This process helps management set carried loss reserves based upon the actuaries’ best estimates, using estimates made by segment, product or line of business, territory, and accident year. The actuaries also separately estimate loss reserves from LAE reserves and within LAE reserves estimates are made for defense and cost containment expenses or Allocated Loss Adjustment Expenses (“ALAE”) and for other claims adjusting expenses or Unallocated Loss Adjustment Expenses (“ULAE”). The amount of loss and LAE reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and LAE reserves for unreported claims are determined using historical information by line of business as adjusted to current conditions. Since our process produces loss reserves set by management based upon the actuaries’ best estimate, there is no explicit or implicit provision for uncertainty in the carried loss reserves, except for required provisions in connection with acquisitions which are separately determined.
Other income (expense). Other income for the year ended 2009 was $19.8 million whereas in 2010, we recorded other expenses of $0.5 million. The other income in 2009 consisted of $13.2 million gain on bargain purchase related to the acquisition of SUA in the fourth quarter of 2009 and a gain of $7.4 million on the revaluation of the shares owned in CastlePoint at the time of the acquisition offset by the Company’s $0.8 million equity in the net loss of CastlePoint prior to its acquisition on February 5, 2009. Other expenses in 2010 were not significant at $0.5 million.
Income tax expense. Income tax expense increased in 2010 compared to 2009. The increase in the income tax expense is attributable to the higher income before taxes in the current year, a higher effective tax rate in 2010 and an increase in state taxes from fee income associated with managing the Reciprocal Exchanges. The effective income tax rate (including state and local taxes) was 34.3% for the year ended December 31, 2010, compared to 32.0% for the same period in 2009. The gain on bargain purchase of SUA in 2009 decreased the effective tax rate in that year as this gain was not subject to tax.
ULAE expenses were reduced $18.1 million comprised of $3.7 million in lower paid ULAE in the fourth quarter and $14.4 million in ULAE reserves at the end of the year. These favorable changes resulted from a revised study of the cost of settling claims, which was finalized at the end of the year.
Net premiums. Net premium written for the year ended December 31, 2010 was $326.8 million, an increase of $171.5 million over prior year. The acquisition of OBPL accounted for $167.8 million of the increase.
The increase in gross premiums earned for the year ended December 31, 2009 was lower than the growth in written premiums due to seasonality in the writing of business, as 58% of the 2009 gross premiums were written in the second half of 2009.
the management companies remaining after such declaration or payment will at least equal the amount of their stated capital. The management companies declared dividends of $7.5 million, $6.0 million and $7.2 million in 2010, 2009 and 2008, respectively.
The Insurance Subsidiaries maintain sufficient liquidity to pay claims, operating expenses and meet other obligations. We held $102.9 million and $164.9 million of cash and cash equivalents at December 31, 2010 and 2009, respectively. We monitor the expected claims payment needs and maintain a sufficient portion of our invested assets in cash and cash equivalents to enable us to fund the claims payments without having to sell longer-duration investments. As necessary, we adjust the holdings of short-term investments and cash and cash equivalents to provide sufficient liquidity to respond to changes in the anticipated pattern of claims payments. See “Business-Investments.”
and, if not, whether it is not more likely than not that the Company will be required to sell the security before recovery of its cost or amortized cost basis; (vi) specific cash flow estimations for fixed-maturity securities and (vii) current economic conditions. If an other-than-temporary-impairment (“OTTI”) loss is determined for a fixed-maturity security (and management does not intend to sell the security or it is not more likely than not that the Company will be required to sell the security), the credit portion is recorded in the statement of income as net realized losses on investments and the non-credit portion is recorded in accumulated other comprehensive income. The credit portion results in a permanent reduction of the cost basis of the underlying investment. OTTI losses on fixed-maturity securities management has the intent to sell or it is more likely than not that the Company will be required to sell and on equity securities are reported in realized losses for the entire impairment.
In January 2010, the FASB issued new guidance that requires additional disclosure of the fair value of assets and liabilities. This guidance requires additional disclosures to be made about significant transfers in and out of Levels 1 and 2 of the fair value
This guidance will be effective for fiscal years beginning after December 15, 2011 with earlier adoption permitted as of the first day of a company’s fiscal year. The Company expects to early adopt this guidance retrospectively as of January 1, 2011 and believes the reduction to deferred acquisition costs will range from $71.0 million to $75.0 million and the reduction to stockholders’ equity could range from $46.2 million to $48.8 million as of December 31, 2010.
The following table presents information regarding invested assets that were in an unrealized loss position at December 31, 2010 and December 31, 2009 by amount of time in a continuous unrealized loss position:
The unrealized loss on the investment in preferred securities was primarily due to market disruptions. All of the preferred securities that were in an unrealized loss position as of December 31, 2010 were evaluated. The evaluation consisted of a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts’ reports, past earning trends and analysts’ earnings expectations for the next 12 months, liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.
The following table provides a reconciliation of the beginning and ending balances for unpaid losses and LAE for the years ended December 31, 2010, 2009 and 2008:
Incurred losses and LAE are net of amounts ceded under reinsurance contracts of $93.0 million, $91.3 million and $125.6 million in 2010, 2009 and 2008, respectively.
The carrying amount reported for the subordinated debentures was $235.1 million at December 31, 2010 and 2009. The fair value of the subordinated debt was $246.6 million and $248.4 million at December 31, 2010 and 2009, respectively. Tower’s investment in the common securities of the trusts is reported in Other Assets.
The Company has designated and accounts for the Swaps as cash flow hedges. The Swaps are considered to have no ineffectiveness, and, accordingly, changes in their fair values will be recorded in Accumulated Other Comprehensive Income (“AOCI”). For the year ended December 31, 2010, $18,000 was reclassified from AOCI to interest expense for the effects of the hedges.
In accordance with the two-class method, undistributed net earnings (net income less dividends declared during the period) are allocated to both common stock and unvested share-based payment awards (“unvested restricted stock”). Because the common shareholders and share-based payment award holders share in dividends on a 1:1 basis, the earnings per share on undistributed earnings is equivalent. Undistributed earnings are allocated to all outstanding share-based payment awards, including those for which the requisite service period is not expected to be rendered.
The following table shows the computation of the earnings per share pursuant to the two-class method: