Risks factors, including the effect on reserves and underwriting results, associated with changing market conditions that result from fluctuating cyclical patterns of property and casualty insurance business;
Developments in global financial markets that could affect our investment portfolio and financing plans;
Our insurance subsidiary, First Professionals, assumes reinsurance from PRI. As discussed above, program business assumed by PRI in Pennsylvania was written on First Professionals’ policy forms, as fronting carrier, through July 31, 2003. Effective August 1, 2003, PRI engaged an unrelated fronting carrier for this business and, with the exception of tail coverage, no new or renewal business is being written on First Professionals’ policy forms.
Our net investment income declined 12% to $18.4 million for the year ended December 31, 2003 from $21.0 million for the year ended December 31, 2002. These declines in our net investment income are primarily the result of the prolonged status of prevailing interest rates at historically low levels. As a result, we continue to invest current funds primarily in fixed income securities with shorter maturities and durations and maintain significant short-term invested cash. While these holdings reduce our exposure to losses should the interest environment change and rates begin to rise, they also produce lower current income.
We realized gains of $11.2 million and losses of $4.1 million on investment securities sold during the year 2003, resulting in net realized investment gains on sales of debt and equity securities of $7.1 million for the year ended December 31, 2003. We also realized gains of $0.2 million on the sale of real estate during the first quarter of 2003.
Our net deferred tax asset (“DTA”) remained level as of December 31, 2003 when compared with December 31, 2002. Increases in our net DTA resulting from growth in our business and the related additional discounting of loss and LAE reserves, the 20% reduction in unearned premiums, and other temporary differences that generate DTAs, were essentially offset by the continued amortization of tax deductible goodwill, for which a DTA is realized and reduced annually.
The following table summarizes our significant contractual obligations and commitments as of December 31, 2003 and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. Additional information regarding these obligations is provided in Note 13, Long Term Debt, Revolving Credit Facility and Term Loan and Note 16, Commitments and Contingencies to the consolidated financial statements. The table below does not include contractual obligations with respect to our employee benefit plans, which are described more fully in Note 19, Employee Benefit Plans to the consolidated financial statements.
Deferred policy acquisition costs ((Includes related party amounts of $3,500 and $3,274) Note 22)
Use of Estimates. Management is responsible for making estimates in the preparation of FPIC’s financial statements. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates most susceptible to change are those used in determining the liability for losses and loss adjustment expenses (“LAE”). Although these estimates can vary, we believe that the liability for losses and LAE is adequate. However, there can be no assurance that the estimated amounts will not differ from actual results and such differences could be material.
Property and Equipment. The cost of property and equipment is depreciated over the estimated useful lives of the related assets ranging from three to fifteen years. Depreciation is computed on the straight-line basis. Leasehold improvements are stated at cost less accumulated amortization and amortized over the shorter of the useful life or the term of the lease. Gains and losses upon asset disposal are taken into income in the year of disposition.
FPIC also has direct and assumed liabilities associated with covered extended reporting endorsements under claims-made MPL policy forms, which provide, at no additional charge, continuing MPL coverage for claims-made insureds in the event of death, disability or retirement (“DD&R reserves”). These DD&R reserves, which possess elements of both loss reserves and pension-type liabilities, are carried within unearned premiums and are estimated using assumptions for mortality, morbidity, retirement, interest and inflation.
The liabilities for losses and LAE, DD&R reserves, and the related estimation methods are continually reviewed and revised to reflect current conditions and trends. The resulting adjustments are reflected in current year net income. While management believes the liabilities for losses and LAE are adequate to cover the ultimate liability, the actual ultimate loss costs may vary from the amounts presently estimated and such differences could be material.
In May 2003, the FASB issued FAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. The issuer will be required to classify as liabilities three types of freestanding financial instruments, which are: mandatory redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets, and certain obligations to issue a variable number of shares. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We have reviewed FAS 150 and complied with the reporting requirements therein. Adopting the provisions of FAS 150 did not have a significant impact on our consolidated financial statements.
Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Quoted market prices are used where available. In other cases, fair values are based on estimates using valuation techniques, such as discounting estimated future cash flows using a rate commensurate with the risks involved or other acceptable methods. These techniques involve uncertainties and are significantly affected by the assumptions used and the judgments made regarding risk characteristics of various financial instruments, prepayments, discount rates, estimates of future cash flows, future anticipated loss experience and other factors. Changes in assumptions could significantly affect these estimates. Independent market data may not be available to validate those fair value estimates that are based on internal valuation techniques. Moreover, such fair value estimates may not be indicative of the amounts that could be realized in an immediate sale of the instrument. Also, because of differences in methodologies and assumptions used to estimate fair values, the fair values of FPIC’s financial instruments may not be comparable to those of other companies.
At December 31, 2003 and 2002, property and equipment consisted of the following:
FPIC’s provision for income taxes for 2003, 2002 and 2001 consisted of the following:
Under the asset approach, the value of a reporting unit is the difference in the fair value of total assets and the fair value of total liabilities. The fair value of each asset and liability may in turn be estimated using an income approach, market approach or cost approach.
The remaining portion of our reinsurance recoverables as of December 31, 2003, $19,188, is due from APAL under a 25% quota share reinsurance agreement we had, and is collateralized by securities in trust, an irrevocable letter of credit and other funds held totaling $16,846. Subsequent to year-end, $1,806 was collected from APAL in cash on amounts due, reducing exposure in excess of collateral to $536. We believe these amounts are recoverable.
interest at three-month LIBOR plus 4.1% (5.28% at December 31, 2003).
We established three wholly owned, but not consolidated, trusts, FPIC Capital Trust I, FPIC Capital Statutory Trust II and FPIC Capital Statutory Trust III, for the sole purpose of issuing the trust preferred securities. The proceeds received by the three trusts were used to purchase junior subordinated debentures from FPIC of the same amounts, maturities and other applicable terms and features. The debentures issued by FPIC, which are reported as long term debt in the consolidated statements of financial position, to the three trusts are subordinated to all senior indebtedness, including the senior notes, and are equal in standing to one another.
Both FPIC and AFP maintain a diversified investment strategy in managing its defined benefit plans and consider investment risk and return on assets. This is accomplished by maintaining portfolios of managed pooled separate accounts with their administrator-investment providers, which include investments in equity and debt securities, and to a limited extent real estate. The plans assets are not invested in securities such as derivatives or hedge funds.
Corresponding unearned premiums under fronting arrangements was ($12,848) and ($14,145) as of December 31, 2003 and 2002, respectively.