The insurance industry has historically been cyclical. During the past five years, many admitted insurers returned to more risk-based underwriting disciplines in the standard market, resulting in higher premium rates, less flexible terms and, in some cases, an unavailability of adequate insurance coverage in the standard market in some classes. We, along with other excess and surplus lines insurers, benefited from this increase in rates and volume. During 2006, however, the excess and surplus lines industry began to experience softer market conditions primarily attributed to intensified competition from admitted and surplus lines insurers, resulting in volume and rate decreases. This increased competition intensified in 2007 and is continuing in 2008. We will continue to monitor our rates and control our costs in an effort to maximize profits during softening market conditions.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006. Net income was $24.8 million for the year ended December 31, 2007 compared to net income of $20.9 million for the year ended December 31, 2006. The increase in net income for the year ended December 31, 2007 was primarily attributable to an increase in net investment income, coupled with a lower combined ratio as a result of a reduction of the loss and loss expense ratio. The reduction in the loss and loss expense ratio was driven by a favorable decrease in the current accident year loss and loss expense ratio compared to the 2006 current accident year that decreased loss and loss expenses by $653,000 and a favorable decrease in the prior accident years’ loss and loss expense ratio that decreased loss and loss expenses by $9.1 million.
Premiums in the course of collection, deferred policy acquisition costs, loss and loss expense reserves and unearned premiums were higher by $16.7 million, $2.7 million, $2.6 million, and $16.2 million, respectively.
The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel, economic inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for loss and loss expense is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policy holder events and when it is actually reported to us). We attempt to consider all significant facts and circumstances known at the time loss reserves are established. In addition, we continually refine our loss reserve estimates as historical loss experience develops and additional claims are reported and settled.
claim reporting patterns were increased by amounts ranging from 10% to 1%
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006. Other operating expenses increased by 7.3% for the year ended December 31, 2007, respectively compared to the same period in 2006. The overall expense ratio for year ended December 31, 2007 was 33.8% compared to 32.6% for the year ended December 31, 2006. The increase in other operating expenses for the year ended December 31, 2007 compared to the same period in 2006, is due to higher agent contingent commissions, resulting from the favorable loss experience that we experienced during 2007 and higher amortization of deferred policy acquisition costs with an increase of binding.
Catastrophe Exposures: Certain insurance coverages that the Company writes include exposure to catastrophic events such as fire following an earthquake, hurricanes, tornados, hail storms, winter storms and freezing. As a result, a single catastrophe occurrence or destructive weather pattern could materially adversely affect the results of operations and surplus of our insurance subsidiaries.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (“SFAS No. 123R”), using the modified prospective application transition method. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). The Company previously followed the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), the Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25), and other related accounting interpretations for the Company’s share option and restricted common share plans utilizing the “intrinsic value method.” The Company also followed the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for the Company’s share option grants, as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure; an amendment of FASB Statement No. 123.
remaining equity securities that have been in an unrealized loss position for one year or longer relate to preferred share investments in issuers each of which has shown an improved or stable financial performance during the past twelve months. In addition, these four equity securities have an aggregate fair market value equal to 83.7% of their book value as of December 31, 2007. All 141 of the fixed-maturity securities are current on interest and principal and all seven of the equity securities continue to pay dividends at a level consistent with the prior year. Management believes that it is probable that all contract terms of each fixed-maturity security will be satisfied. The unrealized loss position of the fixed-maturity securities is due to the changes in interest rate environment and the Company has the positive intent and ability to hold these securities until they mature or recover in value. The unrealized loss position in the equity securities is due to current market conditions and the Company has the positive intent and ability to hold these securities until they recover in value within a reasonable period of time.
A summary of all employee time-based restricted share activity during the year ended December 31, 2007 is as follows:
In 2005, the Company entered into a 50% quota share agreement with Evergreen whereby, the Company would assume certain special surety bonds (including landfill). During 2006 and 2005, the Company recorded $2.6 million and $2.4 million of assumed bonds, respectively. This agreement was terminated on August 15, 2006.
The Company is named from time to time as defendants in various legal actions that are incidental to our business and arise out of or are related to claims made in connection with our insurance policies, claims handling,