The following is management’s discussion and analysis of the financial condition and results of operations of Atlantic American Corporation (“Atlantic American” or the “Company”) and its subsidiaries for each of the three years in the period ended December 31, 2003. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein.
The accounting and reporting policies of Atlantic American and its subsidiaries are in accordance with accounting principles generally accepted in the United States and, in management’s belief, conform to general practices within the insurance industry. The following is an explanation of the Company’s accounting policies and the resultant estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual results could differ from management’s initial estimates. Atlantic American does not expect that changes in the estimates determined using these policies would have a material effect on the Company’s financial condition or liquidity, although changes could have a material effect on its consolidated results of operations.
Unpaid loss and loss adjustment expense comprised 42% of the Company liabilities at December 31, 2003. This obligation includes an estimate for: 1) unpaid losses on claims reported prior to December 31, 2003, 2) future development on those reported claims, 3) unpaid ultimate losses on claims incurred prior to December 31, 2003 but not yet reported to the Company and 4) unpaid claims adjustment expense for reported and unreported claims incurred prior to December 31, 2003. Quantification of loss estimates for each of these components involves a significant degree of judgment and estimates may vary, materially, from period to period. Estimated unpaid losses on reported claims are developed based on historical experience with similar claims by the Company. Future development on reported claims, estimates of unpaid ultimate losses incurred prior to December 31, 2003 but not yet reported to the Company, and estimates of unpaid claims adjustment expense are developed based on the Company’s historical experience using actuarial methods to assist in the analysis. The Company’s actuarial staff develops ranges of estimated future development on reported and unreported claims as well as loss adjustment expenses using various methods including the paid-loss development method, the reported-loss development method, the paid Bornhuetter-Ferguson method, the reported Bornhuetter-Ferguson method, the Berquist-Sherman method and a frequency-severity method. Any single method used to estimate ultimate losses has inherent advantages and disadvantages due to the trends and changes affecting the business environment and the Company’s administrative policies. Further, a variety of external factors, such as legislative changes, medical inflation, and others may directly or indirectly impact the relative adequacy of liabilities for unpaid losses and loss adjustment expense. The Company’s approach is the selection of an estimate of ultimate losses based on comparing results of a variety of reserving methods, as opposed to total reliance on any single method. Unpaid loss and loss adjustment expenses are generally reviewed quarterly for significant lines of business, and when current results differ from the original assumptions used to develop such estimates, the amount of the Company’s recorded liability for unpaid claims and claim adjustment expenses is adjusted.
Future policy benefits comprised 13% of the Company’s total liabilities at December 31, 2003. These liabilities relate to life insurance products and are based upon assumed future investment yields, mortality
rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Cash and investments comprised 72% of the Company’s total assets at December 31, 2003. Substantially all investments are in bonds and common and preferred stocks, which are subject to significant market fluctuations. The Company carries all investments as available for sale and accordingly at their estimated market values. On occasion, the value of an investment may decline to a value below its amortized purchase price and remain at such value for an extended period of time. When an investment’s indicated market value has declined below its cost basis for a period of time, generally, not less than nine months, the Company evaluates such investment for other than a temporary impairment. If other than a temporary impairment is deemed to exist, then the Company will write down the amortized cost basis of the investment to a more appropriate value. While such write down does not impact the reported value of the investment in the Company’s balance sheet, it is reflected as a realized investment loss in the Company’s Consolidated Statements of Operations.
