On April 10, 2007, we completed the acquisition of 100% of the issued and outstanding stock of Preserver for a base purchase price of approximately $64.7 million. In addition, $12 million of Preserver’s trust preferred securities remain outstanding. Preserver was a privately-held company that offered products similar to ours in the Northeast, particularly in New Jersey, Maine and Massachusetts. Preserver’s insurance subsidiaries, PIC, NEIC and MVIC, are rated “A−” (Good) by A.M. Best Company. This transaction accelerated our regional expansion by allowing us to access Preserver’s approximately 250 agents, who produce business in various Northeastern states.
Gross premiums. For the year ended December 31, 2008 brokerage business gross premiums written in our Insurance segment was $525.4 million and does not include premiums placed through our Insurance Services segment on behalf of CPIC in the amount of $175.4 million. Total brokerage business gross premiums written and placed, excluding $5.2 million of assumed premiums written and produced by TRM, increased by $111.7 million, or 19.1%, to $695.6 million from $583.9 million in the prior year.
The commission portion of the gross expense ratio, which expresses direct commission expense paid to our producers as a percentage of gross premiums earned, was 16.7% for 2007, compared to 16.1% for 2006. The increase is partially due to higher commissions on program business.
In addition, in certain instances, given the market dislocation, we deemed it necessary to utilize Level 3 pricing over available pricing service valuations used throughout 2008, resulting in transfers from Level 2 to Level 3 throughout 2008. In the periods of market dislocation, the observability for prices and inputs may be reduced for many instruments as currently is the case for certain non-agency residential mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities.
A number of our Level 3 investments have been written down as a result of our impairment analysis. At December 31, 2008, there were 60 securities that were priced in Level 3 with a fair value of $18.1 million and an unrealized loss of $12.4 million.
We have determined that we do not hold any remaining investments, after recording the charge for OTTI, that would have been considered other than temporarily impaired, and that the recent increase in the gross unrealized investment loss was caused by the lack of liquidity in the capital markets. We expect cash flows from operations to be sufficient to meet our liquidity requirements.
The gross loss reserves payments due by period in the table above are based upon the loss and loss expense reserves estimates as of December 31, 2008 and actuarial estimates of expected payout patterns by line of business. As a result, our calculation of loss reserve payments due by period is subject to the same uncertainties associated with determining the level of reserves and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. The projected gross loss payments presented do not include the estimated ceded reserves recoverable from reinsurers that amounted to $222.2 million, which are estimated to be recovered as follows: less than one year, $72.6 million; one to three years, $87.7 million; four to five years, $42.0 million; and after five years, $19.9 million. The interest on the subordinated debentures is calculated using interest rates in effect at December 31, 2008 for variable rate debentures.
We have no off balance sheet arrangements at December 31, 2008.
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2008, 2007 and 2006
The Company changed its presentation of its business results in the first quarter of 2008 by combining its previously reported insurance segment with its reinsurance segment based on the way management organizes the segments for making operating decisions and assessing profitability. This results in the reporting of two operating segments. The prior period segment disclosures have been restated to conform to the current presentation.
The Company has reclassified certain amounts in its 2007 consolidated balance sheet to conform to the 2008 presentation. None of these reclassifications had an effect on the Company’s consolidated net earnings, total stockholders’ equity or cash flows.
The amortized cost and fair value of investments in fixed-maturity securities and equities are summarized as follows:
In an effort to manage the cost of quota share reinsurance in the time of rising cost and limited availability, the Company implemented provisions for loss ratio caps to provide the reinsurers with some limit on the amount of potential loss being assumed, while maintaining the transfer of significant insurance risk with the possibility of a significant loss to the reinsurer, and thereby to reduce the cost of reinsurance. Loss ratio caps cut off the reinsurers’ liability for losses above a specified loss ratio. The loss ratio caps in the 2005, 2004 and 2003 quota share agreements were 95.0%, 95.0% and 92.0%, respectively. The loss ratio cap in the 2008 SwissRe quota share agreement was 120%. There was no loss ratio cap in 2007 and 2006.
At December 31, 2008, the Company’s maximum exposure to a loss from its investment in CastlePoint was approximately $29.3 million, which consists of its equity ownership interest of approximately $24.7 million and the fair value of the warrant the Company received from CastlePoint of $4.6 million. The carrying value of the Company’s equity investment in CastlePoint as of December 31, 2008 and 2007 is as follows:
For LAE stemming from defense by other attorneys who are not Tower’s employees, the Company implemented automated legal fee auditing in the fourth quarter of 2008.
The following table provides an analysis of stock option activity during the three years ended December 31, 2008.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. As of December 31, 2008, the Company had no material unrecognized tax benefit and no adjustments to liabilities or operations were required.
Certain amounts related to cede reinsurance are reported on a net basis within the statutory basis financial statements. GAAP requires these amounts to be shown gross.
For the years ended December 31, 2008, 2007 and 2006, the Company’s Insurance Subsidiaries had statutory basis net income/(loss) of $30.2 million, $43.6 million and $20.5 million, respectively. At December 31, 2008 and 2007 the Company’s Insurance Subsidiaries had reported statutory basis surplus as regards policyholders of $305.2 million, and $293.2 million, respectively, as filed with the insurance regulators.