An insurance company earns investment income on what is commonly referred to as the “float.” The float is money that we hold, in the form of investments, from premiums that we have collected. While a substantial portion of the premiums we collect will ultimately be used to make claim payments and to pay for claims adjustment expenses, the period of time that we hold the float prior to paying losses can extend over several years, especially with a long-tailed line of business such as medical professional liability. The key factors that determine the amount of investment income we are able to generate are the rate of return, or yield, on invested assets and the length of time we are able to hold the float.
The financial condition, near-term and long-term earnings and cash flow prospects of the issuer, including relevant industry conditions and trends, and implications of rating agency actions; and
Federal income taxes do not bear the usual relationship to pre-tax income for the year ended December 31, 2005 as a result of the effect of the reversal of the deferred tax asset valuation allowance. In the second quarter of 2005, we reassessed the need for a valuation allowance, and based on our recent results of operations, concluded that a valuation allowance was no longer necessary. The reversal of the valuation allowance is the primary reason for the unusually large federal income tax benefit reported for 2005. See
The underwriting results of our medical professional liability and other insurance lines segments are discussed in greater detail in the sections that follow. The discussion below focuses on those aspects of our operations that are not specific to the insurance segments.
The following table sets forth summary premium, loss and expense information regarding the underwriting results of our medical professional liability insurance operations for the years ended December 31, 2005, 2004 and 2003.
2005 Compared to 2004. Direct premiums written for the medical professional liability segment decreased in 2005 primarily as a result of exiting the Nevada and Florida markets, discontinuing the alternative risk program and non-renewing a large hospital account due to underwriting considerations. In addition, premiums decreased from 2004 due to a change in the composition of our book of business in Ohio and Kentucky, as we reduced exposures in higher risk geographic markets and specialties in those states. Our insured physician count at December 31, 2005 was 9,561, a decrease of 11.0% from December 31, 2004. The decline in insured physicians was the result of the reasons discussed above as well as increased price competition in selected markets. Our retention ratio, the ratio of previously insured physicians compared to the number of physicians that we renew, was 82% in 2005, compared with 83% in 2004. Despite increasing
The increase in underwriting expenses is primarily attributable to the increase in premium volume. However, a portion is attributable to the absorption of more management and other fixed costs as a result of our exit from our other insurance lines of business.
The decreases in net premiums written were relatively consistent with the decreases in direct premiums written. Net premiums earned, however, did not decrease as much as direct and net premiums written, as premiums associated with workers’ compensation policies written in 2003 continued to be earned in 2004.
There are several limitations to interpreting reserve ranges which apply in this situation. The totals in the above table do not necessarily have the same probabilities as the individual ranges by segment as the segments themselves may not be independent. For example, if workers compensation medical loss costs increase at a rate greater than expected, professional liability loss costs, of which a component is the cost of medical care, may also increase. There are also macroeconomic effects that may cause professional liability loss costs to increase at a more rapid rate due to the prospect of tort reform, which likely will have little or no impact on workers’ compensation loss costs. Other macroeconomic effects which may have differing effects by segment include, but are not limited to, changes in the litigiousness of jurisdictions in which we write business, changes in unemployment rates by geographic location, the influence of legislative actions, and changes in political philosophy. As a result of these factors, as well as other unknown factors, there can be no assurance that reserves will develop within these ranges.
The Company accounted for the transfer of these fixed-income securities from the available-for-sale to the held-to-maturity category at the estimated fair value of the securities at the date of transfer. Any unrealized gains or losses, net of taxes, at the date of transfer continue to be reported as a component of accumulated other comprehensive income, and in effect will be amortized over the remaining life of the security through other comprehensive income. The original premium or discount will continue to be amortized as an adjustment to yield as a component of investment income.
Other investments on the accompanying Consolidated Balance Sheets consists of investment real estate, investment real estate limited partnerships and non-marketable equity securities. Investment real estate is carried at the lesser of historical cost, less accumulated depreciation or at estimated fair market value based on recent sales or offers for similar properties. Real estate limited partnerships are accounted for using the equity method. Non-marketable equity securities, which include our investment in Physicians Insurance Company of Wisconsin, Inc. (“PICW”), are carried at cost. See Note 18 for additional information regarding the Company’s investment in PICW.
These interest-only certificates were carried on the balance sheet at fair value as fixed-income securities. These certificates were not linked to specific assets or liabilities on the balance sheet or to a forecasted transaction and, therefore, did not qualify for hedge accounting. In addition, the Company could not reliably identify and separately measure the embedded derivative instrument. Accordingly, any changes in the fair value of the interest-only certificates, based on quoted market prices, were recorded in current period earnings as investment income. During the years ended December 31, 2005 and 2004, the fair value of these securities decreased by $1,095,000 and $338,000, respectively. In 2003, the fair value of the securities increased by $432,000. These certificates were sold in 2005.
Net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents (stock options and stock grants) outstanding during each year. As the Company was in a net loss position for the year ended December 31, 2003, no effect of options or other stock awards was calculated as the impact would have been anti-dilutive (See Note 17).
The Company estimates that the adoption of SFAS No. 123R, effective January 1, 2006, will result in additional compensation expense, net of tax, of approximately $285,000, $104,000 and $30,000 in years 2006, 2007 and 2008, respectively. The Company currently does not anticipate any share-based payment charges in 2009 or beyond because it has no present intention of making additional share-based awards. Any “windfall tax benefit” the Company receives from employee option exercise will be credited to additional paid-in-capital in the year it is currently deductible in the Company’s consolidated tax return. In addition, SFAS No. 123R does not permit the creation or presentation of deferred compensation as a separate component of equity for unearned awards. SFAS No. 123R requires companies to eliminate such accounts upon adoption of SFAS No. 123R.
In November 2005, the FASB issued FASB Staff Position (“FSP”) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP addresses the determination as to when an investment is considered impaired, whether the impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP Nos. FAS 115-1 and FAS 124-1 is effective for reporting periods beginning after December 15, 2005; however, the disclosure requirements are already in effect. The adoption of this FSP is not expected to have a material effect on the Company’s results of operations or financial condition.
The following table shows the intraperiod allocation of the change in the deferred tax valuation allowance for the years ended December 31, 2005, 2004 and 2003, and the impact of the reversal of the valuation allowance on federal income tax benefit included in net income (loss), other comprehensive income and shareholders’ equity for the years ended December 31, 2005, 2004 and 2003.
Certain costs associated with the original lease and subleases are variable. As additional information regarding these variable costs becomes available, the estimated future cash flows are adjusted accordingly.
Allocation of taxes among the entities is subject to a written agreement, and is based upon separate return calculations, with current credit for net losses to the extent they can be used in the current year consolidated tax return.