On June 29, 2006, to eliminate our exposure to uncollateralized reinsurance recoverables from PXRE Reinsurance Company (“PXRE”), which had requested the withdrawal of its financial strength and issuer rating from A.M. Best, we concluded, through commutation agreements, PXRE’s participation under various reinsurance agreements with TICNY covering the 2001, 2002 and a portion of the 2003 policy periods. Ceded loss and loss adjustment expense recoverables of $20.5 million, ceded paid losses of $2.4 million and ceding commissions receivable of $8.7 million, totaling $31.6 million of unsecured recoverables were settled with a payment from PXRE of $26.7 million, which represents an estimate of the present value of these recoverables. This resulted in a $4.8 million pre-tax charge, of which $1.6 million was recognized in loss and loss adjustment expenses and $3.2 million was recognized as a reduction to ceding commission income in the second quarter of 2006. In addition, on the same date, novation agreements were executed with PXRE relating to other reinsurance agreements covering business written in 2001, 2002 and 2003 by other insurance companies and managed on their behalf by TRM, our risk management subsidiary. As a result of the novation, TICNY assumed loss reserves of $12.2 million for which it received as consideration $11.4 million in cash and other assets and TRM recorded a reduction in commission liabilities for $0.2 million, the total of which resulted in a $0.6 million pre-tax charge. As a result of the commutation and novation agreements, which are effective as of June 29, 2006, PXRE is discharged from future obligations under the reinsurance agreements. There are no other agreements outstanding with PXRE.
A.M. Best estimates that the industry-wide change in net premiums written in the property and casualty industry was 2.6% in 2006 compared to -0.2% in 2005 and is estimated to be 0.1% in 2007. The change in industry policyholders’ surplus as estimated by A.M. Best was 13.5% in 2006 compared to 9.1% in 2005 and is estimated to be 7.4% in 2007. In addition, the new capacity that has entered the market has placed more demand on production and profitability targets. We expect that premium levels will remain relatively attractive in the business segments we have targeted. These include small, commercial lines of business and modestly valued homeowners and dwelling policies. Management of our mix of business is expected to produce selective growth in the lower premium segment of the middle market. Generally, we will be less interested at the higher premium levels of the middle market in which we see continuing evidence that competitive forces will reduce potential for profitable growth. We expect to continue to maintain underwriting discipline and selectivity in low hazard classes of business, as well as focusing on premium adequacy and appropriate coverage terms. Our broad product line platform continues to allow us the opportunity to adjust our business mix in response to varying market conditions.
Net premiums earned. Premiums written include all premiums received by an insurance company during a specified accounting period, even if the policy provides coverage beyond the end of the year. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in the unearned premium reserve and are realized as income in subsequent periods over the remaining term of the policy. Our policies typically have a term of 12 months. Thus, for example, for a policy that is written on July 1, 2006, one-half of the premiums would be earned in 2006 and the other half would be earned in 2007.
· Other operating expenses. Other operating expenses consist of other underwriting expenses related to TICNY and TNIC’s underwriting operations in our insurance and reinsurance segments and other insurance services expenses related to our managing general agency and reinsurance intermediary operations conducted through TRM in our insurance services segment. Other underwriting expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately and boards, bureaus and taxes, which are the assessments of statistical agencies for items such as rating manuals, rating plans and experience data, as well as state and local taxes based on premiums, licenses and fees, assessments for fire patrol and contributions to workers’ compensation and state and local security funds. Other insurance services expenses include general administrative expenses, principally reimbursements to TICNY for underwriting services, and exclude expenses that are incurred by TRM’s issuing companies such as boards, bureau and taxes. It also excludes general administrative expenses related to claims administration services, which is billed on an hourly basis to TRM’s issuing companies.
The following table reconciles the results of our individual segments to consolidated income before income taxes:
Net investment income and realized gains. Net investment income increased by 195.5% to $15.0 million in 2005 compared to $5.1 million in 2004. This resulted from an increase in invested assets to $357.2 million as of December 31, 2005 compared to $227.0 million as of December 31, 2004, excluding our investments in statutory business trusts underlying our trust preferred securities. Net cash flow provided by operations of $128.5 million contributed to the increase in invested assets in 2005. On a tax equivalent basis, the yield was 5.2% as of December 31, 2005 and 4.4% as of December 31, 2004.
Gross premiums. Gross premiums written increased by 69.5% to $298.6 million for 2005 compared to $176.2 million in 2004. Gross premiums earned increased by 56.2% to $236.2 million for 2005 compared to $151.2 million in 2004. Factors contributing to these increases include a 29.2% increase in the number of policies in force as of December 31, 2005 compared to December 31, 2004 and premium increases on renewed business which averaged 7.6% in personal lines and 5.5% in commercial lines in 2005. The retention rate was 90% for personal lines and 84% for commercial lines. Additionally, premiums written on business subject to the OneBeacon renewal rights agreement, entered into in September 2004,
(2) The reinsurance intermediary fees include commissions earned for placement of reinsurance on behalf of TICNY and TNIC.
On October 20, 2004, we sold 13,000,000 shares in our IPO at $8.50 per share. On the same date, we also effected a concurrent private placement of 500,000 shares of our common stock to an affiliate of Friedman, Billings, Ramsey & Co., Inc., the lead underwriter for our IPO, at a price of $8.50 per share. On November 10, 2004 the underwriters exercised their 30-day over-allotment option after our IPO. Pursuant to this exercise, the underwriters purchased 629,007 additional shares of common stock from us and 1,320,993 shares of common stock from selling shareholders. We received net cash proceeds of $107.8 million from the offering and concurrent private placement after the underwriting discounts, commissions and offering expenses. The total costs of the IPO and private placement were $12.3 million of which $8.4 million was for the underwriting discount, and $3.8 million was for all other costs.
Consolidated Statements of Income and Comprehensive Net Income for the years ended December 31, 2006, 2005 and 2004
Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. The Company regularly reviews its fixed-maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments In evaluating potential impairment, management considers, among other criteria: the current fair value compared to amortized cost or cost, as appropriate; the length of time the security’s fair value has been below amortized cost or cost; management’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in value; specific credit issues related to the issuer; and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment. During 2006, 2005 and 2004, the Company did not record any other-than-temporary impairments.
For the years ended December 31, 2006 and 2005, TNIC reported statutory basis net income/ (loss) of $(596,000) and $116,000, respectively. Reported statutory basis surplus as regards policyholders as December 31, 2006 and 2005 was $9,714,000 and $10,116,000, respectively. As of December 31, 2006 TNIC is required to maintain $6,350,000 of minimum of capital and surplus in accordance with the Commonwealth of Massachusetts Insurance Law.