related to policies of insurance provided.  Should we, as surety, become responsible for such insured obligations, the collateral held may prove to be insufficient.  In this regard, FedEx utilizes significant self-insured retentions and deductibles under policies of insurance provided by us.  In the case of FedEx, we have determined that the financial strength of the customer is sufficient to allow for holding only partial collateral at this time.  Should we become responsible for this customer's entire self-insured retention and deductible obligations, the collateral held would be insufficient, and we would sustain a significant operating loss.

- 17 -


A material drop in interest rates, or disruption in the fixed income markets, could have an adverse impact on our earnings and, potentially, our financial position.
Our income from these investments could be materially reduced, which would reduce our results of operations, equity, business and insurer financial strength rating.  The functioning of the fixed income markets, the values of the investments we hold and our ability to liquidate them may be adversely affected if those markets are disrupted by a change in interest rates or otherwise affected by significant negative factors, including, without limitation: local, national, or international events, such as regulatory changes, wars, or terrorist attacks; a recession, depression, or other adverse developments in either the U.S. or other economies that adversely affects the value of securities held in our portfolio; financial weakness or failure of one or more financial institutions that play a prominent role in securities markets or act as a counterparty for various financial instruments, which could further disrupt the markets; inactive markets for specific kinds of securities, or for the securities of certain issuers or in certain sectors, which could result in decreased valuations and impact our ability to sell a specific security or a group of securities at a reasonable price when desired; a significant change in inflation expectations; or the onset of deflation or stagflation.

Our investment portfolio is subject to market and credit risks, which could affect our financial results and ability to conduct business.
We have a large portfolio of securities and limited partnership investments which can fluctuate in value with a wide variety of market conditions.  A decline in the aggregate value of the securities and limited partnership investments would result in a commensurate decline in our shareholders' equity, either through the income statement or directly to equity.  The resultant decline could, at least temporarily, materially adversely affect our results of operations, equity, business and insurer financial strength ratings.

Technological advances, including those specific to the transportation industry, could present us with added competitive risks.
An increase in accident prevention technologies and the growth of autonomous or partially autonomous vehicles could reduce the amount of accidents over time and shift the liability from the owner of the vehicle to the manufacturer, which would cause automobile insurance to become a smaller portion of our overall property and casualty insurance book of business.  Innovations in telematics and the increase in usage-based information have become more important and will likely change the way premiums are determined in the future.  These advances in technology could materially change the way products in the transportation industry are designed, priced and underwritten, and it will take time for us to adjust to these changes.

Our information technology systems and other operational systems may fail to operate properly or become disabled as a result of events or circumstances wholly or partly beyond our control.
We rely upon our information technology systems and other operational systems and on the integrity and timeliness of our data to run our businesses and service our customers.  These information technology and other systems could be subject to physical or electronic break-ins, unauthorized tampering or other cyber security breaches, resulting in a failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to customers, or in theft of intellectual property or proprietary information.  A failure to maintain proper security, confidentiality or privacy of sensitive data residing on such systems could delay or disrupt our ability to do business and service customers, harm our reputation, subject us to litigation, regulatory fines, a loss of customers and revenues or otherwise adversely affect our business.
Our operations rely upon complex and expensive information technology systems for interacting with policyholders, brokers and employers.  The pace at which information systems must be upgraded is continually increasing, requiring an ongoing commitment of significant resources to maintain or upgrade to current standards.  Our success may be impacted if we are not able to develop and expand the effectiveness of existing systems and to continue to enhance information systems that support our operations in a cost effective manner.

- 18 -


Disruptions or breaches of our information systems could adversely affect us.
Despite our implementation of network security measures, which have focused on prevention, mitigation, resilience, and recovery, our network and products may be vulnerable to cybersecurity attacks, computer viruses, break-ins and similar disruptions.  Cybersecurity attacks and intrusion efforts are continuous and evolving, and in certain cases they have been successful at the most robust institutions.  The scope and severity of risks that cyber threats present have increased dramatically, and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, exploiting weaknesses related to vendors or other third parties that could be exploited to attack our systems, denials of service, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data.  Any such event could have a material adverse effect on our business, operating results and financial condition, as we face regulatory, reputational and litigation risks resulting from potential cyber incidents, as well as the potential of incurring significant remediation costs.
Our daily business operations require us to retain sensitive data such as proprietary business information and data related to customers, claimants and business partners within our network infrastructure.  The loss or breach of such information could result in wide reaching negative impacts to our business, and as such, the ongoing maintenance and security of this information is pertinent to the success of our business operations and our strategic goals.
Our networking infrastructure and related assets may be subject to unauthorized access by hackers, employee errors, or other unforeseen activities that could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third party will exploit our critical assets such as proprietary business information and data related to our customers and business partners.  To the extent that such disruptions occur, our business operating results and financial condition could be materially and adversely affected resulting in a possible loss of business.

Changes in current accounting practices and future pronouncements may materially impact our reported financial results.
Developments in accounting practices may require us to incur considerable additional expenses to comply with such developments, particularly if we are required to prepare information relating to prior periods for comparative purposes or to apply the new requirements retroactively.  The impact of changes in current accounting practices and future pronouncements cannot be predicted but may affect the calculation of net income, net equity and other historical financial statement line items that are important to users of our financial statements.  Changes could also introduce significant volatility in our results of operations, equity, business and insurer financial strength rating.

We may be unable to attract and retain qualified employees.
We depend on our ability to attract and retain qualified executive officers, experienced underwriters, claims professionals and other skilled employees who are knowledgeable about our specialty lines of business. If we are unable to attract and retain such individuals, we may be unable to maintain our current competitive position in the specialty markets in which we operate and may be unable to achieve our growth strategy.

Future changes to U.S. tax laws, if adopted, could have an adverse effect on our business, financial condition, results of operations and cash flows.
The enactment of the U.S. Tax Act significantly reduced our income tax rate beginning in 2018.  However, from time to time legislation is proposed that would, if enacted, make significant changes to U.S. tax laws, including changes to U.S. corporate tax rates. Such proposed changes in U.S. tax laws, if adopted, or other similar changes that reduce or eliminate deductions currently available to us, could adversely affect our business, financial condition, results of operations and cash flows.  The IRS has not yet published all of the detailed regulations resulting from the enactment of the U.S. Tax Act; therefore, we have not completed our accounting for the tax effects, but we have made a reasonable estimate of the effects on our existing deferred tax balances at December 31, 2017.  We re-measured deferred tax assets and liabilities based on the rates at which they are expected to be utilized in the future, which is generally 21%.  However, we are still analyzing certain aspects of the U.S. Tax Act and refining our calculations, which could potentially affect the measurement of those balances or give rise to new deferred tax amounts.
 
- 19 -

Item 1B.  UNRESOLVED STAFF COMMENTS

None.

