Blueprint

 
United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  FOR THE TRANSITION PERIOD FROM                               TO                       
 
Commission File Number 0-1665
 
KINGSTONE COMPANIES, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
36-2476480
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
15 Joys Lane, Kingston, New York
12401
(Address of principal executive offices)
(Zip Code)
 
(845) 802-7900
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock
Nasdaq Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
 
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit 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. (Check one):
 
Large accelerated filer ☐
Accelerated filer ☒
 
 
Non-accelerated ☐
Smaller reporting company ☒
 
 
Emerging growth company ☐
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
 
As of June 30, 2018, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $163,449,432 based on the closing sale price as reported on the Nasdaq Global Select Market. As of March 12, 2019, there were 10,760,042 shares of common stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
None

 
 
INDEX
 
 
Page No.
1
PART I
 
 
2
19
28
28
28
28
PART II
 
 
29
29
30
61
61
61
61
65
PART III
 
 
66
71
76
78
79
PART IV
 
 
80
81
 
82
 
 
 
 
 
 
 
 PART I
 
Forward-Looking Statements
 
This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The events described in forward-looking statements contained in this Annual Report may not occur. Generally, these statements relate to business plans or strategies, projected or anticipated results or other consequences of our plans or strategies, projected or anticipated results from acquisitions to be made by us, or projections involving anticipated revenues, earnings, costs or other aspects of our operating results. The words “may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “intend,” “estimate,” and “continue,” and their opposites and similar expressions are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Factors which may cause actual results and outcomes to differ materially from those contained in the forward-looking statements include, but are not limited to the risks and uncertainties discussed in Part I Item 1A of this Annual Report under “Factors That May Affect Future Results and Financial Condition.”
 
 
Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise except as required by law.
 
 
1
 
 
ITEM 1.    BUSINESS.
 
(a)            
Business Development
 
General
 
As used in this Annual Report on Form 10-K (the “Annual Report”), references to the “Company,” “we,” “us,” or “our” refer to Kingstone Companies, Inc. (“Kingstone”) and its subsidiaries.
 
We offer property and casualty insurance products to individuals and small businesses through our wholly owned subsidiary, Kingstone Insurance Company (“KICO”), domiciled in the state of New York. KICO is a licensed property and casualty insurance company in New York, New Jersey, Connecticut, Massachusetts, Pennsylvania, Rhode Island, Maine, and New Hampshire. KICO is currently offering its property and casualty insurance products in New York, New Jersey, Rhode Island, Massachusetts, and Pennsylvania. Although in 2018 KICO wrote 93.7% of its direct written premiums in New York, we believe that New Jersey, Connecticut, Massachusetts, Pennsylvania, Rhode Island, Maine, and New Hampshire will represent an increasing portion of the total over the coming years.
 
Recent Developments
 
Developments During 2018
 
Expanded Licensing; Connecticut, Maine, and New Hampshire Expansion
 
In 2018, KICO continued to expanded its regional capabilities by obtaining a license to write insurance policies in Connecticut, Maine, and New Hampshire. Also in 2018, KICO’s homeowners insurance product was launched in Massachusetts. We anticipate writing business in Connecticut and Maine, in 2019.
 
● 
Increased Rate of Dividends Declared
 
In February 2018, we increased the quarterly dividends on our common stock from $.08 per share to $.10 per share.
 
Dividends of $.10 per share were declared on February 28, 2018, May 31, 2018, August 31, 2018, and November 30, 2018 which were paid on March 15, 2018, June 15, 2018, September 14, 2018, and December 14, 2018, respectively.
 
● 
Reduced Reliance on Quota Share Reinsurance
  
Effective July 1, 2018, KICO reduced the ceding percentage for its personal lines quota share reinsurance treaty from 20% to 10%. The reduction of the quota share ceding percentage allows KICO to retain a higher portion of its premiums and resultant expected profits.
 
 
2
 
 
● 
Increased Catastrophe Reinsurance Coverage
 
Effective July 1, 2018, KICO increased the top limit of its catastrophe reinsurance coverage to $450,000,000, which equates to more than a 1-in-250 year storm event according to the primary industry catastrophe model that we follow.
 
Developments During 2017
 
Public Offering of Common Stock
 
In January and February 2017, we sold a total of 2,692,500 newly issued shares of common stock in an underwritten public offering at a public offering price of $12.00 per share. We received net proceeds from the public offering of approximately $30,137,000 after deducting underwriting discounts and commissions, and other offering expenses. Concurrently, selling shareholders sold a total of 700,000 shares of our common stock. On March 1, 2017, we used $23,000,000 of the net proceeds from the offering to contribute capital to KICO in support of our ratings upgrade plan and anticipated growth, including geographic and product expansion.
 
A.M. Best Rating
 
In April 2017, A.M. Best upgraded our financial strength rating from B++ (Good) to A- (Excellent). This upgrade means that KICO has achieved its long-standing goal of becoming an A-rated carrier. The upgrade has resulted in increased growth from existing agents and additional opportunities with new agents and in new markets.
  
Expanded Licensing; New Jersey, Rhode Island, and Massachusetts Expansion
 
In 2017, KICO expanded its ability to write property and casualty insurance by obtaining a license to write insurance policies in Massachusetts. Also in 2017, KICO’s homeowners insurance products were launched in New Jersey and Rhode Island. We began writing New Jersey homeowners business in May and Rhode Island homeowners business in December.
  
Increased Rate of Dividends Declared
 
In May 2017, we increased the quarterly dividends on our common stock from $.0625 per share to $.08 per share.
 
A dividend of $.0625 per share was declared on February 7, 2017 and was paid on March 15, 2017. Dividends of $.08 per share were declared on May 10, 2017, August 9, 2017 and November 8, 2017 and were paid on June 15, 2017, September 15, 2017, and December 15, 2017, respectively.
 
 
3
 
 
● 
Reduced Reliance on Quota Share Reinsurance
 
Effective July 1, 2017, KICO reduced the ceding percentage for its personal lines quota share reinsurance treaty from 40% to 20%. The reduction of the quota share ceding percentage allows KICO to retain a higher portion of its premiums and resultant expected profits.
 
● 
Increased Catastrophe Reinsurance Coverage
 
Effective July 1, 2017, KICO increased the top limit of its catastrophe reinsurance coverage to $320,000,000, which equated, at that time, to more than a 1-in-250 year storm event according to the primary industry catastrophe model that we follow.
 
● 
Member of the Federal Home Loan Bank of New York (“FHLBNY”),
 
In July 2017, KICO became 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 various credit products, enabling members to customize advances. Advances are to be fully collateralized; eligible collateral to pledge includes residential and commercial mortgage backed securities, along with U.S. Treasury and agency securities.
 
Public Debt Offering
 
On December 19, 2017, we issued $30,000,000 of our 5.50% Senior Unsecured Notes due December 30, 2022, in an underwritten public offering. The net proceeds to us were approximately $29,122,000. On December 20, 2017, we used $25,000,000 of the net proceeds from the debt offering to contribute capital to KICO, to support additional growth. The remainder of the net proceeds will be used for general corporate purposes. Interest is payable semi-annually in arrears on June 30 and December 30 of each year, beginning on June 30 2018 at the rate of 5.50% per year from December 19, 2017.
 
(b) 
Business
 
Property and Casualty Insurance
 
Overview
 
Property and casualty insurance companies provide policies in exchange for premiums paid by their customers (the “insureds”). An insurance policy is a contract between the insurance company and its insureds where the insurance company agrees to pay for losses that are covered under the contract. Such contracts are subject to legal interpretation by courts, sometimes involving legislative rulings and/or arbitration. Property insurance generally covers the financial consequences of accidental losses to the insured’s property, such as a home and the personal property in it, or a business owner’s building, inventory and equipment. Casualty insurance (also referred to as liability insurance) generally covers the financial consequences related to the legal liability of an individual or an organization resulting from negligent acts and omissions that cause bodily injury and/or property damage to a third party. Claims for property coverage generally are reported and settled in a relatively short period of time, whereas those for casualty coverage may take many years to settle.
 
We generate revenues from earned premiums, ceding commissions from quota share reinsurance, net investment income generated from our investment portfolio, and net realized gains and losses on investment securities. We also collect a variety of policy feesincluding installment fees, reinstatement fees, and non-sufficient fund fees related to situations involving extended premium payment plans. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that coverage is provided (i.e., ratably over the life of the policy). All of our policies are 12 month policies; therefore, a significant period of time can elapse between the receipt of insurance premiums and the payment of claims. During this time, KICO invests the premiums, earning investment income and generating net realized and unrealized gains and losses on associated investments.
 
 
4
 
 
Insurance companies incur a significant amount of their total expenses from insured losses, which are commonly referred to as claims. In settling insured losses, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and legal expenses. In addition, insurance companies incur policy acquisition expenses, such as commissions paid to producers, premium taxes, and other expenses related to the underwriting process, including their employees’ compensation and benefits.
 
The key measure of relative underwriting performance for an insurance company is the combined ratio. An insurance company’s combined ratio is calculated by taking the ratio of incurred loss and LAE to earned premiums (the “loss and LAE ratio”) and adding it to the ratio of policy acquisition and other underwriting expenses to earned premiums (the “expense ratio”). A combined ratio under 100% indicates that an insurance company is generating an underwriting profit prior to the impact of investment income. After considering investment income and investment gains or losses, insurance companies operating at a combined ratio of greater than 100% can also be profitable.
 
Business; Strategy
 
We are a multi-line regional property and casualty insurance company writing business exclusively through retail and wholesale agents and brokers (“producers”) appointed by our wholly owned subsidiary, KICO. We are licensed to write insurance policies in New York, New Jersey, Connecticut, Maine, Massachusetts, New Hampshire, Pennsylvania, and Rhode Island.
 
We seek to deliver an attractive return on capital and to provide consistent earnings growth through underwriting profits and income from our investment portfolio. Our goal is to allocate capital efficiently to those lines of business that generate sustainable underwriting profits and to avoid lines of business for which an underwriting profit is not likely. Our strategy is to be the preferred multi-line property and casualty insurance company for selected producers in the geographic markets in which we operate. We believe producers place profitable business with us because we provide excellent, consistent service to insureds and claimants. Producers also value our financial stability coupled with competitive rate and commission structures. We offer a variety of personal and commercial lines products that further differentiate us from other companies that distribute through our selected producers.
 
Our principal objectives are to grow profitably while managing risk through prudent use of reinsurance in order to strengthen our capital base. We generate underwriting income through adequate pricing of insurance policies and by effectively managing our other underwriting and operating expenses. We are pursuing profitable growth by increasing the volume of business that we write with existing producers in existing markets, by developing new geographic markets and producer relationships, and by introducing niche products that are relevant to our producers and insureds.
 
For the year ended December 31, 2018, our gross written premiums totaled $146.7 million, an increase of 20.7% from the $121.6 million in gross written premium for the year ended December 31, 2017.
 
Product Lines
 
Our product lines include the following:
 
Personal lines - Our largest line of business is personal lines, consisting of homeowners and dwelling fire multi-peril, cooperative/condominiums, renters, and personal umbrella policies. Personal lines policies accounted for 81.8% of our gross written premiums for the year ended December 31, 2018.
 
 
5
 
 
Commercial liability - We offer businessowners policies that consist primarily of small business retail, service and office risks with limited a residential exposure. We also write artisan’s liability policies for small independent contractors with seven or fewer employees.  In addition, we write special multi-peril policies for larger and more specialized risks and businessowners risks, including those with limited residential exposures. Further, we write commercial umbrella policies above our supporting commercial lines policies. Commercial lines policies accounted for 11.4% of our gross written premiums for the year ended December 31, 2018.
 