On a consolidated basis, the Company had net income for 2003 of $6.8 million, or $.25 per diluted share. In 2002, the Company had a net loss of $12.2 million, or $.63 per diluted share. Net income was $3.6 million, or $.10 per diluted share in 2001. The net loss for 2002 was primarily the result of a non-cash charge of $15.8 million to reflect a change in accounting for goodwill. Total revenue for 2003 increased slightly to $171.6 million from $170.2 million in 2002. The moderate increase in revenue during 2003 is primarily attributable to the non-renewal of several accounts that were unprofitable in addition to the loss of one of the Company’s larger contracts early in the second quarter of 2003, offset by continued new business growth and premium increases on existing business. Total revenue for 2002 increased $6.9 million, or 4.2%, to $170.2 million from $163.3 million in 2001. The increase in revenue during 2002 was primarily due to significant premium rate increases at both Georgia Casualty and Bankers Fidelity on new and renewal business. During 2003, net income was favorably impacted by a $1.5 million deferred tax benefit related to a reduction of the Company’s valuation allowance compared to a similar $1.3 million and $0.8 million deferred tax benefit in 2002 and 2001, respectively. The reduction of the valuation allowance was the result of reassessment as to the realization of certain net operating loss carry forwards. Also, during 2003, the Company recognized a tax benefit of approximately $1.0 million related to prior years’ alternative minimum tax payments, which did not occur in 2002 or 2001. At the time such payments were made there was no assurance that such amounts could be recovered in future periods. After filing the Company’s 2002 tax returns in 2003 and assessing the current status of the life insurance versus non-life insurance subsidiaries, the Company determined that the realization of future benefit from prior years’ alternative minimum tax payments was probable and, accordingly, the benefit was recognized. Income before income taxes and cumulative effect of change in accounting principle increased 110.3% to
$6.5 million in 2003 as compared to 2002 primarily due to better operating performance from all of the Company’s subsidiaries. Income before income taxes and cumulative effect of change in accounting principle decreased to $3.1 million in 2002 from $4.3 million in 2001. The decrease during 2002 was primarily due to adverse development on prior years’ claims as well as a significant increase in the second injury trust fund and insolvency assessments, both in the casualty division.
Ceded premiums decreased $0.4 million, or 6.4%, during 2003. Although American Southern has experienced an increase in reinsurance rates, the effective percent of premiums ceded to premiums earned remained virtually unchanged in 2003 from 2002. Rate increases were offset by a reduction in reinsurance costs attributable to the loss of American Southern’s largest account discussed previously. This contract, which terminated on April 30, 2003, had higher reinsurance costs than the other accounts in American Southern’s book of business.
premiums was the loss of one state contract in July 2001, which had contributed approximately $2.0 million in written premiums during 2001. The loss of this particular contract resulted in a reduction in annualized premium for 2002 of approximately $4.0 million.
Net earned premiums for 2003 decreased $2.6 million, or 6.4%, from 2002 primarily due to the loss of American Southern’s largest contract, which has been previously discussed, partially offset by the new more diversified business written in 2003.
Net earned premiums for 2002 increased $0.9 million, or 2.3%, over 2001 also primarily due to the factors discussed previously.
The performance of an insurance company is often measured by the combined ratio. The combined ratio represents the percentage of losses, loss adjustment expenses and other expenses that are incurred for each dollar of premium earned by the company. A combined ratio of under 100% represents an underwriting profit while a combined ratio of over 100% indicates an underwriting loss. The combined ratio is divided into two components, the loss ratio (the ratio of losses and loss adjustment expenses incurred to premiums earned) and the expense ratio (the ratio of expenses incurred to premiums earned).
loss ratios of the business they write. The majority of American Southern’s business is structured in such a way that the agents are rewarded or penalized based upon the loss ratio of the business they submit. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with American Southern. As a result of this arrangement, in periods where losses and the loss ratio decrease, commission and underwriting expenses increase. American Southern is also experiencing an increase in acquisition costs, specifically in net fixed commissions, associated with new programs and accounts the company has underwritten in 2003. As a percentage of gross written premiums, net fixed commissions have increased from 9.2% in 2002 to 14.2% in 2003.
Excludes the interest expense on an intercompany surplus note associated with the acquisition of Association Casualty.