Item 2.  PROPERTIES

The Company owns its home office building and the adjacent real estate in Carmel, Indiana, approximately 14 miles from downtown Indianapolis.  The home office building contains a total of 181,000 usable square feet, and the Company currently occupies approximately 72% of this space, with the remainder being leased to non-affiliated entities on short-term leases expiring through 2023.

The Company also owns a building and the adjacent real estate in Indianapolis, approximately nine miles from its main office in Carmel.  The building contains approximately 15,000 square feet of usable space, and is used primarily for off-site data storage and as a contingent back up and disaster recovery site.

The Company's entire operations are conducted from these two facilities.  The current facilities are expected to be adequate for the Company's operations for the near future.

Item 3.  LEGAL PROCEEDINGS

In the ordinary, regular and routine course of their business, the Company and its Insurance Subsidiaries are frequently involved in various matters of litigation relating principally to claims for insurance coverage provided.  No currently pending matter is deemed by management to be material to the Company or outside the ordinary course of business.

Item 4. MINE SAFETY DISCLOSURES

Not applicable.


- 20 -


PART II


Item 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES


The Company's Class A and Class B common stocks are traded on Nasdaq under the symbols BWINA and BWINB, respectively.  The Class A and Class B common shares have identical rights and privileges, except that Class B shares have no voting rights other than on matters for which Indiana law requires class voting. As of February 28, 2018 there were approximately 400 record holders of Class A Common Stock and approximately 1,000 record holders of Class B Common Stock.
The table below sets forth the range of high and low sale prices for the Class A and Class B Common Stock for 2017 and 2016, as reported by Nasdaq and published in the financial press, as well as the cash dividends paid by the Company.


                           
Cash
 
   
Class A
   
Class B
   
Dividends
 
   
High
   
Low
   
High
   
Low
   
Declared
 
                               
2017:
                             
Fourth Quarter
 
$
24.36
   
$
21.95
   
$
24.70
   
$
22.30
   
$
.27
 
Third Quarter
   
23.85
     
21.41
     
24.90
     
21.20
     
.27
 
Second Quarter
   
26.95
     
23.15
     
25.40
     
23.45
     
.27
 
First Quarter
   
26.04
     
22.73
     
25.45
     
22.60
     
.27
 
                                         
2016:
                                       
Fourth Quarter
   
26.10
     
23.21
     
27.70
     
23.45
     
.26
 
Third Quarter
   
26.50
     
23.04
     
27.25
     
24.43
     
.26
 
Second Quarter
   
24.90
     
22.50
     
25.28
     
23.33
     
.26
 
First Quarter
   
24.02
     
22.00
     
25.10
     
22.11
     
.26
 


The Company has paid quarterly cash dividends continuously since 1974.  The current regular quarterly dividend rate of $.27 per share, effective February 2017, was increased to $.28 per share, effective February 2018.  The Company expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions and are subject to regulatory restrictions.  At December 31, 2017, $104.9 million, or 25.1% of shareholders' equity, represented net assets of the Company's Insurance Subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements.  However, management believes that these restrictions do not currently pose any material dividend payment concerns for the Company.  The Board intends to address the subject of dividends at each of its future meetings and will consider the Company's earnings, returns on investments and its capital needs.

On August 31, 2017, the Company's Board of Directors authorized the reinstatement of its share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B common stock.  The Company may amend, suspend or discontinue the share repurchase program at any time.

- 21 -


Corporate Performance
The following graph shows a five year comparison of cumulative total return for the Company's Class B common shares, the Russell 2000 Index and the Company's peer group as determined by management (the "BWINB Peer Group").  The basis of comparison is a $100 investment at December 31, 2012, in each of (i) Baldwin & Lyons, Inc., (ii) the Russell 2000 Index and (iii) the BWINB Peer Group.  All dividends are assumed to be reinvested.




         
Period Ending
       
Index
 
12/31/12
   
12/31/13
   
12/31/14
   
12/31/15
   
12/31/16
   
12/31/17
 
Baldwin & Lyons, Inc.
   
100.00
     
119.26
     
117.09
     
113.91
     
124.49
     
123.93
 
Russell 2000 Index
   
100.00
     
138.82
     
145.62
     
139.19
     
168.85
     
193.58
 
Peer Group
   
100.00
     
160.92
     
167.94
     
182.04
     
219.76
     
238.34
 



Baldwin & Lyons, Inc. Peer Group
     
Amerisafe, Inc.
 
Heritage Insurance Holdings, Inc.
Atlas Financial Holdings, Inc.
 
James River Group Holdings, Ltd.
Donegal Group Inc.
 
NMI Holdings, Inc.
EMC Insurance Group Inc.
 
Safety Insurance Group, Inc.
Employers Holdings, Inc.
 
United Insurance Holdings Corp.
Federated National Holding Company
 
Universal Insurance Holdings, Inc.
HCI Group, Inc.
   
Hallmark Financial Services, Inc.
   



- 22 -

 
Item 6.  SELECTED FINANCIAL DATA

The table below provides selected consolidated financial data of the Company.   The information has been derived from our consolidated financial statements for each of the years in the five year period ended December 31, 2017.  You should read this selected consolidated financial data in conjunction with the audited consolidated financial statements and notes as of and for the year ended December 31, 2017 included in Part II, Item 8 "Financial Statements and Supplementary Data", and Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Annual Report on Form 10-K.


   
Year Ended December 31
 
   
2017
   
2016
   
2015
   
2014
   
2013
 
   
(Dollars in thousands, except per share data)
 
                               
Gross premiums written
 
$
504,737
   
$
403,004
   
$
383,553
   
$
382,388
   
$
369,476
 
                                         
Net premiums earned
   
328,145
     
276,011
     
263,335
     
261,627
     
252,743
 
                                         
Net investment income
   
18,095
     
14,483
     
12,498
     
9,055
     
8,770
 
                                         
Net realized gains (losses) on investments
   
19,686
     
23,228
     
(1,261
)
   
14,930
     
23,515
 
                                         
Losses and loss expenses incurred
   
247,518
     
186,481
     
155,750
     
159,596
     
150,701
 
                                         
Net income
   
18,323
     
28,945
     
23,283
     
29,717
     
36,588
 
                                         
Earnings per share -- net income 1
   
1.21
     
1.92
     
1.55
     
1.98
     
2.45
 
                                         
Cash dividends per share
   
1.08
     
1.04
     
1.00
     
1.00
     
1.00
 
                                         
Investment portfolio 2
   
854,595
     
749,501
     
729,877
     
757,421
     
703,259
 
 
                                       
Total assets
   
1,357,016
     
1,154,137
     
1,085,771
     
1,144,247
     
1,072,270
 
                                         
Shareholders' equity
   
418,811
     
404,345
     
394,498
     
399,496
     
381,724
 
                                         
Book value per share 1
   
27.83
     
26.81
     
26.25
     
26.67
     
25.57
 


1   Earnings and book value per share are adjusted for the dilutive effect of restricted stock outstanding.
2   Includes money market instruments classified as cash equivalents in the Consolidated Balance Sheets.



- 23 -

 

Item 7.                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The Company specializes in marketing and underwriting property, liability and workers compensation coverage for trucking and public transportation fleets, as well as coverage for trucking industry independent contractors.  In addition, B&L offers workers' compensation coverage for a variety of operations outside the transportation industry.  The Company operates as one reportable property and casualty insurance segment, offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.

The Company determined that its business constituted one reportable property and casualty insurance segment as of January 1, 2017.  During 2016 and prior years, the Company had two reportable segments – property and casualty insurance and reinsurance.  The Company moved to a single reportable segment based on how its operating results are regularly reviewed by the Company's chief operating decision maker when making decisions about how resources are to be allocated to the segment and assessing its performance.  The prior year segment information throughout this Annual Report on Form 10-K was updated to conform to the current year presentation.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act of 2017 (the "U.S. Tax Act") was signed into law. The U.S. Tax Act lowered the U.S. corporate income rate from 35% to 21% effective January 1, 2018.  GAAP requires the impact of tax legislation to be recognized in the period in which the law was enacted. As a result of the U.S. Tax Act, the Company recorded a tax benefit of $9.6 million related to the re-measurement of its deferred tax assets and liabilities during the fourth quarter of 2017.

Liquidity and Capital Resources
The primary sources of the Company's liquidity are (1) funds generated from insurance operations, including net investment income, (2) proceeds from the sale of investments and (3) proceeds from maturing investments.

The Company generally experiences positive cash flow from operations.  Premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims.  Operating costs of the Company's Insurance Subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, generally average less than one-third of net premiums earned on a consolidated basis and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided and the timing of the claim payments. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, become negative as loss settlements on claim reserves established in prior years exceed current revenues.  The Company's cash flow relating to premiums is significantly affected by reinsurance programs in effect from time-to-time, whereby the Company cedes both premium and risk to other insurance and reinsurance companies.  These programs vary significantly among products and certain contracts call for reinsurance payment patterns, which do not coincide with the collection of premiums by the Company from its insureds.

On August 31, 2017, the Company's Board of Directors authorized the reinstatement of its share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B common stock.  The repurchases may be made in the open market or through privately negotiated transactions, from time-to-time, and in accordance with applicable laws, rules and regulations. On September 21, 2017, the Company entered into a stock repurchase plan for the purpose of repurchasing up to $17.5 million of shares of its common stock, at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Exchange Act (the "Rule 10b5-1 Plan"). The Rule 10b5-1 Plan was established pursuant to, and as part of, the Company's share repurchase program and permitted shares to be repurchased in accordance with pre-determined criteria when repurchases would otherwise be prohibited, such as during self-imposed blackout periods, or under insider trading laws. The Rule 10b5-1 Plan expired on March 5, 2018. The Company's share repurchase program may be amended, suspended or discontinued at any time and does not commit the Company to repurchase any shares of its common stock. The Company has funded, and intends to continue to fund, the share repurchase program from cash on hand. The actual number and value of the shares to be purchased will depend on the performance of the Company's stock price, market volume and other market conditions.  For the year ended December 31, 2017, the Company paid $1.9 million to repurchase 84,960 shares of its Class B common stock under its share repurchase program.

- 24 -

For several years, the Company's investment philosophy has emphasized the purchase of shorter-duration bonds.  As flat yield curves have not provided an incentive to lengthen maturities in recent years, the Company has continued to maintain its fixed maturity portfolio at short-term levels.  The average contractual life of the Company's fixed maturity and short-term investment portfolio increased slightly to 4.9 years during 2017 from 4.5 years during 2016.  The average duration of the Company's fixed maturity portfolio remains much shorter than both the contractual maturity average and the duration of the Company's liabilities.  Our investments in the equity markets reflect a conservative, value driven approach, which has been implemented through partnerships, advisors and the Investment Committee.  The long-term horizon for the Company's equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus.  Investments made by the Company's domestic Insurance Subsidiaries are regulated by guidelines promulgated by the NAIC, which are designed to provide protection for both policyholders and shareholders.

Net cash flows from operations increased $61.3 million to $93.7 million for full year 2017 from $32.4 million in 2016.  The increase in operating cash flow was primarily related to higher premium volume in 2017.  Net cash flows from operations decreased $5.8 million to $32.4 million for full year 2016 compared to $38.2 million in 2015.  The decrease in operating cash flow resulted mainly from increased loss and loss adjustment expenses in 2016.

Net cash used in investing activities increased $47.0 million to $74.3 million for full year 2017, as compared to 2016.  The increase in cash used in investing activities was the result of the normal timing of purchases and sales and maturities in our investment portfolio, partially offset by higher distributions from limited partnership investments and proceeds from maturities in 2017. Net cash used in investing activities increased $14.5 million to $27.4 million for full year 2016 compared to $12.8 million in 2015.  The increase in cash used in investing activities was also the result of the normal timing of purchases and sales and maturities in our investment portfolio.

Net cash used in financing activities for full year 2017 consisted of regular cash dividend payments to shareholders of $16.3 million ($1.08 per share) and $1.9 million to repurchase 84,960 shares of the Company's Class B common stock.  Financing activities for full year 2016 and 2015 consisted solely of the regular cash dividend payments to shareholders of $15.8 million ($1.04 per share) and $15.0 million ($1.00 per share), respectively.

The Company's assets at December 31, 2017 included $59.2 million of investments included within cash and cash equivalents on the consolidated balance sheet that are readily convertible to cash without market penalty and an additional $54.6 million of fixed maturity investments maturing in less than one year.  The Company believes that these liquid investments, plus the expected cash flow from premium collections, are more than sufficient to provide for projected claim payments and operating cost demands.  In the event competitive conditions produce inadequate premium rates and the Company chooses to further restrict volume, the liquidity of its investment portfolio would permit management to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time.  In addition, the Company's reinsurance program is structured to avoid significant cash outlays that accompany large losses.

The Company maintains a revolving line of credit with a $40.0 million limit and an expiration date of September 23, 2018.  Interest on this line of credit is referenced to LIBOR and can be fixed for periods of up to one year at the Company's option.  Outstanding drawings on this line of credit were $20.0 million as of December 31, 2017 and December 31, 2016.  At December 31, 2017, the effective interest rate was 2.65%.  The Company had $20.0 million remaining unused under the line of credit at December 31, 2017.  The Company's revolving line of credit has three financial covenants, each of which were met as of December 31, 2017.  The three financial covenants relate to a minimum GAAP net worth, a minimum statutory surplus and a minimum A.M. Best rating.

Net premiums written by the Company's Insurance Subsidiaries for 2017 equaled approximately 84% of the combined statutory surplus of these subsidiaries, a level consistent with higher premiums written.  Premium writings of up to 100% and in some cases up to 200% of surplus are generally considered acceptable by regulatory authorities.  Further, the statutory capital of each of the Insurance Subsidiaries substantially exceeded minimum risk based capital requirements set by the NAIC as of December 31, 2017.  Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.