Livery physical damage - We write for-hire vehicle physical damage only policies for livery and car service vehicles and taxicabs, primarily based in New York City. These policies insure only the physical damage portion of insurance for such vehicles, with no liability coverage included. These policies accounted for 6.7% of our gross written premiums for the year ended December 31, 2018.
 
Other - We write canine legal liability policies and have a small participation in mandatory state joint underwriting associations. These policies accounted for 0.1% of our gross written premiums for the year ended December 31, 2018.
 
Our Competitive Strengths
 
History of Growing Our Profitable Operations
 
KICO has been in operation in the State of New York for over 130 years. We have consistently grown the amount of profitable business that we write by introducing new products, increasing volume written with our selected producers in existing markets, and developing new producer relationships and markets. KICO has earned an underwriting profit in each of the past ten years, including in 2012 and 2013 when our financial results were adversely impacted by Superstorm Sandy. The extensive heritage of our insurance company subsidiary and our commitment to the markets in which we operate is a competitive advantage with producers and insureds.
 
Strong Producer Relationships
 
Within our selected producers’ offices, we compete with other property and casualty insurance carriers available to those producers. We carefully select the producers that distribute our insurance policies and continuously monitor and evaluate their performance. We believe our insurance producers value their relationships with us because we provide excellent, consistent personal service coupled with competitive rates and commission levels. We have consistently been rated by insurance producers as above average in the important areas of underwriting, claims handling and service. In the biennial performance surveys conducted by the Professional Insurance Agents of New York and New Jersey of its membership since 2010, KICO was rated as one of the top performing insurance companies in New York, twice ranking as the top rated carrier among all those surveyed. Our relationship with Selected Producers was further strengthened by the A.M. Best upgrade to a financial strength rating of A- (Excellent) in April 2017. This has allowed us to provide many producers with an A- rated carrier option that was not previously available to them in the markets where we operate.
 
We offer our selected producers access to a variety of personal and commercial lines products, including some that are unique to us. Many of our producers write multiple lines of business with us which is an advantage relative to competitors that are focused on a single product. We provide a multi-policy discount on homeowners policies in order to attract and retain more of this multi-line business. We have had a consistent presence in the New York market and our producers value the longevity of the relationship. We believe that the excellent service provided to our selected producers, our broad product offerings, and our consistent prices and financial stability provide a strong foundation for continued profitable growth.
 
 
6
 
 
Sophisticated Underwriting and Risk Management Practices
 
We believe that a significant underwriting advantage exists due to our local market presence and expertise. Our underwriting process evaluates and screens out certain risks based on property reports, individual insurance scoring, and information collected from physical property inspections and driving records. We maintain certain policy exclusions that reduce our exposure to risks that can create severe losses. We target a preferred risk profile in order to reduce adverse selection from risks seeking the lowest premiums and minimal coverage levels.
 
Our underwriting procedures, premium rates and policy terms support the underwriting profitability of our personal lines policies. We apply premium surcharges for certain coastal properties and maintain deductibles for hurricane-prone exposures in order to provide an appropriate premium for the risk of loss. We manage coastal risk exposure through use of individual catastrophe risk scoring and prudent use of reinsurance.
 
Our underwriting expertise and risk management practices enable us to profitably write personal and commercial lines business in our markets without the need for frequent rate adjustments, in contrast to many of our competitors. We believe that consistency in rates and availability of our insurance products are important factors in maintaining our selected producer relationships.
 
Effective Utilization of Reinsurance
 
Our reinsurance treaties allow us to limit our exposure to the financial impact of catastrophe losses and to reduce our net liability on individual risks. Our reinsurance program is structured to enable us to grow our premium volume while maintaining regulatory capital and other financial ratios within thresholds used for regulatory oversight purposes.
 
Our reinsurance program also provides income from ceding commissions earned pursuant to quota share reinsurance contracts. The income we earn from ceding commissions typically exceeds our fixed operating costs, which consist of other underwriting expenses. Quota share reinsurance treaties transfer a portion of the profit (or loss) associated with the subject insurance policies to the reinsurers. We believe that the continued reduction in our reliance on quota share reinsurance could increase our overall net underwriting profits.
 
Scalable, Low-Cost Operations
 
We focus on efficiently managing our expenses, and invest in tools and processes that improve the effectiveness of underwriting risks and processing claims. We evaluate the costs and benefits of each new tool or process in order to achieve optimal results. While the majority of our policies are written for risks in downstate New York, our Kingston, New York location provides a low-cost operating environment. We now have a dedicated customer service unit located in Kingston that has significantly improved the speed at which we respond to customers.
 
 
7
 
 
We continue to invest in improving our online application and quoting systems for our personal lines and commercial products. We have leveraged a paperless workflow management and document storage tool that has improved efficiency and reduced costs. In late 2017, we introduced an online payment portal that provides the ability for insureds to make payments and to view policy information for all of our products in one location. Our ability to control the growth of our operating and other expenses while expanding our operations and growing revenue at a higher rate is a key component of our business model and is important to our future financial success.
 
               Underwriting and Claims Management Philosophy
 
Our underwriting philosophy is to target niche risk segments for which we have detailed expertise and can take advantage of market conditions. We monitor results on a regular basis and our selected producers are reviewed by management on at least a quarterly basis.
 
We believe that our rates are appropriately competitive with other carriers in our target markets.  We believe that rate consistency and the reliable availability of our products is important to producers.  We do not seek to grow by competing based solely upon price.  We seek to develop long-term relationships with our selected producers who understand and appreciate the consistent path we have chosen.  We carefully underwrite our business utilizing industry claims databases, insurance scoring reports, physical inspection of risks and other individual risk underwriting tools. We write homeowners and dwelling fire business in coastal markets and are cognizant of our exposure to hurricanes. We have mitigated this risk through appropriate catastrophe reinsurance and application of hurricane deductibles. We handle claims fairly while ensuring that coverage provisions and exclusions are properly applied. Our claims and underwriting expertise supports our ability to grow our profitable business.
 
Distribution
 
We generate business through our relationships with over 500 producers. We carefully select our producers by evaluating numerous factors such as their need for our products, premium production potential, loss history with other insurance companies that they represent, product and market knowledge, and agency size. We only distribute through agents and have never sought to distribute our products direct to the consumer. We monitor and evaluate the performance of our producers through periodic reviews of volume and profitability. Our senior executives are actively involved in managing our producer relationships.
 
Each producer is assigned to a personal and commercial lines underwriter and the producer can call that underwriter directly on any matter. We believe that the close relationship and personal service received from with their underwriters is a principal reason producers place their business with us. Our producers have access to a KICO website portal that provides them the ability to quote risks for various products and to review policy forms and underwriting guidelines for all lines of business. We send out frequent “Producer Grams” in order to inform our producers of updates at KICO. In addition, we have an active Producer Council, made up of 11 active producers, to advise us on market developments; and we have at least one annual meeting with all of our producers.
 
Competition; Market
 
The insurance industry is highly competitive. We constantly assess and make projections for the market conditions and prices for our products, but we cannot fully know our profitability until all claims have been reported and settled.
 
Our policyholders are located primarily in the downstate regions of New York State, but we are actively growing into other Northeast markets, including New Jersey and Rhode Island during 2017 followed by Massachusetts in 2018. In addition, we are licensed to write insurance policies in Connecticut, Maine, New Hampshire and Pennsylvania. We anticipate launching a homeowners product in Connecticut and Maine in 2019. These new homeowners markets align well with the niche markets that have generated profitable results in New York, and we believe that our market expertise can be effectively utilized in these new markets.
 
 
8
 
 
In 2017, KICO was the 15th largest writer of homeowners and dwelling fire insurance in the State of New York, according to data compiled by SNL Financial LLC. Based on the same data, in 2017, we had a 1.3% market share for this combined group of personal lines property business. We compete with large national carriers as well as regional and local carriers in the property and casualty marketplace in New York and other states. We believe that many national and regional carriers have chosen to limit their rate of premium growth or to decrease their presence in Northeastern states due to the relatively high coastal population and associated catastrophe risk that exists in the region.
 
Given present market conditions, we believe that we have the opportunity to significantly expand the size of our personal and commercial lines business in New York, New Jersey, and other northeastern states in which we are licensed.
 
Loss and Loss Adjustment Expense Reserves
 
We are required to establish reserves for incurred losses that are unpaid, including reserves for claims and loss adjustment expenses (“LAE”), which represent the expenses of settling and adjusting those claims. These reserves are balance sheet liabilities representing estimates of future amounts required to pay losses and loss expenses for claims that have occurred at or before the balance sheet date, whether already known to us or not yet reported. We establish these reserves after considering all information known to us as of the date they are recorded.
 
Loss reserves fall into two categories: case reserves for reported losses and LAE associated with specific reported claims, and reserves for losses and LAE that are incurred but not reported (“IBNR”). We establish these two categories of loss reserves as follows:
 
Reserves for reported losses - When a claim is received, we establish a case reserve for the estimated amount of its ultimate settlement and its estimated loss expenses. We establish case reserves based upon the known facts about each claim at the time the claim is reported and we may subsequently increase or reduce the case reserves as additional facts and information about each claim develops.
 
IBNR reserves - We also estimate and establish reserves for loss and LAE amounts incurred but not reported (“IBNR”). IBNR reserves are calculated in bulk as an estimate of ultimate losses and LAE less reported losses and LAE. There are two types of IBNR; the first is a provision for claims that have occurred but are not yet reported or known. We refer to this as ‘Pure’ IBNR, and due to the fact that we write primarily quickly reported property lines of business, this type of IBNR does not make up a large portion of KICO’s total IBNR. The second type of IBNR is a provision for expected future development on known claims, from the evaluation date until the time claims are settled and closed. We refer to this as ‘Case Development’ IBNR and it makes up the majority of the IBNR that KICO records. Ultimate losses driving the determination of appropriate IBNR levels are projected by using generally accepted actuarial techniques.
 
The liability for loss and LAE represents our best estimate of the ultimate cost of all reported and unreported losses that are unpaid as of the balance sheet evaluation date. The liability for loss and LAE is estimated on an undiscounted basis, using individual case-basis valuations, statistical analyses and various actuarial procedures. The projection of future claim payment and reporting is based on an analysis of our historical experience, supplemented by analyses of industry loss data. We believe that the reserves for loss and LAE are adequate to cover the ultimate cost of losses and claims to date. However, because of the uncertainty from various sources, including changes in claims settlement patterns and handling procedures, litigation trends, judicial decisions, and economic conditions, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such liabilities at the balance sheet date. As adjustments to these estimates become necessary, they are reflected in the period in which the estimates are changed. Because of the nature of the business historically written, we believe that we have limited exposure to asbestos and environmental claim liabilities.
 
 
9
 
 
We engage an independent external actuarial specialist (the ‘Appointed Actuary’) to opine on our recorded statutory reserves. The Appointed Actuary estimates a range of ultimate losses, along with a range and recommended central estimate of IBNR reserve amounts. Our carried IBNR reserves are based on an internal actuarial analysis and reflect management’s best estimate of unpaid loss and LAE liabilities, and fall within the range of those determined as reasonable by the Appointed Actuary.
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Principal Revenue and Expense Items” in Item 7 of this Annual Report and Note 2 and Note 11 in the accompanying Financial Statements for additional information and details regarding our LAE.
Reconciliation of Loss and Loss Adjustment Expenses
 
The table below shows the reconciliation of loss and LAE on a gross and net basis, reflecting changes in losses incurred and paid losses:
 
 
 
 Years ended
 
 
 
 December 31,
 
 
 
2018
 
 
2017
 
 
 
 
 
 Balance at beginning of period
 $48,799,622 
 $41,736,719 
 Less reinsurance recoverables
  (16,748,908)
  (15,776,880)
 Net balance, beginning of period
  32,050,714 
  25,959,839 
 
    
    
 Incurred related to:
    
    
 Current year
  57,143,077 
  34,246,081 
 Prior years
  1,152,128 
  (60,544)
 Total incurred
  58,295,205 
  34,185,537 
 
    
    
 Paid related to:
    
    
 Current year
  34,025,387 
  18,194,860 
 Prior years
  15,794,673 
  9,899,802 
 Total paid
  49,820,060 
  28,094,662 
  
    
    
 Net balance at end of period
  40,525,859 
  32,050,714 
 Add reinsurance recoverables
  15,671,247 
  16,748,908 
 Balance at end of period
 $56,197,106 
 $48,799,622 
  
Our claims reserving practices are designed to set reserves that, in the aggregate, are adequate to pay all claims at their ultimate settlement value.
 
Loss and Loss Adjustment Expenses Development
 
The table below shows the net loss development of reserves held as of each calendar year-end from 2008 through 2018.
 
The first section of the table reflects the changes in our loss and LAE reserves after each subsequent calendar year of development. The table displays the re-estimated values of incurred losses and LAE at each succeeding calendar year-end, including payments made during the years indicated. The second section of the table shows by year the cumulative amounts of loss and LAE payments, net of amounts recoverable from reinsurers, as of the end of each succeeding year. An example with respect to the net loss and LAE reserves of $6,001,000 as of December 31, 2009 is as follows. By December 31, 2011 (two years later), $3,992,000 had actually been paid in settlement of the claims that relate to liabilities as of December 31, 2009. The re-estimated ultimate reserves for those claims as of December 31, 2011 (two years later) had grown to $6,393,000.
 
The “cumulative redundancy (deficiency)” represents, as of December 31, 2018, the difference between the latest re-estimated liability and the amounts as originally estimated. A redundancy means that the original estimate was higher than the current estimate. A deficiency means that the current estimate is higher than the original estimate. Estimates for the liabilities in place as of more recent evaluation dates have developed more favorably than those from older evaluation points, especially as a percentage of the starting estimate.
 
 
10
 
 
 
 
(in thousands of $)
 
2008
 
 
2009
 
 
2010
 
 
2011
 
 
2012
 
 
2013
 
 
2014
 
 
2015
 
 
2016
 
 
2017
 
 
2018
 
Reserve for loss and loss adjustment expenses, net of reinsurance recoverables
  5,823 
  6,001 
  7,280 
  8,520 
  12,065 
  17,139 
  21,663 
  23,170 
  25,960 
  32,051 
  32,051 
Net reserve estimated as of One year later
  6,119 
  6,235 
  7,483 
  9,261 
  13,886 
  18,903 
  21,200 
  23,107 
  25,899 
  33,203 
    
Two years later
  6,609 
  6,393 
  8,289 
  11,022 
  16,875 
  18,332 
  21,501 
  24,413 
  26,970 
    
    
Three years later
  6,729 
  6,486 
  9,170 
  12,968 
  16,624 
  18,687 
  22,576 
  25,509 
    
    
    
Four years later
  6,711 
  7,182 
  10,128 
  12,552 
  16,767 
  19,386 
  23,243 
    
    
    
    
Five years later
  7,261 
  7,766 
  9,925 
  12,440 
  16,985 
  19,449 
    
    
    
    
    
Six years later
  7,727 
  7,602 
  9,932 
  12,367 
  16,959 
    
    
    
    
    
    
Seven years later
  7,554 
  7,615 
  9,779 
  12,307 
    
    
    
    
    
    
    
Eight years later
  7,511 
  7,455 
  9,676 
    
    
    
    
    
    
    
    
Nine years later
  7,330 
  7,406 
    
    
    
    
    
    
    
    
    
Ten years later
  7,284 
    
    
    
    
    
    
    
    
    
    
Net cumulative redundancy (deficiency)
  (1,461)
  (1,405)
  (2,396)
  (3,787)
  (4,894)
  (2,310)
  (1,580)
  (2,339)
  (1,010)
  (1,152)
    
 
(in thousands of $)
 
2008
 
 
2009
 
 
2010
 
 
2011
 
 
2012
 
 
2013
 
 
2014
 
 
2015
 
 
2016
 
 
2017
 
 
2018
 
Cumulative amount of reserve paid, net of reinsurance recoverable through
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One year later
  2,533 
  2,307 
  3,201 
  3,237 
  4,804 
  6,156 
  8,500 
  8,503 
  9,900 
  15,795 
 
 
 
Two years later
  3,974 
  3,992 
  4,947 
  5,661 
  8,833 
  10,629 
  12,853 
  14,456 
  17,187 
    
 
 
 
Three years later
  5,054 
  4,659 
  6,199 
  8,221 
  11,873 
  13,571 
  16,564 
  19,533 
    
    
 
 
 
Four years later
  5,373 
  5,238 
  7,737 
  10,100 
  13,785 
  16,166 
  19,838 
    
    
    
 
 
 
Five years later
  5,717 
  5,997 
  8,585 
  10,903 
  15,479 
  17,262 
    
    
    
    
 
 
 
Six years later
  6,224 
  6,562 
  8,941 
  11,417 
  15,882 
    
    
    
    
    
 
 
 
Seven years later
  6,718 
  6,749 
  9,275 
  11,725 
    
    
    
    
    
    
 
 
 
Eight years later
  6,853 
  7,022 
  9,559 
    
    
    
    
    
    
    
 
 
 
Nine years later
  7,103 
  7,298 
    
    
    
    
    
    
    
    
 
 
 
Ten years later
  7,190 
    
    
    
    
    
    
    
    
    
 
 
 
 
    
    
    
    
    
    
    
    
    
    
 
 
 
Net reserve -
    
    
    
    
    
    
    
    
    
    
 
 
 
December 31,
  5,823 
  6,001 
  7,280 
  8,520 
  12,065 
  17,139 
  21,663 
  23,170 
  25,960 
  32,051 
  40,526 
* Reinsurance Recoverable
  9,766 
  10,512 
  10,432 
  9,960 
  18,420 
  17,364 
  18,250 
  16,707 
  15,777 
  16,749 
  15,671 
* Gross reserves -
    
    
    
    
    
    
    
    
    
    
    
  December 31,
  15,589 
  16,513 
  17,712 
  18,480 
  30,485 
  34,503 
  39,913 
  39,877 
  41,737 
  48,800 
  56,197 
 
    
    
    
    
    
    
    
    
    
    
    
Net re-estimated reserve
  7,284 
  7,406 
  9,676 
  12,307 
  16,959 
  19,449 
  23,243 
  25,509 
  26,970 
  33,203 
    
Re-estimated reinsurance recoverable
  12,503 
  12,506 
  13,154 
  13,797 
  28,355 
  21,048 
  21,231 
  18,810 
  17,285 
  16,852 
    
Gross re-estimated reserve
  19,787 
  19,912 
  22,830 
  26,104 
  45,314 
  40,497 
  44,474 
  44,319 
  44,255 
  50,055 
    
 
    
    
    
    
    
    
    
    
    
    
    
Gross cumulative redundancy (deficiency)
  (4,198)
  (3,399)
  (5,118)
  (7,624)
  (14,829)
  (5,994)
  (4,561)
  (4,442)
  (2,518)
  (1,255)
    
 
               Reinsurance
 
We purchase reinsurance to reduce our net liability on individual risks, to protect against possible catastrophes, to remain within a target ratio of net premiums written to policyholders’ surplus, and to expand our underwriting capacity. Participation in reinsurance arrangements does not relieve us from our obligations to policyholders. Our reinsurance program is structured to reflect our obligations and goals. 
 
 
11
 
 
Reinsurance via quota share allows a carrier to write business without increasing its underwriting leverage above a level determined by management. The business written under a quota share reinsurance structure obligates a reinsurer to assume some portion of the risks involved, and gives the reinsurer the profit (or loss) associated with such in exchange for a ceding commission.  We have determined it to be in the best interests of our shareholders to prudently reduce our reliance on quota share reinsurance.  This will result in higher earned premiums and a reduction in ceding commission revenue in future years but will allow us to retain more net income from our profitable business.
 
Our quota share reinsurance treaties in effect for the year ended December 31, 2018 for our personal lines business, which primarily consists of homeowners policies, were covered under the July 1, 2017/June 30, 2018 treaty year and the new treaty year that began on July 1, 2018 (“2017/2019 Treaty”) (two year treaty). In August 2018, we terminated our contract with one of the reinsurers that was a party to the 2017/2019 Treaty. This termination was retroactive to July 1, 2018 and had the effect of reducing the quota share ceding rate to 10% from 20%.
 
 Excess of loss contracts provide coverage for individual loss occurrences exceeding a certain threshold. The quota share reinsurance treaties inure to the benefit of our excess of loss treaties, as the maximum net retention on any single risk occurrence is first limited through the excess of loss treaty, and then that loss is shared again through the quota share reinsurance treaty. Our maximum net retention under the quota share and excess of loss treaties for any one personal lines occurrence for dates of loss on or after July 1, 2018 is $900,000. Commercial lines policies are not subject to a quota share reinsurance treaty. Our maximum net retention under the excess of loss treaties for any one commercial general liability occurrence for dates of loss on or after July 1, 2018 is $750,000.
 
We earn ceding commission revenue under the quota share reinsurance treaties based on a provisional commission rate on all premiums ceded to the reinsurers as adjusted by a sliding scale based on the ultimate treaty year loss ratios on the policies reinsured under each agreement. The sliding scale provides minimum and maximum ceding commission rates in relation to specified ultimate loss ratios.
 
Under the 2017/2019 Treaty and 2016/2017 Treaty, KICO is receiving a higher upfront fixed provisional rate than in prior years’ treaties. In exchange for the higher provisional rate, KICO has a reduced opportunity to earn sliding scale contingent commissions.
 
The 2017/2019 Treaty and the 2016/2017 Treaty are on a “net” of catastrophe reinsurance basis, as opposed to the “gross” arrangement that existed in prior treaties. Under a “net” arrangement, all catastrophe reinsurance coverage is purchased directly by us. Since we pay for all of the catastrophe coverage, none of the losses covered under a catastrophic event will be included in the quota share ceded amounts, drastically reducing the adverse impact that a catastrophic event can have on ceding commissions.
 
In 2018, we purchased catastrophe reinsurance to provide coverage of up to $450,000,000 for losses associated with a single event. One of the most commonly used catastrophe forecasting models prepared for us indicates that the catastrophe reinsurance treaties provide coverage in excess of our estimated probable maximum loss associated with a single more than one-in-250 year storm event. The direct retention for any single catastrophe event is $5,000,000. Effective July 1, 2018 losses on personal lines policies are subject to the 10% quota share treaty, which results in a net retention by us of $4,500,000 of exposure per catastrophe occurrence. Effective July 1, 2018, we have reinstatement premium protection on the first $210,000,000 layer of catastrophe coverage in excess of $5,000,000. This protects us from having to pay an additional premium to reinstate catastrophe coverage for an event up to this level.
 
 
12
 
 
Investments
 
Our investment portfolio, including cash and cash equivalents, and short term investments, as of December 31, 2018 and 2017, is summarized in the table below by type of investment.
 
