KINGSTONE COMPANIES, INC. (KINS) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

We offer property and casualty insurance products to individuals through our wholly owned subsidiary, Kingstone Insurance Company (“KICO”). KICO’s insureds are located primarily in downstate New York, consisting of New York City, Long Island and Westchester County, although we are actively writing business in New Jersey, Rhode Island, Connecticut and Massachusetts. We are licensed in the States of New York, New Jersey, Rhode Island, Connecticut, Massachusetts, Pennsylvania, Maine, and New Hampshire. For the year ended December 31, 2022, 80.6% of KICO’s direct written premiums came from the New York policies.

In addition, our subsidiary, Cosi Agency, Inc. (“Cosi”), a multi-state licensed general agency, receives commission revenue from KICO for the policies it places with others and pays commissions to these agencies. Cosi retains the profit between the commission revenue received and the commission expense paid (“Net Cosi Revenue”). Commission expense is reduced by Net Cosi Revenue and Cosi-related operating expenses are included in other operating expenses. Cosi-related operating expenses are not included in our stand-alone insurance underwriting business and, accordingly, Cosi’s expenses are not included in the calculation of our combined ratio as described below.

We derive substantially all of our revenue from KICO, which includes revenues from earned premiums, ceding commissions from quota share reinsurance, net investment income generated from its portfolio, and net realized gains and losses on investment securities. All of KICO’s insurance policies are written for a one-year term. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the one-year life of the policy). A significant period of time can elapse from the receipt of insurance premiums to the payment of insurance claims. During this time, KICO invests the premiums, earns investment income and generates net realized and unrealized investment gains and losses on investments. Our holding company earns investment income from its cash holdings and may also generate net realized and unrealized investment gains and losses on future investments.

Our expenses include the insurance underwriting expenses of KICO and other operating expenses. Insurance companies incur a significant amount of their total expenses from losses incurred by policyholders, which are referred to as claims. In settling these claims, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and legal expenses. In addition, insurance companies incur policy acquisition costs. Policy acquisition costs include commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including employees’ compensation and benefits.

Other operating expenses include our corporate expenses as a holding company and operating expenses of Cosi. These corporate expenses include legal and auditing fees, executive employment costs, and other costs directly associated with being a public company. Cosi operating expenses primarily include employment, occupancy and consulting costs.

Principal Revenue and Expense Items

Net premiums earned: Net premiums earned is the earned portion of our written premiums, less that portion of premium that is ceded to third party reinsurers under reinsurance agreements. The amount ceded under these reinsurance agreements is based on a contractual formula contained in the individual reinsurance agreement. Insurance premiums are earned on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our insurance policies have a term of one year. Accordingly, for a one-year policy written on July 1, 2022, we would earn half of the premiums in 2022 and the other half in 2023.

Ceding commission revenue: Commissions on reinsurance premiums ceded to quota share treaties are earned in a manner consistent with the recognition of the direct acquisition costs of the underlying insurance policies, generally on a pro-rata basis over the terms of the policies reinsured.

Net investment income and net gains (losses) on investments: We invest in cash and cash equivalents, short-term investments, fixed-maturity and equity securities, and other investments. Our net investment income includes interest and dividends earned on our invested assets, less investment expenses. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify our fixed-maturity securities as either available-for-sale or held-to-maturity. Net unrealized gains (losses) on those securities classified as available-for-sale are reported separately within accumulated other comprehensive (loss) income on our balance sheet while our equity securities and other investments report changes in fair value through earnings. See Note 2 in the accompanying consolidated financial statements for a further discussion of our accounting policies following Item 16 of this Annual Report.

Other income: We recognize installment fee income and fees charged to reinstate a policy after it has been cancelled for non-payment.

Loss and loss adjustment expenses incurred: Loss and LAE incurred represent our largest expense item, and for any given reporting period include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and LAE related to estimates of future claim payments based on case-by-case valuations, statistical analyses and actuarial procedures. We seek to establish all reserves at the most likely ultimate liability based on our historical claims experience. It is typical for certain claims to take several years to settle and we revise our estimates as we receive additional information on such claims. Our ability to estimate loss and LAE accurately at the time of pricing our insurance policies is a critical factor affecting our profitability.

