(5) The ratio of net premiums written divided by ending statutory surplus.
(6) Earnings per share data for 2004 reflects only net income for the period from October 16, 2004 through December 31, 2004, the period after the Conversion. Net income during this period was $902,711.
The Bornhuetter-Ferguson expected loss projection method based on incurred loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis were selected judgmentally. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected incurred loss development factors. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses.
In estimating our loss reserves for the multi-peril lines of business (homeowners, farmowners and commercial) and the general liability line of business we relied on the incurred Bornhuetter-Ferguson method for accident years 2005 to 2008 and the incurred loss development for accident years prior to 2005.
For the workers’ compensation line of business we relied on the incurred Bornhuetter-Ferguson method for accident years 2003 to 2008 and the incurred loss development method for all prior years. Given the longer tail development of workers’ compensation claims and the fact that the Company’s workers’ compensation book of business is relatively small we placed more reliance on the incurred Bornhuetter-Ferguson method.
Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss adjustment expenses will likely differ from the amount recorded at December 31, 2008.
In 2008, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $2,722,000. The redundant development included $814,000 related to homeowners, $864,000
In 2006, the Company experienced favorable development on losses and loss adjustment expenses for prior accident years of $5,224,000. During 2006, all product lines experienced favorable development as follows: homeowners-$1,340,000, personal auto-$1,329,000, commercial multi-peril-$1,247,000, workers compensation-$715,000, farm-$379,000 while the remaining product lines had redundant development of $214,000. There were no significant changes in the key assumptions utilized in the analysis and calculations of the Company’s reserves during 2006. The favorable development was concentrated in accident years 2003 through 2005 and is a result of downward development on both case and incurred but not reported reserves and loss adjusting expense reserves.
Investments. At December 31, 2008 and 2007, all of the Company’s investments are classified as available-for-sale and are those investments that would be available to be sold in response to the Company’s liquidity needs, changes in market interest rates and asset-liability management strategies, among others. Available-for-sale investments are recorded at fair value, with the corresponding unrealized appreciation or depreciation, net of deferred income taxes and any corresponding deferred tax asset valuation allowance, reported as a component of accumulated other comprehensive income or loss until realized.
Federal Income Taxes. Deferred federal income tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amount of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized.
Consolidated Results of Operations. The following table shows the underwriting gain or loss as well as other revenue and expense items included in our consolidated statements of income for the years ended December 31, 2008 and 2007. The Company’s underwriting gain or loss consists of net premiums earned less
While the commercial segment, especially property driven accounts, has been hit hardest by the soft market, Fremont was able to gain market share and increase its commercial direct premiums written by 9.6%. All commercial product lines showed positive growth with commercial auto up 24.9%, business owners (BOP) up 3.2%, commercial package (CPP) up 2.5% and workers compensation up 29.1%. Our agents have begun to look to Fremont for their commercial business and we were able to write several larger commercial accounts which accounted for upwards of over $325,000 in new business premium. Commercial policy count was up 7.4%.
Consolidated Results of Operations. The following table shows the underwriting gain or loss as well as other revenue and expense items included in our consolidated statements of income for the years ended December 31, 2007 and 2006. The Company’s underwriting gain or loss consists of net premiums earned less loss and LAE and policy acquisition and other underwriting expenses. The Company’s underwriting performance is the most important factor in evaluating the overall results of operations given the fluctuations which can occur in loss and LAE due to weather related events as well as the uncertainties involved in the process of estimating reserves for losses and LAE. The underwriting results and the fluctuations in other revenue and expense items are discussed in greater detail below.
Underwriting Results. The following table shows the components of the Company’s underwriting gain or loss for the years ended December 31:
Loss and Loss Adjustment Expenses (LAE). The Company’s net loss and LAE by major business segment as well as the loss and LAE ratio’s are shown in the tables below:
The personal segment experienced an increase in incurred loss and loss adjusting expense as well as the loss and LAE ratio driven by increased severity in the homeowner product line coupled with increased claim frequency in the personal auto line. Incurred losses for homeowners and personal auto increased $3,169,000 and $2,017,000, respectively, during 2007 compared to 2006. The homeowner line experienced increased loss severity as a result of snow, ice and water damage losses caused by the colder winter weather experienced during the first quarter 2007 and wind, hail and lightening damages sustained during the second and third quarters. Weather related losses increased approximately $2,245,000 during 2007 as compared to 2006. During the first quarter of 2007 Michigan experienced a more normalized winter weather pattern evidenced by consistent below-freezing temperatures and significant snow accumulation. During the first quarter of 2006 Michigan did not
experience the consistent below freezing temperatures as those experienced in 2007 which resulted in lower claim severity in 2006. Weather patterns experienced during 2007 reflected more traditional weather activity typically experienced in Michigan. Although the Company did experience summer storm activity in 2006 it was not near the extent of storm activity experienced in 2007. Loss and LAE from personal auto increased due to increased claim frequency driven by volume growth in this line. The personal auto line’s direct premiums written increased 26.3% in 2007 compared to 2006. Furthermore, the majority of the increase in the incurred claim count for the personal segment was from increased personal auto claims particularly auto physical damage.
The expense ratio increased 2.6 percentage points in 2007 compared to 2006. The significant items and the related impact on the expense ratio include: non-recurring assessments from state mandated pools and associations in which the Company is required to participate (1.6 percentage points), increased depreciation (0.3 percentage points) and premium tax refunds received in 2006 (which reduced the 2006 expense ratio by 0.7 percentage points).
During 2007, the Company increased its holdings in tax exempt municipals in order to take advantage of the higher tax equivalent yields in that sector. This was accomplished by selling both corporate securities and other tax exempt municipals which had lower yields. The shift resulted in net realized losses of $233,000.
During 2007, the Company sold approximately $8.4 million in equity securities which generated $2,211,000 in realized gains. The sales were generated in order to reduce the level of equity risk in the portfolio, rebalance the equity portfolio and take advantage of the unrealized market value appreciation in the equity portfolio. The cash generated from the equity sales was placed into the fixed portfolio.
Cash used in investing activities was $6,087,000 and $2,000,000 during the years ended December 31, 2008 and 2007, respectively, an increase of $4,087,000. During 2008, net cash invested into the Company’s investment portfolio was $4,945,000 compared to $494,000 in 2007, an increase of $4,451,000. The increase in cash placed into the investment portfolio was due to the increase in cash provided by operations. During 2008, there was a decrease in capital expenditures of $367,000. The majority of the Company’s capital expenditures were related to Fremont Complete. Cash used in financing activities of $821,000 consisted primarily of share repurchase of common stock of $732,000 and dividends paid to shareholders of $105,000.
During the third quarter of 2008, the Holding Company began paying a quarterly cash dividend. The Holding Company paid a quarterly dividend of $.03 per share in both the third and fourth quarters. Each dividend totaled approximately $53,000. The Company cannot assure our stockholders that dividends will continue to be paid in the future. The Holding Company’s principal source of cash available for payment of dividends is dividends from the Insurance Company. The annual future cash requirements of the Holding Company are not foreseen to be significant. They include dividends paid to shareholders and other administrative expenses related to annual filings such as income tax returns and other compliance type filings. During 2008, the Board of Directors of the Insurance Company declared and paid ordinary dividends totaling $700,000 to the Holding Company, its sole shareholder. As of December 31, 2008, the Holding Company had a cash balance of approximately $67,000.
The payment of dividends by the Insurance Company is subject to limitations imposed by the Michigan Insurance Code. The Insurance Company may not pay an extraordinary dividend unless it notifies the Insurance Commissioner and he does not disapprove the payment. An extraordinary dividend includes any dividend which, when taken together with other dividends paid within the preceding 12 months, exceeds the greater of 10% of the Insurance Company’s statutory policyholders’ surplus as of December 31 of the immediately preceding year or its statutory net income, excluding realized capital gains, for the 12-month period ending December 31 of the immediately preceding year. During the year ending December 31, 2009, the Insurance Company can pay a non-extraordinary dividend of up to $2,688,000 without prior approval from the Insurance Commissioner. In order to pay any dividends, the Insurance Company must be in a position to satisfy the requirement that the company continue to be safe, reliable and entitled to public confidence. Also, in the absence of approval of the Insurance Commissioner, dividends may only be paid from statutory earned surplus. Also, dividends may not exceed the amount of the Insurance Company’s statutory capital stock account in any one-year unless it meets certain other requirements.
In accordance with FASB Statement No. 109, Accounting for Income Taxes, we may recognize certain tax assets whose realization depends upon generating future taxable income. These tax assets can only be realized through the generation of future taxable income and thereby utilizing the net operating loss (NOL) and Alternative Minimum Tax (AMT) credit carry-forwards we have available. At December 31, 2008, the Company has NOL carryforwards of approximately $6,948,000 and an AMT credit carryforward of approximately $358,000. The AMT credit carryforward can be carried forward indefinitely. The NOL carryforward expires as follows:
As a result of the Holding Company’s acquisition of the stock of the Insurance Company a limitation on the ability to fully utilize the NOL occurred. The amount of annual taxable income that can be offset each year by the NOL carryforward is approximately $400,000. See Note 5 to the consolidated financial statements, included elsewhere in this report, for further information regarding federal income taxes. Such information is incorporated herein by reference.
We have audited the accompanying consolidated balance sheets of Fremont Michigan InsuraCorp, Inc. as of December 31, 2008 and 2007 and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. Our responsibility is to express an opinion on these financial statements based on our audits.
The fair value of shares issued for stock dividends of 25% or less is transferred from retained earnings to additional paid-in capital, to the extent of available retained earnings. No transfer is recorded for stock dividends or splits in excess of 25%. All share and per share amounts are retroactively adjusted for stock dividends and stock splits. On October 17, 2006, the Company’s Board of Directors approved a two-for-one stock split on its common stock which was accomplished through a stock dividend paid on November 17, 2006. On May 8, 2008, the Board of Directors declared a 3% stock dividend, which was paid on June 5, 2008.
At December 31, 2008 and 2007, all of the Company’s investments are classified as available-for-sale and are those investments that would be available to be sold in response to the Company’s liquidity needs, changes in market interest rates and asset-liability management strategies, among others. Available-for-sale investments are recorded at fair value, with the corresponding unrealized appreciation or depreciation, net of deferred income taxes and any corresponding deferred tax asset valuation allowance, reported as a component of accumulated other comprehensive income or loss until realized.
Insurance premium revenue is recognized on a pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in-force. Generally, premiums are collected in advance of providing risk coverage, minimizing the Company’s exposure to credit risk. Premiums due from policyholders are net of an allowance for doubtful accounts of $58,678 and $39,029 at December 31, 2008 and 2007, respectively.
The Company presents other comprehensive income or loss as a component of stockholders’ equity on the consolidated statements of stockholders’ equity and comprehensive income. For the years ended December 31, 2008, 2007, and 2006 the components of other comprehensive income consisted of the following:
The components of and changes to accumulated other comprehensive income (loss) as of and for the years ended December 31, 2008, 2007 and 2006 were as follows:
The Company provides certain postretirement health care benefits for retired employees. In December 2004, the Company’s board of directors approved an amendment to the plan, effective December 31, 2004, which significantly reduced the number of eligible participants in the plan, discontinued future eligibility for all other employees and reduced the level of health care benefits for future retirees determined to be eligible as of December 31, 2004. The Company accrues service cost as incurred. The Company’s measurement date for plan assets and obligations is its fiscal year-end.
In 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value as the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date, and establishes a framework to make the measurement of fair value more consistent and comparable. In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets (“market approach”). We have determined that our fair value measurements are in accordance with the requirements of SFAS No. 157, therefore, the implementation of SFAS No. 157 which was effective on January 1, 2008 did not have any impact on our consolidated financial condition or results of operations. The implementation of SFAS No. 157 resulted in expanded disclosures about securities measured at fair value, as discussed below.
non-financial liabilities. Accordingly, the provisions of FAS 157 were not applied to nonfinancial assets and nonfinancial liabilities within the scope of FSP FAS 157-2.
SFAS No. 157 established a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”). The hierarchy level assigned to each security in our available-for-sale portfolio is based on our assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:
If the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement.
In 2007, the FASB issued Statement No. 159, “The Fair Value Option of Financial Assets and Financial Liabilities” (“SFAS No. 159”). Under this standard, we are permitted to elect to measure financial instruments and certain other items at fair value, with the change in fair value recorded in earnings. We implemented SFAS No. 159 effective January 1, 2008 and elected not to measure any eligible items using the fair value option in accordance with SFAS No. 159. We believe the current accounting is appropriate for our investments as we have the ability to hold our investments for the long-term, therefore, SFAS No. 159 did not have any impact on our consolidated financial condition or results of operations.
In February 2007, the FASB issued FSP No. FAS 158-1, “Conforming Amendments to the Illustrations in FASB Statements No. 87, No. 88 and No. 106 and to the Related Staff Implementation Guides.” This FSP provides conforming amendments to the illustrations in SFAS 87, 88, and 106 and to related staff implementation guides as a result of the issuance of SFAS 158. The conforming amendments made by this FSP are effective as of the effective dates of SFAS 158. The unaffected guidance that this FSP codifies into SFAS 87, 88, and 106 does not contain new requirements and therefore does not require a separate effective date or transition method. The implementation of FSP No. FAS 158-1 did not have a material impact on the Company’s consolidated financial statements.
No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS No. 161 will not affect our consolidated financial condition and results of operations, but may require additional disclosures if we enter into derivative and hedging activities.
The cost or amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value of investments at December 31, 2008 and 2007 are as follows:
Net investment income for the years ended December 31, 2008, 2007 and 2006 is summarized as follows:
As of December 31, 2008, the portfolio included 26 fixed maturity securities and 10 equity securities in an unrealized loss position for less than 12 months and 12 fixed maturity securities and 5 equity securities in an unrealized loss position for more than 12 months. Of the fixed maturity securities, five were trading between 73% and 84% of amortized cost, twelve were trading between 85% and 94% of amortized cost and the remaining twenty-one were trading at or above 95% of amortized cost. All of the fixed maturity securities in an unrealized loss position and assigned a rating by a commercial credit rating agency are rated investment grade securities.
Of the fifteen equity securities in an unrealized loss position, the range of market value to cost was from 37% up to 83%. While all of these securities are monitored for potential impairment, the Company’s experience indicates that they generally do not present as great a risk of impairment, as fair value often recovers over time. These securities have generally been adversely affected by the downturn in the financial markets and overall economic conditions. Management believes that the analysis of each of these securities in addition to the fact that the Company has both the intent and ability to hold these securities until their recovery supports our view that these securities were not other-than-temporarily impaired.
The Company holds collateral in the form of letters of credit, trust accounts or funds withheld accounts for amounts recoverable from reinsurers that are not considered authorized insurers by the State of Michigan Office of Financial and Insurance Regulation. At December 31, 2008, the Company had 7 reinsurance recoverable amounts from reinsurers whose individual recoverable balance exceeded 5% of the total recoverable amount. The amount due from these 7 reinsurers accounts for 94% of the total recoverable.
Actual federal income taxes vary from amounts computed by applying the current federal income tax rate of 34 percent to income before federal income taxes. For the years ended December 31, 2008, 2007 and 2006 the reasons for these differences and the tax effects thereof, are as follows:
The Company assesses the recoverability of deferred policy acquisition costs against future expected underwriting income and reduces deferred policy acquisition costs if it appears that a premium deficiency may exist. There were no premium deficiencies at December 31, 2008, 2007 and 2006.
The Company provides certain postretirement health care benefits for retired employees. In December 2004 the Company’s board of directors approved an amendment to the plan effective December 31, 2004 which significantly reduced the number of eligible participants in the plan, discontinued future eligibility for all other employees and reduced the level of health care benefits for future retirees determined to be eligible as of December 31, 2004. The plan amendment resulted in a reduction to the accumulated projected benefit obligation at December 31, 2004 of $2,003,943 of which $486,915 reduced the unrecognized transition obligation while the remaining credit balance of $1,517,028 represents the unrecognized reduction to prior service cost as a result of
At December 31, 2008, 2007 and 2006 the funded status of $1,738,697, $1,895,238 and $1,961,826, respectively, is recognized in the accompanying balance sheet as accrued expenses and other liabilities.
Components of net periodic benefit cost and the weighted average discount rate are below:
The estimated prior service credit and net actuarial loss that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $85,682 and $1,014, respectively.
