The Company recognized an increase in its equity interest in limited partnerships from 2011 to 2012 totaling $1.0 million, primarily reflecting an increase in its multi-strategy fund of funds and structured finance opportunity fund interests.
Other revenue. Other revenue includes fees earned for claim administration and risk management services provided to self-insured property/casualty customers. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other entities within the consolidated group. The segregated portfolio cells recognize an expense for such items (included as part of its ceding commission) and a corresponding revenue item is recognized by the affiliate providing the service. For segment reporting purposes, such revenue items primarily include claims administration, risk management, and cell rental fees. Fronting fees are included in acquisition and other underwriting expenses as an offset to the direct costs incurred. For segment reporting purposes, such fees are recognized ratably over the period in which the service is provided, which generally corresponds to the earned portion of net premiums written for the underlying policies.
Paid Loss Development Method. The paid loss development method relies on paid losses to estimate ultimate losses and is mechanically identical to the incurred loss development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using a paid loss development approach can be affected by many conditions, such as internal claim department processing changes, legal changes or variations in a company’s mix of business from one year to the next. Also, since the percentage of losses paid for immature years is often low, development factors are more volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimate liability for losses and LAE. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques.
(1) The workers’ compensation insurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in acquisition and other underwriting expenses. Fees incurred for the years ended December 31, 2012 and 2011 totaled $6.1 million and $5.5 million, respectively. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.
The improvement in the Company’s financial results primarily reflect a reduction in the combined ratio, partially offset by the aforementioned decline in the limited partnership interests and a decrease in net realized investment gains.
Depreciation and amortization expense totaled $814, $741, and $691 for the years ended December 31, 2012, 2011 and 2010, respectively.
The expected life shown above was imputed based upon the combination of vesting provisions and the termination, retirement and early exercise assumptions input to the binomial option valuation model. As trading in the Company’s stock began in June 2006, the expected stock price volatility reflects a weighted average of the Company’s estimated historical volatility since trading in the Company’s stock began and the average 6-month implied volatility for six comparable companies with listed options applied to the Company’s estimated historical volatility. The Company’s estimated historical volatility was calculated by applying the average ratio of the annualized price volatility over the last 10 years compared to the last 5.5 years for ten comparable companies to the Company’s actual price volatility over the last 5.5 years. Risk free interest rates applicable to maturities from one month up to ten years were taken from the spot rate curve estimated and published by the Federal Reserve from the prices of U.S. Treasury Securities on the grant date.
Eastern Re’s stockholder’s equity as of December 31, 2012 and 2011 and net income (loss) for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands):
As of December 31, 2012, the only restrictions on the Company’s ability to redeem its interest in its limited partnership investments relate to the timing of redemption (i.e., monthly, quarterly). There are no restrictions related to the amount the Company can redeem, in the event it chooses to redeem all or a portion of its interest in its limited partnership investments. The Company has no unfunded commitments related to these investments as of December 31, 2012.
Management has evaluated the unrealized losses related to its fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other-than-temporarily impaired as of December 31, 2012.
As of December 31, 2012, the net deferred tax asset of $3,239 has not been reduced by a valuation allowance because management believes that, while it is not assured, it is more likely than not that the Company will generate sufficient future taxable income to utilize these net future tax deductions. The amount of the net deferred tax asset considered realizable, however, could be materially reduced in the near term if estimates of future taxable income in the years in which the differences are expected to reverse are decreased.
There were no unrecognized tax benefits recorded by the Company in 2010.
The Company’s share of the segregated portfolio dividend, which is included in the corporate/other segment, was as follows for the years ended December 31, 2012, 2011 and 2012, respectively (in thousands):
The Company commenced an audit of the claims covered under the Treaties during the third quarter of 2012. The claim audit is on-going and the Company has requested and is awaiting additional files and further information from AIG Companies, which will allow the Company to complete the audit. All of the information obtained and reviewed will be evaluated to determine whether such information would cause the Company to revise its estimates or position with respect to the pending arbitration.