Commission expenses and other underwriting expenses: Other underwriting expenses include policy acquisition costs and other expenses related to the underwriting of policies. Policy acquisition costs represent the costs of originating new insurance policies that vary with, and are primarily related to, the production of insurance policies (principally commissions, premium taxes and certain underwriting salaries). Policy acquisition costs are deferred and recognized as expense as the related premiums are earned. Other underwriting expenses represent general and administrative expenses of our insurance business and are comprised of other costs associated with our insurance activities such as regulatory fees, telecommunication and technology costs, occupancy costs, employment costs, and legal and auditing fees.

Other operating expenses: Other operating expenses include the corporate expenses of our holding company, Kingstone Companies, Inc., and operating expenses of Cosi. These expenses include executive employment costs, legal and auditing fees, and other costs directly associated with being a public company. Cosi operating expenses primarily include employment costs, occupancy costs and consulting costs.

Stock-based compensation: Non-cash equity compensation includes the fair value of stock grants issued to our directors, officers and employees, and amortization of stock options issued to the same.

Depreciation and amortization: Depreciation and amortization includes the amortization of intangibles related to the acquisition of KICO, depreciation of the real estate used in KICO’s operations, as well as depreciation of capital expenditures for information technology projects, office equipment and furniture.

Interest expense: Interest expense represents amounts we incur on our outstanding indebtedness at the applicable interest rates. Interest expense also includes amortization of debt discount and issuance costs.

Income tax expense: We incur federal income tax expense on our consolidated statement of operations as well as state income tax expense for our non-insurance underwriting subsidiaries.

Product Lines

Our product lines include the following:

Personal lines: Our largest line of business is personal lines, consisting of homeowners, dwelling fire, cooperative/condominium, renters, and personal umbrella policies.

Commercial liability: Through July 2019, we offered businessowners policies, which consist primarily of small business retail, service, and office risks, with limited property exposures. We also wrote artisan’s liability policies for small independent contractors with smaller sized workforces. In addition, we wrote special multi-peril policies for larger and more specialized businessowners risks, including those with limited residential exposures. Further, we offered commercial umbrella policies written above our supporting commercial lines policies.

In May 2019, due to the poor performance of this line we placed a moratorium on new commercial lines and new commercial umbrella submissions while we further reviewed this business. In July 2019, due to the continuing poor performance of these lines, we made the decision to no longer underwrite commercial lines or commercial umbrella risks. In-force policies as of July 31, 2019 for these lines were non-renewed at the end of their annual terms. As of December 31, 2022 and 2021, there were no commercial liability policies in-force. As of December 31, 2022, these expired policies represent approximately 17.9% of loss and LAE reserves net of reinsurance recoverables. See discussion below under “Additional Financial Information”.

Livery physical damage: We write for-hire vehicle physical damage only policies for livery and car service vehicles and taxicabs. These policies insure only the physical damage portion of insurance for such vehicles, with no liability coverage included.

Other: We write canine legal liability policies and have a small participation in mandatory state joint underwriting associations.

Key Measures

We utilize the following key measures in analyzing the results of our insurance underwriting business:

Net loss ratio: The net loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.

Net underwriting expense ratio: The net underwriting expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs (the most significant being commissions paid to our producers) and other underwriting expenses less ceding commission revenue less other income to net premiums earned.

Net combined ratio: The net combined ratio is a measure of an insurance company’s overall underwriting profit. This is the sum of the net loss and net underwriting expense ratios. If the net combined ratio is at or above 100 percent, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient.

Underwriting income: Underwriting income is net pre-tax income attributable to our insurance underwriting business before investment activity. It excludes net investment income, net realized gains from investments, and depreciation and amortization (net premiums earned less expenses included in combined ratio). Underwriting income is a measure of an insurance company’s overall operating profitability before items such as investment income, depreciation and amortization, interest expense and income taxes.

Critical Accounting Policies and Estimates

Our consolidated financial statements include the accounts of Kingstone Companies, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these consolidated financial statements, our management has utilized information including our past history, industry standards, and the current economic environment, and other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates in these financial statements may not materialize. Application of the critical accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of similar companies.

We believe that the most critical accounting policies relate to the reporting of reserves for loss and LAE, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred income taxes, the impairment of investment securities, and the valuation of warrants. See Note 2 to the consolidated financial statements following Item 16 of this Annual Report.

Consolidated Results of Operations

The following table summarizes the changes in the results of our operations for the periods indicated:

Direct Written Premiums

Direct written premiums during the year ended December 31, 2022 (“Year Ended 2022”) were $201,255,000 compared to $181,665,000 during the year ended December 31, 2021 (“Year Ended 2021”). The increase of $19,590,000, or 10.8%, was primarily due an increase in premiums from our personal lines business. Direct written premiums from our personal lines business for Year Ended 2022 were $188,105,000, an increase of $16,385,000, or 9.5%, from $171,720,000 in Year Ended 2021. The increase in premiums from our personal lines business was primarily due to rate increases, offset by a modest decrease in policies in force as of December 31, 2022 compared to December 31, 2021. Direct written premiums from our livery physical damage business for Year Ended 2022 were $12,993,000, an increase of $3,276,000, or 33.7%, from $9,717,000 in Year Ended 2021. The increase in livery physical damage direct written premiums was due to the declining effect of the COVID-19 pandemic in our geographic area.

Beginning in 2017 we started writing homeowners policies in New Jersey. Through 2019 we expanded to Rhode Island, Massachusetts and Connecticut. We refer to our New York business as our “Core” business and the business outside of New York as our “Expansion” business. Direct written premiums from our Core business were $162,255,000 in Year Ended 2022 compared to $144,449,000 in Year Ended 2021. Direct written premiums from our Expansion business were $39,000,000 in Year Ended 2022 compared to $37,216,000 in Year Ended 2021.

Net Written Premiums and Net Premiums Earned

Effective December 31, 2021, we entered into a quota share reinsurance treaty for our personal lines business covering the period from December 31, 2021 through January 1, 2023 (“2021/2023 Treaty”). There was no quota share reinsurance treaty in effect in Year Ended 2021. Net written premiums decreased $6,695,000, or 5.2%, to $122,060,000 in Year Ended 2022 from $128,755,000 in Year Ended 2021. Net written premiums include direct and assumed premiums, less the amount of written premiums ceded under our reinsurance treaties (quota share, excess of loss, and catastrophe). In Year Ended 2022, our premiums ceded under quota share treaties increased by $23,899,000 in comparison to ceded premiums in Year Ended 2021 (see table above). Our personal lines business was subject to the 2021/2023 Treaty in Year Ended 2022, compared to no personal lines quota share treaty in Year Ended 2021.

Excess of loss reinsurance treaties

An increase in written premiums will increase the premiums ceded under our excess of loss treaties. In Year Ended 2022, our ceded excess of loss reinsurance premiums increased by $1,267,000 over the comparable ceded premiums for Year Ended 2021. The increase was due to an increase in subject premiums and additional coverage obtained. Effective January 1, 2022, we entered into an underlying excess of loss reinsurance treaty covering the period from January 1, 2022 through January 1, 2023. The treaty provides 50% reinsurance coverage for losses of $400,000 in excess of $600,000. Losses from named storms are excluded from the treaty.

Catastrophe reinsurance treaties

Most of the premiums written under our personal lines policies are also subject to our catastrophe treaties. An increase in our personal lines business gives rise to more property exposure, which increases our exposure to catastrophe risk; therefore, our premiums ceded under catastrophe treaties will increase. This results in an increase in premiums ceded under our catastrophe treaties provided that reinsurance rates are stable or are increasing. In Year Ended 2022, our premiums ceded under catastrophe treaties increased by $1,119,000 over the comparable ceded premiums in Year Ended 2021. Effective July 1, 2020, and continuing through June 30, 2021, our ceded catastrophe premiums were paid based on the total insured value of our risks calculated as of August 31, 2020. Effective July 1, 2021, and continuing through June 30, 2022, our ceded catastrophe premiums were paid based on the total insured value of our risks as of August 31, 2021. Effective July 1, 2022, and continuing through June 30, 2023, our ceded catastrophe premiums will be paid based on the total insured value of our risks as of August 31, 2022.

Net premiums earned

Net premiums earned decreased $29,497,000, or 20.5%, to $114,385,000 in Year Ended 2022 from $143,882,000 in Year Ended 2021. The decrease was due to the inception of the 2021/2023 Treaty on December 31, 2021. The decrease resulting from the 2021/2023 Treaty in Year Ended 2022 was partially offset by an increase in direct written premiums.

Ceding Commission Revenue

The following table summarizes the changes in the components of ceding commission revenue (in thousands) for the periods indicated:

Ceding commission revenue was $19,319,000 in Year Ended 2022 compared to $90,000 in Year Ended 2021. The increase of $19,229,000 was due to an increase in both provisional ceding commissions earned and contingent ceding commissions earned. See below for a discussion of provisional ceding commissions earned and contingent ceding commissions earned.

Provisional Ceding Commissions Earned

In Year Ended 2022 we earned provisional ceding commissions from personal lines earned premiums ceded under the 2021/2023 Treaty which was effective as of December 31, 2021. There was no personal lines quota share in effect in Year Ended 2021.

Contingent Ceding Commissions Earned

The structure of the 2021/2023 Treaty calls for a fixed provisional ceding commission with no opportunity to earn additional contingent ceding commissions. Under our prior years’ quota share treaties, we received a contingent ceding commission based on a sliding scale in relation to the losses incurred under our quota share treaties. The lower the ceded loss ratio, the more contingent commission we received.

Net Investment Income

Net investment income was $4,937,000 in Year Ended 2022 compared to $6,621,000 in Year Ended 2021, a decrease of $1,684,000, or 25.4%. The decrease in investment income is partially attributable to a $766,000 reversal of prior years’ estimated accrued interest income stemming from an error in third party investment reporting. The decline of investment income is also attributable to the disposal of income bearing equity securities. The average yield on invested assets was 3.42% as of December 31, 2022 compared to 3.25% as of December 31, 2021.

Cash and invested assets were $191,046,000 as of December 31, 2022 compared to $237,885,000 as of December 31, 2021. The $46,839,000 decrease in cash and invested assets was primarily attributable to cash paid to reinsurers at the inception of the 2021/2023 Treaty, losses paid in connection with catastrophe losses incurred in 2021 and 2022 and unrealized losses on our investment portfolio.

Net (Losses) Gains on Investments

Net losses on investments were $(9,392,000) in Year Ended 2022 compared to net gains of $9,787,000 in Year Ended 2021. Unrealized losses on our equity securities and other investments in Year Ended 2022 were $(9,252,000), compared to net unrealized gains of $2,469,000 in Year Ended 2021. Realized losses on sales of investments were $(140,000) in Year Ended 2022 compared to realized gains of $7,318,000 in Year Ended 2021.

Other Income

Other income was $910,000 in Year Ended 2022 compared to $851,000 in Year Ended 2021, an increase of $59,000, or 6.9%.

Net Loss and LAE

Net loss and LAE was $88,390,000 for Year Ended 2022 compared to $101,973,000 for Year Ended 2021. The net loss ratio was 77.3% in Year Ended 2022 compared to 70.9% in Year Ended 2021, an increase of 6.4 percentage points.

The following graph summarizes the changes in the components of net loss ratio for the periods indicated, along with the comparable components excluding commercial lines business:

(Percent components may not sum to totals due to rounding)

The loss ratio for Year Ended 2022 was higher than Year Ended 2021 due to two factors. The predominant reason was the impact from climbing inflation leading to higher severity of claim settlements. A slightly elevated frequency of water damage claims was also observed, partially driven by winter-related claims resulting from freezing temperatures.

The estimated net catastrophe losses were $7,632,000 for Year Ended 2022, which contributed 6.7 points to the loss ratio. This was mostly driven by two winter events in the first quarter and one winter event (Winter Storm Elliott) in the fourth quarter. There were also another seven minor wind catastrophe events for Year Ended 2022, but the impact was not significant. As a comparison, catastrophe events had a loss ratio impact of 10.3 points for Year Ended 2021 due to a more active hurricane season including the named storm, Ida.

Prior years in total have unfavorable development of $2,700,000 for Year Ended 2022, driven mostly by large fire losses which occurred in 2021 and the volatility of liability claim settlements from the discontinued commercial multi-peril line. This contributed 2.4 points to the loss ratio.

See table below under “Additional Financial Information” summarizing net loss ratios by line of business.

Commission Expense

Commission expense was $34,582,000 in Year Ended 2022 or 18.1% of direct earned premiums. Commission expense was $33,114,000 in Year Ended 2021 or 19.0% of direct earned premiums. The increase of $1,468,000 was primarily due to an increase in direct earned premiums of $17,607,000 to $191,522,000 offset in part by a reduction of commission rate on our Select products and the reduction to contingent commissions, which the producers now earn only if KICO has an operating profit.

Other Underwriting Expenses

Other underwriting expenses were $26,697,000, or 13.9% of direct earned premiums, in Year Ended 2022 compared to $26,254,000, or 15.1% of direct earned premiums, in Year Ended 2021. The increase of $443,000, or 1.7%, was primarily due to increases in expenses related to our growth in direct earned premiums, salaries, and our continuing initiative to reduce expenses with the use of technology, partially offset by decreases in professional fees, state insurance department fees, and policy management system fees as result of the completion of customized efficient policy management software which allowed us to eliminate multiple legacy systems.

Our largest single component of other underwriting expenses is salaries and employment costs, with costs of $10,799,000 in Year Ended 2022 compared to $10,189,000 in Year Ended 2021. The increase of $610,000, or 6.0%, compares favorably with the 10.8% increase in direct written premiums. In the periods following Year Ended 2021, we invested in the hiring of higher-level managers and staff to implement our goals of modernization and efficiency, which we refer to as Kingstone 2.0.

Our net underwriting expense ratio in Year Ended 2022 was 36.0% compared to 40.6% in Year Ended 2021. The following table shows the individual components of our net underwriting expense ratio for the periods indicated:

The overall 16.8 percentage point increase in the benefit from ceding commissions in Year Ended 2022 was driven by the increase in provisional ceding commission revenue due to the inception of the 2021/2023 Treaty on December 31, 2021. The components of our net underwriting expense ratio related to other underwriting expenses and commissions increased due to a higher percentage of our direct earned premiums in Year Ended 2022 being ceded due to the inception of the 2021/2023 Treaty.

Other Operating Expenses

Other operating expenses, related to the expenses of our holding company and Cosi, were $3,113,000 for Year Ended 2022 compared to $4,183,000 for Year Ended 2021. The following table shows a breakdown of the significant components of other operating expenses for the periods indicated:

(Components may not sum to totals due to rounding)

The decrease in Year Ended 2022 of $1,069,000, or 25.6%, as compared to Year Ended 2021 was primarily due to a decrease in employment costs. The decrease in employment costs was due to staff reductions and fluctuations in deferred compensation liability related to changes in the underlying invested portfolio. The decrease in employment costs was partially offset by an increase in professional fees attributable to a non-binding indication of interest from a third party related to a then contemplated acquisition of all of the outstanding equity of our company.

Depreciation and Amortization

Depreciation and amortization was $3,300,000 in Year Ended 2022 compared to $3,290,000 in Year Ended 2021. The increase of $10,000, or 0.3%, in depreciation and amortization was primarily due to assets previously put into service that are currently being utilized and being fully depreciated. The increase was partially offset by the completion of customized policy management software, now allowing us to consolidate multiple legacy systems into one efficient system. In the last quarter of 2021, due to the extended useful life of assets related to our system platforms, Management determined that such systems, currently put into service, should be depreciated over five years reflecting their expected useful lives as compared to the previous three years.

Interest Expense

Interest expense in Year Ended 2022 was $2,019,000 compared to $1,826,000 in Year Ended 2021, an increase of $193,000 or 10.6%. In Years Ended 2022 and 2021 we incurred interest expense in connection with the 2017 Notes, our $30.0 million issuance of long-term debt in December 2017. In Year Ended 2022, as disclosed in Note 9 to the consolidated financial statements, we also incurred debt in the fourth quarter of 2022 with respect to the 2022 Notes and an equipment financing.

Income Tax Benefit

Income tax benefit in Year Ended 2022 was $5,418,000, which resulted in an effective tax benefit rate of 19.4%. Income tax benefit in Year Ended 2021 was $2,031,000, which resulted in an effective tax rate of 21.6%. Loss before taxes was $27,942,000 in Year Ended 2022 compared to $9,409,000 in Year Ended 2021. The difference in effective tax rate is due to the effect of permanent differences in Year Ended 2022 compared to Year Ended 2021.

