Principally, all of our goodwill and intangible assets relate to our agency acquisitions. Our insurance company segment has no material associated goodwill or intangible assets. We test our goodwill and intangible assets for impairment annually, or more frequently if impairment indicators arise. We test for impairment based upon the following: (1) the historical financial performance of the unit; (2) the most recent financial performance of the unit; (3) management’s financial forecast for the unit; (4) information regarding publicly available financial terms of recent transactions in the insurance industry; and (5) other publicly available information. We perform impairment tests annually on September 30. The test performed as of September 30, 2004 indicated there was no goodwill or indefinite life intangible asset impairment.
As of December 31, 2004, we have recorded in our financial statements $67.4 million of goodwill, $14.7 million of indefinite life intangible assets and $3.7 million of intangible assets having estimated lives of between two and 20 years.
For the years ended December 31, 2003 and 2002 our insurance companies’ expenses consisted primarily of policy acquisition expenses, less ceding commissions that we received under reinsurance contracts, and a small amount of operating and general expenses. Because our insurance companies received ceding commissions from Vesta Fire that exceeded their policy acquisition expenses, our insurance company segment reported negative expenses during the years ended December 31, 2003 and 2002. Beginning January 1, 2004, our insurance companies’ expenses include:
Policy acquisition and operating expenses for the year ended December 31, 2004 were $79.7 million as compared to a negative $544,000 for the prior year. Our policy acquisition and operating expense ratio for the year ended December 31, 2004 was 35.8%. The increase in our policy acquisition and operating expenses was due to our termination of reinsurance agreements with Vesta. The negative expense reported for the prior year is a result of our insurance companies receiving ceding commission in an amount greater than their policy acquisition and operating expenses.
Commissions related to our retail agencies’ sales of unaffiliated insurance companies’ products were $6.9 million for the year ended December 31, 2003, an increase of $2.1 million, or 44.0%, as compared to commissions related to the sale of unaffiliated insurance companies’ products of $4.8 million in the prior year.
Credit risk. An additional exposure to our fixed income securities portfolio is credit risk. We attempt to manage our credit risk by investing only in investment grade securities and limiting our exposure to a single issuer. As of December 31, 2004, our fixed income investments were invested in the following: U.S. Treasury securities - 3.3%, mortgage-backed securities - 11.9%, corporate securities - 15.3%, and municipal securities - 69.5%. As of December 31, 2004, all of our fixed income securities were rated A- or better by nationally recognized statistical rating organizations.
We are subject to credit risks with respect to our reinsurers. Although a reinsurer is liable for losses to the extent of the coverage which it assumes, our reinsurance contracts do not discharge our insurance companies from primary liability to each policyholder for the full amount of the applicable policy, and consequently our insurance companies remain obligated to pay claims in accordance with the terms of the policies regardless of whether a reinsurer fulfills or defaults on its obligations under the related reinsurance agreement. In order to mitigate credit risk to reinsurance companies, we attempt to select financially strong reinsurers with an A.M. Best rating of “A-” or better and continue to evaluate their financial condition.
In December 2002, the Financial Accounting Standards Board, or FASB, issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. We had previously adopted all provisions of SFAS No. 123. Accordingly, the initial adoption of SFAS No. 148 did not have an impact on our financial condition or results of operations, nor does our management believe the provisions of this standard will have a material impact on our future operations.
The $4.7 million of other intangible assets acquired was allocated to brand name, which is not subject to amortization.
We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2004 pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and principal financial officer concluded that as of December 31, 2004 our disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and include controls and procedures designed to ensure that information we are required to disclose in such reports is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The information relating to this Item 13 is incorporated by reference to the Proxy Statement for our 2005 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2004.
Private Passenger Automobile Quota Share Reinsurance Contract issued to Affirmative Insurance Company and Insura Property & Casualty Insurance Company, covering Illinois, Indiana and Missouri business, effective January 1, 2004 (incorporated by reference to Exhibit 10.9 to Amendment No. 3 to our Registration Statement on Form S-1 filed with the SEC on June 14, 2004, File No. 333-113793).
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Intangible assets consist of brand names, agency relationships, and non-compete agreements; and goodwill represents the excess cost over the fair value of identifiable net assets acquired. Goodwill and indefinite life intangible assets are not amortized but are subject to periodic impairment testing. Finite life intangible assets are amortized over their expected useful lives, ranging from two to twenty years (Note 9).
Effective May 1, 2004, we entered into a quota share reinsurance agreement with an unaffiliated reinsurer to cede 25.0% of the business written through our Florida underwriting agency. This contract continues in force until terminated by us or our reinsurers at any April 30 with not less than 90 days prior notice. We can terminate this agreement on April 30, 2005 on a run-off basis. The reinsurance under this agreement is provided by Folksamerica, which reinsures 100% of all premiums we cede. Folksamerica is rated “A” by A.M. Best.
As of December 31, 2004, analysis completed by our actuaries indicated that the expected range for the ultimate liability for our loss and loss adjustment expense reserves was between $75.9 million and $101.6 million on a gross basis and between $41.5 million and $53.6 million on a net basis. Our loss and loss adjustment expense reserves were $93.0 million on a gross basis and $50.0 million on a net basis, which were our best estimates as of December 31, 2004.
The condensed financial information of the parent company, Affirmative Insurance Holdings, Inc. only as of December 31, 2004 and 2003, and for the years ended December 31, 2004, 2003, and 2002 is presented as follows: