(2) Calculated by dividing losses and loss adjustment expenses incurred by net premiums earned.
As a result of the acquisition of EHC on June 16, 2006, the Company’s financial results for the year ended December 31, 2006 include the results of operations for the workers’ compensation insurance, segregated portfolio cell reinsurance, and specialty reinsurance segments for the period from June 17, 2006 to December 31, 2006. The Company’s financial results for the year ended December 31, 2005 represent the results of operations of the group benefits insurance segment.
the Company’s business as well as required payments to the Security Fund. There were no Security Fund assessments incurred by the Company in 2007 or 2006. In the segregated portfolio cell reinsurance and specialty reinsurance segments, acquisition and other underwriting expenses consist of ceding commissions earned under the respective reinsurance agreements. Ceding commissions received are netted against acquisition and other underwriting expenses.
The Company establishes reserves for unpaid losses and LAE for its workers’ compensation, segregated portfolio cell reinsurance, group benefits insurance, and specialty reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves is an imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverables and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded as of December 31, 2007, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.
On a quarterly basis, the Company prepares actuarial analyses to assess the reasonableness of the recorded reserves for unpaid losses and LAE in its workers’ compensation insurance segment. These actuarial analyses incorporate various methodologies, including paid loss development, incurred loss development and a combination of other actuarial methodologies that incorporate characteristics of incurred and paid methodologies combined with a review of the Company’s exposure base. The recorded amount in each accident year is then compared to the results of these methodologies, with consideration being given to the age of the accident year. As accident years mature, the various methodologies generally produce consistent loss estimates. For more recent accident years, the methodologies produce results that are not as consistent. Accordingly, more emphasis is placed on supplementing the methodologies in more recent accident years with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things.
The increase in consolidated net income primarily reflects the acquisition of EHC on June 16, 2006. The increase in the net loss in the corporate/other segment primarily reflects stock compensation expense related to the Company’s stock compensation plan and ESOP of $2.4 million, and intangible asset amortization of $1.8 million for the year ended December 31, 2007, compared to stock compensation expense and intangible asset amortization of $525,000 and $1.1 million, respectively, for the year ended December 31, 2006.
The decrease in losses and LAE reflects the improved loss experience and favorable development in the dental, long-term disability and term life lines of business, and the decrease in net premiums earned. The calendar period loss ratios, by line of business, for the years ended December 31, 2006 and 2005 were as follows:
The decrease in cash flows from investing activities from 2005 to 2006 primarily reflects cash paid to acquire EHC and the investment activity of EHC from June 19, 2006 to December 31, 2006.
In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS No. 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS No. 141R retains the fundamental requirements of SFAS No. 141 in that the acquisition method of accounting is still used, and an acquirer must be identified in all business combinations. SFAS No. 141R applies prospectively to business combinations which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited from applying SFAS No. 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS No. 141R.
The assumptions used to calculate the fair value of future options granted are evaluated and revised, as necessary, to reflect market conditions and the Company’s historical experience and future expectations. The calculated fair value is recognized as compensation expense in the Company’s consolidated statements of operations and comprehensive income over the requisite service period of the entire award. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant and evaluated and adjusted periodically to reflect the Company’s historical experience and future expectations. Any change in the forfeiture assumption is accounted for as a change in estimate, with the cumulative effect of the change on periods previously reported being reflected in the financial statements of the period in which the change is made.
Pension costs are funded to the limits specified by the Employee Retirement Income Security Act of 1974, as amended. From time to time, the Company may contribute additional amounts to the pension plan as it deems appropriate, subject to funding limitations. Based on the funded status of the pension plan at December 31, 2007, the Company is not required to make a contribution in 2008 and does not anticipate making a contribution. The Company does anticipate making a contribution to the postretirement plan in 2008 totaling approximately $45 to cover the Company’s portion of retirees’ healthcare premiums.
The accumulated benefit obligation of the pension plan at December 31, 2007 and 2006 was $5,065 and $9,335, respectively, and the accumulated benefit obligation of the postretirement plan was $334 and $324, respectively.