Pre-tax investment income increased 32% during 2006 to $19.5 million as yields were up 24% on average and invested assets increased by 5% despite lower cash flow from operations and the payment of over $38 million in cash dividends to shareholders during the year. This improvement followed similar increases in 2005. Short-term pre-tax rates increased most dramatically during 2006, averaging 55% higher than 2005. The after-tax investment income yield increased by 36% from 2005 as the movement of substantial portions of short-term funds into short and moderate term municipal bonds enhanced after-tax yields by 29% compared to the prior year.
to a lesser extent, real estate development. The estimated market value of these investments was $44.7 million at December 31, 2005 and the aggregate of the Company’s share of earnings in these entities totaled approximately $11.2 million during 2006. While this lagged the $14.8 million of appreciation reported during 2005, it represented a return of over 25% for the year. The Company follows the equity method of accounting for its investments in limited partnerships. To the extent that the limited partnerships include realized and unrealized gains or losses in their net income, the Company’s proportionate share of net income will include unrealized as well as realized gains or losses. The current year limited partnership total is composed of estimated realized income of $5.0 million and estimated unrealized income of $6.2 million, as reported to the Company by the general partners. Inception to date unrealized gains included in the December 31, 2006 asset valuation total $23.8 million. The final component of investment gains, consisting of adjustments attributable to “other-than-temporary impairment,” was not significant during 2006 or 2005 and is more fully explained in Note B.
The Fleet trucking loss ratio for 2006 was favorably impacted by an increase in savings on prior year loss developments and a lack of extremely severe accidents. The number of severe fleet trucking losses during 2005 was also below recent historical averages. Factors such as fluctuations in premium volume, the levels of self-insured retentions and the Company’s higher net retention under reinsurance treaties in recent years tend to allow for more volatility in losses. The increase in the private passenger automobile loss ratio is associated with product modifications in response to competitive conditions and the higher small fleet trucking loss ratio resulted largely from geographic expansion with higher loss ratios during the first half of the year and more favorable results in the second half.
impacted. Further, as inflation affects current market rates of return, previously committed investments might increase or decline in value depending on the type and maturity of investment. (See comments under Market Risk, following.)
Reference is made to the discussion of limited partnership investments in the Critical Accounting Policies portion of this report. All of the market risks, attendant to equity securities, apply to the underlying assets in these partnerships, and to a greater degree because of the generally more aggressive investment philosophies utilized by the partnerships. In addition, these investments are illiquid. There is no primary or secondary market on which these limited partnerships trade and, in most cases, the Company is prohibited from disposing of its limited partnership interests for some period of time and must seek approval from the general partner for any such disposal. Distributions of earnings from these partnerships are largely at the sole discretion of the general partners and distributions are generally not received by the Company for many years after the earnings have been reported. Finally, through the application of the equity method of accounting, the Company’s share of net income reported by the limited partnerships may include significant amounts of unrealized appreciation on the underlying investments. As such, the likelihood that reported income from limited partnership investments will be ultimately returned to the Company in the form of cash is markedly lower than the Company’s other investments, where income is reported only when a security is actually sold.
Investments: Carrying amounts for fixed maturity securities (bonds and notes) represent fair value and are based on quoted market prices, where available, or broker/dealer quotes for specific securities where quoted market prices are not available. Equity securities (common stocks) are carried at quoted market prices (fair value). Limited partnerships are accounted for using the equity method with the corresponding change in value recorded as a component of net gains or losses on investments. Other investments are carried at either market value or cost, depending on the nature of the investment. All fixed maturity and equity securities are considered to be available for sale; the related unrealized net gains or losses (net of applicable tax effect) are reflected directly in shareholders’ equity unless a decline in value is determined to be other-than-temporary, in which case, the loss is charged to income. In determining if and when a decline in market value below cost is other-than-temporary, an objective analysis is made of each individual security where current market value is less than cost. For any security where the unrealized loss exceeds 20% of original or adjusted cost, and where that decline has existed for a period of at least six months, the decline is treated as an other-than-temporary impairment, without subjective evaluation as to possible future recovery. Although the Company has classified fixed maturity investments as available for sale, it has the ability to, and generally does, hold its fixed maturity investments to maturity. Short-term investments are carried at cost which approximates their fair values. Realized gains and losses on disposals of investments are determined by specific identification of cost of investments sold and are included in income.
The fair value of the market value options granted during 2005 was determined using a Black-Scholes-Merton option pricing model with the following assumptions: risk-free interest rate of 3.0% and 1.0%, respectively; dividend yield of 1.6%; volatility factor of the expected market price of the Company’s common stock of .30; and an expected life of the option of 7 years.
Options to purchase 35,422 shares of the Company’s Class B common stock were excluded in 2005 from the above reconciliation in that inclusion would have an anti-dilutive effect.