Net Loss

Net loss was $22,525,000 in Year Ended 2022 compared to $7,378,000 in Year Ended 2021. The increase in net loss of $15,147,000 was due to the circumstances described above.

Additional Financial Information

We operate our business as one segment, property and casualty insurance. Within this segment, we offer an array of property and casualty policies to our producers. The following table summarizes gross and net premiums written, net premiums earned, and loss and loss adjustment expenses by major product type, which were determined based primarily on similar economic characteristics and risks of loss.

Insurance Underwriting Business on a Standalone Basis

Our insurance underwriting business reported on a standalone basis for the years ended December 31, 2022 and 2021 follows:

An analysis of our direct, assumed and ceded earned premiums, loss and loss adjustment expenses, and loss ratios is shown below:

(Percentage components may not sum to totals due to rounding)

The key measures for our insurance underwriting business for the years ended December 31, 2022 and 2021 are as follows:

Investments

Portfolio Summary

The following table presents a breakdown of the amortized cost, estimated fair value, and unrealized gains and losses of our investments in fixed-maturity securities classified as available-for-sale as of December 31, 2022 and 2021:

Available-for-Sale Securities

Equity Securities

The following table presents a breakdown of the cost and estimated fair value of, and gross gains and losses on, investments in equity securities as of December 31, 2022 and 2021:

Other Investments

The following table presents a breakdown of the cost and estimated fair value of, and gross gains on, our other investments as of December 31, 2022 and 2021:

Held-to-Maturity Securities

The following table presents a breakdown of the amortized cost and estimated fair value of, and gross unrealized gains and losses on, investments in held-to-maturity securities as of December 31, 2022 and 2021:

Held-to-maturity U.S. Treasury securities are held in trust pursuant to various states’ minimum fund requirements.

A summary of the amortized cost and estimated fair value of our investments in held-to-maturity securities by contractual maturity as of December 31, 2022 and 2021 is shown below:

Credit Rating of Fixed-Maturity Securities

The table below summarizes the credit quality of our available-for-sale fixed-maturity securities as of December 31, 2022 and 2021 as rated by Standard and Poor’s (or, if unavailable from Standard and Poor’s, then Moody’s, Fitch, or Kroll):

The table below details the average yield by type of fixed-maturity security as of December 31, 2022 and 2021:

The table below lists the weighted average maturity and effective duration in years on our fixed-maturity securities as of December 31, 2022 and 2021:

Fair Value Consideration

As disclosed in Note 4 to the consolidated financial statements, with respect to “Fair Value Measurements,” we define fair value as the price that would be received to sell an asset or paid to transfer a liability in a transaction involving identical or comparable assets or liabilities between market participants (an “exit price”). The fair value hierarchy distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy prioritizes fair value measurements into three levels based on the nature of the inputs. Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumption that market participants would use, having the lowest priority (“Level 3”). As of December 31, 2022 and 2021, 65% and 62%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices.

The table below summarizes the gross unrealized losses of our fixed-maturity securities available-for-sale and equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2022 and 2021:

There were 155 securities at December 31, 2022 that accounted for the gross unrealized loss of our fixed-maturity securities available-for-sale, none of which were deemed by us to be other than temporarily impaired. There were 48 securities at December 31, 2021 that accounted for the gross unrealized loss of our fixed-maturity securities available-for-sale, none of which were deemed by us to be other than temporarily impaired. Significant factors influencing our determination that unrealized losses were temporary included credit quality considerations, the magnitude of the unrealized losses in relation to each security’s cost, the nature of the investment and interest rate environment factors, management’s intent not to sell these securities and it being not more likely than not that we will be required to sell these investments before anticipated recovery of fair value to our cost basis.

Liquidity and Capital Resources

Cash Flows

The primary sources of cash flow are from our insurance underwriting subsidiary, KICO, and include direct premiums written, ceding commissions from our quota share reinsurers, loss recovery payments from our reinsurers, investment income and proceeds from the sale or maturity of investments. Funds are used by KICO for ceded premium payments to reinsurers, which are paid on a net basis after subtracting losses paid on reinsured claims and reinsurance commissions. KICO also uses funds for loss payments and loss adjustment expenses on our net business, commissions to producers, salaries and other underwriting expenses as well as to purchase investments and fixed assets.