Ceded premiums at Association Casualty increased $0.4 million, or 10.0%, during 2003. In 2003, Association Casualty’s primary reinsurance agreement expired. Due to the proposed renewal rates and terms associated therewith, Association Casualty terminated the relationship with its existing reinsurer and entered into a new reinsurance agreement. The new reinsurance rates will result in a prospective pricing
increase of approximately 12% over previous rates. Furthermore, Association Casualty has also experienced higher reinsurance rates due to the change in the company’s book of business. Ceded premiums have increased disproportionately due to the higher reinsurance costs associated with these new lines of business. Excluding assumed written premiums of $3.6 million in 2003 that are not subject to reinsurance and did not exist in 2002, reinsurance premiums ceded as a percentage of written premiums increased to 19.7% in 2003 from 15.6% in 2002.
Gross written premiums at Association Casualty decreased $7.9 million, or 22.7%, during 2002 as compared to 2001. The primary reasons for this decline were as follows: a cessation of writing accident and health policies in the first quarter of 2002 resulting in a $1.0 million decline in 2002 as compared to 2001; a $3.0 million decline in 2002 as a result of the company’s change late in 2000 and throughout 2001 in recognizing written premiums on an annualized basis instead of the installment method and; an extensive re-underwriting of the workers’ compensation book of business, which even after significant rate increases resulted in a decline in 2002 premiums. Association Casualty increased rates on renewal business by approximately 17% in 2002.
Ceded premiums at Association Casualty increased $0.5 million, or 12.8%, during 2002. As Association Casualty continued its diversification into commercial lines other than workers’ compensation, ceded premiums increased significantly due to the higher reinsurance costs associated with these new lines of business.
The combined ratio for Association Casualty decreased from 118.0% in 2002 to 114.9% in 2003. The loss ratio decreased from 84.2% in 2002 to 74.9% in 2003. The decrease in the loss ratio was primarily attributable to an extensive re-underwriting of the workers’ compensation book of business that began in 2002. Although Association Casualty is benefiting from these initiatives, it continues to be adversely impacted by the liberal interpretation of the workers’ compensation laws in the state of Texas. As the law has evolved, interpretive changes in the application of “life time medical” and “impairment rating” provisions have resulted in increased medical costs and the need to provide for additional reserves. Association Casualty continues to increase pricing and improve underwriting criteria to help to mitigate these costs, as well as others. The expense ratio increased to 40.0% in 2003 from 33.8% in 2002, primarily as a result of a consistent level of fixed expenses coupled with a decrease in earned premiums.
The combined ratio for Association Casualty decreased from 123.5% in 2001 to 118.0% in 2002. The loss ratio decreased from 91.8% in 2001 to 84.2% in 2002. The decrease in the loss ratio was primarily attributable to significant premium rate increases in addition to benefits from non-renewing its unprofitable workers’ compensation business as discussed previously. The expense ratio increased to 33.8% in 2002 from 31.7% in 2001, primarily as a result of the change in the book of business and the decline in earned premiums.
The following table summarizes, for the periods indicated, Georgia Casualty’s premiums, losses and underwriting ratios:
Gross written premiums at Georgia Casualty decreased $0.7 million, or 1.2%, in 2003. The decrease in premiums was primarily attributable to the non-renewal of several large accounts that were previously unprofitable in addition to the complete elimination of a substandard underwriting program, which began during the latter part of 2002. During 2003, approximately $4.3 million in gross written premiums were non-renewed from these initiatives. Through existing agents, Georgia Casualty continues to produce new business and increase rates on renewal business.
Ceded premiums at Georgia Casualty decreased $3.4 million, or 19.1%, in 2003. The decrease in ceded premiums is primarily due to the quota share reinsurance agreement. During 2003, the 30% quota share reinsurance agreement that Georgia Casualty had put into place in the first quarter of 2002 was reduced to a 20% quota share agreement retroactive to January 1, 2003. The reduction in the quota share agreement resulted in a decrease in ceded premiums of approximately $3.6 million in 2003 as compared to 2002 when the cession rate was higher.
Net earned premiums increased $4.6 million, or 15.4%, during 2003. The increase in earned premiums was due to several reasons including rate increases and new business. While the cession for the quota share was reduced from 40% in 2001 to 30% in 2002, the bulk of written premiums ceded under the 40% quota share agreement during 2001 were recognized in 2002, resulting in lower earned premiums in 2002 as compared to 2003 when the cession rate was lower. Additionally, in 2003 net earned premiums at Georgia Casualty increased by $1.8 million due to another reduction in the quota share reinsurance agreement discussed previously.
Net earned premiums increased $4.2 million, or 16.3%, during 2002 primarily due to the factors discussed previously. Partially offsetting the increase in net earned premiums for 2002 was an increase in ceded earned premiums under the quota share agreement. While the cession for the quota share had been reduced from 40% in 2001 to 30% in 2002, the bulk of the written premiums ceded under this agreement during 2001 were recognized in 2002.
The following summarizes, for the periods indicated, Bankers Fidelity’s premiums and operating expenses:
The increase in both “benefits and losses” and “underwriting expenses” during 2003 and 2002 was primarily attributable to the increase in premiums for those periods. As a percentage of premiums, benefits and losses were 70.0% in 2003 compared to 70.0% in 2002 and 71.6% in 2001. The increase in the loss ratio in 2001 was primarily due to continued aging of the life business and higher medical costs than expected for the health business. Rate increases implemented by the company on the Medicare Supplement line of business have helped to mitigate the impact of higher medical costs.
Bankers Fidelity has been reasonably successful in controlling operating costs, while continuing to add new business. As a percentage of premiums, commissions and underwriting expenses were 30.6% in 2003 compared to 31.0% in 2002 and 31.3% in 2001.
higher yielding fixed maturities. The Company’s investment in fixed maturities increased from $207.0 million at December 31, 2002 to $229.5 million as of December 31, 2003.
Realized investment gains were $0.4 million in 2003, $0.6 million in 2002, and $1.7 million in 2001. During the years ended December 31, 2003 and 2002, the Company recorded impairments of $1.0 million and $0.2 million, respectively, related to a common stock investment and $0.2 million and $0, respectively, related to an other invested asset. There were no impairments recorded for the year ended December 31, 2001. While the impairments did not impact the carrying value of the investments, they resulted in realized losses of $1.2 million in 2003 and $0.2 million in 2002. Management continually evaluates the Company’s investment portfolio and when opportunities arise will divest investments.
Investment income for 2002 of $14.0 million decreased $0.3 million, or 2.1%, from 2001. The decrease in investment income during 2002 was primarily attributable to decreased interest rates. During both years, the decline in interest rates resulted in several of the Company’s higher yielding callable fixed income securities being redeemed by the issuers prior to maturity. The proceeds received from the early redemptions of these fixed income securities were reinvested at a lower yield, and as a result, investment income decreased during 2002. In addition, the Company’s equity investment in its joint venture with AAA Carolinas was reduced by $0.4 million in 2002 to reflect lower than expected premium production and higher expenses compared to a decrease of $0.2 million in the equity investment during 2001.
Other expenses (commissions, underwriting expenses, and other expenses) increased $4.1 million, or 7.5%, in 2003. The increase in other expenses during 2003 is attributable to several factors. First, the Company experienced an increase in acquisition costs on new and renewal business at American Southern, which increased $1.9 million over 2002. Of the $1.9 million increase in acquisition costs in 2003, agents’ profit sharing commissions at American Southern accounted for $0.7 million of the increase due primarily
Dividend payments to the Company by its insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries. At December 31, 2003, the Company’s insurance subsidiaries had statutory surplus of $106.1 million.
