We own the land and an approximately 72,000 square feet corporate headquarters building in Southfield, Michigan. We expect that our corporate headquarters building will be adequate for our current and expected future operations.
We are a publicly traded specialty niche focused commercial insurance underwriter and insurance administration services company. We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis through a broad and diverse network of independent retail agents, wholesalers, program administrators and general agents, who value service, specialized knowledge, and focused expertise. Program business refers to an aggregation of individually underwritten risks that have some unique characteristic and are distributed through a select group of agents. We seek to combine profitable underwriting, income from our net commissions and fees, investment returns and efficient capital management to deliver consistent long-term growth in shareholder value.
The following table sets forth our gross and net reserves for losses and LAE based upon an underlying source of data, at December 31, 2011 (in thousands):
The following table sets forth our net case and IBNR reserves for losses and LAE by line of business at December 31, 2011 (in thousands):
Claims for short-tail lines of business settle more quickly than long-tail lines of business, and in general, loss development factors for short-tail lines are smaller than long-tail lines. For long-tail lines, we tend to rely on initial expected loss methods throughout the current accident year then move to development factor based methods for older accident years. Development methods on short-tail lines are generally reliable in the third and fourth quarter of the initial accident year and recorded loss ratios reflect a blend of the development and forecast methods. Short-tail lines represent 3% of our total reserves at December 31, 2011.
Our range of loss and LAE reserves table shows that presently we estimate them as going from favorable development of 10.4% to unfavorable of 10.8%. The range was evaluated based on the ultimate loss estimates from the actuarial methods described above.
The sensitivity around our workers’ compensation reserves primarily reflects the size and the maturity of the underlying book of business. Our workers’ compensation reserves represent 43% of our total reserves at December 31, 2011.
The sensitivity around our commercial multiple peril / general liability reserves primarily reflects the longer duration of reserves relating to our liability excess program, which started in 2003, and construction defect exposure, which together represent approximately 39% of the $353.3 million reserves in this line of business as of December 31, 2011. These lines of business are subject to greater uncertainty than the remainder of our book of business.
In our risk-sharing programs, we are subject to credit risk with respect to the payment of claims by our clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, or on the portion of risk either ceded to the captives, or retained by the clients. The capitalization and credit worthiness of prospective risk-sharing partners is one of the factors we consider upon entering into and renewing risk-sharing programs. We collateralize balances due from our risk-sharing partners through funds withheld trusts or stand-by letters of credit issued by highly rated banks. We have historically maintained an allowance for the potential uncollectibility of certain reinsurance balances due from some risk-sharing partners, some of which may be in dispute. At the end of each quarter, an analysis of these exposures is conducted to determine the potential exposure to uncollectibility. At December 31, 2011, we believe this allowance is adequate. To date, we have not, in the aggregate, experienced material difficulties in collecting balances from our risk-sharing partners. No assurance can be given, however, regarding the future ability of our risk-sharing partners to meet their obligations.
We are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business. Where appropriate, we vigorously defend such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the policy at issue, errors and omissions insurance or other appropriate insurance. In terms of deductibles associated with such insurance, we have established provisions against these items, which are believed to be adequate in light of current information and legal advice. In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements and the amount of loss is estimable; an accrual is provided for the costs to resolve these claims in our consolidated accompanying financial statements. Period expenses related to the defense of such claims are included in the accompanying consolidated statements of income. We, with the assistance of outside counsel, adjust such provisions according to new developments or changes in the strategy in dealing with such matters. On the basis of current information, we do not expect the outcome of the claims, lawsuits and proceedings to which we are subject to, either individually, or in the aggregate, will have a material adverse effect on our financial condition. However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.
Our results for the year ended December 31, 2011, include the positive impact from continued selective growth, coupled with our adherence to strict corporate underwriting guidelines and a focus on current accident year price adequacy. Our generally accepted accounting principles (“GAAP”) combined ratio was 99.7% for the year ended December 31, 2011, compared to 95.0% in 2010. Our accident year combined ratio was 98.7% for the year ended December 31, 2011, compared to 99.7% in 2010. The year-to-date 2011 results were impacted by higher than expected or ‘normal level’ storm losses that occurred during 2011, which added 1.2 percentage points to both the GAAP and accident year combined ratios.
Net realized gains increased by $1.1 million, to a $2.9 million gain for the year ended December 31, 2011, from a $1.8 million gain for the comparable period in 2010. The increase in realized gains relates to our efforts to generate capital gains as a result of our tax strategy to utilize the benefit from our capital tax loss carry-forward.
Expenses increased $114.2 million from $669.3 million for the year ended December 31, 2010 to $783.5 million for the year ended December 31, 2011.
General, selling and administrative costs increased $2.3 million, to $24.8 million for the year ended December 31, 2011, from $22.5 million for the same period in 2010. This increase relates primarily to investments in new sales initiatives to stimulate net commission and fee revenue growth, as well as a shift in certain overhead expenses from direct insurance operations to corporate overhead. These items were partially offset by a reduction in performance based variable compensation in 2011 as compared to 2010.