For the year ended December 31, 2022, the primary source of cash flow for our holding company was the dividends received from KICO, subject to statutory restrictions. For the year ended December 31, 2022, KICO paid dividends of $5,250,000 to us. On October 27, 2022, KICO entered a sale-leaseback transaction whereby KICO sold substantially all its information technology assets for approximately $8,100,000. Subsequent to the closing of the sale-leaseback transaction, KICO paid a dividend of $3,000,000 to us. In addition, on October 17, 2022 we entered into a seven year loan agreement with KICO with regard to a loan from KICO to us in the amount of $6,450,000. As of December 31, 2022, KICO had a negative unassigned surplus of $5,069,000 and will not be able to pay any distributions to us without prior regulatory approval.

KICO is a member of the Federal Home Loan Bank of New York (“FHLBNY”), which provides additional access to liquidity. Members have access to a variety of flexible, low cost funding through FHLBNY’s credit products, enabling members to customize advances. Advances are to be fully collateralized; eligible collateral to pledge to FHLBNY includes residential and commercial mortgage backed securities, along with U.S. Treasury and agency securities. See Note 3 – Investments to our consolidated financial statements for eligible collateral held in a designated custodian account available for future advances. Advances are limited to 5% of KICO’s net admitted assets as of the end of the previous quarter, which is September 30, 2022, and are due and payable within 90 days of borrowing. The maximum allowable advance as of December 31, 2022, based on the net admitted assets as of September 30, 2022, was approximately $13,192,000. Available collateral as of December 31, 2022 was approximately $12,228,000. Advances are limited to 85% of the amount of available collateral. There were no borrowings under this facility during the year ended December 31, 2022.

On December 15, 2022, we issued $19,950,000 of our 2022 Notes pursuant to the Exchange Agreement. We are required to make a mandatory redemption of 2022 Notes on December 30, 2023 as discussed in Note 9 – Debt of the consolidated financial statements included in this Annual Report.

Our reconciliation of net income to net cash provided by operations is generally influenced by the collection of premiums in advance of paid losses, the timing of reinsurance, issuing company settlements and loss payments.

Cash flow and liquidity are categorized into three sources: (1) operating activities; (2) investing activities; and (3) financing activities, which are shown in the following table:

Net cash used in operating activities was $916,000 in Year Ended 2022 as compared to $24,346,000 provided by operating activities in Year Ended 2021. The $25,262,000 decrease in cash flows provided by operating activities in Year Ended 2022 as compared to Year Ended 2021 was primarily the result of a decrease in cash arising from net fluctuations in operating assets and liabilities, partially offset by net loss (adjusted for non-cash items) of $4,073,000. The increase in cash used in operating activities is also attributable to the payment of $13,245,000 to reinsurers in Year Ended 2022 pursuant to the inception of our quota share reinsurance treaty, effective December 31, 2021. In addition, the increase of reinsurance recoverables by $26,173,000 also contributed to the increase in cash used during Year Ended 2022. The net fluctuations in assets and liabilities are related to operating activities of KICO as affected by growth or declines in its operations, payments on claims and other changes, which are described above.

Net cash used investing activities was $5,906,000 in Year Ended 2022 compared to $15,948,000 used in investing activities in Year Ended 2021. In Year Ended 2022, we had net investing activity used in our investment portfolio of $1,355,000, compared to $11,449,000 used in Year Ended 2021 resulting in a $10,094,000 decrease in net cash used investing activities.

Net cash used in financing activities was $5,511,000 in Year Ended 2022 compared to $3,572,000 used in Year Ended 2021. The $1,939,000 increase in net cash used in financing activities was attributable to a $10,050,000 principal payment on the 2017 Notes and $1,758,000 of bond issue costs, both paid in connection with the Exchange Agreement. In addition, we paid $192,000 of principal payments on our equipment financing in connection with KICO’s sale-leaseback transaction and there was a $186,000 increase in the amount of withholding taxes paid on the vesting of restricted stock awards. The increases in cash used in financing activities were partially offset by $8,097,000 of proceeds from equipment financing in connection with KICO’s sale-leaseback transaction and a decrease of $1,672,000 in the purchase of treasury stock.

Reinsurance

The following table provides summary information with respect to each reinsurer that accounted for more than 10% of our reinsurance recoverables on paid and unpaid losses and loss adjustment expenses as of December 31, 2022:

Effective December 31, 2021, we entered into a quota share reinsurance treaty for our personal lines business, which primarily consisted of homeowners’ and dwelling fire policies, covering the period from December 31, 2021 through January 1, 2023 (“2021/2023 Treaty”). Upon the expiration of the 2021/2023 Treaty on January 1, 2023, we entered into a new quota share reinsurance treaty for our personal lines business, covering the period from January 1, 2023 through January 1, 2024 (“2023/2024 Treaty”).

We entered into new excess of loss and catastrophe reinsurance treaties effective July 1, 2022. Effective October 18, 2021, we entered into a stub catastrophe reinsurance treaty covering the period from October 18, 2021 through December 31, 2021. The treaty provided reinsurance coverage for catastrophe losses of $5,000,000 in excess of $5,000,000. Effective January 1, 2022, we entered into an underlying excess of loss reinsurance treaty (“Underlying XOL Treaty”) covering the period from January 1, 2022 through January 1, 2023. The Underlying XOL Treaty provides 50% reinsurance coverage for losses of $400,000 in excess of $600,000. Losses from named storms are excluded from the Underlying XOL Treaty. Effective January 1, 2023, the Underlying XOL Treaty was renewed covering the period from January 1, 2023 through January 1, 2024. Material terms for our reinsurance treaties in effect for the treaty years shown below are as follows:

Inflation

Premiums are established before we know the amount of losses and loss adjustment expenses or the extent to which inflation may affect such amounts. We attempt to anticipate the potential impact of inflation in establishing our reserves, especially as it relates to medical and hospital rates where historical inflation rates have exceeded the general level of inflation. Inflation in excess of the levels we have assumed could cause loss and loss adjustment expenses to be higher than we anticipated, which would require us to increase reserves and reduce earnings.

Fluctuations in rates of inflation also influence interest rates, which in turn impact the market value of our investment portfolio and yields on new investments. Operating expenses, including salaries and benefits, generally are impacted by inflation.

Year Ended 2022 included elevated economic inflation, which resulted in a significant increase in interest rates, a widening of credit spreads, lower public equity valuations, and significant financial market volatility. The higher interest rates and widening of credit spreads reduced the value of our fixed income securities, which lowered our stockholders’ equity materially for Year Ended 2022. The higher economic inflation impacted our loss and loss adjustment expenses as well; should these trends continue in the near-term, it would in all likelihood negatively impact our profitability.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, or liquidity that are material to investors.

Outlook

The COVID-19 pandemic caused significant financial market volatility, economic uncertainty, and interruptions to normal business activities. As of the date of this Annual Report, we expect the effect of the COVID-19 pandemic on claims currently under our coverages to be manageable, based on the information presently available. However, the effects of the COVID-19 pandemic, including the emergence of variant strains, continue to evolve and we cannot predict the extent to which our business, results of operations, financial condition, liquidity and capital position, the value of investments we hold in our investment portfolio, the premiums we charge, the demand for our products, our ability to collect premiums or any requirement to return premiums to our policyholders will ultimately be impacted. The impact of COVID-19 on our results for the year ended December 31, 2022 may not be indicative of its impact on our future results. For additional information on the risks posed by COVID-19, see “The impact of pandemics and other public health issues (like COVID-19) and related risks could materially affect our results of operations, financial position and/or liquidity” included in Part I, Item 1A— “Risk Factors” in this Annual Report.

Our net premiums earned may be impacted by a number of factors. Net premiums earned are a function of net written premium volume. Net written premiums comprise both renewal business and new business and are recognized as earned premium over the term of the underlying policies. Net written premiums from both renewal and new business are impacted by competitive market conditions as well as general economic conditions. As a result of COVID-19, economic conditions in the United States rapidly deteriorated. The decreased levels of economic activity negatively impacted premium volumes generated by new business. We began to experience this impact in March 2020 and it became more significant in the second and third quarters of 2020. While we are now seeing a reversal of this impact, it may resume in the future, but the degree of any new impact will depend on the extent and duration of any economic contraction and could be material. We have also made underwriting changes to emphasize profitability over growth and have culled out the type of risks that do not generate an acceptable level of return. This action has led, and may continue to lead, to a slowdown in premium growth, particularly in new business.