The Company provides certain administrative, purchasing and other services for each of its subsidiaries. The amount charged to and paid by the subsidiaries was $7.6 million, $6.7 million, and $5.9 million in 2003, 2002, and 2001, respectively. In addition, the Company has a formal tax-sharing agreement with each of its insurance subsidiaries. A net total of $0.9 million, $2.8 million and $1.3 million was paid to the Company under the tax sharing agreement in 2003, 2002, and 2001, respectively. Dividends were paid to Atlantic American by its subsidiaries totaling $5.7 million in 2003, $7.1 million in 2002, and $7.1 million in 2001. As a result of the Company’s tax loss carryforwards, which totaled approximately $17.2 million at December 31, 2003, it is anticipated that the tax sharing agreement will continue to provide the Company with additional funds with which to meet its cash flow obligations.
At December 31, 2003, the Company’s $56.2 million of borrowings consisted of $15.0 million outstanding under a bank loan with Wachovia Bank, N.A. (“Wachovia”) and an aggregate of $41.2 million of outstanding junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”). Effective June 30, 2003, the Company executed an amended and restated credit agreement (“Term Loan”) with Wachovia with respect to the outstanding $15.0 million bank debt. Terms of the agreement require the Company to repay $2.0 million in principal on July 1, 2004 and $1.0 million on December 31, 2004. Beginning in 2005 and each year thereafter, the Company must repay $0.5 million on June 30 and $1.3 million on December 31 with one final payment of $6.8 million at maturity on June 30, 2008. The interest rate on the Term Loan is equivalent to three-month LIBOR plus an applicable margin, which was 2.50% at December 31, 2003. The margin varies based upon the Company’s leverage ratio (debt to total capitalization) and ranges from 1.75% to 2.50%. The Term Loan requires the Company to
At December 31, 2003, the Company had a $15.0 million notional amount interest rate swap agreement with Wachovia that matures on June 30, 2004. The Company pays a fixed interest rate of 5.1% and receives 3-month LIBOR until maturity. Due to the significant decrease in LIBOR since the interest rate swap agreement was incepted in 2001, and assuming no future change in the LIBOR rate, the Company expects a reduction in interest expense of approximately $0.3 million subsequent to the swap maturity at June 30, 2004 through December 31, 2004.
At December 31, 2003, the Company had two series of preferred stock outstanding, substantially all of which was held by affiliates of the Company’s chairman and principal shareholders. The outstanding shares of Series B Preferred Stock (“Series B Preferred Stock”) have a stated value of $100 per share; accrue annual dividends at a rate of $9.00 per share and are cumulative; in certain circumstances may be convertible into an aggregate of approximately 3,358,000 shares of common stock; and are redeemable at the Company’s option. The Series B Preferred Stock is not currently convertible. At December 31, 2003, the Company had accrued, but unpaid, dividends on the Series B Preferred Stock totaling $9.6 million. The shares of Series C Preferred Stock (“Series C Preferred Stock”) had a stated value of $100 per share; accrued annual dividends at a rate of $9.00 per share and are cumulative. During 2003, in accordance with the terms of the Series C Preferred Stock, the Company exercised its right to redeem 20,000 shares of the outstanding shares of the Series C Preferred Stock. These shares were redeemed at the redemption price specified in the terms of the Series C Preferred Stock, $100 per share, for $2.0 million, bringing the total outstanding shares of Series C Preferred stock to 5,000 from 25,000 as of December 31, 2003. The Company paid $0.1 million and $0.2 million in dividends to the holders of the Series C Preferred Stock during 2003 and 2002, respectively. Subsequent to December 31, 2003, the remaining 5,000 shares of Series C Preferred Stock were redeemed for $100 per share, or $0.5 million.
regulatory authorities which, if implemented, would have a material adverse effect on the Company’s liquidity, capital resources or operations.
In January 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, which addresses the accounting and disclosure implications that are expected to arise as a result of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Adoption of this statement is not anticipated to have an impact on the Company’s financial condition or results of operations.
In December 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. This statement requires additional detailed disclosures regarding pension plan assets, benefit obligations, cash flows, benefit costs and related information. The Company adopted the new disclosures required as of December 31, 2003.