Net earned premiums increased $120.2 million, or 22.3%, to $659.8 million for the year ended December 31, 2010, from $539.6 million in the comparable period in 2009. This increase was primarily the result of growth within our existing programs and the new business we began writing in 2009.
Management fees decreased $3.5 million, or 17.6%, to $16.2 million for the year ended December 31, 2010, from $19.7 million for the comparable period in 2009. This decrease primarily reflects the impact of a program we previously managed that decided to perform its own policy administration services, the conversion of an existing program into an insured program within the Company’s underwriting subsidiary during 2010, as well as a decrease in fees for self-insured programs, caused by a decrease in premium volume from continued competition, economic conditions, and higher unemployment.
Net investment income increased $3.8 million, or 7.6%, to $54.2 million for the year ended December 31, 2010, from $50.4 million in 2009. This increase primarily reflects the increase in average invested assets from $1.1 billion in 2009 to $1.3 billion in 2010. The increase in our average investment balance is because of growth in underwriting profits, growth in investment income, and a slight lengthening of our loss and LAE reserve duration. The average investment yield for December 31, 2010 was 4.3% compared to 4.4% in 2009. The current pre-tax book yield was 4.2% compared to 4.4% in 2009. The current after-tax book yield was 3.1% compared to 3.4% in 2009. The effective duration of the investment portfolio was 5.0 years at December 31, 2010 and 5.1 years at December 30, 2009.
Net loss and loss adjustment expenses (“LAE”) increased $72.3 million, to $399.7 million for the year ended December 31, 2010, from $327.4 million for the same period in 2009. Our loss and LAE ratio was 60.6% for the year ended December 31, 2010 and 60.7% for the year ended December 31, 2009. The accident year loss and LAE ratio was 65.3% for the year ended December 31, 2010 down from 66.0% in the comparable period in 2009. Additional discussion of our reserve activity is described below within the Other Items ~ Reserves section.
For the twelve months ended December 31, 2011, we reported an increase in net ultimate loss estimates for accident years 2010 and prior of $7.3 million, or 0.9% of $784.2 million of beginning net loss and LAE reserves at December 31, 2010. The change in net ultimate loss estimates reflected revisions in the estimated reserves as a result of actual claims activity in calendar year 2011 that differed from the projected activity. There were no significant changes in the key assumptions utilized in the analysis and calculations of our reserves during 2010 and for the twelve months ended December 31, 2011. The major components of this change in ultimates are as follows (in thousands):
The projected net ultimate loss estimate for the workers’ compensation line of business excluding residual markets increased $9.2 million, or 3.2% of net workers’ compensation reserves. This net overall increase reflects increases of $8.7 million, $3.8 million, and $1.1 million for accident years 2010, 2009, and 2003, respectively. This increase in the net ultimate loss estimate for these accident years was due to greater than expected claim emergence. The 2009 and 2010 accident years’ emergence was from two countrywide programs, a New England program, three California programs, and a Nevada program. Accident year 2003 emergence came from a single claim reserve increase. These increases were partially offset by decreases of $1.0 million, $2.0 million, $533,000 and $763,000 for accident years 2008, 2007, 2006, and 2005 respectively. The decrease in the net ultimate loss estimates for these accident years was due to less than expected claim emergence in two countrywide programs and a Florida program. The change in ultimate loss estimates for all other accident years was insignificant.
The commercial multiple peril line and general liability line of business had a decrease in net ultimate loss estimates of $5.1 million, or 1.5% of net commercial multiple peril and general liability reserves. The net decrease reflects decreases of $7.0 million, $3.1 million, $681,000, $2.1 million, $665,000, and $873,000 in the ultimate loss estimates for accident years 2010, 2009, 2008, 2007, 2002, and 1996 respectively. The decreases in the net ultimate loss estimates for these accident years were due to better than expected claim emergence in several general liability programs and an excess liability program. The decreases were offset by increases of $841,000, $4.2 million, $2.4 million, $686,000, $522,000 and $852,000 for accident years 2006, 2005, 2004, 2003, 2000, and 1997, respectively. These increases in the net ultimate loss estimates for these accident years was due to greater than expected claim emergence in an excess liability program and a contractors program. The change in ultimate loss estimates for all other accident years was insignificant.
The projected net ultimate loss estimate for the commercial automobile line of business increased $5.3 million, or 4.8% of net commercial automobile reserves. This net overall increase reflects increases in the net ultimate loss estimate of $2.7 million, $2.4 million and $646,000 for accident years 2010, 2009, and 2007, respectively. This increase in the net ultimate loss estimates for this accident year was due to greater than expected claim emergence in a garage program, a California program, an excess program, and a transportation program. This increase was partially offset by a decrease of $630,000 for accident year 2005. The decrease in the net ultimate loss estimates for this accident year was due to less than expected claim emergence spread across several programs. The change in ultimate loss estimates for all other accident years was insignificant.