- 25 -


At December 31, 2017, $104.9 million, or 25.1% of shareholders' equity, represented net assets of the Company's Insurance Subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements.  At December 31, 2017, $59.1 million may be transferred by dividend or loan to the parent company without approval by, or prior notification to, regulatory authorities.  An additional $256.4 million of shareholders' equity of the Insurance Subsidiaries could be advanced or loaned to the parent company with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical.  The Company believes that these restrictions do not currently pose any material liquidity concerns to the Company.  We expect financial strength and stability of the Insurance Subsidiaries to permit access by the parent company to short-term and long-term sources of credit when needed.  The parent company had cash and marketable securities valued at $26.5 million at December 31, 2017.


Results of Operations

2017 Compared to 2016

Gross premiums written for 2017 totaled $504.7 million, an increase of $101.7 million (25.2%) from 2016. Net premiums earned totaled $328.1 million for 2017 compared to $276.0 million for 2016, an increase of $52.1 million (18.9%).  The increase in net premiums earned was primarily due to an increase of $60.8 million in net premiums earned related to commercial automobile products and $3.7 million higher net premiums earned related to workers' compensation products, which were consistent with the Company's growth strategy. These increases were partially offset by $8.1 million of lower premiums generated by reinsurance products, reflective of management's decision to completely withdraw from the property catastrophe reinsurance market, and a decrease of $3.9 million in premiums earned from personal automobile products. The difference in the percentage change for premiums written compared to earned is reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.

Premiums ceded to reinsurers averaged 30.0% of gross premiums written for 2017, compared to 32.6% for 2016. The percentage of premiums ceded to reinsurance decreased as a result of changes in the Company's reinsurance structure.  The change in net premiums earned, compared to growth in gross premiums written, was a function of premium adjustment provisions in the Company's historical commercial automobile reinsurance treaties.  This historical reinsurance structure, which was revised in the latest reinsurance renewal, causes an adjustment for ceded premiums when the ultimate loss estimate changes for a reinsurance treaty year.

Pre-tax investment income of $18.1 million during 2017 was 24.9% higher than 2016 primarily due to higher interest rates leading to higher reinvestment yields for core fixed income securities, increased dividends from equity securities and an increase in average funds invested resulting from positive cash flow.  After-tax investment income of $12.7 million increased 23.0% during 2017 compared to the prior year reflecting the above factors, as well as the mix between taxable and tax-exempt investment income.

Net gains on investments, before taxes, totaled $19.7 million in 2017 compared to $23.2 million during 2016.  Direct trading gains during 2017 were $8.2 million lower compared to the prior year. Other-than-temporary impairments of $0.4 million, netted with gains of $1.6 million on previously impaired available-for-sale securities that were sold in 2017, are included in the net gains stated above. Investments in limited partnerships produced gains of $12.5 million in 2017, compared to gains of $2.5 million during the prior year.  Limited partnership investments utilized by the Company are primarily engaged in long-short equities, private equity, country focused funds and real estate development as an alternative to direct equity investments.  The aggregate of the Company's share of gains and losses in these entities represented a 16.3% appreciation in value for 2017, compared to a 3.3% increase in value for 2016.

Losses and loss expenses incurred during 2017 increased $61.0 million (32.7%) from 2016 to $247.5 million, due primarily to adverse prior accident year development and growth in net premiums earned.  The 2017 consolidated loss and loss expense ratio was 75.4%, compared to 67.6% for 2016.  The Company's loss and loss expense ratios for major product lines are summarized in the following table:

   
2017
   
2016
 
Fleet transportation
   
73.9
%
   
63.4
%
All other
   
94.0
     
95.5
 
All lines
   
75.4
     
67.6
 

 
- 26 -

The higher loss ratio for fleet transportation during 2017 was the result of adverse loss development in the Company's commercial auto related liability coverages from prior accident years.  The prior year reserve deficiency in 2017 increased the 2017 calendar loss ratio by 5.9 percentage points compared to a 5.0 percentage point increase experienced in 2016 due to the prior year reserve deficiencies in 2016.
The Company had an overall reserve deficiency on prior year claims during 2017 of $19.2 million.  This net deficiency is included in the computation of loss ratios shown in the previous table, as is the $13.8 million deficiency for 2016 on prior year claims. Because of the high limits provided by the Company to its fleet transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process.  Changes in both gross premium volumes and the Company's reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent year to year.

Other operating expenses for 2017 increased $24.1 million (27.0%) to $113.6 million from $89.5 million in 2016.  This increase was due primarily to an increase in commission expense as a result of the increase in premiums written and higher salary and salary related expenses, reflective of the Company's increased workforce in response to the continued expansion of the Company's products and services.   Reinsurance ceded credits, included as an offset to other operating expenses, were 30.8% lower in 2017, resulting primarily from ceding a lower percentage of workers' compensation premium to reinsurers in our most recent reinsurance treaty.

Income tax benefit was $8.2 million for full year 2017 compared to income tax expense of $14.1 million in 2016.  The Company recorded a benefit of $9.6 million related to the re-measurement of deferred tax assets and liabilities in the fourth quarter of 2017 pursuant to the U.S. Tax Act.  The Company's effective federal tax rate for 2017 was (81.0%) as compared to 32.8% in 2016.  The effective tax rate for 2017 was affected primarily by the impact of the U.S. Tax Act discussed above.

Net income for 2017 decreased $10.6 million to $18.3 million compared to $28.9 million in 2016, with the decrease primarily attributable to the reserve strengthening that occurred during 2017, partially offset by the income tax benefit described above.  Diluted earnings per share of $1.21 were recorded in 2017 compared to diluted earnings per share of $1.92 in 2016.


 2016 Compared to 2015

Gross premiums written for 2016 totaled $403.0 million, an increase of $19.5 million (5.1%) from 2015. Net premiums earned totaled $276.0 million for 2016 compared to $263.3 million for 2015, an increase of $12.7 million (4.8%).  The increase in premiums earned reflected higher premiums from fleet transportation products of $28.1 million as a result of the addition of several new accounts during 2016, rate increases and higher miles driven by our insureds, which was immediately reflected in premiums earned.  These increases were partially offset by $9.7 million of lower premiums generated by property reinsurance products reflective of management's decision to completely withdraw from the property catastrophe reinsurance market and a decrease of $6.6 million in premiums earned by primary professional liability and personal automobile, which reflected the Company's strategic initiatives of reducing exposures in these products.
Premiums ceded to reinsurers averaged 32.6% of gross written premiums for 2016, compared to 33.6% for 2015, with the variation attributable to a fluctuation in the mix of business as well as reinsurance treaty changes.

Pre-tax investment income of $14.5 million during 2016 was 16% higher than 2015, reflecting an increased allocation to higher-yielding bonds and increases in average invested assets.  After tax investment income increased by 15% during 2016 compared to the prior year reflecting the mix between taxable and tax-exempt investment income.
 