For measurement purposes as of December 31, 2008, 2007 and 2006 the annual rate of increase in the per capita cost of covered health care benefits assumed for the subsequent year was 9.0%, 8.0% and 8.5%, respectively. The rate was assumed to decrease to an ultimate rate of 5.0% in 2013. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one percentage-point change in assumed health care cost trend rates would have the following effects:
The Company has a defined contribution 401(k) plan covering substantially all employees meeting certain eligibility requirements. The 401(k) plan provides for matching contributions and /or profit sharing contributions as defined by the Board of Directors. Company contributions approximated $150,000 in 2008, $135,000 in 2007 and $117,000 in 2006.
As of December 31, 2008 and 2007, approximately $92,613,000 and $86,806,000, respectively, of consolidated assets represent assets of FIC that are subject to regulation and may not be transferred to FMIC in the form of dividends, loans or advances without the prior approval of the Michigan Office of Financial and Insurance Regulation (“OFIR”). Dividends paid by FIC are subject to limitations imposed by the Michigan Insurance Code (“Code”). Under the Code, FIC may pay dividends only from statutory earnings and capital and surplus. In addition, FIC may not declare an “extraordinary” dividend to its shareholders without the prior
approval of OFIR. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of statutory capital and surplus as of December 31, of the preceding year or the statutory net income, excluding net realized investment gains, for the immediately preceding calendar year. Accordingly, FIC may pay dividends of approximately $2,688,000 in 2009 without prior approval. However, the OFIR has the authority to prohibit payment of any dividend.
During 2005, the Company issued a $130,000 mortgage receivable to an agent of the Company. The note requires a monthly payment, including interest at 8%, of $1,097, which is based on a 15 year amortization. The note includes a 5 year balloon payment, which becomes due June 2010. During 2008, 2007 and 2006 the agent earned $70,586, $62,946 and $55,117, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.
note includes a 5 year balloon payment, which becomes due January 2009. During 2008, 2007 and 2006, the agent earned $91,082, $90,422 and $73,292, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.
Three nonemployee directors of the Company are also owners of independent insurance agencies. These individuals are currently appointed as agents with and write insurance for the Company. The terms and conditions of the agency agreements between these agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays all agencies commissions on business produced. All agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. Total regular and profit sharing commissions earned by these agencies approximated $545,000, $526,000 and $484,000 in 2008, 2007 and 2006, respectively. The commission rates, including profit sharing commission opportunity, are the same as other agents of the Company. The agencies are independent agents and also write with regional and national insurers that may be competitors of the Company.
Various agents of the Company participated in the surplus note offerings and held surplus notes at December 31, 2006. The notes were paid in full in September 2007, as disclosed in Note 9-Surplus Notes. The terms and conditions of the agency agreements between the agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays the agencies commissions on business produced. The agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. For the years ending December 31, 2007 and 2006 agents holding surplus notes earned regular and profit sharing commissions of approximately $224,000 and $223,000, respectively.
A non-employee director of the Company also participated in the surplus note offerings and held a surplus note at December 31, 2006. The note was paid in full in September 2007, as disclosed in Note 9-Surplus Notes. For the years ending December 31, 2007 and 2006 the non-employee director holding a surplus note received director fees of $11,350 and $10,875, respectively.
The Company evaluates product line profitability based on underwriting gain (loss). Certain expenses are allocated based on net premiums earned and net losses incurred. Underwriting gain (loss) by product line would change if different methods were applied.
Basic earnings per share are calculated by dividing net income by the weighted-average common shares outstanding. Diluted earnings per share are calculated by dividing net income by the weighted-average common shares outstanding and the weighted-average dilutive share equivalents outstanding. The computation of basic and diluted earnings per share is as follows:
The Company has two stock-based compensation plans which are described below. The compensation cost for these plans that has been charged against income for the years ended December 31, 2008, 2007 and 2006 was $103,228, $95,772 and $43,867, respectively. The total income tax benefit recognized in the statement of operations for stock-based compensation was $35,098, $32,562 and $14,915 for the years ended December 31, 2008, 2007 and 2006, respectively.
The weighted-average grant-date fair value of options granted in 2008, 2007 and 2006 was $5.20, $8.30 and $11.72, respectively. The total intrinsic value of options exercised in 2008, 2007 and 2006 was $24,177, $38,800 and $17,370, respectively.
As of December 31, 2008, there was $314,086 of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under both plans. That cost is expected to be recognized over a weighted average period of 3.4 years.