We believe that our ability to enter into a variety of business relationships with third parties allows us to maximize sales penetration and profitability through industry cycles better than if we employed a single, vertically integrated operating structure.
Based upon the results of the assessment, we concluded that the carrying values of goodwill and other intangible assets were not impaired as of September 30, 2010.
Due to the loss development recognized in the fourth quarter, the Company revised its five-year forecast and performed an updated discounted cash flow model to assess the recoverability of recorded goodwill as of December 31, 2010. Certain assumptions used to determine the fair value of the Company were revised, as of December 31, including, in part, discount rate, additional rate increases implemented in the fourth quarter of 2010, and enhanced product design.
Net expenses, defined as the sum of selling, general and administrative expenses and depreciation and amortization less commission income and fees, as a percentage of net premiums earned (the net expense ratio) increased to 27.9% in 2010 compared with 25.4% in 2009. The increase was primarily due to an 8.8% decrease in net premiums earned and a 2.6% increase in SG&A expenses, which were partially offset by a 5.2% increase in commission income and fees. Net expenses as a percentage of net premiums earned increased to 25.4% in 2009 compared with 20.0% in 2008. The increase was primarily due to a 17.1% increase in selling, general and administrative expenses driven by increasing our retained premiums (reducing reinsurance) and contingent commissions on prior accident year development. The following table sets forth the components of the net expenses and the computation of the net expense ratios (in thousands):
(4) The principal amount of the Borrowing is payable in quarterly installments with the remaining balance due on the seventh anniversary of the closing of the facility. Beginning in 2008, we are also required to make additional annual principal payments that are to be calculated based upon our financial performance during the preceding fiscal year. In addition, certain events, such as the sale of material assets or the issuance of significant new equity, necessitate additional required principal repayments.
We have audited Affirmative Insurance Holdings, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying section of Item 9A. titled Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
Deferred Acquisition Costs • Deferred acquisition costs represent the deferral of expenses that the Company incurs to acquire new business or renew existing insurance policies. Acquisition costs, consisting primarily of commissions, advertising, premium taxes, underwriting and agency expenses, are deferred and charged against income ratably over the terms of the related policies. The Company regularly reviews the categories of acquisition costs that are deferred and assesses the recoverability of this asset. A premium deficiency, and a corresponding charge to income, is recognized if the sum of the expected losses and loss adjustment expenses, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and anticipated investment income. Amounts received as expense allowances on reinsurance contracts that represent reimbursement of acquisition costs are recorded as reductions of deferred acquisition costs. Amortization of deferred policy acquisition costs is recorded in SG&A expenses in the consolidated statements of income (loss).
The interest rate on the borrowings under the facility at December 31, 2010 was 9.25%, which is the sum of the LIBOR floor of 3.0% plus 6.25%, based on the Company’ s leverage ratio.
In May 2010, the Company entered into a capital lease obligation related to certain computer software, software licenses, and hardware used in the Company’s insurance operations. The Company received cash proceeds from the financing in the amount of $28.2 million. As required by the lease agreements, the Company purchased $28.2 million of FDIC-insured certificates of deposit held in brokerage accounts and pledged as collateral against all of the Company’s obligations under the lease. The dollar amount of collateral pledged is set to decline over the term of the lease as the Company makes the scheduled lease payments. The lease term is 60 months with monthly rental payments totaling approximately $0.6 million. At the end of the initial term, the Company will have the right to purchase the software for a nominal fee, after which all rights, title and interest would transfer to the Company.