Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. The MD&A is divided into subsections entitled “Business Overview,” “Critical Accounting Policies,” “Results of Operations,” “Liquidity and Capital Resources” and “Losses and Loss Adjustment Expenses.”
AmerInst has two operating segments: (1) reinsurance activity, which includes investments and other activities, and (2) insurance activity, which offers professional liability solutions to professional service firms. See Note 13, Segment Information, of the notes to the consolidated financial statements contained in Item 8 of this annual report on Form 10-K for financial information concerning these segments.
The reinsurance segment had revenues of $3,373,308 for the year ended December 31, 2012 and $2,601,937 for the year ended December 31, 2011. Total losses and expenses for this segment were $2,428,293 for the year ended December 31, 2012 and $1,379,756 for the year ended December 31, 2011. This resulted in segment income of $945,015 and $1,222,181 for the years ended December 31, 2012 and 2011, respectively.
AmerInst has filed an application with the U.S. Patent and Trademark Office for a patent on a unique financing concept called RINITS™ that it has developed to securitize insurance and reinsurance risk, involving property, casualty, life and health. Such securitization would be by equity and debt financing of Bermuda special purpose companies licensed as reinsurers. It is AmerInst’s intention to grant patent licenses to the special purpose companies and investment banking organizations which would market the securities. In addition to the license royalties, AmerInst would manage the special purpose companies for a fee, and at its option could invest in them as well. However, AmerInst may not be issued a patent, and even if so, may not be able to license such patent.
The net loss recorded for the year ended December 31, 2012 was largely attributable to operating and management expenses incurred by APSL, which were partially offset by (1) net realized gains on investments, (2) net premiums earned under the Reinsurance Agreement, (3) commission income earned under the Agency Agreement, and (4) other income, as discussed below in further detail. The net loss recorded during the year ended December 31, 2011 was largely attributable to operating and management expenses incurred by APSL, which were partially offset by net realized gains on investments and the recognition of the additional recoveries associated with the Arbitration.
For the years ended December 31, 2012 and 2011, we recorded commission income under the Agency Agreement of $855,597 and $388,488, respectively, an increase of $467,109 or 120.2%. This increase resulted from a higher volume of premiums written under the Agency Agreement in 2012.
our equity investment portfolio in prior years and (2) net interest received from PDIC in the amount of $38,156 in relation to funds that were held in deposit by PDIC pursuant to the 2003 excess of loss reinsurance agreement between AMIC Ltd. and PDIC. No other income was recorded for the year ended December 31, 2011.
Sales of securities during the year ended December 31, 2012 resulted in realized gains on investments net of impairment of $1,615,628 compared to $1,779,892 during the year ended December 31, 2011, a decrease of $164,264 or 9.2%. The decrease in realized gains primarily related to decreased sales of equity securities in an unrealized gain position in 2012 compared to 2011.
For the year ended December 31, 2012, we recorded loss and loss adjustment expenses of $711,124, derived by multiplying a loss ratio of 57.9% and the net premiums earned under the Reinsurance Agreement of $1,231,436, partially offset by favorable development on PDIC. For the year ended December 31, 2011, we recorded loss and loss adjustment recoveries of $153,028 as a result of the recognition of the additional recoveries awarded to the Company following the Arbitration in the amount of $315,299, net of loss and loss adjustment expenses of $162,271, derived by multiplying a loss ratio of 77.6% and the net premiums earned under the Reinsurance Agreement of $423,364, offset by favorable development on CAMICO and PDIC. The reduction in the loss ratio associated with the Reinsurance Agreement resulted from favorable development in the 2010 and 2011 policy years.
If we conclude a security is other-than-temporarily impaired, we write down the amortized cost of the security to fair value, with a charge to net realized investment gains (losses) in the Consolidated Statement of Operations. Gross unrealized losses on the investment portfolio as of December 31, 2012 and December 31, 2011, relating to three and two fixed maturity securities and one and two equity securities, amounted to $17,440 and $39,791, respectively. This decrease was attributable to equity securities which we determined were not other than temporarily impaired based on the process described above. The Company has the intent and ability to hold these securities either to maturity or until the fair value recovers above the adjusted cost. The unrealized losses on these available for sale fixed maturity securities were not as a result of credit, collateral or structural issues. As a result of the decline in fair value below cost, the Company recorded a total other-than-temporary impairment charge of $229,697 and $152,450 on three and two equity securities during the years ended December 31, 2012 and 2011, respectively.
Our fixed income portfolio is managed with the target objectives of achieving an annualized rate of return for the trailing 5-year period of 250 basis points over the Consumer Price Index, and total returns commensurate with Merrill Lynch’s U.S. Domestic Index. Our overall fixed income portfolio is required to have at least an “A” S&P rating, an “A2” Moody’s rating or an equivalent rating from comparable rating agencies.
Our equity portfolios are managed with the target objectives of achieving an annualized rate of return over a trailing 3-year to 5-year period of 400 basis points over the Consumer Price Index, total returns at least equal to representative benchmarks such as the various S&P indices, and a ranking in the top half of the universe of other actively managed equity funds with similar objectives and risk profiles.
Equity securities, at fair value: Comprised primarily of investments in the common stock of publicly traded companies in the U.S. All of the Company’s equities are included in the Level 1 fair value hierarchy. The Company receives prices based on closing exchange prices from independent pricing sources to measure fair values for the equities.
As of December 31, 2012, our total investments were $20,249,302, a decrease of $2,496,248, or 11%, from $22,745,550 at December 31, 2011. The decrease was primarily due to sales of certain equity securities, the maturity of two fixed maturity securities and the increase in time deposits placed with FDIC insured commercial banks and saving associations classified as other invested assets. The cash and cash equivalents balance increased from $904,485 at December 31, 2011 to $1,034,485 at December 31, 2012, an increase of $130,000 or 14.4%. The amount of cash and cash equivalents varies depending on the maturities of fixed term investments and on the level of funds invested in money market funds. The restricted cash and cash equivalents balance increased from $435,924 at December 31, 2011 to $1,349,744 at December 31, 2012, an increase of $913,820 or 209.6%. The increase is due to the timing of sales and maturities of investments held as restricted cash at December 31, 2012 that have not yet been reinvested. As discussed above, during 2012, the Company invested in CDs classified as other invested assets in the amount of $1,470,000. The ratio of cash, total investments and other invested assets to total liabilities at December 31, 2012 was 6.34:1, compared to a ratio of 8.25:1 at December 31, 2011.
The decrease in total cash and investments at December 31, 2012, compared to December 31, 2011 resulted primarily from (1) net cash outflows to fund the operations of APSL, (2) $369,031 related to share repurchases
during 2012, and (3) dividends of $327,992 paid during 2012. These reductions were partially offset by the increase in the fair value of certain equity securities as a result of favorable market conditions and positive cash inflows in relation to net investment income and net premiums received under the Reinsurance Agreement in the amount of $833,757.
Our cash needs consist of settlement of losses and expenses under our reinsurance treaties and funding day-to-day operations. During the continued implementation of our business plan, our management expects to meet these cash needs from cash flows arising from our investment portfolio. Because substantially all of our assets are marketable securities, we expect that we will have sufficient flexibility to provide for unbudgeted cash needs which may arise without resorting to borrowing, subject to regulatory limitations.
Prepaid expenses and other assets were $412,065 at December 31, 2012, an increase of 8.9% from December 31, 2011. The balance primarily relates to (1) prepaid directors’ and officers’ liability insurance costs, (2) the prepaid directors’ retainer, (3) prepaid professional fees and (4) premiums due to APSL under the Agency Agreement. The increase in the balance was attributable to an increase in prepaid professional fees. This balance fluctuates due to the timing of the prepayments.
AmerInst paid two semi-annual dividends of $0.25 and $0.47 per share during 2012 and 2011, respectively. During 2012, the total dividend amount was reduced by $14,585 which represents a write back of uncashed
Total dividends declared were $327,992 and $615,993 in 2012 and 2011, respectively, net of the recorded write backs. Continuation of dividend payments is subject to the Board of Directors’ continuing evaluation of our level of surplus compared to our capacity to accept more business. One of our objectives is to retain sufficient surplus to enable the successful implementation of our new business plan.
AMIC Ltd.’s ability to pay dividends to AmerInst is subject to the provisions of the Bermuda insurance and companies laws and the requirement to provide the ceding companies with collateral. Under the Companies Act, AMIC Ltd. would be prohibited from declaring or paying a dividend at December 31, 2012 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. As of December 31, 2012, approximately $33 million was available for the declaration of dividends to shareholders. However, due to the requirement to provide the ceding companies with collateral, approximately $25 million was available for the payment of dividends to the shareholders. In addition, AMIC Ltd. must be able to pay its liabilities as they fall due after the payment of a dividend. Our ability to pay dividends to common shareholders and to pay our operating expenses is dependent on cash dividends from our subsidiaries. The payment of such dividends by AMIC Ltd., including its subsidiary Investco, to us is also limited under Bermuda law by the Insurance Act and Related Regulations which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2012 and 2011 these requirements have been met as follows:
The BMA has authorized Investco to purchase the Company’s common shares from shareholders who have died or retired from the practice of public accounting and on a negotiated basis. Through March 1, 2013, Investco had purchased 152,801 common shares from shareholders who had died or retired for a total purchase price of $4,229,376. From time to time, Investco has also purchased shares in privately negotiated transactions. Through that date, Investco had purchased an additional 75,069 common shares in such privately negotiated transactions for a total purchase price of $1,109,025.
PDIC was a new program for the Company in 2003. The relationship with the carrier of that insurance ended on December 31, 2003. Therefore, policies written during 2003 are the only ones we have reinsured. To calculate the policy year ultimate losses and allocated loss adjustment expenses for PDIC the actuary applied incurred loss development, incurred Bornhuetter-Ferguson (“BF”), and expected loss methods to the actual PDIC experience. In the calculations, the actuary used industry incurred loss and allocated loss adjustment expenses development patterns and an a priori loss and allocated loss adjustment expenses ratio for use in the BF and expected loss and allocated loss adjustment expenses method calculations. The a priori loss and allocated loss adjustment expenses ratio was selected judgmentally based on the Company’s unpaid claim liability review as of December 31, 2011. The actuary selected low and high scenario loss ratio estimates around the central loss ratio estimates. The low and high scenario ultimate loss and allocated loss adjustment expenses estimates were calculated by multiplying net earned premium through December 31, 2012 by the low and high scenario loss ratio selections. The final reported claim was closed during 2011 and although we no longer anticipate any liability for further claims related to this period of coverage, there is a remote possibility further claims could be reported.
The above table of losses re-estimated has been prepared on a net basis (i.e., loss and loss adjustment expenses and reinsurance recoveries receivable have not been grossed-up. The table has been prepared on a net basis due to the relative immateriality of reinsurance balances when considered in relation to total loss and loss adjustment expense reserves, and due to the costs of providing such information relative to any benefits of providing it.
The above table presents the development of balance sheet liabilities for 2002 through 2012 as of year-end 2012, and includes the CNA program liabilities through 2008. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years.
The lower section of the table shows the cumulative amount paid in respect of the previously recorded liability as of the end of each succeeding year. For example, the 2005 year end liability was originally $28,885,000. As of December 31, 2012, we had paid $13,752,000 of the currently estimated $13,782,000 of losses and LAE that had been incurred for 2005 and prior years through the end of 2012; thus an estimated $30,000 in losses incurred through 2005 remain unpaid as of the current financial statement date.
In evaluating this information, it should be understood that each amount includes the effects of all changes in amounts for prior periods. This table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
We have audited the accompanying consolidated balance sheets of AmerInst Insurance Group, Ltd. and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, other comprehensive loss, changes in shareholders’ equity and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index and included in Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
AmerInst Insurance Group, Ltd., (“AmerInst” or the “Company”) was formed under the laws of Bermuda in 1998. The Company, through its wholly owned subsidiary AmerInst Insurance Company, Ltd. (“AMIC Ltd.”) and its predecessor AmerInst Insurance Company, Inc. (“AIIC Inc.”), were engaged in the reinsurance of claims-made insurance policies of participants in an American Institute of Certified Public Accountants (“AICPA”) sponsored insurance program that provides accountants’ professional liability insurance coverage (“AICPA Plan”) through December 31, 2008.
On May 15, 2009, AMIC Ltd. and CNA entered into a Commutation Agreement whereby, effective January 1, 2009, in exchange for a payment of a portion of the reserves which we had previously set aside, CNA assumed responsibility for prior years’ undetermined and unpaid liabilities.
On January 1, 2003, we entered into a 15% participation of Professionals Direct Insurance Company’s (“PDIC”) attorneys’ professional liability 1st excess cover. This participation terminated on December 31, 2003. The final reported claim was closed during 2011 and although we no longer anticipate we will be liable for further claims related to this period of coverage, there is a remote possibility further claims could be reported.
AmerInst has filed an application for a U.S. patent on a unique financing concept called RINITS™ that it has developed to securitize insurance and reinsurance risk, involving property, casualty, life and health. Such securitization would be by equity and debt financing of Bermuda special purpose companies licensed as reinsurers. It is AmerInst’s intention to grant patent licenses to the special purpose companies and investment banking organizations which would market the securities. In addition to the license royalties, AmerInst would manage the special purpose companies for a fee and at its option could invest in them as well. However, AmerInst may not be issued a patent, and, even if so, may not be able to license such patent.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing 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 periods in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized. Management evaluates the reliability of the deferred tax assets and assesses the need for additional valuation allowance annually.
In May 2011, the Financial Accounting Standards Board (“FASB”) issued amendments to disclosure requirements for common fair value measurement. These amendments, effective for the interim and annual
In June 2011, the FASB issued new guidance revising the manner in which entities present comprehensive income in their financial statements. The option to report other comprehensive income and its components in the statement of changes in shareholders’ equity was eliminated. Components of comprehensive income may be reported in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The new requirements were effective for the interim and annual periods beginning on or after December 15, 2011 and require retrospective application; early adoption was permitted. As the new guidance does not change the items that constitute net income and/or other comprehensive income, the timing of reclassifications from other comprehensive income to net income or the earnings per share computation, the adoption of this guidance has not impacted our results of operations, financial condition or liquidity.
The Company has determined that all other recently issued accounting pronouncements do not apply to its operations.
As of December 31, 2011, there were four securities in an unrealized loss position with an estimated fair value of $1,394,125. Of these securities, none had been in an unrealized loss position for 12 months or greater. As of December 31, 2011, none of these securities were considered to be other than temporarily impaired. The
Company has no intent to sell and it is not more likely than not that the Company will be required to sell these securities before their fair values recover above the adjusted cost. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
Information on sales and maturities of investments during the twelve months ended December 31, 2012 and 2011 are as follows:
Hedge fund: Comprised of a hedge fund whose objective is to seek attractive long-term returns with lower volatility by investing in a range of diversified investment strategies. The fund invests in a diversified pool of hedge fund managers, generally across six different strategies: long/short equities, long/short credit, macro, multi-strategy opportunistic, event-driven, and portfolio hedge. The fair value of the hedge fund is based on the net asset value of the fund as reported by the external fund manager. The use of net asset value as an estimate of the fair value for investments in certain entities that calculate net asset value is a permitted practical expedient. The fair value of our hedge fund is included in the Level 3 fair value hierarchy.
There have been no material changes to any of our valuation techniques from what was used as of December 31, 2011. Since the fair value of a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets or transfer our liabilities in an orderly transaction between participants at the measurement date.
During 2012, the Company invested in certificates of deposit (“CD”) in the amount of $1,470,000 comprising of fully insured time deposits placed with Federal Deposit Insurance Corporation (“FDIC”) insured commercial banks and savings associations. The FDIC, an independent agency of the United States government, protects depositors up to an amount of $250,000 per depositor, per insured institution. FDIC insurance is backed by the full faith and credit of the United States government. The stated interest rate of an FDIC insured CD varies greatly among commercial banks and savings associations, depending on the term of the CD and the institution’s need for funding. The liquidity of “marketable” CDs is marginal, even though they are assigned an FDIC number, a CUSIP number and are held in book-entry form through the Depository Trust Company. Depending on market liquidity and conditions, the bid price for an FDIC insured CD would reflect the supply of and the demand for deposits of the particular bank or savings association, as well as prevailing interest rates, the remaining term of the deposit, specific features of the CD, and compensation of the broker arranging the sale of the CD. These time deposits have maturities ranging from two to five years and are classified as other invested assets on the Company’s consolidated balance sheet.
Details of the liability for unpaid losses and loss adjustment expenses at December 31, 2012 and 2011 are as follows:
As a result of the change in estimates of insured events in prior years, the provision for losses and loss adjustment expenses increased by $202,553 and decreased by $428,532 in 2012 and 2011, respectively. The 2012 increase resulted from reserves established under the Reinsurance Agreement, partially offset by favorable development on the PDIC treaty. The 2011 decrease resulted from (1) favorable development on the CAMICO and PDIC treaties and (2) the recoveries from VSC as a result of the Arbitration’s final outcome, partially offset by reserves established pursuant to the Reinsurance Agreement.
On February 25, 2011, the Board of Directors amended and restated AmerInst’s Statement of Share Ownership Policy to better manage the Company’s cash flow from year to year. Under the new policy that became effective immediately, the Company limits Investco’s repurchase of Company stock to $500,000 per calendar year. In addition, Investco will only be authorized to repurchase shares, without Board approval, from shareholders upon their death, disability or retirement from the practice of public accounting. Except as approved by the Board, negotiated purchases that do not satisfy these criteria will be discontinued for the foreseeable future.
Premiums written were $1,600,919 and $710,679 during 2012 and 2011, respectively. The premiums written during the year ended December 31, 2012 and 2011 were attributable to premium cessions from C&F under the Reinsurance Agreement in the amount of $1,564,885 and $721,203 and to revisions to CAMICO premium estimates for prior years in the amount of $36,034 and $(10,524), respectively. The increase in premiums written under the Reinsurance Agreement resulted from increased cessions from C&F in 2012, as a result of a higher level of underwriting activity under the Agency Agreement resulting from the marketing of the program by APSL.
AmerInst’s ability to pay common shareholders’ dividends and its operating expenses is dependent on cash dividends from AMIC Ltd. and its other subsidiaries. The payment of such dividends by AMIC Ltd. to AmerInst is limited under Bermuda law by the Bermuda Insurance Act 1978 and Related Regulations, as amended, which require that AMIC Ltd. maintain minimum levels of solvency and liquidity. For the years ended December 31, 2012 and 2011 these requirements have been met as follows:
Statutory loss for the years ended December 31, 2012 and 2011 was $340,078 and $209,202, respectively.
AmerInst Professional Services Limited (“APSL”), a subsidiary of AmerInst, has entered into employment agreements with four key members of senior management, which grant them phantom shares of the Company. Under these agreements, these employees were initially granted a total of 75,018 phantom shares of the Company on the date of their employment. The phantom shares are eligible for phantom dividends paid at the same rate as regular dividends on the Company’s common shares. The phantom dividends may be used only to purchase additional phantom shares with the purchase price of such phantom shares being the net book value of the Company’s actual common shares as of the end of the previous quarter. During the year ended December 31, 2012, 1,202 phantom shares were granted arising from the dividends declared on the Company’s common shares. 80,074 phantom shares were outstanding at December 31, 2012.
The employees’ interest in the phantom shares initially granted as well as any additional shares granted from dividends declared will vest on January 1, 2015. The liability payable to the employees under this phantom share plan is equal to the value of the phantom shares based on the net book value of the Company’s actual common shares at the end of the previous quarter less the initial value and is payable in cash upon the earlier of the employee attaining 65 years of age or within 60 days of death or permanent disability, including if such death or permanent disability occurs before January 1, 2015.
Upon the vesting of the phantom shares, should the net book value of the Company’s common shares be lower than the initial net book value of the common shares at the point of the initial grant, then the phantom shares would vest at no value.