Other Differences-For the year ended December 31, 2003, the Company identified errors in the allocation of income taxes between comprehensive loss, continuing operations, deferrable capital security distributions, and discontinued operations. The allocation errors stem from the application of the intra-period tax allocation provisions of SFAS No. 109, “Accounting for Income Taxes”. These errors decreased consolidated net loss available to common shareholders, by $2.8 million, predominantly related to adjusting the tax effect on other comprehensive income and correctly reflecting the tax benefit in continuing operations. In addition, the income tax benefit of $335 thousand and $8.7 million previously reflected in the deferrable capital security distributions and loss from discontinued operations, respectively, are now reflected as a component of the income tax (benefit) expense line item.
Life Insurance Reinsurance Adjustments-For the year ended December 31, 2003, the Company identified errors in the recording of ceded losses to certain external reinsurers of AFLIC. Specifically, we identified that the Company had erroneously ceded too many losses to these reinsurers. As a result, the Company’s policyholder benefits expense was understated by $213 thousand, net of a tax benefit of
Income tax expense (benefit)-The Company determined that errors occurred in 2003 and 2002 relating to the reconciliation of our reported tax expense amounts and the amounts included in our general ledger systems and income tax footnote. These errors resulted in an increase to income tax expense attributable to continuing operations of approximately $0.6 million for the year ended December 31, 2003 and a reduction in income tax expense attributable to continuing operations of $1.5 million for the year ended December 31, 2002.
Loss from discontinued operations-The Company determined that an error occurred in 2003 relating to the reporting of the loss stemming from the sale of Aegis Financial Corporation. Specifically, the Company incorrectly reported the loss from this transaction by approximately $799 thousand. Accordingly, the adjusted loss from discontinued operations was reduced by $799 thousand.
These adjustments did not have an impact on Consolidated Stockholders’ Equity in 2003.
For the year ended December 31, 2004, the loss ratio for standard property-casualty segment was 92.2% compared with 66.3% at December 31, 2003. The increase in the loss ratio was primarily attributable to the $88.3 million of catastrophe losses and related reinstatement premiums in 2004 representing 37.4 loss ratio points. The loss ratio in 2003 included the effects of $32.4 million of catastrophe losses in 2003 primarily stemming from a series of hailstorms in Texas, representing 10.3 loss ratio points. Excluding these losses, the loss ratio in 2004 was 54.8% compared to 56.0% in 2003.
In 2004, the Company recorded an impairment charge of $57.7 million associated with our homeowners insurance operations reporting unit goodwill and $1.5 million of other intangibles. As discussed previously, the impairment was primarily attributed to the reduction of our statutory surplus in this reporting until as well as the Company’s projection of future catastrophe activity which was influenced by our recent catastrophe loss experience over the past three years.
Life insurance premiums and policy fees increased to $12.3 million in 2004 from $11.1 million in the prior year. The increase was primarily due to increased premium income attributable to the impact of the acquisition of a closed block of life policies acquired in the fourth quarter of 2004. Investment income decreased $0.6 million, or 2.3%, to $25.9 million in 2004 from $26.5 million the prior year. The decrease in investment income is attributed to several factors. This decrease was predominantly due to a decrease in the yield on the overall portfolio. The weighted average annual yield (excluding realized and unrealized gains and losses) on invested assets for the year ended December 31, 2004 was 4.78% compared to 5.0% in the prior year. Offsetting the decrease in yields was an $11.9 million, or 2.1% increase in the average invested assets, excluding policy fees.
In conjunction with the initial public offering of Affirmative in the 3rd quarter of 2004 and the resulting application of the equity method of accounting to our remaining 42.9% ownership, we reflected our pro-rata share of Affirmative’s net income as “Equity in net earnings of investee, net of tax”. Our pro-rata share of Affirmative’s net income since the date of the initial public offering is $5.6 million.
$6.7 million for the commutation of various assumed and commercial reinsurance treaties in both 2004 and in 2005;
approximately $27 million of loans held as assets by American Founders. During 2002, we actively sought collection of these loans, including the filing of civil lawsuits seeking to collect these loans and cooperation with the Mexican Attorney General in a criminal investigation related to the conduct of some of the individuals responsible for these loans. As of December 31, 2002, we had seen no indications that these individuals would voluntarily perform on these loans, and we expected to engage in protracted civil litigation regarding this matter. Accordingly, we concluded that these loans were impaired and recorded an estimated loss on these loans equal to their entire balance. This write-off reduced American Founders’ statutory surplus significantly.