 
 
December 31, 2018
 
 
December 31, 2017
 
 
 
 Carrying
 
 
% of
 
 
 Carrying
 
 
% of
 
 Category
 
 Value
 
 
Portfolio
 
 
 Value
 
 
Portfolio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Cash and cash equivalents
 $21,138,403 
  10.8%
 $48,381,633 
  25.8%
 
    
    
    
    
 Held to maturity
    
    
    
    
 U.S. Treasury securities and
    
    
    
    
 obligations of U.S. government
    
    
    
    
 corporations and agencies
  729,507 
  0.4%
  729,466 
  0.4%
 
    
    
    
    
 Political subdivisions of states,
    
    
    
    
 territories and possessions
  998,803 
  0.5%
  998,984 
  0.5%
 
    
    
    
    
 Corporate and other bonds
    
    
    
    
 Industrial and miscellaneous
  2,494,545 
  1.3%
  3,141,358 
  1.7%
 
    
    
    
    
 Available for sale
    
    
    
    
 U.S. Treasury securities and
    
    
    
    
 obligations of U.S. government
    
    
    
    
 corporations and agencies
  8,220,381 
  4.2%
  - 
  0.0%
 
    
    
    
    
 Political subdivisions of states,
    
    
    
    
 territories and possessions
  6,341,608 
  3.2%
  11,315,443 
  6.0%
 
    
    
    
    
 Corporate and other bonds
    
    
    
    
 Industrial and miscellaneous
  115,750,293 
  59.2%
  88,141,465 
  47.0%
 
    
    
    
    
 Residential mortgage backed securities
  21,465,234 
  11.0%
  20,531,348 
  10.9%
 
    
    
    
    
 Other
    
    
    
    
 Preferred stocks
  6,152,956 
  3.1%
  7,000,941 
  3.7%
 
    
    
    
    
 Common stocks
  10,419,660 
  5.3%
  7,285,257 
  3.9%
 
    
    
    
    
 Other investments
  1,855,225 
  1.0%
  - 
  0.0%
 Total
 $195,566,615 
  100.0%
 $187,525,895 
  100.0%
 
 
13
 
 
The table below summarizes the credit quality of our fixed-maturity securities available-for-sale as of December 31, 2018 and 2017 as rated by Standard and Poor’s (or if unavailable from Standard and Poor’s, then Moody’s or Fitch):
 
 
 
December 31, 2018
 
 
December 31, 2017
 
 
 
 
 
 Estimated
 
 
 Percentage of
 
 
 Estimated
 
 
 Percentage of
 
 
 
 
 
 Fair Market
 
 
 Fair Market
 
 
 Fair Market
 
 
 Fair Market
 
 

 
 
 Value
 
 
 Value
 
 
 Value
 
 
 Value
 
 
 
 
 
 
 
 
 
 
 Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 U.S. Treasury securities
 
 $8,220,381 
  5.4%
 $- 
  0.0%
 
 
 
    
    
    
    
 
 Corporate and municipal bonds
 
    
    
    
    
 
AAA
 
  979,123 
  0.6%
  1,358,143 
  1.1%
 
AA
 
  8,350,910 
  5.5%
  11,319,057 
  9.4%
     A 
  27,665,961 
  18.2%
  17,199,631 
  14.3%
 
BBB
 
  85,095,907 
  56.1%
  68,704,768 
  57.3%
 
BB
 
  - 
  0.0%
  875,310 
  0.7%
 
 Total corporate and municipal bonds
 
  122,091,901 
  80.4%
  99,456,909 
  82.8%
    
    
    
    
    
 
 Residential mortgage backed securities
 
    
    
    
    
 
AAA
 
  999,640 
  0.7%
  2,013,010 
  1.7%
 
AA
 
  12,743,906 
  8.5%
  11,021,144 
  9.2%
     A 
  4,777,356 
  3.1%
  3,902,768 
  3.3%
 
    CCC
 
  1,440,825 
  0.9%
  1,420,296 
  1.2%
 
    CC
 
  109,648 
  0.1%
  120,742 
  0.1%
     C 
  24,050 
  0.0%
  28,963 
  0.0%
     D 
  390,542 
  0.3%
  1,659,479 
  1.4%
 
 Non rated
 
  979,267 
  0.6%
  364,945 
  0.3%
 Total residential mortgage backed securities
  21,465,234 
  14.2%
  20,531,347 
  17.2%
    
    
    
    
    
 
 Total
 
 $151,777,516 
  100.0%
 $119,988,256 
  100.0%
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Principal Revenue and Expense Items” in Item 7 of this Annual Report and Note 2 and Note 11 in the accompanying Financial Statements for additional information.
 
Ratings
 
Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by A.M. Best and other agencies to assist them in assessing the financial strength and overall quality of the companies with which they do business and from which they are considering purchasing insurance or in determining the financial strength of the company that provides insurance with respect to the collateral they hold. A.M. Best financial strength ratings are derived from an in-depth evaluation of an insurance company’s balance sheet strengths, operating performances and business profiles. A.M. Best evaluates, among other factors, the company’s capitalization, underwriting leverage, financial leverage, asset leverage, capital structure, quality and appropriateness of reinsurance, adequacy of reserves, quality and diversification of assets, liquidity, profitability, spread of risk, revenue composition, market position, management, market risk and event risk. A.M. Best financial strength ratings are intended to provide an independent opinion of an insurer’s ability to meet its obligations to policyholders and are not an evaluation directed at investors.
 
 
14
 
 
In November 2016, we commenced a plan of action to upgrade KICO’s A.M. Best rating. In April 2017, A.M. Best upgraded the Financial Strength Rating (FSR) of KICO to A- (Excellent) from B++ (Good). The A.M. Best financial strength rating of A- (Excellent) has created significant additional demand from our existing producers, particularly for our New York homeowners business where we compete against many carriers that are not A- rated by A.M. Best. Other ratings assigned to KICO and Kingstone by A.M. Best and Kroll Bond Rating Agency are as follows:
 
 
 
 
 Kingstone
 
 KICO
 
 Companies
 
 
 
 
 A.M. Best Long-Term issuer credit rating (ICR)
 a- (stable outlook)
 
 bbb- (stable outlook)
 A.M. Best Long-Term issue credit rating (IR)
 
 
 
 $30.0 million, 5.50% senior unsecured notes due Dec. 30, 2022
 n/a
 
 bbb- (stable outlook)
 Kroll Bond Rating Agency insurance financial strength rating (IFSR)
 A- (stable outlook)
 
 n/a
 Kroll Bond Rating Agency issuer rating
 n/a
 
 BBB- (stable outlook)
 $30.0 million, 5.50% senior unsecured notes due Dec. 30, 2022
 n/a
 
 BBB- (stable outlook)
 
KICO also has a Demotech financial stability rating of A (Exceptional) which generally makes its policies acceptable to mortgage lenders that require homeowners to purchase insurance from highly rated carriers.
 
Catastrophe Losses
 
In 2018 we had catastrophe losses, which are defined as losses from an event for which a catastrophe bulletin and related serial number has been issued by the Property Claims Services (PCS) unit of the Insurance Services Office (ISO). PCS catastrophe bulletins are issued for events that cause more than $25 million in total insured losses and affect a significant number of policyholders and insurers. Our predominant market, downstate New York, was affected by several events, including one large event during the winter of 2018. These claims were primarily from losses due to frozen pipes and related water damage resulting from abnormally low temperatures for an extended period. The effects of this catastrophe and other minor catastrophes during the year increased our net loss ratio by 6.0 percentage points in 2018. During the relatively mild winter of 2017, there was no catastrophe impact from large storm events.
 
Government Regulation
 
Holding Company Regulation
 
We, as the parent of KICO, are subject to the insurance holding company laws of the state of New York. These laws generally require an insurance company to register with the New York State Department of Financial Services (the “DFS”) and to furnish annually financial and other information about the operations of companies within our holding company system. Generally, under these laws, all material transactions among companies in the holding company system to which KICO is a party must be fair and reasonable and, if material or of a specified category, require prior notice and approval or acknowledgement (absence of disapproval) by the DFS.
 
Change of Control
 
The insurance holding company laws of the state of New York require approval by the DFS for any change of control of an insurer. “Control” is generally defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the company, whether through the ownership of voting securities, by contract or otherwise. Control is generally presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. Any future transactions that would constitute a change of control of KICO, including a change of control of Kingstone Companies, Inc., would generally require the party acquiring control to obtain the approval of the DFS (and in any other state in which KICO may operate). Obtaining these approvals may result in the material delay of, or deter, any such transaction. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of Kingstone Companies, Inc., including through transactions, and in particular unsolicited transactions, that some or all of our stockholders might consider to be desirable.
 
 
15
 
 
State Insurance Regulation
 
Insurance companies are subject to regulation and supervision by the department of insurance in the state in which they are domiciled and, to a lesser extent, other states in which they conduct business. The primary purpose of such regulatory powers is to protect individual policyholders. State insurance authorities have broad regulatory, supervisory and administrative powers, including, among other things, the power to grant and revoke licenses to transact business, set the standards of solvency to be met and maintained, determine the nature of, and limitations on, investments and dividends, approve policy forms and rates, and in some instances to regulate unfair trade and claims practices.
 
KICO is required to file detailed financial statements and other reports with the insurance regulatory authorities in the states in which it is licensed to transact business. These financial statements are subject to periodic examination by the insurance regulators.
 
In addition, many states have laws and regulations that limit an insurer’s ability to withdraw from a particular market. For example, states may limit an insurer’s ability to cancel or not renew policies. Furthermore, certain states prohibit an insurer from withdrawing from one or more lines of business written in the state, except pursuant to a plan that is approved by the insurance regulatory authority. The state regulator may reject a plan that may lead to market disruption. Laws and regulations, including those in New York, that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict the ability of KICO to exit unprofitable markets. Such laws did not affect KICO’s ability to withdraw from the commercial auto market in New York State in 2015. On January 29, 2019, KICO was granted permission by the Texas Department of Insurance to withdraw from the Texas insurance market for which it never commenced business since receiving its certificate of authority in August 2015.
 
Federal and State Legislative and Regulatory Changes
 
From time to time, various regulatory and legislative changes have been proposed in the insurance industry. Among the proposals that either have been or are being considered are the possible introduction of Federal regulation in addition to, or in lieu of, the current system of state regulation of insurers, and proposals in various state legislatures. Some of these proposals have been enacted to conform portions of their insurance laws and regulations to various model acts adopted by the National Association of Insurance Commissioners (the “NAIC”).
 
In 2017, the DFS implemented new comprehensive cybersecurity regulations, which became effective on March 1, 2017 with transitional implementation periods. When fully implemented, in March 1, 2019, the regulations require covered entities, including KICO, to establish a cybersecurity policy, a chief information security officer, oversight over third party service providers, penetration and vulnerability assessments, secure systems to maintain an audit trail, risk assessments to include access privileges to nonpublic information, use of multi-factor authentication, and an incident response plan, among other provisions. Commencing February 15, 2018, and annually thereafter, KICO must certify compliance to the DFS with the applicable cybersecurity regulatory provisions.
 
