The following table sets forth our selected historical financial information and that of our predecessor for the periods ended and as of the dates indicated. This information comes from our consolidated financial statements and those of our predecessor. You should read the following selected financial information along with the information contained in our financial statements and related notes and the reports of the independent registered public accounting firm included under the heading “Item 8. Financial Statements And Supplementary Data” in PART II of this annual report. These historical results are not indicative of results to be expected for any future period.
The following tables include our loss development history of loss and loss adjustment expense reserves for business generated subsequent to our acquisition of Potomac Insurance Company of Illinois on November 23, 2004. We commenced our operations in 2005.
Our business model is designed to better serve the specialty property and casualty marketplace by recognizing the void that exists in these underserved niche markets and the problems that undisciplined underwriting has created. Our business model emphasizes our relationship with a select number of partner agents, who have specialized business knowledge in the types of business classes we underwrite. We rely on these partner agents for industry insights and their understanding of the specific risks in the niche markets we serve. We bring together that knowledge with our disciplined underwriting practices and leading-edge technology and systems capabilities to provide insurance programs and products that are customized to the needs of the specialty markets that we serve.
Our business model is also designed to realign the interests of carriers, agents and insureds. Our partner agents are required to enter into agreements with us which provide that in exchange for marketing and pre-qualifying business for us, our partner agents receive an up-front commission designed to cover their costs and an underwriting profit-based commission paid over several years. In addition, each partner agent is required to purchase Class B Shares, which further aligns their interests with us and that of our shareholders. In return, we provide our partner agents with a five-year exclusive arrangement (generally allowing partner agents to offer other companies’ products if we decline to offer coverage to a prospective insured) covering a specific class of business and territory. Further, we have implemented a centralized information system designed to reduce processing and administrative time. Lastly, we are a stable, dedicated source of specialty program commercial property and casualty insurance capacity.
The following table summarizes our results of operations for the years ended December 31, 2008, 2007 and 2006, respectively:
Gross written premiums were $146.2 million for the year ended December 31, 2008 compared to $160.4 million for the comparable period ended December 31, 2007. The decrease in gross written premiums is attributable to decreasing premiums in our workers’ compensation and general liability lines of business. The decrease in gross written premiums was partially offset by the addition of our eighth and ninth partner agents, First Light Program Managers, Inc. and Northern Star Management, Inc., during the third quarter of 2007 and first quarter of 2008, respectively, which both principally produce commercial automobile.
Our gross written premiums for the years ended December 31, 2008 and 2007 by state were as follows:
Our premiums in 2008 remained concentrated in California, Florida and Texas. The increase in California premium resulted from an increase in commercial automobile writings, the addition of our temporary staffing program, and a significant public entity account which increase was offset by a significant reduction in our contractors program due to the economic downturn affecting the housing and construction markets. The decrease in Florida premium resulted from a rate decrease in workers’ compensation of 18.4% in 2008. An additional rate decrease of 18.6% went into effect on January 1, 2009 which should be partially offset by a 6.4% increase due to go into effect on April 1, 2009 and an expected further increase in January of 2010.
Our mix of business by agent, state and line of business was influenced by a large general liability account we wrote in the third quarter of 2008 in our public entity customer class which partially offset a continued reduction in our contractors program as a result of fewer construction projects being started, the rate reduction in workers’ compensation in Florida and changes in the makeup of our insured’s payrolls resulting in lower exposure bases and therefore less premium.
Earned premiums were $143.5 million for the twelve months ended December 31, 2008 compared to $152.5 million for the comparable period in 2007.
Our net loss and loss adjustment expense ratio by line of business for the years ended December 31, 2008 and December 31, 2007 was as follows:
Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006
We continued to increase our number of partner agents. On October 1, 2007 we signed First Light Program Managers, Inc. as a partner agent, writing commercial general liability, commercial automobile and physical damage for selected customer classes in the trucking industry in the southeastern region. We continued to add new programs during 2007, such as temporary staffing with Risk Transfer Holdings, Inc.
Our written premium was concentrated in four of our eight partner agents, though there was continued diversification in the percentage of premium written. Premium breakdown by partner agent was as follows:
Our workers’ compensation business was impacted by rate decreases in Florida and California. Florida approved a rate decrease recommended by the National Council for Compensation Insurance, or the NCCI, of 15.7% effective January 1, 2007. We matched the recommended rate decrease in Florida. The California Insurance Commissioner recommended a 9.5% decrease in advisory pure premium rates on new and renewal policies effective on or after January 1, 2007. On May 29, 2007, the California Insurance Commissioner recommended a 14.2% decrease in rates effective July 1, 2007.
Other operating expenses were $22.6 million for the year ended December 31, 2007, which consisted of salaries and benefit costs of $7.0 million, $3.2 million of professional and consulting fees, $5.0 million of depreciation and amortization expense, $1.1 million of stock based compensation expense and $6.3 million of other expenses. For
the year ended December 31, 2006, other operating expenses were $19.9 million, which consisted of salaries and benefit costs of $6.1 million, $4.2 million of professional and consulting fees, $2.6 million of depreciation and amortization, $1.1 million of stock based compensation expense and $5.9 million of other expenses. We remain committed to operating efficiently and increasing staff only as our business volume requires. The increase in salaries and benefit costs in 2007 was offset by a decrease in professional and consulting services as we continued to bring previously outsourced services in-house.