For the year ended December 31, 2003, we recorded an after-tax loss of $17.1 million for reinsurance assumed and commercial lines businesses primarily related to the recording of an after-tax charge of $10.5 million on the CIGNA Property and Casualty Insurance Company arbitration reinsurance assumed receivables and the settlement of other litigation, and an after-tax charge of $6.6 million related to reserve adjustments and valuation allowances for receivables related to our commercial and assumed reinsurance books of business.
In addition to the contractual obligations of our holding company to third parties presented in the tables above, our holding company owes contractual obligations to certain of our subsidiaries that are eliminated in consolidation of our financial statements. As of December 31, 2004, our insurance company subsidiaries held $13.2 million face amount of our 8.75% Senior Debentures due 2025 and $44.1 million face amount of our 12.5% Senior Notes due in December of 2005. Our holding company paid these subsidiaries approximately $6.8 million in interest payments in 2004 which was eliminated in consolidation.
As discussed in Note B to the consolidated financial statements, the Company restated its 2003 and 2002 consolidated financial statements.
9. The Company did not maintain effective controls over the estimation and monitoring of gross insurance reserves for certain discontinued product lines. Specifically, the Company did not have procedures in place to ensure changes in the estimation of life expectancy and other assumptions critical to the calculation were accurate, complete and timely considered in the determination of the gross reserve estimates. This control deficiency resulted in an audit adjustment to the third quarter 2004 financial statements to correct gross insurance reserves and reinsurance recoverable.
Summarized below are the consolidated results of operations for the years ended December 31, 2004 and 2003 on an unaudited pro forma basis as if the disposition of 57.1% of Affirmative had occurred as of December 31, 2002. The pro forma information is based on our consolidated restated results of operations for the years ended December 31, 2004 and 2003. The pro forma financial information does not purport to be indicative of results of operations that would have occurred had the transactions occurred on the basis assumed above (in thousands, except for share amounts and unaudited):
In February 2003, we completed the acquisition of the approximate 27% remaining ownership from the minority owners of American Founders Financial Corporation (“AFFC”). The purchase price for this acquisition was $12.9 million, which approximated the recorded minority interest balance.
Reserve Reconciliations. The Illinois Department of Insurance (the governing authority for Vesta Fire Insurance Corporation, our primary insurance subsidiary) imposes a “reserve reconciliation test”. Generally, the reserve reconciliation test requires an insurance company to maintain a specified amount of high quality liquid assets. At December 31, 2004, the minimum level required pursuant to this test exceeded the qualifying assets of Vesta Fire Insurance Corporation by approximately $14.5 million. This shortfall is the result of funding of claims related to hurricane losses during the third quarter of 2004. As a result of this shortage, the Company developed and submitted a plan to the Illinois Department of Insurance describing how the Company planned to resolve this shortage. Our plan includes (1) dissolution of insurance subsidiary that was not being utilized; (2) an exchange of Affirmative common stock owned by Vesta Insurance Group for non-qualifying assets of Vesta Fire; (3) the sale of our life insurance operations; (4) the commutation of our 2004 50% and 25% Quota Share Agreement and (5) the repayment of our standard property and casualty segment Federal Home Loan Bank advances. This plan was accepted by the Illinois Department of Insurance. Although all of these components of our plan were executed in 2005, catastrophe activity in 2005 was such that Vesta Fire again failed the reserve reconciliation test. The Company submitted a plan to the Illinois Department of Insurance as to how Vesta Fire will address this deficiency. The plan submitted included several of the possible transactions discussed in Note C.
The table below presents a reconciliation of beginning and ending loss and LAE reserves for the last three years (in thousands):
In 2002, Vesta received arbitration rulings related to litigation with USF&G and NRMA. Both companies reinsured Vesta companies, and Vesta fully expected to recover all unpaid liabilities. However, as disclosed last year, the impact of these cases resulted in adverse development to Vesta of $37.2 million. The adjustments affected prior accident years.
The following table summarizes amounts recorded for interest and income taxes paid (in thousands):
Effective July 1, 2005, the Company commuted both the 2004 50% Quota Share Agreement and the 2004 25% Quota Share Agreement on a cut-off basis. Under the terms of the commutation, the Company’s insurance subsidiaries received payment for all reserves previously ceded to reinsurers and will be responsible for any adverse development on losses that occurred on or prior to June 30, 2005 from policies subject to this agreement.
corporate operating expenses; (4) realized gains and losses from the sale of investment securities from our property-casualty investment portfolio or the repurchases of our own debt securities at a discount; and (5) our pro rata share of the net earnings of Affirmative.
In April of 2005, we redeemed $5.0 million face amount of Deferrable Capital Securities in exchange for approximately 1.0 million shares of common stock. As a result of the early redemption, we will record a gain of approximately $1.5 million in the second quarter of 2005.