 
16
 
 
In 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became law. It established a Federal Insurance Office (the “FIO”) within the U.S. Department of the Treasury. The FIO is initially charged with monitoring all aspects of the insurance industry (other than health insurance, certain long-term care insurance and crop insurance), gathering data, and conducting a study on methods to modernize and improve the insurance regulatory system in the United States. In December 2013, the FIO issued a report (as required under the Dodd-Frank Act) entitled “How to Modernize and Improve the System of Insurance Regulation in the United States” (the “Report”), which stated that, given the “uneven” progress the states have made with several near-term state reforms, should the states fail to accomplish the necessary modernization reforms in the near term, “Congress should strongly consider direct federal involvement.” The FIO continues to support the current state-based regulatory regime, but will consider federal regulation should the states fail to take steps to greater uniformity (e.g., federal licensing of insurers). In 2017, the new President indicated that the provisions of this law should be reviewed. In its September 2018 Annual Report on the Insurance Industry (the “Report”), FIO provided an overview of its statutory responsibilities and its role, as described in the October 2017 Treasury report, A Financial System That Creates Economic Opportunities: Asset Management and Insurance (the “EO Report”). The Report then summarizes FIO’s key activities since those described in its 2017 Annual Report on the Insurance Industry. Next, the Report provides a summary of the EO Report. Sections II through V are organized around the four key themes from the EO Report: (1) Systemic Risk and Solvency; (2) Efficient Regulation and Government Processes; (3) International Engagement; and (4) Economic Growth and Informed Choices. The Report concludes with a discussion and analysis of the insurance industry’s financial performance in calendar year 2017, its financial condition as of December 31, 2017, and the domestic insurance market outlook for 2018.
 
On December 22, 2017, President Donald Trump signed into law a budget reconciliation act commonly referred to as the Tax Cuts and Jobs Act (TCJA). Overall, the reduction of the U.S. corporate tax rate to 21 percent will generally lower the effective tax rates of insurance companies operating in the United States.
 
State Regulatory Examinations
 
As part of their regulatory oversight process, state regulatory authorities conduct periodic detailed examinations of the financial reporting of insurance companies domiciled in their states, generally once every three to five years. Examinations are generally carried out in cooperation with the insurance regulators of other states under guidelines promulgated by the NAIC. The New York DFS commenced its examination of KICO in 2016 as of December 31, 2015. The examination was completed in 2017 without any material adverse findings.
 
Risk-Based Capital Regulations
 
State regulatory authorities impose risk-based capital (“RBC”) requirements on insurance enterprises. The RBC Model serves as a benchmark for the regulation of insurance companies. RBC provides for targeted surplus levels based on formulas, which specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk, and are set forth in the RBC requirements. Such formulas focus on four general types of risk: (a) the risk with respect to the company’s assets (asset or default risk); (b) the risk of default on amounts due from reinsurers, policyholders, or other creditors (credit risk); (c) the risk of underestimating liabilities from business already written or inadequately pricing business to be written in the coming year (underwriting risk); and (d) the risk associated with items such as excessive premium growth, contingent liabilities, and other items not reflected on the balance sheet (off-balance sheet risk). The amount determined under such formulas is called the authorized control level RBC (“ACL”).
 
The RBC guidelines define specific capital levels based on a company’s ACL that are determined by the ratio of the company’s total adjusted capital (“TAC”) to its ACL. TAC is equal to statutory capital, plus or minus certain other specified adjustments. KICO’s TAC is far above the ACL and is in compliance with New York’s RBC requirements as of December 31, 2018.
 
Dividend Limitations
 
Our ability to receive dividends from KICO is restricted by the state laws and insurance regulations of New York. These restrictions are related to surplus and net investment income. Dividends are restricted to the lesser of 10% of surplus or 100% of investment income (on a statutory accounting basis) for the trailing 36 months, less dividends by KICO paid during such period.
 
 
17
 
 
Insurance Regulatory Information System Ratios
 
The Insurance Regulatory Information System (“IRIS”) was developed by the NAIC and is intended primarily to assist state insurance regulators in meeting their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business. As of December 31, 2018, KICO did not have any ratios outside the usual range.
 
Accounting Principles
 
Statutory accounting principles (“SAP”) are a basis of accounting developed by the NAIC. They are used to prepare the statutory financial statements of insurance companies and to assist insurance regulators in monitoring and regulating the solvency of insurance companies. SAP is primarily concerned with measuring an insurer’s policyholder surplus. Accordingly, statutory accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state.
 
Generally accepted accounting principles (“GAAP”) are concerned with a company’s solvency, but are also concerned with other financial measurements, principally income and cash flows. Accordingly, GAAP gives more consideration to appropriate matching of revenue and expenses and accounting for management’s stewardship of assets than does SAP. As a direct result, different types and amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as compared to SAP.
 
Statutory accounting practices established by the NAIC and adopted in part by New York insurance regulators determine, among other things, the amount of statutory surplus and statutory net income of KICO and thus determine, in part, the amount of funds that are available to Kingstone Companies, Inc. from which to pay dividends.
 
Legal Structure
 
             We were incorporated in 1961 and assumed the name DCAP Group, Inc. in 1999. On July 1, 2009, we changed our name to Kingstone Companies, Inc.
 
Offices
 
             Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are filed with the U.S. Securities and Exchange Commission (the “SEC”). Such reports and other information filed by us with the SEC are available free of charge at the investor relations section of our website at www.kingstonecompanies.com as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Copies are also available, without charge, by writing to Kingstone Companies, Inc., Investor Relations, 15 Joys Lane, Kingstone, New York 12401. The SEC also maintains a website, www.sec.gov, which contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The inclusion of our website address in this Annual Report does not include or incorporate by reference the information on our website into this Annual Report.
 
 
18
 
 
Employees
 
As of December 31, 2018, we had 101 employees all of whom are located in New York. None of our employees are covered by a collective bargaining agreement. We believe that our relationship with our employees is good.
 
ITEM 1A.    RISK FACTORS.
 
Factors That May Affect Future Results and Financial Condition
 
Based upon the following factors, as well as other factors affecting our operating results and financial condition, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. These factors, among others, may affect the accuracy of certain forward-looking statements contained in this Annual Report.
 
Risks Related to Our Business
 
As a property and casualty insurer, we may face significant losses from catastrophes and severe weather events.
 
Because of the exposure of our property and casualty business to catastrophic events (such as Superstorm Sandy) and other severe weather events, our operating results and financial condition may vary significantly from one period to the next. Catastrophes can be caused by various natural and man-made disasters, including earthquakes, wildfires, tornadoes, hurricanes, severe winter weather, storms and certain types of terrorism. We have catastrophe reinsurance coverage with regard to losses of up to $450,000,000. The initial $5,000,000 of losses in a catastrophe are subject to a 10% quota share reinsurance treaty, such that we retain $4,500,000 of risk per catastrophe occurrence. With respect to any additional catastrophe losses of up to $445,000,000, we are 100% reinsured under our catastrophe reinsurance program. Catastrophe coverage is limited on an annual basis to two times the per occurrence amounts. We may incur catastrophe losses in excess of: (i) those that we project would be incurred, (ii) those that external modeling firms estimate would be incurred, (iii) the average expected level used in pricing or (iv) our current reinsurance coverage limits. Despite our catastrophe management programs, we are exposed to catastrophes that could have a material adverse effect on our operating results and financial condition. Our liquidity could be constrained by a catastrophe, or multiple catastrophes, which may result in extraordinary losses or a downgrade of our financial strength ratings. In addition, the reinsurance losses that are incurred in connection with a catastrophe could have an adverse impact on the terms and conditions of future reinsurance treaties.
 
In addition, we are subject to claims arising from non-catastrophic weather events such as hurricanes, tropical storms, severe winter weather, rain, hail and high winds. The incidence and severity of weather conditions are largely unpredictable. There is generally an increase in the frequency and severity of claims when severe weather conditions occur.
 
 
19
 
 
Unanticipated increases in the severity or frequency of claims may adversely affect our operating results and financial condition.
 
Changes in the severity or frequency of claims may affect our profitability. Changes in homeowners claim severity are driven by inflation in the construction industry, in building materials and home furnishings, and by other economic and environmental factors, including increased demand for services and supplies in areas affected by catastrophes. Changes in bodily injury claim severity are driven primarily by inflation in the medical sector of the economy and by litigation costs. Changes in auto physical damage claim severity are driven primarily by inflation in auto repair costs, prices of auto parts and used car prices. However, changes in the level of the severity of claims are not limited to the effects of inflation and demand surge in these various sectors of the economy. Increases in claim severity can arise from unexpected events that are inherently difficult to predict, such as a change in the law or an inability to enforce exclusions and limitations contained in our policies. Although we pursue various loss management initiatives to mitigate future increases in claim severity, there can be no assurances that these initiatives will successfully identify or reduce the effect of future increases in claim severity, and a significant increase in claim frequency could have an adverse effect on our operating results and financial condition.
 
A downgrade in our financial strength rating from A.M. Best may have a material adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition.
 
In April 2017, A.M. Best upgraded the financial strength rating of KICO to A- (Excellent) from B++ (Good). Financial strength ratings are important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company's business. Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by A.M. Best and other agencies to assist them in assessing the financial strength and overall quality of the companies with which they do business or from which they are considering purchasing insurance or in determining the financial strength of the company that provides insurance with respect to the collateral they hold. A.M. Best ratings are derived from an in-depth evaluation of an insurance company’s balance sheet strengths, operating performances and business profiles. A.M. Best evaluates, among other factors, the company’s capitalization, underwriting leverage, financial leverage, asset leverage, capital structure, quality and appropriateness of reinsurance, adequacy of reserves, quality and diversification of assets, liquidity, profitability, spread of risk, revenue composition, market position, management, market risk and event risk. On an ongoing basis, rating agencies such as A.M. Best review the financial performance and condition of insurers and can downgrade or change the outlook on an insurer's ratings due to, for example, a change in an insurer's statutory capital, a reduced confidence in management or a host of other considerations that may or may not be under the insurer's control. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. A downgrade in our financial strength rating from A.M. Best could have a material adverse effect on our competitiveness, the marketability of our product offerings and our ability to grow in the marketplace.
 
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or our ability to obtain credit on acceptable terms.
 
The capital and credit markets can experience periods of volatility and disruption. In some cases, markets have exerted downward pressure on the availability of liquidity and credit capacity. In the event that we need access to additional capital to support our operating expenses, make payments on our outstanding and any future indebtedness, pay for capital expenditures, or increase the amount of insurance that we seek to underwrite or to otherwise grow our business, our ability to obtain such capital may be limited and the cost of any such capital may be significant. Our access to additional financing will depend on a variety of factors, such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity as well as lenders' perception of our long or short-term financial prospects. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. If a combination of these factors occurs, our internal sources of liquidity may prove to be insufficient and, in such case, we may not be able to successfully obtain additional financing on favorable terms.
 
 
20
 
 
We are exposed to significant financial and capital markets risk which may adversely affect our results of operations, financial condition and liquidity, and our net investment income can vary from period to period.
 
We are exposed to significant financial and capital markets risk, including changes in interest rates, equity prices, market volatility, general economic conditions, the performance of the economy in general, the performance of the specific obligors included in our portfolio, and other factors outside our control. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, which would be offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, which would be offset by lower rates of return on funds reinvested.
 
In addition, market volatility can make it difficult to value certain of our securities if trading becomes less frequent. As such, valuations may include assumptions or estimates that may have significant period to period changes which could have a material adverse effect on our consolidated results of operations or financial condition. If significant, continued volatility, changes in interest rates, changes in defaults, a lack of pricing transparency, market liquidity and declines in equity prices, individually or in tandem, could have a material adverse effect on our results of operations, financial condition or cash flows through realized losses, impairments, and changes in unrealized positions.
 
 Reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business or maintain our financial strength rating from A.M. Best.
 
We purchase reinsurance to reduce our net liability on individual risks, to protect against possible catastrophes, to remain within a target ratio of net premiums written to policyholders’ surplus and to expand our underwriting capacity. Participation in reinsurance arrangements does not relieve us from our obligations to policyholders. Our personal lines catastrophe reinsurance program was designed, utilizing our risk management methodology, to address our exposure to catastrophes. Market conditions beyond our control impact the availability and cost of the reinsurance we purchase. No assurances can be given that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as currently available. For example, our ability to afford reinsurance to reduce our catastrophe risk may be dependent upon our ability to adjust premium rates for its cost, and there are no assurances that the terms and rates for our current reinsurance program will continue to be available in the future. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we will have to either accept an increase in our exposure risk, reduce our insurance writings or seek other alternatives. Our ability to maintain our financial strength rating from A.M. Best depends, in part, on our ability to purchase a sufficient level of catastrophe reinsurance.
 
Reinsurance subjects us to the credit risk of our reinsurers, which may have a material adverse effect on our operating results and financial condition.
 
The collectability of reinsurance recoverables is subject to uncertainty arising from a number of factors, including changes in market conditions, whether insured losses meet the qualifying conditions of the reinsurance contract and whether reinsurers, or their affiliates, have the financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract. Since we are primarily liable to an insured for the full amount of insurance coverage, our inability to collect a material recovery from a reinsurer could have a material adverse effect on our operating results and financial condition.
 
 
21
 
 
Applicable insurance laws regarding the change of control of our company may impede potential acquisitions that our shareholders might consider desirable.
 
We are subject to statutes and regulations of the state of New York which generally require that any person or entity desiring to acquire direct or indirect control of KICO, our insurance company subsidiary, obtain prior regulatory approval. In addition, a change of control of Kingstone Companies, Inc. would require such approval. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of our company, including through transactions, and in particular unsolicited transactions. Some of our shareholders might consider such transactions to be desirable. Similar regulations may apply in other states in which we may operate.
 
The insurance industry is subject to extensive regulation that may affect our operating costs and limit the growth of our business, and changes within this regulatory environment may adversely affect our operating costs and limit the growth of our business.
 
We are subject to extensive laws and regulations. State insurance regulators are charged with protecting policyholders and have broad regulatory, supervisory and administrative powers over our business practices. These include, among other things, the power to grant and revoke licenses to transact business and the power to regulate and approve underwriting practices and rate changes, which may delay the implementation of premium rate changes, prevent us from making changes we believe are necessary to match rate to risk or delay or prevent our entry into new states. In addition, many states have laws and regulations that limit an insurer’s ability to cancel or not renew policies and that prohibit an insurer from withdrawing from one or more lines of business written in the state, except pursuant to a plan that is approved by state regulatory authorities. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict our ability to exit unprofitable markets.
 
Because the laws and regulations under which we operate are administered and enforced by a number of different governmental authorities, including state insurance regulators, state securities administrators and the SEC, each of which exercises a degree of interpretive latitude, we are subject to the risk that compliance with any particular regulator's or enforcement authority's interpretation of a legal issue may not result in compliance with another's interpretation of the same issue, particularly when compliance is judged in hindsight. In addition, there is risk that any particular regulator's or enforcement authority's interpretation of a legal issue may change over time to our detriment, or that changes in the overall legal and regulatory environment may, even in the absence of any change to a particular regulator's or enforcement authority's interpretation of a legal issue changing, cause us to change our views regarding the actions we need to take from a legal risk management perspective, thereby necessitating changes to our practices that may, in some cases, limit our ability to grow and/or to improve the profitability of our business.
 
While the United States federal government does not directly regulate the insurance industry, federal legislation and administrative policies can affect us. Congress and various federal agencies periodically discuss proposals that would provide for a federal charter for insurance companies. We cannot predict whether any such laws will be enacted or the effect that such laws would have on our business. Moreover, there can be no assurance that changes will not be made to current laws, rules and regulations, or that any other laws, rules or regulations will not be adopted in the future, that could adversely affect our business and financial condition.
 
 
22
 
 
We may not be able to maintain the requisite amount of risk-based capital, which may adversely affect our profitability and our ability to compete in the property and casualty insurance markets.
 
The DFS imposes risk-based capital requirements on insurance companies to ensure that insurance companies maintain appropriate levels of surplus to support their overall business operations and to protect customers against adverse developments, after taking into account default, credit, underwriting and off-balance sheet risks. If the amount of our capital falls below certain thresholds, we may face restrictions with respect to soliciting new business and/or keeping existing business. Similar regulations apply in other states in which we operate.
 
Changing climate conditions may adversely affect our financial condition, profitability or cash flows.
 
We recognize the scientific view that the world is getting warmer. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency and/or severity of weather events and affect the affordability and availability of homeowners insurance.
 
 Our operating results and financial condition may be adversely affected by the cyclical nature of the property and casualty business.
 
The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates. A downturn in the profitability cycle of the property and casualty business could have a material adverse effect on our operating results and financial condition.
 
Because substantially all of our revenue is currently derived from sources located in New York, our business may be adversely affected by conditions in such state.
 
Over 90% of our revenue is currently derived from sources located in the State of New York and, accordingly, is affected by the prevailing regulatory, economic, demographic, competitive and other conditions in the state. Changes in any of these conditions could make it costlier or difficult for us to conduct our business. Adverse regulatory developments in New York, which could include fundamental changes to the design or implementation of the insurance regulatory framework, could have a material adverse effect on our results of operations and financial condition.
 
              We are highly dependent on a relatively small number of insurance brokers for a large portion of our revenues.
 
We market our insurance products primarily through insurance brokers. A large percentage of our gross premiums written are sourced through a limited number of brokers. For the year ended December 31, 2018, twenty-four brokers provided a total of 35.4% of our total gross premiums written for the year ended December 31, 2018. The nature of our dependency on these brokers relates to the high volume of business they consistently refer to us. Our relationship with these brokers is based on the quality of the underwriting and claims services we provide to our clients and on our financial strength ratings. Any deterioration in these factors could result in these brokers advising clients to place their risks with other insurers rather than with us. A loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our financial condition and results of operations.
 
 
23
 
 
Actual claims incurred may exceed current reserves established for claims, which may adversely affect our operating results and financial condition.
 
Recorded claim reserves for our business are based on our best estimates of losses after considering known facts and interpretations of circumstances. Internal and external factors are considered. Internal factors include, but are not limited to, actual claims paid, pending levels of unpaid claims, product mix and contractual terms. External factors include, but are not limited to, changes in the law, court decisions, changes in regulatory requirements and economic conditions. Because reserves are estimates of the unpaid portion of losses that have occurred, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses may vary materially from recorded reserves, and such variance may adversely affect our operating results and financial condition.
 
As a holding company, we are dependent on the results of operations of our subsidiary, KICO; there are restrictions on the payment of dividends by KICO.
 
We are a holding company and a legal entity separate and distinct from our operating subsidiary, KICO. As a holding company with limited operations of our own, currently the principal sources of our funds are dividends and other payments from KICO. Consequently, we must rely on KICO for our ability to repay debts (including $30,000,000 in aggregate principal amount of 5.5% Senior Unsecured Notes due December 30, 2022 (the “Notes’)), pay expenses and pay cash dividends to our shareholders.
 
State insurance laws limit the ability of KICO to pay dividends and require KICO to maintain specified minimum levels of statutory capital and surplus. Maximum allowable dividends by KICO to us are restricted to the lesser of 10% of surplus or 100% of net investment income (on a statutory accounting basis) for the trailing 36 months, less dividends paid by KICO during such period. As of December 31, 2018, the maximum permissible distribution that KICO could pay without prior regulatory approval was approximately $4,846,000. The aggregate maximum amount of dividends permitted by law to be paid by an insurance company does not necessarily define an insurance company’s actual ability to pay dividends. The actual ability to pay dividends may be further constrained by business and regulatory considerations, such as the impact of dividends on surplus, by our competitive position and by the amount of premiums that we can write. State insurance regulators have broad discretion to limit the payment of dividends by insurance companies. Our ability to pay interest on the Notes as it comes due and the principal of the Notes at their maturity may be limited by these regulatory constraints.
 
We may not be able to generate sufficient cash to service our debt obligations, including the Notes.
 
Our ability to make payments on and to refinance our indebtedness, including the Notes, will depend on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may be unable to maintain a sufficient level of cash flows from operating activities to permit us to pay the principal, premium, if any, and interest on our indebtedness, including the Notes.
 
Our future results are dependent in part on our ability to successfully operate in an insurance industry that is highly competitive.
 
The insurance industry is highly competitive. Many of our competitors have well-established national reputations, substantially more capital and significantly greater marketing and management resources. Because of the competitive nature of the insurance industry, including competition for customers, agents and brokers, there can be no assurance that we will continue to effectively compete with our industry rivals, or that competitive pressures will not have a material adverse effect on our ability to grow our business and to maintain profitable operating results or financial condition.
 
 
24
 
 
If we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered.
 
Our future success will depend, in part, upon the efforts of Barry Goldstein, our Executive Chairman, Dale Thatcher, our President and Chief Executive Officer, and Benjamin Walden, Executive Vice President and Chief Actuary of KICO. The loss of Messrs. Goldstein, Thatcher, Walden or other key personnel could prevent us from fully implementing our business strategies and could materially and adversely affect our business, financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, but we may not be able to do so. Our ability to recruit and retain such personnel will depend upon a number of factors, such as our results of operations and prospects and the level of competition prevailing in the market for qualified personnel. Mr. Goldstein entered into an amended and restated employment agreement effective January 1, 2019 and expiring December 31, 2021 in which Mr. Goldstein stepped down as Chief Executive Officer and became Executive Chairman of the Board. Mr. Thatcher entered into an amended and restated employment agreement effective January 1, 2019 and expiring on December 31, 2021, whereby Mr. Thatcher became Chief Executive Officer. Mr. Walden is not a party to an employment agreement with KICO.
 
Difficult conditions in the economy generally could adversely affect our business and operating results.
 
As with most businesses, we believe that difficult conditions in the economy could have an adverse effect on our business and operating results. General economic conditions also could adversely affect us in the form of consumer behavior, which may include decreased demand for our products. As consumers become more cost conscious, they may choose to purchase lower levels of insurance.
 
Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our reported results of operations and financial condition.
 
Our financial statements are subject to the application of generally accepted accounting principles, which are periodically revised, interpreted and/or expanded. Accordingly, we are required to adopt new guidance or interpretations, which may have a material adverse effect on our results of operations and financial condition that is either unexpected or has a greater impact than expected.
 
Our business could be adversely affected by a security breach or other attack involving our computer systems or those of one or more of our vendors.
 
Our business requires that we develop and maintain computer systems to run our operations and to store a significant volume of confidential data. Some of these systems rely on third-party vendors, through either a connection to, or an integration with, those third-parties’ systems. In the course of our operations, we acquire the personal confidential information of our customers and employees. We also store our intellectual property, trade secrets, and other sensitive business and financial information.
 
 
25
 
 
All of these systems are subject to “cyber attacks” by sophisticated third parties with substantial computing resources and capabilities, and to unauthorized or illegitimate actions by employees, consultants, agents and other persons with legitimate access to our systems. Such attacks or actions may include attempts to:
 
steal, corrupt, or destroy data, including our intellectual property, financial data or the personal information of our customers or employees
misappropriate funds
disrupt or shut down our systems
deny customers, agents, brokers, or others access to our systems, or
infect our systems with viruses or malware.
 
While we can take defensive measures, there can be no assurance that we will be successful in preventing attacks or detecting and stopping them once they have begun. Our business could be significantly damaged by a security breach, data loss or corruption, or cyber attack. In addition to the potentially high costs of investigating and stopping such an event and implementing necessary fixes, we could incur substantial liability if confidential customer or employee information is stolen. In addition, such an event could cause a significant disruption of our ability to conduct our insurance operations. We have a cyber insurance policy to protect against the monetary impact of some of these risks. However, the occurrence of a security breach, data loss or corruption, or cyber-attack, if sufficiently severe, could have a material adverse effect on our business results.
 
We rely on our information technology and telecommunication systems, and the failure of these systems could materially and adversely affect our business.
 
Our business is highly dependent upon the successful and uninterrupted functioning of our information technology and telecommunications systems. We rely on these systems to support our operations. The failure of these systems could interrupt our operations and result in a material adverse effect on our business.
 
Risks Related to Our Common Stock
 
Our stock price may fluctuate significantly and be highly volatile and this may make it difficult for shareholders to resell shares of our common stock at the volume, prices and times they find attractive.
 
The market price of our common stock could be subject to significant fluctuations and be highly volatile, which may make it difficult for shareholders to resell shares of our common stock at the volume, prices and times they find attractive. There are many factors that will impact our stock price and trading volume, including, but not limited to, the factors listed above under “Risks Related to Our Business.”
 
Stock markets, in general, have experienced in recent years, and continue to experience, significant price and volume volatility, and the market price of our common stock may continue to be subject to similar market fluctuations that may be unrelated to our operating performance and prospects. Increased market volatility and fluctuations could result in a substantial decline in the market price of our common stock.
 
The trading volume in our common stock has been limited. As a result, shareholders may not experience liquidity in their investment in our common stock, thereby potentially limiting their ability to resell their shares at the volume, times and prices they find attractive.
 
Our common stock is currently traded on The Nasdaq Global Select Market (“Nasdaq”). Our common stock has substantially less liquidity than the average trading market for many other publicly traded insurance and other companies. An active trading market for our common stock may not develop or, if developed, may not be sustained. Such stocks can be more volatile than stocks trading in an active public market. Therefore, shareholders have reduced liquidity and may not be able to sell their shares at the volume, prices and times that they desire.
 
 
26
 
  
There may be future issuances or resales of our common stock which may materially and adversely affect the market price of our common stock.
 
Subject to any required state insurance regulatory approvals, we are not restricted from issuing additional shares of our common stock in the future, including securities convertible into, or exchangeable or exercisable for, shares of our common stock. Our issuance of additional shares of common stock in the future will dilute the ownership interests of our then existing shareholders.
 
We have an effective registration on Form S-3 under the Securities Act of 1933, as amended (the “Securities Act”) registering for resale 595,238 shares of our common stock and effective registration statements on Form S-8 under the Securities Act registering an aggregate of 700,000 shares of our common stock issuable under our 2005 Equity Participation Plan and an aggregate of 700,000 shares of our common stock issuable under our 2014 Equity Participation Plan. Options to purchase 37,500 shares of our common stock are outstanding under the 2014 plan and 466,124 shares are reserved for issuance thereunder.  We have also registered up to $39,290,000 of our securities pursuant to registration statements on Form S-3, which we may sell from time to time in one or more offerings. The shares subject to the registration statements on Form S-3 will be freely tradeable in the public market. In addition, the shares issuable pursuant to the registration statements on Form S-8 will be freely tradable in the public market, except for shares held by our affiliates.
 
              The sale of a substantial number of shares of our common stock or securities convertible into, or exchangeable or exercisable for, shares of our common stock, whether directly by us, by selling shareholders in future offerings or by our existing shareholders in the secondary market, the perception that such issuances or resales could occur or the availability for future issuances or resale of shares of our common stock or securities convertible into, or exchangeable or exercisable for, shares of our common stock could materially and adversely affect the market price of our common stock and our ability to raise capital through future offerings of equity or equity-related securities on attractive terms or at all.
 
In addition, our board of directors is authorized to designate and issue preferred stock without further shareholder approval, and we may issue other equity and equity-related securities that are senior to our common stock in the future for a number of reasons, including, without limitation, to support operations and growth, to maintain our capital ratios, and to comply with any future changes in regulatory standards.
 
Our executive officers and directors own a substantial number of shares of our common stock. This will enable them to significantly influence the vote on all matters submitted to a vote of our shareholders.
 
As of March 12, 2019, our executive officers and directors beneficially owned 911,508 shares of our common stock (including options to purchase 10,000 shares of our common stock and 13,295 shares of our common stock issuable upon the vesting of restricted stock within 60 days), representing 8.5% of the outstanding shares of our common stock.
 
Accordingly, our executive officers and directors, through their beneficial ownership of our common stock, will be able to significantly influence the vote on all matters submitted to a vote of our shareholders, including the election of directors, amendments to our restated certificate of incorporation or amended and restated bylaws, mergers or other business combination transactions and certain sales of assets outside the usual and regular course of business. The interests of our executive officers and directors may not coincide with the interests of our other shareholders, and they could take actions that advance their own interests to the detriment of our other shareholders.
 
 
27
 
  
Anti-takeover provisions and the regulations to which we may be subject may make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to our shareholders.
 
We are a holding company incorporated in Delaware. Anti-takeover provisions in Delaware law and our restated certificate of incorporation and bylaws, as well as regulatory approvals required under state insurance laws, could make it more difficult for a third party to acquire control of us and may prevent shareholders from receiving a premium for their shares of common stock. Our certificate of incorporation provides that our board of directors may issue up to 2,500,000 shares of preferred stock, in one or more series, without shareholder approval and with such terms, preferences, rights and privileges as the board of directors may deem appropriate. These provisions, the control of our executive officers and directors over the election of our directors, and other factors may hinder or prevent a change in control, even if the change in control would be beneficial to, or sought by, our shareholders.
 
ITEM 1B    UNRESOLVED STAFF COMMENTS.
 
None.
 
ITEM 2.      PROPERTIES.
 
Our principal executive offices are currently located at 15 Joys Lane, Kingston, New York 12401. Our insurance underwriting business is located principally at 15 Joys Lane, Kingston, New York 12401. Our insurance underwriting business also maintains an executive office located at 70 East Sunrise Highway, Valley Stream, New York 11581, at which we lease 4,985 square feet of space.
 
We own the building at which our insurance underwriting business principally operates, free of mortgage.
 
ITEM 3.    LEGAL PROCEEDINGS.
 
None.
 
ITEM 4.    MINE SAFETY DISCLOSURES.
 
Not applicable.
 
 
28
 
 
PART II
 
ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
Market Information
 
Our common stock is quoted on The Nasdaq Global Select Market under the symbol “KINS.”
 
Holders
 
As of March 12, 2019, there were approximately 236 record holders of our common stock.
 
Dividends
 
    Holders of our common stock are entitled to dividends when, as and if declared by our Board of Directors out of funds legally available. We have paid a cash dividend in each quarter since September 2011.
 
    Future dividend policy will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that future dividends of any kind will continue to be paid to holders of our common stock.
 
Our ability to pay dividends depends, in part, on the ability of KICO to pay dividends to us. KICO, as an insurance subsidiary, is subject to significant regulatory restrictions limiting its ability to declare and pay dividends. These restrictions are related to surplus and net investment income. Without the prior approval of the DFS, dividends are restricted to the lesser of 10% of surplus or 100% of investment income (on a statutory accounting basis) for the trailing 36 months, less dividends paid by KICO during such period. As of December 31, 2018, the maximum distribution that KICO could pay without prior regulatory approval was approximately $4,846,000, which is based on investment income for the trailing 36 months, net of dividends paid by KICO during such period. See “Business – Government Regulation” and “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Liquidity” in Items 1 and 7, respectively, of this Annual Report.
 
Recent Sales of Unregistered Securities
 
None.
 
Issuer Purchases of Equity Securities
 
There were no purchases of common stock made by us or any “affiliated purchaser” during the quarter ended December 31, 2018.
 
ITEM 6SELECTED FINANCIAL DATA.
 
This item is not applicable to smaller reporting companies.
 
 
29
 
 
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
Overview
 
We offer property and casualty insurance products to individuals and small businesses 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, Pennsylvania and Massachusetts. We are licensed in the States of New York, New Jersey, Rhode Island, Massachusetts, Pennsylvania, Connecticut, Maine, and New Hampshire. For the year ended December 31, 2018, 93.7% of KICO’s direct written premiums came from the New York policies.
 
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 commonly 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. These expenses include legal and auditing fees, executive employment costs, and other costs directly associated with being a public company.
 
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, 2018, we would earn half of the premiums in 2018 and the other half in 2019.
 
Ceding commission revenue:  Commissions on reinsurance premiums ceded 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.
 
 
30
 
 
Net investment income and net gains (losses) on investments:  We invest in cash and cash equivalents, short-term investments, fixed-maturity and equity securities. 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 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 further discussion over our accounting policies following Item 15 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. These expenses include executive employment costs, legal and auditing fees, and other costs directly associated with being a public company.
 
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.
 
 
31
 
 
Income tax expense:  We incur federal income tax expense on our consolidated operations as well as state income tax expense for our non-insurance underwriting subsidiaries.
 
Product Lines
 
Our active 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.
 
We offer businessowners policies, which consist primarily of small business retail, service, and office risks, with limited residential exposure. We also write artisan’s liability policies for small independent contractors with smaller sized workforces.  In addition, we write special multi-peril policies for larger and more specialized businessowners risks, including those with limited residential exposures. Further, we offer commercial umbrella policies written above our supporting commercial lines policies.
 
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 loss adjustment expenses (“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.
 
 
32
 
 
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 accounting principles generally accepted in the United States 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, among 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 estimates inherent in these financial statements might not materialize. However, 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 companies in similar businesses.
 
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 ceding commission revenue, deferred policy acquisition costs, deferred income taxes, the impairment of investment securities, intangible assets and the valuation of stock-based compensation. See Note 2 (Summary Significant Accounting Policies) of the Notes to Consolidated Financial Statements following Item 15 of this Annual Report.
 
Outlook
 
Overall, we are pleased with our continuing year over year growth. We anticipate launching homeowners products in Connecticut and Maine during 2019, which will add to our already expanding market share in the Northeast.
 
Turning to 2019 expectations:  Based on our current view of the marketplace, we expect the following:
 
A GAAP combined ratio, excluding catastrophe losses, between 82.0% and 84.0%.
 
This assumes no prior-year casualty reserve development;
Catastrophe losses of approximately 4.0 points.
 
 
33
 
 
Consolidated Results of Operations
 
The following table summarizes the changes in the results of our operations for the periods indicated:
 
 
 
Years ended December 31,
 
($ in thousands)
 
2018
 
 
2017
 
 
Change
 
 
 Percent
 
 Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 Direct written premiums
 $146,716 
 $121,575 
 $25,141 
  20.7%
 Assumed written premiums
  1 
  23 
  (22)
  (95.7)%
 
  146,717 
  121,598 
  25,119 
  20.7%
 Ceded written premiums
    
    
    
    
 Ceded to quota share treaties in force during the period
  15,880 
  23,623 
 (7,743)
  (32.8)%
 Return of premiums previously ceded to prior quota share treaties (1)
  (4,553)
  (7,140)
  2,587 
  (36.2)%
 Ceded to quota share treaties
  11,327 
  16,483 
  (5,156)
  (31.3)%
 Ceded to excess of loss treaties
  1,386 
  1,209 
  177 
  14.6%
 Ceded to catastrophe treaties
  14,210 
  11,037 
  3,173 
  28.7%
 Total ceded written premiums
  26,923 
  28,729 
  (1,806)
  (6.3)%
 
    
    
    
    
 Net written premiums
  119,794 
  92,869 
  26,925 
  29.0%
 
    
    
    
    
 Change in unearned premiums
    
    
    
    
 Direct and assumed
  (13,384)
  (10,653)
  (2,731)
  25.6%
 Ceded to quota share treaties
  (2,995)
  (4,865)
  1,870 
  (38.4)%
 Change in net unearned premiums
  (16,379)
  (15,518)
  (861)
  5.5%
 
    
    
    
    
 Premiums earned
    
    
    
    
 Direct and assumed
  133,333 
  110,945 
  22,388 
  20.2%
 Ceded to reinsurance treaties
  (29,918)
  (33,594)
  3,676 
  (10.9)%
 Net premiums earned
  103,415 
  77,351 
  26,064 
  33.7%
 Ceding commission revenue
    
    
    
    
 Excluding the effect of catastrophes
  5,792 
  9,933 
  (4,141)
  (41.7)%
 Effect of catastrophes
  (459)
  - 
  (459)
  n/a%
 Total ceding commission revenue
  5,333 
  9,933 
  (4,600)
  (46.3)%
 Net investment income
  6,186 
  4,133 
  2,053 
  49.7%
 Net (losses) gains on investments
  (2,496)
  84 
  (2,580)
  (3,071.4)%
 Other income
  1,334 
  1,268 
  66 
  5.2%
 Total revenues
  113,772 
  92,769 
  21,003 
  22.6%
 Expenses
    
    
    
    
 Loss and loss adjustment expenses
    
    
    
    
 Direct and assumed:
    
    
    
    
 Loss and loss adjustment expenses excluding the effect of catastrophes
  61,950 
  48,253 
  13,697 
  28.4%
 Losses from catastrophes (2)
  10,828 
  - 
  10,828 
  n/a%
 Total direct and assumed loss and loss adjustment expenses
  72,778 
  48,253 
  24,525 
  50.8%
 
    
    
    
    
 Ceded loss and loss adjustment expenses:
    
    
    
    
 Loss and loss adjustment expenses excluding the effect of catastrophes
  9,882 
  14,067 
  (4,185)
  (29.8)%
 Losses from catastrophes (2)
  4,600 
  - 
  4,600 
  n/a%
 Total ceded loss and loss adjustment expenses
  14,482 
  14,067 
  415 
  3.0%
 
    
    
    
    
 Net loss and loss adjustment expenses:
    
    
    
    
 Loss and loss adjustment expenses excluding the effect of catastrophes
  52,068 
  34,186 
  17,882 
  52.3%
 Losses from catastrophes (2)
  6,228 
  - 
  6,228 
  n/a%
 Net loss and loss adjustment expenses
  58,296 
  34,186 
  24,110 
  70.5%
 
    
    
    
    
 Commission expense
  25,342 
  21,182 
  4,160 
  19.6%
 Other underwriting expenses
  20,943 
  18,116 
  2,827 
  15.6%
 Other operating expenses
  2,575 
  3,513 
  (938)
  (26.7)%
 Depreciation and amortization
  1,787 
  1,403 
  384 
  27.4%
 Interest expense
  1,822 
  60 
  1,762 
  2,936.7%
 Total expenses
  110,765 
  78,460 
  32,305 
  41.2%
 
    
    
    
    
 Income from operations before taxes
  3,007 
  14,309 
  (11,302)
  (79.0)%
 Income tax (benefit) expense
  (86)
  4,323 
  (4,409)
  (102.0)%
 Net income
 $3,093 
 $9,986 
 $(6,893)
  (69.0)%
 
 
34
 
 
(1) Effective July 1, 2018, we decreased the quota share ceding rate in our personal lines quota share treaty from 20% to 10% (the “2018 cut-off”). The 2018 cut-off resulted in an approximately $4,553,000 return of unearned premiums from our reinsurers that were previously ceded under the expiring personal lines quota share treaty. Effective July 1, 2017, we decreased the quota share ceding rate in our personal lines quota share treaty from 40% to 20% (the “2017 cut-off”). The 2017 cut-off resulted in an approximately $7,140,000 return of unearned premiums from our reinsurers that were previously ceded under the expiring personal lines quota share treaty.
 
(2) The year ended December 31, 2018 includes catastrophe losses, which are defined as losses from an event for which a catastrophe bulletin and related serial number has been issued by the Property Claims Services (PCS) unit of the Insurance Services Office (ISO). PCS catastrophe bulletins are issued for events that cause more than $25 million in total insured losses and affect a significant number of policyholders and insurers.
 
 
 
Years ended December 31,
 
 
 
2018
 
 
2017
 
 
Percentage Point Change
 
 
 Percent Change
 
 
 
 
 
 
 
 
 
 
 
 
   
 
 Key ratios:
 
 
 
 
 
 
 
 
 
 
   
 
 Net loss ratio
  56.4%
  44.2%
  12.2 
  27.6%
 Net underwriting expense ratio
  38.4%
  36.4%
  2.0 
  5.5%
 Net combined ratio
  94.8%
  80.6%
  14.2 
  17.6%
 
Direct Written Premiums
 
Direct written premiums during the year ended December 31, 2018 (“Year Ended 2018”) were $146,716,000 compared to $121,575,000 during the year ended December 31, 2017 (“Year Ended 2017”). The increase of $25,141,000, or 20.7%, was primarily due to an increase in policies in-force during Year Ended 2018 as compared to Year Ended 2017. We wrote more new policies as a result of continued demand for our products in the markets that we serve. Policies in-force increased by 19.3% as of December 31, 2018 compared to December 31, 2017.
 
During Year Ended 2017, we started writing homeowners policies in New Jersey and Rhode Island. In Year Ended 2018, we started writing homeowners policies in Massachusetts. 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 Expansion business were $9,080,000 in Year Ended 2018, compared to $1,800,000 in Year Ended 2017.
 
Net Written Premiums and Net Premiums Earned
 
The following table describes the quota share reinsurance ceding rates in effect during Year Ended 2018 and Year Ended 2017, respectively. This table should be referred to in conjunction with the discussions for net written premiums, net premiums earned, ceding commission revenue and net loss and loss adjustment expenses that follow.
 
 
35
 
  
 
 Year ended December 31, 2018
 Year ended December 31, 2017
 
January 1,
to
June 30, 
July 1,
 to
December 31,
January 1,
 to
June 30,
July 1,
 to
December 31,
 
("2017/2019 Treaty")
("2017/2019 Treaty")
("2016/2017 Treaty")
("2017/2019 Treaty")
 
 
 
 
 
 Quota share reinsurance rates
 
 
 
 
 Personal lines
20% (1)
10% (1)
40%
20% (1)
 
(1) 
2017/2019 Treaty is a two-year treaty, quota share reinsurance rate was reduced to 10% effective July 1, 2018. See “Reinsurance” below for changes to our personal lines quota share treaties effective July 1, 2018 and 2017.
 
Net written premiums increased $26,925,000, or 29.0%, to $119,794,000 in Year Ended 2018 from $92,869,000 in Year Ended 2017. 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). Our personal lines business is currently subject to a quota share treaty. A reduction to the quota share percentage or elimination of a quota share treaty will reduce our ceded written premiums, which will result in a corresponding increase to our net written premiums. The increase in net written premiums is due to growth and the reductions of our personal lines quota share reinsurance rate to 20% and 10% on July 1, 2017 and July 1, 2018, respectively.
 
Change in quota share ceding rate
 
Effective July 1, 2018, we decreased the quota share ceding rate in our personal lines quota share treaty from 20% to 10%. The Cut-off of this treaty on July 1, 2018 resulted in a $4,553,000 return of unearned premiums from our reinsurers that were previously ceded under the expiring personal lines quota share treaty. Our quota share ceding rate changed from 40% to 20% in Year Ended 2017 resulting in a $7,140,000 return of unearned premiums from our reinsurers that were previously ceded. The table below shows the effect of the $4,553,000 and $7,140,000 return of ceded premiums on net written premiums for Year Ended 2018 and Year Ended 2017, respectively:
 
 
 
Years ended December 31,
 
($ in thousands)
 
2018
 
 
2017
 
 
Change
 
 
Percent
 
 
 
 
 
 
 
 
 
 
 
 
   
 
 Net written premiums
 $119,794 
 $92,869 
 $26,925 
  29.0%
 Return of premiums previously ceded to prior quota share treaties
  4,553 
  7,140 
  (2,587)
            (36.2)%
 Net written premiums without the effect of the July 1, 2017 Cut-off
 $115,241 
 $85,729 
 $29,512 
  34.4%
 
Without the effect of the 2018 Cut-off and 2017 Cut-off, net written premiums increased by $29,512,000, or 34.4%, in 2018 compared to 2017.
 
Excess of loss reinsurance treaties
 
An increase in written premiums will, to a lesser extent than the change in quota share ceding rate, increase the premiums ceded under our excess of loss treaties. In Year Ended 2018, our ceded excess of loss reinsurance premiums increased by $177,000 over the comparable ceded premiums for Year Ended 2017. The increase was due to an increase in premiums subject to excess of loss reinsurance.
 
 
36
 
 
Catastrophe reinsurance treaty
 
Most of the premiums written under our personal lines 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 2018, our premiums ceded under catastrophe treaties increased by $3,173,000 over the comparable ceded premiums for Year Ended 2017. The increase was due to an increase in our catastrophe coverage and an increase in premiums subject to catastrophe reinsurance, partially offset by more favorable reinsurance rates in Year Ended 2018. Our ceded catastrophe premiums are paid based on the total direct written premiums subject to the catastrophe reinsurance treaty.
 
Our ceded catastrophe premiums are paid based on the total direct written premiums subject to the catastrophe reinsurance treaty.
 
Net premiums earned
 
Net premiums earned increased $26,064,000, or 33.7%, to $103,415,000 in Year Ended 2018 from $77,351,000 in Year Ended 2017. The increase was due to the increase in written premiums discussed above and our retaining more earned premiums effective July 1, 2017 and 2018, as a result of the reductions of the quota share percentage in our personal lines quota share treaties.
 
Ceding Commission Revenue
 
The following table details the quota share provisional ceding commission rates in effect during Year Ended 2018 and Year Ended 2017. This table should be referred to in conjunction with the discussion for ceding commission revenue that follows.
 
 
Year ended December 31, 2018
Year ended December 31, 2017
 
January 1,
to
June 30, 
July 1,
 to
December 31,
January 1,
to
June 30, 
July 1,
 to
December 31,
 
("2017/2019 Treaty")
("2017/2019 Treaty")
("2015/2016 Treaty")
("2016/2017 Treaty")
 
 
 
 
 
Provisional ceding commission rate on quota share treaty
 
 
 
 
 Personal lines
53%
53%
52%
53%
 
The following table summarizes the changes in the components of ceding commission revenue (in thousands) for the periods indicated:
 
 
 
Years ended December 31,
 
($ in thousands)
 
2018
 
 
2017
 
 
Change
 
 
 Percent
 
 
 
 
 
 
 
 
 
 
 
 
   
 
 Provisional ceding commissions earned
 $6,746 
 $10,677 
 $(3,931)
  (36.8)%
 
    
    
    
    
 Contingent ceding commissions earned