(8) Underwriting and other expenses not directly associated with policy acquisition divided by net premiums earned.
Our internal actuaries and the independent actuarial consulting firm we have retained prepare estimates of our insurance subsidiaries' IBNR reserves by state and loss year using generally accepted actuarial techniques. These estimates are currently prepared quarterly and semi-annually, respectively. Our independent actuarial firm participates in our IBNR estimation process three times annually (as of June 30, September 30 and December 31). These estimates are analyzed on a gross of reinsurance basis and on a net of all reinsurance recoverables basis. Estimation of loss reserves is subject to variation as a
In order to use reinsurance accounting for a reinsurance treaty, the treaty must pass risk transfer requirements. Specifically, it must be reasonably possible that the reinsurer may realize a significant loss from the transaction under the terms of such treaty.
Reinsurance recoverables represent: (1) amounts currently due from reinsurers on paid losses and LAE, (2) amounts recoverable from reinsurers on case basis estimates of reported losses and LAE and (3) amounts recoverable from reinsurers on actuarial estimates of IBNR for losses and LAE. These recoverables, by necessity, are based upon estimates and are reported on our balance sheet separately as assets, as reinsurance does not relieve us of our legal liability to policyholders. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. We continually monitor the financial condition and rating agency ratings of our reinsurers. We require reinsurers that are not admitted reinsurers in Florida (where our insurance subsidiaries are domiciled) to collateralize their share of the unearned premiums and unpaid loss reserves in order that our insurance subsidiaries receive credit for reinsurance on their statutory financial statements. We bear credit risk with respect to the reinsurers, which can be significant considering that some of the unpaid losses and LAE remain outstanding for an extended period of time. While management believes that the amount accrued is collectible, the ultimate recovery may be greater or less than the amount accrued.
GROSS PREMIUMS WRITTEN. Gross premiums written is the sum of direct premiums written and assumed premiums written. Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten by our insurance subsidiaries. Assumed premiums written represents our share of the premiums assumed from the NWCRP. We use gross premiums written, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.
GROSS PREMIUMS EARNED. Gross premiums earned represents that portion of gross premiums written equal to the expired portion of the time for which the insurance policy was in effect during the financial year. For each day a one-year policy is in force, we earn 1/365th of the annual premium.
We believe that our increase in gross premiums written in 2004 was primarily due to insurance agents' ability to market our products and services and reduced competition due to the withdrawal of several workers' compensation insurance underwriters in most states in which we do business. Unlike in 2003, when surplus constraints required us to limit our volume in order to keep our insurance subsidiaries' net premiums written to surplus ratios at no greater than a self-imposed limit of 2.5-to-1, we were able to increase writings without capacity constraints during 2004 due to the addition of $32.0 million in third party surplus notes issued by one of our insurance subsidiaries.
In 2004, underwriting and other expenses increased $2.0 million, or 6.7% from 2003. Although the overall increase appears moderate, there were significant differences in the expense categories. In 2004, the allowance for bad debt was $6.0 million compared to $8.8 million in 2003 because of an improvement in our collection experience and the related bad debt exposure. As a result, in 2003 bad debt expense was $4.4 million, compared to the $0.2 million in 2004. In 2003, there was a $3.1 million charge against assessments for a receivable from the Florida Department of Labor and Employment Security ("FDLES"), which was written off when we determined it was uncollectible. Excluding these items, expenses increased $8.0 million in 2004 over 2003 primarily in areas directly proportionate to staffing increases, software expenses and agent-related expenses.
Our insurance subsidiaries are also subject to statutory insurance laws and regulations that limit the amount of dividends or distributions that may be paid by an insurance company to its stockholders. Pursuant to the Florida Insurance Code, our insurance subsidiaries may not, without the prior approval of the Florida OIR, pay to us dividends or other distributions of cash or property, the total fair market value of which generally exceeds the lesser of 10% of their surplus as of the prior December 31 or net income for the calendar year then ended, excluding realized capital gains, plus a two-year carryback of realized capital gains. At December 31, 2005, $9.7 million was available for stockholder dividends from our insurance subsidiaries without prior approval. No dividends were paid by the insurance subsidiaries during 2005, 2004 or 2003.
(3) The municipal bonds' yields to maturity have been shown on a tax-equivalent basis. The tax impact was 2.1% on the yield to maturity for municipal bonds and 0.3% on the yield to maturity for total cash and investments.
The Company's long-term source of consolidated earnings is principally the income from its workers' compensation insurance business and investment income from its investment portfolio. Workers' compensation insurance provides coverage for the statutorily prescribed benefits that employers are required to provide to their employees injured in the course of employment. The Company is licensed to provide workers' compensation insurance in 22 states, but currently focuses its resources in 11 states that it believes provide greater opportunity for near-term profitable growth, with the most significant concentrations in Florida, Indiana, Texas and Wisconsin.
UNAUDITED PRO FORMA NET INCOME PER SHARE--Pro forma basic and diluted income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the year plus the number of shares of common stock resulting from the conversion upon the closing of the initial public offering of the outstanding convertible preferred stock (see Notes 15 and 17).
As of December 31, 2005 and 2004, AmCOMP Preferred's and AmCOMP Assurance's total adjusted capital is above all regulatory action levels.
2005 2004 ------- ------- AmComp Preferred(a) ........................ $96,175 $81,652 AmComp Assurance ........................... 55,337 48,465 (a) includes AmCOMP Preferred's equity ownership in AmCOMP Assurance's capital and surplus
Major categories of the Company's premiums receivable at December 31, 2005 and 2004 are summarized as follows (in thousands):
Effective December 26, 2003, the Company executed reinsurance commutation and release agreements to terminate these reinsurance agreements. As a result, the reinsurer is no longer liable for any losses that were previously covered by these agreements. The Company received $34.13 million in cash from the reinsurer and recorded a pretax charge of $2.06 million. The pretax charge was the difference between the consideration received from the reinsurer and the insurance deposit balance on the Company's books at the time of commutation.
Income tax at statutory rate ......................... $ 9,139 35.0% $ 3,164 34.0% $ 548 35.0% Permanent differences: State income taxes ................................. 844 3.2 159 1.7 56 3.6 Tax-exempt interest ................................ (584) (2.2) (199) (2.1) (105) (6.7) Non-deductible meals and entertainment ............. 350 1.3 152 1.6 94 6.0 Change in deferred tax rate ........................ -- -- 1,216 13.1 -- -- Other expense--net ................................. (423) (1.6) (217) (2.3) 39 2.5 --------- -------- --------- -------- --------- -------- Effective income tax expense ......................... $ 9,326 35.7% $ 4,275 46.0% $ 632 40.4% ========= ======== ========= ======== ========= ========
CASH AND CASH EQUIVALENTS--The carrying amount reported in the balance sheet for cash and cash equivalents approximates fair value due to the short-term nature of those items.
The Company has elected to follow Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations in accounting for its stock options granted to employees and directors. Under APB No. 25, because the exercise price of the Company's employee stock options equals or is greater than the estimated fair value of the underlying stock on the date of grant, no compensation expense is recognized.