The workers’ compensation residual market line of business had a decrease in net ultimate loss estimate of $1.4 million, or 7.5% of net reserves. This decrease reflects a reduction of $1.3 million in accident year 2009. We record loss reserves as reported by the National Council on Compensation Insurance (“NCCI”), plus a provision for the reserves incurred but not yet analyzed and reported to us due to a two quarter lag in reporting. These changes reflect a difference between our estimate of the lag incurred but not reported and the amounts reported by the NCCI in the year. The change in ultimate loss estimates for all other accident years was insignificant.
A significant portion of our consolidated assets represents assets of our Insurance Company Subsidiaries that may not be transferable to the holding company in the form of dividends, loans or advances in accordance with state insurance laws. These laws generally specify that dividends can be paid only from unassigned surplus and only to the extent that all dividends in the current twelve months do not exceed the greater of 10% of total statutory surplus as of the end of the prior fiscal year or 100% of the statutory net income for the prior year, less any dividends paid in the prior twelve months. Using these criteria, the available ordinary dividend available to be paid from the Insurance Company Subsidiaries during 2011 is $43.8 million without prior regulatory approval. Of this $43.8 million, ordinary dividends of $22.6 million have been declared and paid as of December 31, 2011. In addition to ordinary dividends, the Insurance Company Subsidiaries have the capacity to pay $111.9 million of extraordinary dividends in 2011, subject to prior regulatory approval. The Insurance Company Subsidiaries’ ability to pay future dividends without advance regulatory approval is dependent upon maintaining a positive level of unassigned surplus, which in turn, is dependent upon the Insurance Company Subsidiaries generating net income. Total ordinary dividends paid from our Insurance Company Subsidiaries to our holding company were $22.6 million and $42.0 million as of December 31, 2011 and 2010, respectively. We remain well within our targets as they relate to our premium leverage ratios, even taking into consideration the dividends paid by our Insurance Company Subsidiaries. Our targeted maximum leverage ratios for gross and net written premium to statutory surplus are 2.75 to 1.0 and 2.25 to 1.0, respectively. As of December 31, 2011, on a trailing twelve month statutory consolidated basis, the gross and net premium leverage ratios were 2.3 to 1.0 and 2.0 to 1.0, respectively.
We have a total revolving credit facility of $35.0 million, which may include up to $15.0 million in letters of credit. As of December 31, 2011, we had $4.5 million outstanding balance on our revolving credit facility and $0.5 million in letters of credit issued. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to our Insurance Company Subsidiaries to support premium growth or strategic acquisitions.
Refer to Note 7 ~ Derivative Instruments for additional information specific to our interest rate swaps.
Refer to Note 6 ~ Debt for additional information specific to our credit facilities and debentures.
As of December 31, 2011 and December 31, 2010, the recorded values of our investment portfolio, including cash and cash equivalents, were $1.5 billion and $1.3 billion, respectively.
In general, we believe our overall investment portfolio is conservatively invested. The effective duration of the investment portfolio at December 31, 2011 and 2010, was 4.9 years and 5.0 years, respectively. Our current pre-tax book yield is 4.0% compared to 4.2% in 2010. The current after-tax yield is 3.0%, compared to 3.1% in 2010. Approximately 98.9% of our fixed income investment portfolio is investment grade.
The following table is a summary of our contractual obligations and commitments as of December 31, 2011 (in thousands):
(2) Five year call feature associated with debentures, estimated seven year repayment. For a description of our debentures and related interest rate terms, as well as actual rates in accordance with our interest rate swap transactions, refer to Note 6 ~ Debt and Note 7 ~ Derivative Instruments.
(3) Relates to the junior subordinated debentures acquired in conjunction with the ProCentury merger.
Our Compensation Committee also is authorized to issue restricted stock awards when the Company achieves various financial, operational and strategic goals and objectives.
With the ProCentury merger our Compensation Committee and Board of Directors determined that our opportunity for successfully integrating the ProCentury merger would be heightened and shareholder value increased, if all participants were in the same equity-based plan beginning in 2009. As a result, our Compensation Committee approved the termination of our current 2007-2009 LTIP effective December 31, 2008 and established a new plan for 2009-2011 based on new performance targets. Based on this amendment, the LTIP participants would receive their award based on a two-year performance period, rather than a three-year period. Therefore, the total award would be approximately two-thirds of the original three-year award. There were no accounting adjustments as a result of the amendment as there were no changes to the underlying plan, only an adjustment to the performance period.
All of our plans are administered by the Compensation Committee of the Board of Directors and all awards are reviewed and approved by the Board of Directors at both inception and at distribution.
At December 31, 2011, each of our Insurance Company Subsidiaries was in excess of any minimum threshold at which corrective action would be required.
In regard to our excess-of-loss reinsurance, we manage our credit risk on reinsurance recoverables by reviewing the financial stability, A.M. Best rating, capitalization, and credit worthiness of prospective or existing reinsurers. We generally do not seek collateral where the reinsurer is rated “A−” or better by A. M. Best, has $500 million or more in surplus, and is admitted in the state of Michigan. The following table sets forth information relating to our five largest unaffiliated excess-of-loss reinsurers based upon ceded premium as of December 31, 2011:
Refer to list of Financial Statement Schedules and Note 18 ~ Quarterly Financial Data (Unaudited) of the Notes to the Consolidated Financial Statements.