The Company’s investments in bonds, preferred stock, and common stock are classified as available for sale and are carried at their fair value. In 2007, the difference between amortized cost and fair value of these investments, excluding the Company’s convertible bond and preferred stock portfolios, net of the effect of deferred income taxes, is reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income other than for impairments deemed to be other than temporary. The difference between amortized cost and fair value of the convertible bonds and preferred stocks is included in income. Prior to 2007, the difference between amortized cost and fair value of these investments, excluding the derivative components of the Company’s convertible bond and convertible preferred stock portfolios, net of the effect of deferred income taxes, was reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income
The process of establishing the liability for unpaid losses and loss adjustment expenses of a property and casualty insurance company is complex, requiring the use of informed actuarially based estimates and judgments. In some cases, significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of that loss to the Company. To establish this liability, the Company regularly reviews and updates the methods of making such estimates and establishing the resulting liabilities. Any resulting adjustments are recorded in income during the period in which the determination is made.
During 2007 and 2006, the Company’s reinsurance receivables and related unpaid losses and loss adjustment expenses were decreased by $262.8 million and $295.7 million, respectively. Of these amounts, $152.6 million and $107.1 million, respectively, were due to the Company’s review of unpaid loss and loss adjustment expenses, and the remainder was due to the payment of losses in the ordinary course of business. At the Wind River Acquisition date, discounts and risk margins were applied to reinsurance receivables related to ceded loss reserves. During 2007 and 2006, the Company decreased its discount and risk margin purchase adjustment by $1.0 million and $2.7 million, respectively, due to (1) reductions in ceded loss reserves that existed as of the Wind River Acquisition date and (2) decreases to the amount of discount due to the passage of time. This adjustment equally affected reinsurance receivables and loss reserves and had no impact on the net income of the Company during 2007 and 2006.
In 2007, the Company experienced $24.7 million of favorable development related to prior year reserves. The reduction was comprised of a net reduction of $42.5 million for primary liability, umbrella and excess, construction defect, and lines in run-off due to both lower than expected frequency and severity emergence, offset by a $17.8 million increase in net reserves for unallocated loss adjustment expenses (“ULAE”) and asbestos and environmental (“A&E”). The Company also reduced its reinsurance reserve allowance by $4.4 million due to better than anticipated collections from troubled reinsurers and loss emergence that has been lower than anticipated. In 2006, the Company decreased its net loss reserve relative to accident years 2005 and prior by $7.0 million due to favorable development relative to construction defect losses as well as primary general liability, umbrella and excess, and asbestos and environmental, and by $8.6 million as a reduction of its reinsurance reserve allowance. In 2005, the Company decreased its net loss reserve relative to accident years 2004 and prior by $1.3 million due to lower than anticipated frequency in its animal mortality program.
Notes payable and term loans assumed through the acquisition of Penn Independent Corporation consisted of a $2.5 million revolving line of credit, bearing interest at the bank’s prime rate less 1.25% payable monthly. During September 2007, all amounts due on the line were paid, and the line was terminated. Interest expense resulting from the line of credit was $0.02 million, $0.2 million, and $0.1 million for 2007, 2006, and 2005, respectively.
Edward J. Noonan, the chairman and chief executive officer of Validus, was a member of the Company’s Board of Directors until June 1, 2007, when he resigned from the Company’s Board. Although Validus is no longer a related party as a result of Mr. Noonan’s resignation, the current quota share retrocession agreement with Wind River Reinsurance was put in place during the period when Validus was a related party.
The following table provides information with respect to the Class A common shares that were surrendered or repurchased in 2007:
The above table includes 245,208 shares that were purchased by key employees in 2003.
The Restricted Shares awards under the Plan are included in the Restricted Shares section above. In May 2005, shareholders approved the Amended and Restated United America Indemnity, Ltd. Annual Incentive Awards
The Company’s U.S. insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis, and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2007, the maximum amount of distributions that could be paid by the United National Insurance Companies and the Penn-America Insurance Companies as dividends under applicable laws and regulations without regulatory approval is approximately $46.9 million and $23.5 million, respectively. The Penn-America Insurance Companies limitation includes $7.7 million that would be distributed to United National Insurance Company or its subsidiary Penn Independent Corporation based on the December 31, 2007 ownership percentages. For 2007, United National Insurance Companies and Penn-America Insurance Companies declared and paid dividends of $23.3 million and $14.8 million, respectively.
The Insurance Operations segment, the Reinsurance Operations segment, and the discontinued Agency Operations segment follow the same accounting policies used for the Company’s consolidated financial statements. For further disclosure regarding the Company’s accounting policies, please see Note 2.