Effective December 31, 2003, the Company adopted the disclosure requirements of Emerging Issues Task Force (“EITF”) Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. Disclosures are required for unrealized losses on fixed maturity and equity securities classified as either available-for-sale or held-to-maturity. The disclosure requirements include quantitative information regarding the aggregate amount of unrealized losses and the associated fair value of the investments in an unrealized loss position, segregated into time periods for which the investments have been in an unrealized loss position. Certain qualitative disclosures about the unrealized holdings are also required in order to provide additional information that the Company considered in concluding that the unrealized losses were not other than temporary.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (“FIN 46”), which requires an enterprise to assess whether consolidation of an entity is appropriate based upon its interests in a variable interest entity (“VIE”). The adoption of FIN 46 did not have a material impact on the Company’s consolidated financial condition or results of operations as there were no material VIEs identified which required consolidation.
In April 2002, the FASB issued FASB No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. Adoption of the provisions of SFAS No. 145 did not have an impact on the Company’s financial condition or results of operations.
In July 2003, AcSEC issued financial Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (the “SOP”). The SOP addresses a wide variety of topics, many of which are not applicable to the business which the Company sells. Adoption of this statement is not expected to have a material impact on the Company’s financial condition or results of operations.
As of December 31, 2003 the Company did not have any material off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
We have audited the accompanying consolidated balance sheets of ATLANTIC AMERICAN CORPORATION and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. Our audit also included the 2003 and 2002 financial statement schedules listed in the index at Item 15(a). These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the 2003 and 2002 financial statements and financial statement schedules based on our audits. The financial statements and financial statement schedules of the Company as of December 31, 2001, and for the year then ended, before the inclusion of the disclosures discussed in Note 1 to the consolidated financial statements, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements and stated that such 2001 financial statement schedules, when considered in relation to the basic 2001 financial statements taken as a whole, fairly state, in all material respects the financial data required to be set forth therein, in their report dated March 25, 2002.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). SFAS No. 142 provides guidance on the financial accounting and reporting for acquired goodwill and other intangible assets. The Company adopted SFAS No. 142 on January 1, 2002 and accordingly goodwill and indefinite lived intangible assets are no longer amortized but are subject to impairment tests in accordance with the statement. Intangible assets with finite lives continue to be amortized over their useful lives, which is no longer limited to a maximum of forty years. The criteria for recognizing an intangible asset have also been revised. SFAS No. 142 requires that goodwill be tested for impairment at least annually. The goodwill impairment test requires goodwill to be allocated to reporting units. The fair value of the reporting unit is then compared to the carrying value of the reporting unit. If the fair value of the reporting unit is less than the carrying value of the reporting unit, a goodwill impairment may exist. The implied fair value of the goodwill is then compared to the carrying value of the goodwill and an
impairment loss is recognized to the extent that the carrying value of the goodwill exceeds the implied fair value of the goodwill. The impact of adopting SFAS No. 142 resulted in an impairment loss of $15,816 in the casualty division, and such loss was reflected as a cumulative effect of change in accounting principle in the Company’s 2002 results of operations. The following presents the impact on net income (loss) and net income per share of SFAS No. 142:
Deferred income taxes represent the expected future tax consequences when the reported amounts of assets and liabilities are recovered or paid. They arise from differences between the financial reporting and tax basis of assets and liabilities and are adjusted for changes in tax laws and tax rates as those changes are enacted. The provision for income taxes represents the total amount of income taxes due related to the current year, plus the change in deferred taxes during the year. A valuation allowance is recognized if, based on management’s assessment of the relevant facts, it is more likely than not that some portion of the deferred tax asset will not be realized.
Stock options are reported under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” instead of the fair value approach recommended in SFAS No. 123 “Accounting for Stock-Based Compensation”. Accordingly, no stock-based employee compensation cost attributable to stock options is reflected in net income, as all stock options granted have an exercise price equal to the market value of the underlying common stock on the date of grant. In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure”. SFAS No. 148 amends SFAS No. 123 to provide 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 prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. If the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation, the Company’s net income (loss) and earnings (loss) per share would have been as follows:
Based on income before cumulative effect of change in accounting principle.