For the year ended December 31, 2008 net cash from operating activities was $46.1 million, principally consisting of premium and deposit collections exceeding losses and expenses paid out. This amount compares to net cash from operating activities of $69.6 million for the year ended December 31, 2007, which also consisted principally of premium and deposit collections exceeding losses and expenses paid out. For the year ended December 31, 2006, net cash from operating activities was $60.3 million, which also consisted principally of premium and deposit collections exceeding losses and expenses paid out. The decrease in net cash from operating activities from 2007 to 2008 is a result of the maturation of our business combined with a decrease in premium in 2008.
Cash used for investment activities was $47.5, $72.3 and $66.4 million for the years ended December 31, 2008, 2007 and 2006, respectively, principally representing new purchases of investments of $40.2, $63.1 and $60.6 million and additions to equipment and capitalized software of $7.3, $9.2 and $5.8 million, respectively.
During the third quarter of 2008, certain of our available-for-sale securities with a fair value of $0.9 million and a book value of $1.7 million experienced an other-than-temporary impairment of $0.8 million. For information about our methodology for determining whether a security has experienced impairment see the discussion under the heading “Item 8. Financial Statements - Note 2 - Summary of significant Accounting Policies” in PART II of this annual report.
Liquidity. SUA generates liquidity primarily by collecting and investing earned premiums in advance of paying claims. We believe that SUA maintains sufficient liquidity to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. The principal sources of liquidity are existing cash and short-term investments. Cash and short-term investments were $46.9 million at December 31, 2008, compared to $52.6 million at December 31, 2007.
“Purchase Obligation” means an agreement to purchase goods or services that is enforceable and legally binding on the registrant that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. This table does not include our accounts payable reflected in our audited consolidated balance sheet data that are included in our consolidated financial statements contained elsewhere in this report.
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our financial statements, which have been prepared in accordance with generally accepted accounting principals in the United States of America, or GAAP. The financial statements presented herein include all adjustments considered necessary by management to fairly present the financial position, results of operations and cash flows of the Company. The preparation of financial statements in conformity with GAAP requires management to make
Acquisition Expenses. We establish an asset for certain acquisition expenses such as up-front commissions, premium taxes and other variable costs incurred in connection with writing our lines of business. These acquisition expenses are deferred and amortized over the period of coverage of the policies written which is 12 months. Acquisition expenses that do not vary with premium production are expensed immediately. We assess the recoverability of deferred acquisition expenses which are limited to the estimated amounts recoverable from future income after providing for losses and expenses included in future income that are expected to be incurred, based upon historical and current experience. If such costs are estimated to be unrecoverable, they will be expensed. Judgments as to ultimate recoverability of such deferred acquisition expenses is highly dependent on future estimates of loss costs associated with unearned premium. The process of establishing loss reserves is complex and judgmental, as it must take into consideration many variables that are subject to the outcome of future events. There have been no historical changes in the recoverability of our deferred acquisition expenses. We do not believe that any reasonably likely change in our loss development will affect the recoverability of acquisition expenses. See the subheading “Losses, Claims and Settlement Expenses” below.
Losses, Claims and Settlement Expenses. Our most significant estimates relate to our reserves for property and casualty losses and loss adjustment expenses. We establish reserves for the estimated total unpaid cost of losses and loss adjustment expenses for events that have already occurred. These reserves reflect our best estimates of the total cost of claims that were reported to us, but not yet paid, referred to as case reserves, and the cost of claims “incurred but not yet reported” to us, referred to as IBNR Reserves.
Our general liability product line is considered a long-tail coverage, as it takes a relatively long period of time to finalize claims from a given accident year. General liability reserves are comprised primarily of bodily injury and, to a lesser extent, property damage. Bodily injury claims arise from physical injury as a result of the policyholder’s legal obligation arising from non-intentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage
Reserving Methodologies. Instead of any single method, we use a combination of various actuarial and analytical methods to estimate the amount of reserves for each line of business on the basis of historical, statistical and industry information. The primary methods that we utilize to determine our ultimate losses and loss adjustment expenses include:
The following table shows for SUA the recorded reserves and the high and low ends of the range of reasonable loss and LAE reserve estimates at December 31, 2008.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies previously issued guidance on fair value. The Company’s adoption of FAS 157, effective January 1, 2008, results in additional financial statement disclosures and has no effect on the conduct of the Company’s business, its financial condition and results of operations.
In October 2008, the FASB issued FASB Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP FAS 157-3”). FSP FAS 157-3 clarifies the application of SFAS 157, Fair Value Measurements, in a market that is not active. The Company adopted FSP FAS 157-3 on issuance, applicable to the third quarter 2008 financial statements. The adoption of this standard did not have any material impact on the Company’s financial statements.