- 27 -

Net gains on investments, before taxes, totaled $23.2 million in 2016 compared to net pre-tax losses on investments of $1.3 million during 2015.  The 2016 results were heavily influenced by direct trading results, with gains of $13.3 million in 2016 compared to direct trading gains of $4.5 million in 2015.  In addition, our investments in limited partnerships produced gains (appreciation) of $2.5 million in 2016, compared to losses (depreciation) of $1.7 million during the prior year.  Limited partnership investments utilized by the Company are primarily engaged in long-short equities, private equity, country focused funds and real estate development as an alternative to direct equity investments.  The aggregate of the Company's share of gains and losses in these entities represented a 3.3% appreciation in value for 2016, compared to a 2% decrease in value for 2015.  Other-than-temporary impairments of $5.7 million, netted with gains of $12.3 million on previously impaired available-for-sale securities that were sold in 2016, are included in the net gains stated above.
Losses and loss expenses incurred during 2016 increased $30.7 million (19.7%) from 2015 to $186.5 million, due primarily to prior accident year development and growth in net premiums earned.  The 2016 consolidated loss and loss expense ratio was 67.6%, compared to 59.2% for 2015.  The Company's loss and loss expense ratios for major product lines are summarized in the following table:

   
2016
   
2015
 
Fleet transportation
   
63.4
%
   
55.7
%
All other
   
95.5
     
96.4
 
All lines
   
67.6
     
59.2
 

The higher loss ratio for fleet transportation during 2016 was the result of less favorable development related to prior accident year losses.  The prior year reserve deficiency in 2016 increased the 2016 calendar year fleet transportation loss ratio by 5.0 percentage points compared to a 4.3 percentage point decrease experienced in 2015 due to the prior year reserve savings in 2015.
The Company had an overall reserve deficiency on prior year claims during 2016 of $13.8 million.  This net deficiency is included in the computation of loss ratios shown in the previous table, as is the $10.1 million savings for 2015 on prior year claims.  Because of the high limits provided by the Company to its fleet transportation insureds, the length of time necessary to settle larger, more complex claims and the volatility of the fleet transportation liability insurance business, the Company believes it is important to take a conservative posture in its reserving process.  Changes in both gross premium volumes and the Company's reinsurance structure for its fleet transportation business can have a significant impact on future loss developments and, as a result, loss and loss expense ratios and prior year reserve development may not be consistent from year to year.

Other operating expenses for 2016, before credits for ceding allowances from reinsurers, increased $3.4 million (3%) to $123.0 million, generally in line with increases in premium written.  This increase was primarily due to an increase in salary and salary related expenses, reflective of the Company's increased workforce in response to the continued expansion of the Company's products and services.   Reinsurance ceded credits were 16% higher in 2016, resulting primarily from favorable changes to the terms of certain reinsurance treaties.  After consideration of these expense offsets, operating expenses decreased $1.1 million, or 1%, from the prior year.

The effective federal tax rate on the consolidated pre-tax income for 2016 was 32.8% as compared to 31.4% in 2015.  The effective rate differs from the normal statutory rate primarily as a result of tax-exempt investment income.

Net income for 2016 increased $5.6 million to $28.9 million with the increase primarily attributable to realized investment gains.  Diluted earnings per share of $1.92 were recorded in 2016 compared to diluted earnings per share of $1.55 in 2015.
 
- 28 -


Critical Accounting Policies
The Company's significant accounting policies which are material and/or subject to significant degrees of judgment are highlighted below.
Investment Valuation
All marketable securities are included in the Company's balance sheets at current fair market value.

Approximately 64% of the Company's assets are composed of investments at December 31, 2017.  Approximately 92% of these investments are publicly-traded, owned directly and have readily-ascertainable market values.  The remaining 8% of investments are composed primarily of minority interests in several limited partnerships.  These limited partnerships are engaged in long-short equities, private equity, country focused funds and real estate development as an alternative to direct equity investments.  These partnerships, themselves, do not have readily-determinable market values.  Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the partnerships.  While a substantial portion of the underlying assets are publicly-traded securities, those which are not publically-traded have been valued by the respective partnerships using their experience and judgment.

Under FASB guidance, if a fixed maturity security is in an unrealized loss position and the Company has the intent to sell the security, or it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to net realized losses on investments in the consolidated statements of income.  For impaired fixed maturity securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in net realized losses on investments in the consolidated statements of income and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity (accumulated other comprehensive income).

In determining if and when an equity security's decline in market value below cost is other-than-temporary, we first make an objective analysis of each individual equity security where current market value is less than cost.  For any equity security where the unrealized loss exceeds 20% of original or adjusted cost and, where that decline has existed for a period of at least six months, the decline is treated as an other-than-temporary impairment, without any subjective evaluation as to possible future recovery.  For individual issues where the decline in value is less than 20% but the amount of the decline is considered significant, we will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other-than-temporary.  In those instances, the Company also considers its intent and ability to hold equity investments until recovery can be reasonably expected.  Additionally, for any equity security where the decline has existed for a period of at least one year, the decline is treated as an other-than-temporary impairment.  For any decline which is considered to be other-than-temporary, we recognize an impairment loss in the current period earnings as an investment loss.  Declines which are considered to be temporary are recorded as a reduction in shareholders' equity, net of related federal income tax benefits.

It is important to note that all available for sale securities included in the Company's financial statements are valued at current fair market values.  The evaluation process for determination of other-than-temporary decline in value of investments, as described above, does not change these valuations but, rather, determines when a decline in value will be recognized in the income statement (other-than-temporary decline) as opposed to a charge to shareholders' equity (temporary decline).  This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors, which relate to an industry in general, but not necessarily to an individual issue.  The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process as described above.  However, to the extent that certain declines in value are reported as unrealized at December 31, 2017, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost.  At December 31, 2017, the total gross unrealized loss included in the Company's investment portfolio was approximately $7.1 million.  No individual issue constituted a material amount of this total.  Had this entire amount been considered other-than-temporary at December 31, 2017, there would have been no impact on total shareholders' equity or book value since the decline in value of these securities was previously recognized as a reduction to shareholders' equity.


- 29 -

Reinsurance Recoverable
Reinsurance ceded transactions were as follows for the years ended December 31 (dollars in thousands):
   
2017
   
2016
   
2015
 
Reinsurance recoverable
 
$
318,331
   
$
255,024
   
$
215,888
 
Premium ceded (reduction to premium earned)
   
145,201
     
130,012
     
128,697
 
Losses ceded (reduction to losses incurred)
   
128,086
     
108,656
     
75,581
 
Reinsurance ceded credits (reduction to operating expenses)
   
23,187
     
33,512
     
28,956
 

A discussion of the Company's reinsurance strategies is presented in Part I, Item 1, "Business", of this Annual Report on Form 10-K.

Amounts recoverable under the terms of reinsurance contracts comprised approximately 24% of total Company assets as of December 31, 2017.  In order to be able to provide the high limits required by the Company's insureds, the Company shares a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts.  Some reinsurance contracts provide that a loss be shared among the Company and its reinsurers on a predetermined pro-rata basis ("quota-share"), while other contracts provide that the Company keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount ("excess of loss").  Some risks are covered by a combination of quota-share and excess of loss contracts.  The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below.  Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers.  Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company.  Further, the high limits provided by certain of the Company's insurance policies for fleet transportation liability, workers' compensation and professional liability risks provide more variability in the estimation process than lines of business with lower coverage limits.

It should be noted, however, that a change in the estimate of amounts due from reinsurers on unpaid claims will not, in itself, result in charges or credits to losses incurred.  This is because any change in estimated recovery follows the estimate of the underlying loss.  Thus, it is the computation of the gross underlying loss that is critical.

As with any receivable, credit risk exists in the recoverability of reinsurance.  This may be even more pronounced than in normal receivable situations since recoverable amounts are not generally due until the loss is settled which, in some cases, may be many years after the contract was written.  If a reinsurer is unable, in the future, to meet its financial commitments under the terms of the contracts, the Company would be responsible to satisfy the reinsurer's portion of the loss.  The financial condition of each of the Company's reinsurers is vetted upon the execution of a given treaty and only reinsurers with superior credit ratings are utilized.  However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period.  Reviews of the current financial strength of each reinsurer are made frequently and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company's additional liability.  Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit loss rather than a deficiency associated with the loss reserving process.


- 30 -


Loss and Loss Expense Reserves
The Company's reserves for losses and loss expenses ("reserves") are determined based on complex estimation processes using historical experience, current economic information and available industry statistics.  The Company's claims range from routine "fender benders" to the highly complex and costly third party bodily injury claims involving large tractor-trailer rigs.  Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment.  The high limits provided in many of the Company's policies provide for greater volatility in the reserving process for more serious claims.  Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims.  The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time.  Changes to previously established reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined.  See Note C to the consolidated financial statements for additional information relating to loss and loss expense reserve development.
The Company's methods for determining loss and loss expense reserves are essentially identical for interim and annual reporting periods.
A detailed analysis and discussion for each of the above basic reserve categories follows:
Reserves for known losses (Case reserves)
Each known claim, regardless of complexity, is handled by a claims adjuster experienced with claims of this nature and a "case" reserve, appropriate for the individual loss occurrence, is established.  For routine "short-tail" claims, such as physical damage, the Company records an initial reserve that is based upon historical loss settlements adjusted for current trends.  As information regarding the loss occurrence is gathered in the claim handling process, the initial reserve is adjusted to reflect the anticipated ultimate cost to settle the claim.  For more complex claims, which can tend toward being "long-tail" in nature, an experienced claims adjuster will review the facts and circumstances surrounding the loss occurrence to make a determination of the reserve to be established.  Many of the more complex claims involve litigation and necessitate an evaluation of potential jury awards, in addition to the factual information, to determine the value of each claim.  Each claim is frequently monitored and the recorded reserve is increased or decreased relative to information gathered during the settlement life cycle.
Reserves for IBNR losses
The Company uses both standard actuarial techniques common to most insurance companies as well as proprietary techniques developed by the Company in connection with its specialty business products.  For its short-tail lines of business, the Company uses predominantly the incurred or paid loss development factor methods.  The Company has found that the use of accident quarter loss development triangles, rather than those based upon accident year, are most responsive to claim settlement trends and fluctuations in premium exposure for its short-tail lines.  A minimum of 12 running accident quarters is used to project the reserve necessary for IBNR losses for its short-tail lines.
The Company also uses the loss development factor approach for its long-tail lines of business.  A minimum of 15 accident years is included in the loss development triangles used to calculate link ratios and the selected loss development factors used to determine the reserves for IBNR losses.  A minimum of 20 accident years is used for long-tail workers' compensation reserve projections.  Significant emphasis is placed on the use of tail factors for the Company's long-tail lines of business.
For the Company's fleet transportation risks, which are covered by regularly changing reinsurance agreements and which contain wide-ranging self-insured retentions ("SIR"), traditional actuarial methods are supplemented by other methods, as described below, in consideration of the Company's exposures to loss.  In situations where the Company's reinsurance structure, the insured's SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous enough with historical loss data to allow for reliable projection of future developed losses.  Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from the Company's extensive, proprietary databases to arrive at the reserve for IBNR losses for the calendar/accident period under review.  As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a monthly and quarterly basis and adjusts reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses.  This process continues until all losses are settled for each period subject to this method.
 
- 31 -

Reserves for loss adjustment expenses
While certain of the Company's products involve case basis reserving for allocated loss adjustment expenses, the majority of such reserves are determined on a bulk basis.  The Company uses historical analysis of the ratios of allocated loss adjustment expenses paid to losses paid on closed claims to arrive at the expected ultimate incurred loss adjustment expense factors applicable to each affected product.  Once developed, the factors are applied to the expected ultimate incurred losses, including IBNR, on all open claims.  The resulting ultimate incurred allocated loss adjustment expense is then reduced by amounts paid to date on all open claims to arrive at the reserve for allocated loss adjustment expenses to be incurred in the future for the handling of specific claims.
For those loss adjustment expenses not specific to individual claims (general claims handling expenses referred to as unallocated loss adjustment expenses) the Company uses a variation of the standard industry loss adjustment expenses paid to losses paid (net of reinsurance) ratio analysis that equally weighs paid and incurred losses to establish the necessary reserves.  The selected factors are applied to 100% of IBNR reserves and to case reserves with consideration given for that portion of loss adjustment expense already paid at the reserve measurement date.  Such factors are monitored and revised, as necessary, on a quarterly basis.
The reserving process requires management to continuously monitor and evaluate the life cycle of claims based on the class of business and the nature of the individual losses.  As previously noted, our claims vary widely in scope and complexity.  Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment.  The high limits provided in certain of the Company's fleet transportation liability policies provide for greater volatility in the reserving process for more serious claims.  Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims.  The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimations, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time.
Sensitivity Analysis - Potential impact on reserve volatility from changes in key assumptions
Management is aware of the potential for variation from the reserves established at any particular point in time.  Savings or deficiencies could develop in future valuations of the currently established loss and loss expense reserve estimates under a variety of reasonably possible scenarios.  The Company's reserve selections are developed to be a "best estimate" of unpaid losses at a point in time and, due to the unique nature of our exposures, particularly in the large fleet transportation excess product, ranges of reserve estimates are not established during the reserving process.  However, basic assumptions that could potentially impact future volatility of our valuations of current loss and loss expense reserve estimates include, but are not limited to, the following:
Consistency in the individual case reserving processes;
The selection of loss development factors in the establishment of bulk reserves for incurred but not reported losses and loss expenses;
Projected future loss trend; and
Expected loss ratios for the current book of business, particularly the Company's fleet transportation products, where the number of accounts insured, selected SIRs, policy limits and reinsurance structures may vary widely from period to period.
Under reasonably possible scenarios, it is conceivable that the Company's selected loss estimates could be 10% or more redundant or deficient.  The majority of the Company's reserves for losses and loss expenses, on a net of reinsurance basis, relate to its fleet transportation products.  Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for the Company's fleet transportation products for policies subject to certain major reinsurance treaties.  The following table presents the approximate impacts on gross and net loss reserves of both a hypothetical 10 percentage point and a hypothetical 20 percentage point increase or decrease in the loss factors actually utilized in the Company's reserve determination at December 31, 2017 for the prior six treaty periods, which covers exposures earned on policies written between July 3, 2011 and December 31, 2017.  The Company's selection of the range of values presented should not be construed as the Company's prediction of future events, but rather simply an illustration of the impact of such events, should they occur.


- 32 -


The variation in impact from loss ratio increases and decreases is attributable to minimum and maximum premium rate factors included in the various reinsurance contracts.  In between the minimum and maximum ceded premium provisions within the treaty terms, net premiums earned can be increased or decreased based on a change in loss expectation.  The total impact to profitability in the same scenarios is shown below ($ in millions):


   
10% Loss Ratio Increase
   
10% Loss Ratio Decrease
   
20% Loss Ratio Increase
   
20% Loss Ratio Decrease
 
Gross Reserves
 
$
61.1
   
(48.4
)
 
$
122.3
   
(82.0
)
                                 
Net Reserves
 
$
17.9
   
(14.0
)
 
$
34.3
   
(24.2
)
Net premiums earned
 
(27.2
)
 
$
31.0
   
(29.6
)
 
$
62.0
 
Cumulative Net Underwriting Income (Loss)
 
(45.1
)
 
$
45.0
   
(63.9
)
 
$
86.2
 


Federal Income Tax Considerations
The liability method is used in accounting for federal income taxes.  Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  The provision for deferred federal income tax is based on items of income and expense that are reported in different years in the financial statements and tax returns and are measured at the tax rate in effect in the year the difference originated.

On December 22, 2017, the U.S. Tax Act was signed into law.  The U.S. Tax Act lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018.  GAAP requires the impact of tax legislation to be recognized in the period in which the law was enacted.  As a result of the U.S. Tax Act, the Company recorded a tax benefit of $9.6 million related to the re-measurement of its deferred tax assets and liabilities during the fourth quarter of 2017.

Net deferred tax liabilities reported at December 31 are as follows (dollars in thousands):


   
2017
   
2016
 
      Total deferred tax liabilities
 
$
(23,836
)
 
$
(24,969
)
      Total deferred tax assets
   
9,478
     
13,557
 
      Net deferred tax liabilities
 
$
(14,358
)
 
$
(11,412
)

Deferred tax assets at December 31, 2017 include approximately $6.8 million related to the timing of deductibility of loss and loss expense reserves, the majority of which relate to policy liability discounts required by the Internal Revenue Code, which are perpetual in nature and, in the absence of the termination of business, will not, in the aggregate, reverse to a material degree in the foreseeable future.  An additional $0.8 million relates to impairment adjustments made to investments, as required by accounting regulations.  The sizable unrealized gains in the Company's investment portfolios would allow for the recovery of this deferred tax at any time.  Unearned premiums discount and deferred ceding commissions represent $1.8 million and $0.6 million of deferred tax assets, respectively.  The balance of deferred tax assets consists of various normal operating expense accruals and is not considered to be material.  As a result of its analysis, management has determined that no valuation allowance is necessary at December 31, 2017.
FASB provides guidance for recognizing and measuring uncertain tax positions and prescribes a threshold condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in the financial statements. Based on this guidance, management regularly analyzes tax positions taken or expected to be taken in a tax return based on the threshold condition prescribed.  Tax positions that do not meet or exceed this threshold condition are considered uncertain tax positions.  Interest related to uncertain tax positions, if any, would be recognized in income tax expense.  Penalties, if any, related to uncertain tax positions would be recorded in income tax expenses.  

- 33 -

Impact of Inflation
To the extent possible, the Company attempts to recover the impact of inflation on loss costs and operating expenses by increasing the premiums it charges.  Within the fleet transportation business, a majority of the Company's accounts are charged as a percentage of an insured's gross revenue, mileage or payroll.  As these charging bases increase with inflation, premium revenues are immediately increased.  The remaining premium rates charged are adjustable only at periodic intervals and often require state regulatory approval.  Such periodic increases in premium rates may lag far behind cost increases.

To the extent inflation influences yields on investments, the Company is also affected.  The Company's short-term and fixed investment portfolios are structured in direct response to available interest rates over the yield curve.  As available market interest rates fluctuate in response to the presence or absence of inflation, the yields on the Company's investments are impacted.  Further, as inflation affects current market rates of return, previously committed investments might increase or decline in value depending on the type and maturity of investment (see additional comments in Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk", in this Annual Report on Form 10-K).

Inflation must also be considered by the Company in the creation and review of loss and loss adjustment expense reserves, as portions of these reserves are expected to be paid over extended periods of time.  The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and loss adjustment expenses.
Contractual Obligations
The table below sets forth the amounts of the Company's contractual obligations at December 31, 2017.


   
Payments Due by Period
 
   
Total
   
Less than 1 year
   
1 - 3 Years
   
3 - 5 Years
   
More Than 5 Years
 
   
(dollars in millions)
 
Loss and loss expense reserves
 
$
680.3
   
$
238.1
   
$
224.5
   
$
81.6
   
$
136.1
 
                                         
Investment commitment
   
1.4
     
1.4
     
-
     
-
     
-
 
                                         
Operating leases
   
0.7
     
0.3
     
0.4
     
-
     
-
 
                                         
Borrowings
   
20.0
     
20.0
     
-
     
-
     
-
 
                                         
Total
 
$
702.4
   
$
259.8
   
$
224.9
   
$
81.6
   
$
136.1
 


The Company's loss and loss expense reserves do not have contractual maturity dates and the exact timing of the payment of claims cannot be predicted with certainty.  However, based upon historical payment patterns, the above table presents an estimate of when we might expect our direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid.  Timing of the collection of the related reinsurance recoverable, estimated to be $318.3 million at December 31, 2017, or 47% of the amounts presented in the above table, would approximate that of the above projected direct reserve payout but could lag behind such payments by several months in some instances.

The investment commitment in the above table relates to a maximum unfunded capital obligation for a limited partnership investment at December 31, 2017.  The actual call dates for such funding could vary from that presented.

Borrowings made under the Company's line of credit can be called by the bank, under certain circumstances, with short notice.  The Company's line of credit has a current expiration date of September 23, 2018; however, management expects that this line of credit will be renewed for a multi-year period prior to maturity.

Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
 
- 34 -

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company operates within the property and casualty insurance industry and, accordingly, has significant invested assets which are exposed to various market risks.  These market risks relate to interest rate fluctuations, credit risks, equity security market prices and, to a lesser extent, foreign currency rate fluctuations.  All of the Company's invested assets, with the exception of investments in limited partnerships, are classified as available for sale.

Based on the structure of the Company's investment portfolio, the most significant of the four identified market risks relates to prices in the equity security market.  Although not the largest category of the Company's invested assets, equity securities have a high potential for short-term price fluctuation.  The market value of the Company's equity positions at December 31, 2017 was $201.8 million, or approximately:
• 24% of the Company's consolidated investment portfolio of $854.6 million, and
• 48% of the Company's shareholders' equity.
This market valuation includes $71.0 million of appreciation over the adjusted cost basis of the equity security investments.  Funds invested in the equities market are not considered to be assets necessary for the Company to conduct its daily operations and, therefore, can be committed for extended periods of time.  The long-term nature of the Company's equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuations, is the primary focus.

Reference is made to the discussion of limited partnership investments in "Critical Accounting Policies" in Part II, Item 7 of this Annual Report on Form 10-K.  All of the market risks attendant to equity securities apply to the underlying assets in these partnerships, and to a greater degree because of the generally more aggressive investment philosophies utilized by the partnerships.  In addition, these investments are illiquid.  There is no primary or secondary market on which these limited partnerships trade and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal.  Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported.   Finally, through the application of the equity method of accounting, the Company's share of net income reported by the limited partnerships often includes significant amounts of unrealized appreciation on the underlying investments.

The Company's fixed maturity portfolio totaled $521.9 million at December 31, 2017.  Approximately 28% of this portfolio is made up of U.S. Government and municipal debt securities, and the average contractual maturity of the Company's fixed maturity investments is approximately 4.9 years with an average modified duration of approximately 2.3 years.  Although the Company is exposed to interest rate risk on its fixed maturity investments, given the anticipated duration of the Company's liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, even a 100 to 200 basis point increase in interest rates would not have a material impact on the Company's ability to conduct daily operations or to meet its obligations and would, in fact, result in significantly higher investment income in a relatively short period of time, as short term investments and maturing bonds could be reinvested in the higher yielding securities very quickly.

There is an inverse relationship between interest rate fluctuations and the fair value of the Company's fixed maturity investments.  Additionally, the fair value of interest rate sensitive instruments may be affected by the financial strength of the issuer, prepayment options, relative values of alternative investments, liquidity of the investment, currency fluctuations for non-U.S. debt holdings and other general market conditions.  The Company monitors its sensitivity to interest rate risk by measuring the change in fair value of its fixed maturity investments relative to hypothetical changes in interest rates.
 
- 35 -


The following tables present the estimated effects on the fair value of financial instruments at December 31, 2017 and 2016 that would result from an instantaneous change in yield rates of varying magnitudes on a static balance sheet to determine the effect such a change in rates would have on current fair value. The analysis presents the sensitivity of the fair value of the Company's financial instruments to selected changes in market rates and prices. The range of rates chosen reflects the Company's view of changes that the Company believes are reasonably possible over a one-year period.  The Company's selection of the range of values chosen to represent changes in interest rates should not be construed as the Company's prediction of future market events, but rather, as an illustration of the impact of such events, should they occur.  The equity portfolio was compared to the S&P 500 index due to its correlation with the vast majority of the Company's current equity portfolio.  The limited partnership portfolio was compared to the S&P 500 and Indian BSE 500 indices due to their significant correlation with the vast majority of our limited partnership portfolio.  As previously indicated, several other factors can impact the fair values of fixed maturity investments and, therefore, significant variations in market interest rates could produce quite different results from the hypothetical estimates presented below.



(Space intentionally left blank)



- 36 -


The following tables present the estimated effects on the fair value of financial instruments at December 31, 2017 and 2016 due to an instantaneous increase in yield rates of 100 basis points and a 10% decline in the S&P 500 and Indian BSE 500 indices (dollars in thousands).

         
Increase (Decrease)
 
   
Fair
   
Interest
   
Equity
 
   
Value
   
Rate Risk
   
Risk
 
2017
                 
Fixed maturities
                 
   Agency collateralized mortgage obligations
 
$
16,586
   
$
(820
)
 
$
-
 
   Agency mortgage-backed securities
   
27,075
     
(1,103
)
   
-
 
   Asset-backed securities
   
43,469
     
(1,381
)
   
-
 
   Bank loans
   
19,488
     
(794
)
   
-
 
   Certificates of deposit
   
3,135
     
(83
)
   
-
 
   Collateralized mortgage obligations
   
6,492
     
(200
)
   
-
 
   Corporate securities
   
198,349
     
(5,126
)
   
-
 
   Mortgage-backed securities
   
24,204
     
(772
)
   
-
 
   Municipal obligations
   
96,650
     
(1,861
)
   
-
 
   Non-U.S. government obligations
   
37,394
     
(959
)
   
-
 
   U.S. government obligations
   
49,011
     
(886
)
   
-
 
      Total fixed maturities
   
521,853
     
(13,985
)
   
-
 
Equity securities:
                       
   Consumer
   
46,578
     
-
     
(4,658
)
   Energy
   
10,278
     
-
     
(1,028
)
   Financial
   
45,470
     
-
     
(4,547
)
   Industrial 
   
25,402
     
-
     
(2,540
)
   Technology
   
13,061
     
-
     
(1,306
)
   Funds (e.g. mutual funds, closed end funds, ETFs)
   
50,291
     
-
     
(5,029
)
   Other
   
10,683
     
-
     
(1,068
)
      Total equity securities
   
201,763
     
-
     
(20,176
)
Limited partnerships
   
70,806
     
-
     
(5,278
)
Short-term
   
1,000
     
-
     
-
 
      Total
 
$
795,422
   
$
(13,985
)
 
$
(25,454
)
                         
2016:
                       
Fixed maturities
                       
   Agency collateralized mortgage obligations
 
$
6,171
   
$
-
   
$
-
 
   Agency mortgage-backed securities
   
4,770
     
(202
)
   
-
 
   Asset-backed securities
   
45,183
     
(1,577
)
   
-
 
   Bank loans
   
10,349
     
-
     
-
 
   Certificates of deposit
   
3,117
     
(111
)
   
-
 
   Collateralized mortgage obligations
   
9,104
     
(302
)
   
-
 
   Corporate securities
   
142,683
     
(4,026
)
   
-
 
   Mortgage-backed securities
   
24,571
     
(780
)
   
-
 
   Municipal obligations
   
129,335
     
(3,028
)
   
-
 
   Non-U.S. government obligations
   
24,681
     
(458
)
   
-
 
   U.S. government obligations
   
91,940
     
(1,249
)
   
-
 
      Total fixed maturities
   
491,904
     
(11,733
)
   
-
 
Equity securities:
                       
   Consumer
   
32,576
     
-
     
(3,258
)
   Energy
   
12,842
     
-
     
(1,284
)
   Financial
   
31,186
     
-
     
(3,119
)
   Industrial