Bonds and short-term investments having an amortized cost of $16,988 and $16,166 were on deposit with insurance regulatory authorities at December 31, 2003 and 2002, respectively, in accordance with statutory requirements.
During the years ended December 31, 2003 and 2002, the Company recorded impairments of $995 and $242, respectively, related to a common stock investment and $159 and $0, respectively, related to an other invested asset. There were no impairments recorded for the year ended December 31, 2001.
As part of the Company’s ongoing investment review, the Company has reviewed its investment portfolio and concluded that there were no additional other than temporary impairments as of December 31, 2003 or 2002. Due to the issuers’ continued satisfaction of the investment obligations in accordance with their contractual terms and management’s expectation that they will continue to do so, management’s intent and ability to hold these securities, as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that unrealized losses on investments at December 31, 2003 and 2002 were temporary.
The evaluation for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates.
The amortized cost and carrying value of fixed maturities and short-term investments at December 31, 2003 by contractual maturity were as follows. Actual maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s investment in the common stock of Wachovia Corporation exceeds 10% of shareholders’ equity at December 31, 2003. The carrying value of this investment at December 31, 2003 was $20,621 with a cost basis of $3,927.
In accordance with general practice in the insurance industry, portions of the life, property and casualty insurance written by the Company are reinsured; however, the Company remains liable with respect to reinsurance ceded should any reinsurer be unable to meet its obligations. Approximately 90% of the reinsurance receivables were due from four reinsurers as of December 31, 2003. Reinsurance receivables of $18,297 were with General Reinsurance Corporation, rated “AAA” by Standard & Poor’s and “A++” (Superior) by A.M. Best, $3,769 were with First Colony Life Insurance Company, rated “AA” by Standard & Poor’s and “A++” (Superior) by A.M. Best, $10,642 were with PMA Capital Insurance Company (“PMA Re”), rated “B++” (Very Good) by A.M. Best and $5,955 were with Swiss Reinsurance Corporation, rated “AA” by Standard & Poor’s and “A+” (Superior) by A.M. Best. Allowances for uncollectible amounts are established against reinsurance receivables, if appropriate. On November 4, 2003, A.M. Best downgraded the financial strength rating of PMA Re to “B++” (Very Good) from “A-” (Excellent). The rating action reflects PMA Re’s weak stand-alone capital position
A reconciliation of the differences between income taxes computed at the federal statutory income tax rate and the (benefit) expense for income taxes was as follows:
Deferred tax liabilities and assets at December 31, 2003 and 2002 were comprised of the following:
decrease of $1,478 and $1,249, respectively, in the valuation allowance was due primarily to the utilization of a portion of these benefits that were previously reserved for. Since the Company’s ability to generate taxable income from operations and utilize available tax-planning strategies in the near term is dependent upon various factors, many of which are beyond management’s control, management believes that the remaining deferred income tax benefits relating to the carryforwards may not be realized. However, realization of the remaining deferred income tax benefits will be assessed periodically based on the Company’s current and anticipated results of operations and amounts could increase or decrease in the near term if estimates of future taxable income change. The Company has formal tax-sharing agreements and files a consolidated income tax return with its subsidiaries.
The Company has guaranteed, on a subordinated basis, all of the obligations under the trust preferred securities, including payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation.
The Company’s rental expense, including common area charges, for operating leases was $1,867, $1,811, and $1,732 in 2003, 2002, and 2001, respectively. The Company’s future minimum lease obligations under non-cancelable operating leases are as follows:
Data on options outstanding and exercisable at December 31, 2003 is as follows:
The Company initiated an employees’ savings plan under Section 401(k) of the Internal Revenue Code in May 1995. The plan covers substantially all of the Company’s employees, except employees of American Southern. Under the plan, employees generally may elect to contribute up to 16% of their compensation to the plan. The Company makes a matching contribution on behalf of each employee in an amount equal to 50% of the first 6% of such contributions. The Company’s matching contribution is in Company stock and had a value of approximately $256, $219, and $159 in 2003, 2002, and 2001, respectively.
The weighted-average assumptions used to determine the benefit obligation at December 31, were as follows:
The qualified defined benefit plan assets were invested in the INVESCO Total Return Fund (the “Fund”), the prospectus for which indicates a 10 year average annual return of approximately 7%; accordingly, a 7.00% rate of return was used to calculate the periodic benefit cost for 2003. The Fund normally invests at least 65% of its assets in common stocks and at least 30% of its assets in debt securities that are investment grade at the time of purchase. The remaining assets of the Fund are allocated to other investments at the Fund manager’s discretion, based upon current business, economic and market conditions.
The Company’s investment strategy with respect to pension assets is to invest the assets in accordance with ERISA and fiduciary standards. The long-term primary investment objectives are to: 1) provide for a reasonable amount of long-term growth of capital, without undue exposure to risk; and protect the assets from erosion of purchasing power, and 2) provide investment results that meet or exceed the actuarially assumed long-term rate of return. The Fund has not included any equity securities of the Company at any time.
The Company expects to contribute $236 for all defined benefit plans in 2004.
The Company had 5,000 shares of Series C Preferred Stock (“Series C Preferred Stock”) outstanding at December 31, 2003, having a stated value of $100 per share. Annual dividends are $9.00 per share and are cumulative. The Series C Preferred Stock is not currently convertible but may become convertible into shares of the Company’s common stock under certain circumstances. In such event, the Series C Preferred Stock would be convertible into an aggregate of approximately 125,000 shares of the Company’s common stock at a conversion price of $3.99 per share. The Series C Preferred Stock is redeemable at the option of the Company. During 2003, in accordance with the terms of the Series C Preferred Stock, the Company exercised its right to redeem 20,000 of the outstanding shares of the Series C Preferred Stock. These shares were redeemed at the redemption price specified in the terms of the Series C Preferred Stock, $100 per share, or $2,000. The Company paid $143 and $225 in dividends to the holders of the Series C Preferred Stock during 2003 and 2002, respectively. For all periods in which the Company had an accumulated deficit, dividends on the Series C Preferred Stock were
The Company leases approximately 65,489 square feet of office and covered garage space from an affiliated company. During the years ended December 31, 2003, 2002, and 2001, the Company paid $1,000, $987 and $961, respectively, under the leases.
The Company has made mortgage loans to finance properties owned by Leath Furniture, LLC (“Leath”), which is owned by an affiliate of the Chairman. At December 31, 2003 and 2002, the balance of mortgage loans owed by Leath to the Company’s insurance subsidiary was $3,152 and $3,292, respectively. For 2003, 2002, and 2001, interest paid by Leath on the mortgage loans totaled $299, $311, and $323, respectively.
In 1998, Georgia Casualty began assuming workers’ compensation premiums from Delta Fire & Casualty Insurance Company which is controlled by certain affiliates of the Company. Premiums assumed and commissions paid in 2003 were $1,817 and $168, respectively, $1,090 and $128 in 2002, respectively and $1,554 and $212 in 2001, respectively.
as from investment income. Substantially all revenue other than that in the corporate and other segment is from external sources.
The carrying amount is determined in accordance with methods prescribed by the NAIC, which do not differ materially from nationally quoted market prices.
The Company’s comprehensive income consists of net income, unrealized gains and losses on securities available for sale and fair value adjustments to the interest rate swap, net of applicable income taxes.
Other than net income, the other components of comprehensive income (loss) for the years ended December 31, 2003, 2002 and 2001 were as follows:
The following table sets forth a summary of the quarterly unaudited results of operations for the two years in the period ended December 31, 2003: