Certain statements made in this report are forward-looking and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, certain discussions relating to future revenue, underwriting income, premium volume, investment income and other investment results, business strategies, profitability, liquidity, capital adequacy, anticipated capital expenditures and business relationships, as well as any other statements concerning the year 2006 and beyond. In some cases you can identify forward-looking statements by such terms as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions or the negative versions of such expressions. These forward-looking statements reflect Midland’s current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties that may cause results to differ materially from those anticipated in those statements. Many of the factors that will determine future events or achievements are beyond Midland’s ability to control or predict. Factors that might cause results to differ from those anticipated include, without limitation, adverse weather conditions, changes in underwriting results affected by adverse economic conditions, fluctuations in the investment markets, changes in the retail marketplace, changes in the laws or regulations affecting the operations of the Company or its subsidiaries, changes in the business tactics or strategies of the Company, its subsidiaries or its current or anticipated business partners, the financial condition of the Company’s business partners, acquisitions or divestitures, changes in market forces, litigation and the other risk factors that have been identified in the Company’s filings with the SEC, any one of which might materially affect the operations of the Company or its subsidiaries. Any forward-looking statements speak only as of the date made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. You should read this document and the documents referenced herein and filed as exhibits herewith completely and with the understanding that Midland’s actual future results may be materially different from what Midland expects. Midland qualifies all of its forward-looking statements by these cautionary statements.
Prior to the 2004 annual report, the Company discussed its operations through three reportable segments: manufactured housing insurance, all other insurance products and services and transportation. However, as the Company has continued to grow its non-manufactured housing insurance products, management’s analysis of its insurance business has evolved in order to facilitate a more focused examination of its varying insurance products. As a result, the Company has divided its insurance products into four distinct groups: residential property, recreational casualty, financial institutions, and all other insurance products. The discussions of “Results of Operations” and “Liquidity, Capital Resources and Changes in Financial Condition” address these four reportable insurance segments and our transportation business. A summary description of the operations of each of these segments is included below.
Our specialty insurance operations are conducted through our wholly-owned subsidiary, American Modern Insurance Group, Inc. (American Modern) which controls eight property and casualty insurance companies, two credit life insurance companies, three licensed insurance agencies and three service companies. American Modern is licensed, through its subsidiaries, to write insurance premiums in all 50 states and the District of Columbia.
The combined ratio for the motorcycle product improved to 91.1% in 2005 compared to 102.3% in 2004. This was due primarily to rate increases and other corrective underwriting actions. Rate increases averaging 19% and 21% were approved by various states’ insurance departments in 2004 and 2003, respectively. These rate increases resulted in an 18.3% increase in motorcycle’s net earned premium in 2004 and a 14% increase in net earned premium during 2005. In addition, we have added expertise to our staff and have refined our product offering to better match the needs of our target market. As we expected, due to the underwriting and rate actions, gross written premium decreased 21.6% to $38.1 million in 2005 compared to $48.6 million in 2004. We believe that the motorcycle product is now positioned to be profitable in the years ahead and enhances our total product package offered to agents. We are not anticipating an overall rate increase in this line during 2006 and we intend to implement strategies that will translate to moderate levels of growth in 2006 and higher levels of growth in the years thereafter.
For the year 2005, American Modern’s property and casualty combined ratio (losses and expenses as a percent of earned premium) improved to 93.8% compared to 96.4% in the prior year. The decrease in the combined ratio is due to the significant decreases in losses related to the motorcycle and excess and surplus lines products. Manufactured housing, our largest product offering, continued to deliver strong underwriting results despite the higher than normal level of catastrophe losses due to hurricanes Katrina, Rita and Wilma. American Modern’s manufactured housing combined ratio for 2005 was 94.4% compared to 94.9% in 2004. Excluding catastrophe losses, the manufactured housing combined ratio improved to 84.7% in 2005 compared to 86.0% in 2004.
During 2005, American Modern’s disciplined exposure management was an essential part of our risk management strategy. We continued to take the necessary underwriting actions, particularly in our watercraft line, to balance our coastal exposures. In addition, over the last 10 years, we have reduced our property exposures in specific coastal states by approximately 30% while, at the same time, manufactured housing shipments to these states constituted over half of the national shipments. We have also benefited by broadening our product platform to include products that do not carry the same level of catastrophic risk, such as motorcycle. We believe these strategies leave us well positioned for profitable future growth.
American Modern’s catastrophe reinsurance program is another significant aspect of our exposure management. Our 2006 reinsurance structure is similar to the 2005 program with a $3.0 million increase in retention, from $7 million to $10 million, and the purchase of an additional $40 million of protection on top of our previous $110 million cover. Due to the volatile weather patterns of 2005, we will absorb a significant increase in our base reinsurance cost in 2006 which will nearly double the base cost of 2005. This increase, along with the additional cover, will adversely impact our 2006 earnings per share by approximately 42 cents. We have already begun efforts to recoup these costs through appropriate rate increases and/or product changes. However, this is a process that takes some time, including additional time after state approvals to get the new rates and product changes into place within the renewal book and earned premium. These efforts will likely produce minimal benefit to our 2006 bottom line, and likely will not be fully realized until 2007.
In September 2001, American Modern exited the manufactured housing park and dealer commercial liability business. We have no outstanding unearned premium related to this business. During 2003, we experienced higher than expected losses related to this line. Due to the adverse development, American Modern strengthened reserves in the latter part of 2003 to address the future run-off claims. In 2004 and 2005, American Modern has experienced favorable development in the claims settled for the year and believes that the loss exposure is adequately reserved for the remainder of the run-off period.
Gross written premiums for our recreational casualty products decreased due primarily to the planned decrease in motorcycle premiums as American Modern took the necessary corrective underwriting actions and rate increases to position the motorcycle product for profitability. In addition, we have added expertise to our staff and have refined our product offering to better match the needs of our target market. As a result of these actions, the combined ratio for the motorcycle product improved to 91.1% in 2005 compared to 102.3% in 2004. As American Modern has now properly positioned the motorcycle product, we intend to implement strategies to profitably increase premiums for the product in the upcoming years.
The following chart is an overview of the results of operations of the company’s financial institutions insurance segment (in 000’s).
Derivatives relate to the equity conversion features attributable to the convertible preferred stocks and convertible debentures held by American Modern. The Company’s investment portfolio does not currently include any other types of derivative investments.
The manufactured housing combined ratio, including catastrophe losses, remained constant at 94.9% in 2004 and in 2003. However, excluding catastrophe losses for both years, the combined ratio improved to 86.0% in 2004 from 88.0% in 2003. This improvement was due primarily to rate increases combined with improved underwriting. The site-built dwelling combined ratio improved to 93.2% in 2004 compared to 108.1% in 2003. The 2003 combined ratio was negatively impacted by the run-off of the homeowner programs combined with higher catastrophe losses related to the California brush fires.
Gross written premiums for our recreational casualty products decreased due primarily to the planned decrease in motorcycle premiums as American Modern took the necessary corrective actions to position the motorcycle product for profitability. Rate increases averaging 19% and 21% were approved by various states’ insurance departments in 2004 and 2003, respectively. In addition, we have added expertise to our staff and have refined our product offering to better match the needs of our target market. As a result of these actions, the combined ratio for the motorcycle product improved to 102.3% in 2004 compared to 131.7% in 2003.
Overall, American Modern’s losses and loss adjustment expenses decreased 11.1% in 2004 to $348.6 million from $392.2 million in 2003. As mentioned in the segment discussions above, the decrease was due to improved underwriting results for the site-built dwelling, motorcycle and discontinued commercial liability products. The overall decrease in losses and loss adjustment expense occurred despite catastrophe losses increasing to $46.0 million in 2004 compared with $37.2 million in 2003.
American Modern’s commissions and other policy acquisition costs increased 13.2% in 2004 to $201.2 million from $177.6 million in 2003. This increase is attributable to the growth in net earned premium combined with the increase in performance-based commission expense as a result of the significantly improved underwriting results achieved in 2004 compared to 2003. The fluctuations in performance-based commission expense are attributable, in part, to American Modern’s “Pay for Performance” commission policy with agents representing the Company which reduces the up-front commission paid but rewards favorable underwriting and growth performance with a higher performance-based commission.
American Modern’s insurance operating and administrative expenses increased 23.7% to $108.5 million in 2004 compared to $87.7 million in 2003. These increases correspond with the increase in revenues combined with increases related to employee incentive plans, depreciation expenses related to modernLINK®, our proprietary information systems and web enablement initiative, and an increase in employee healthcare expenses.
We have certain obligations and commitments to make future payments under contracts. As of December 31, 2005, the aggregate obligations on a consolidated basis were as follows (amounts in 000’s):
The table above excludes contracts and agreements that relate to maintenance and service agreements which, individually and in the aggregate, are not material to the Company’s operations or financial condition and are terminable by the Company with minimal advance notice and little or no cost to the Company.
The insurance policy loss reserve payment projections in the above table are based on actuarial assumptions. The actual payments will vary, in both amount and time periods, from the estimated amounts represented in this table. See further discussion regarding insurance policy loss reserves under the Critical Accounting Policies section.
Also included in the above table is an operating lease arrangement relating to the lease of 20 barges used in the transportation operations. The lease was entered into in 1999 and its term is for 15 years. The barges can be purchased after 12 years at a predetermined price and, at the end of the lease period in 2014, the company can either return the barges or purchase the equipment at fair market value. The 15-year lease period was more attractive at that time than the traditional 5-year financing term for conventional long-term debt. As of December 31, 2005 future lease payments required under this operating lease arrangement are (000’s): 2006 - $544; 2007 through 2010 - $2,289; after 5 years - $2,380. M/G Transport’s operating cash flow is currently sufficient to pay the financial obligations under this agreement. Also included under purchase obligations in the above table is $32.0 million related to a contract to acquire 80 jumbo open barges.
The Company intends to significantly expand its headquarters with construction beginning in the first half of 2006. Since no formal agreement or contract was in place at the end of 2005, the impact of this expansion is not included in the above table. The expansion, which is scheduled for completion in September 2007, will add approximately 205,000 square feet of new office space and will expand an existing training center by approximately 20,000 square feet. The new facility, which is expected to cost approximately $29 million, will be financed through short term debt borrowings during the construction phase. The Company is currently considering various financing options for the building after construction is completed.
The share repurchase program pertains exclusively to shares to be purchased on the open market. This program specifically excludes shares repurchased in connection with stock incentive plans. The Company may periodically repurchase stock awarded to associates in connection with stock incentive programs. Such repurchase transactions essentially accommodate associates funding of the exercise price and any tax liabilities arising from the exercise or receipt of equity based incentive awards. During 2005, the Company repurchased approximately $1.8 million of treasury shares in connection with associate stock programs.
Midland and American Modern are holding companies which rely primarily on dividends and management fees from subsidiaries to assist in servicing debt, paying operating expenses and paying dividends to the respective shareholders. The payment of dividends to these holding companies from American Modern’s insurance subsidiaries is restricted by state regulatory agencies. Such restrictions, however, have not had, and are not expected to have, a significant impact on our, or American Modern’s, liquidity or our and American Modern’s ability to meet our respective long or short-term operating, financing or capital obligations.
During the second quarter of 2004, Midland, through wholly owned trusts, issued $24.0 million of junior subordinated debt securities ($12.0 million on April 29 and $12.0 million on May 26). These transactions were part of the Company’s participation in pooled trust preferred offerings. The proceeds from these transactions are available to fund future growth and for general corporate purposes. The debt issues have 30-year terms and are callable any time after five years at the Company’s option. The interest related to the debt is variable in nature. The debt contains certain provisions which are typical and customary for this type of security.
Based on the above valuations and the application of our other-than-temporary impairment policy criteria, which is more fully discussed in the Critical Accounting Policies section below, we believe the declines in fair value are temporary at December 31, 2005. However, the facts and circumstances related to these securities may change in future periods, which could result in “other-than-temporary” impairment in future periods.
The average duration of the Company’s debt security investment portfolio as of December 31, 2005 was 5.3 years which management believes provides adequate asset/liability matching.
American Modern generates cash inflows primarily from insurance premium, investment income, proceeds from the sale of marketable securities and maturities of debt security investments. The principal cash outflows for the insurance operations relate to the payment of claims, commissions, premium taxes, operating expenses, capital expenditures, income taxes, interest on debt, dividends and inter-company borrowings and the purchase of marketable securities. In each of the periods presented, funds generated from the insurance operating activities were used primarily to purchase investment grade marketable securities, accounting for the majority of the cash used in investing activities.
The amounts expended for the development costs capitalized in connection with the development of modernLINK®, our proprietary information systems and web enablement initiative, amounted to $11.6 million in 2005 and a total of $30.3 million from inception in 2000 through December 31, 2005. The initiative is being designed, developed and implemented in periodic phases to ensure its cost effectiveness and functionality. This project may involve future cash expenditures of approximately $24 million over the next three years, with additional spending thereafter to expand system compatibility and functionality. A portion of such expenditures will be capitalized and amortized over the useful life. However, actual costs may be more or less than what we estimate. The cost of the development and implementation is expected to be funded out of operating cash flow. Significant changes to the technology interface between American Modern and its distribution channel participants and policyholders, while unlikely, could significantly disrupt or alter its distribution channel relationships. If the new information systems are ultimately deemed ineffective, it could result in an impairment charge to our capitalized costs. The unamortized balance of modernLINK®’s software development costs was $20.1 million at December 31, 2005.
During the first quarter of 2002, American Modern entered into an interest rate swap agreement with a consortium of three banks. Under the terms of this agreement, the floating interest rate related to $30.0 million outstanding under American Modern’s long-term credit facility was effectively fixed at 5.6% until December 1, 2005, the maturity date. After the maturity of this agreement American Modern chose not to enter into a new interest rate swap agreement and has no such agreements in place at December 31, 2005.
M/G Transport generates its cash inflows primarily from affreightment revenue. Its primary outflows of cash relate to the payment of barge charter costs, debt service obligations, operating expenses, income taxes, dividends to Midland and the acquisition of capital equipment. Like the insurance operations, cash flow from the transportation subsidiaries is expected to remain sufficiently positive to meet future operating requirements.
As of December 31, 2005, the transportation subsidiaries have $17.9 million of collateralized equipment obligations outstanding.
plans. For the years ended December 31, 2005, 2004 and 2003, such changes increased or (decreased), net of related income tax effects, by the following amounts (amounts in 000’s):
The recorded insurance loss reserves at the balance sheet date represent the Company’s best estimate, based on historical patterns and other assumptions, of its liabilities at that date. Management, along with the Company’s internal actuaries, periodically reviews the level of loss reserves against actual loss development. This retrospective review is the primary criteria used in refining the levels of loss reserves recorded in the financial statements. Additionally, management compares the Company’s estimate of loss reserves to ranges prepared by its external consulting actuaries to ensure that such estimates are within the actuaries’ acceptable range. The external actuaries perform an extensive review of loss reserves at year end using generally accepted actuarial guidelines along with reviews throughout the year to ensure that the recorded loss reserves appear reasonable. At December 31, 2005, loss reserves, net of reinsurance recoverables, for our property and casualty companies totaled $148.1 million. The Company’s estimate was affirmed by the actuaries’ estimated range for net loss reserves of $134.0 million to $153.0 million.
Slowness to recognize or respond to new or unexpected loss patterns, such as those caused by the risk factors listed in the Company’s Safe Harbor Statement, could lead to a shortage in reserves, which would lead to a higher loss and loss expense ratio; each percentage point increase in the loss and loss expense ratio would reduce income before taxes by $6.3 million based on 2005 earned premiums.
American Modern and its independent reinsurance brokers regularly conduct “market security” evaluations of both its current and prospective reinsurers. Such evaluations include a complete review of each reinsurer’s financial condition along with an assessment of credit risk concentrations arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The specific evaluation procedures include, but are not limited to, reviewing the periodic financial statements and ratings assigned to each reinsurer from rating agencies such as S&P, Moody’s and A.M. Best. During 2005, approximately 85% of the Company’s catastrophe reinsurers had an A.M. Best or S&P rating of “A” or higher.
American Modern invests in various securities including U.S. Government securities, corporate debt securities, and corporate stocks. Investment securities in general are exposed to various risks such as interest rate, credit, and overall market volatility. Due to the level of risk associated with these securities, it is reasonably possible that changes in the value of investment securities will occur in the near term and that such changes could be material.
1. The economic outlook is worse than anticipated and has a greater adverse impact on a particular issuer than anticipated.
When a security is considered other-than-temporarily impaired, we monitor trends or circumstances that may impact other material investments in our portfolio. For example, we review any other securities that are held in the portfolio from the same issuer and also consider any circumstances that may impact other securities of issuers in the same industry. At December 31, 2005, we had no significant concentration of unrealized losses in any one issuer, industry or sector.
long-term rate of return and our discount rate, we evaluate input from our actuaries, asset allocations, long-term bond yields and historical performance of the invested pension assets over a ten-year period. If other assumptions were used, the amount recorded as pension expense would be different from our current estimate.
In October 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1. SOP 05-1 provides accounting guidance for deferred policy acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. Internal replacement contracts are those that are substantially changed from the replaced contract and are accounted for as an extinguishment of the replaced contract. Nonintegrated contract features are accounted for as separately issued contracts. Modifications resulting from the election of a feature or coverage within a contract or from an integrated contract feature generally do not result in an internal replacement contract subject to SOP 05-1 provided certain conditions are met. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The SOP is not expected to have a material impact on the Company’s Consolidated Financial Position or Results of Operations.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Marketable Securities - Marketable securities are categorized as fixed income securities (cash equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and equity securities (common, convertible and preferred stocks which do not have redemption provisions). The Company classifies all fixed income and equity securities as available-for-sale and carries such investments at market value. Unrealized gains or losses on investments, net of related income taxes, are included in shareholders’ equity as an item of accumulated other comprehensive income. Realized gains and losses on sales of investments are recognized in income on a specific identification basis. Derivatives are valued separately and the change in market value of the derivatives is included in Net Realized Investment Gains on the Consolidated Statements of Income.
Property and Depreciation - Property, plant and equipment are recorded at cost. The Company periodically measures fixed assets for impairment. Depreciation and amortization are generally calculated over the estimated useful lives of the respective properties (buildings and equipment - 15 to 35 years, furniture and equipment - 3 to 7 years, and barges - 20 years).
The Company has implemented several modules and is continuing the process of developing an information technology system for its insurance operations. The system is known as modernLINK® and its development began in 2000 and will continue over the next several years. Certain costs that are directly related to this system are capitalized. As components of the system are implemented and placed into service, depreciation commences using the straight-line method over periods ranging from four to eight years.
Allowance for Losses - Provisions for losses on receivables are made in amounts deemed necessary to maintain adequate reserves to cover probable future losses.
Derivative Instruments - The Company accounts for its derivatives under Statement of Financial Accounting Standards (“SFAS”) 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. The standard requires recognition of all derivatives as either assets or liabilities in the balance sheet and requires measurement of those instruments at fair value through adjustments to either accumulated other comprehensive income or current earnings or both, as appropriate. During 2002, the Company entered into a series of interest rate swaps to convert $30 million of floating rate debt to a fixed rate. The interest rate swaps were designated as a cash flow hedge and were deemed to be 100% effective. Thus, the changes in the fair value of the swap agreements are recorded as a separate component of shareholders’ equity and have no impact on the Consolidated Statements of Income. The interest rate swap agreements ended during 2005 and, therefore, no balances were outstanding related to these derivatives at December 31, 2005. At December 31, 2004 and 2003, $0.3 million and $0.9 million, respectively, in deferred losses, net of tax, related to this hedge were recorded in accumulated other comprehensive income. The fair value of the Company’s interest rate swaps at December 31, 2004 of $0.4 million is included in Other Payables and Accruals.
Stock Option and Award Plans - Midland has various plans which provide for granting options and common stock to certain employees and independent directors of the Company and its subsidiaries. During the fourth quarter of 2005, the Company elected to early adopt SFAS 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) under the modified retrospective approach, restating only prior interim periods in fiscal 2005. As a result, the Company has applied SFAS 123(R) to new awards and to awards modified, repurchased or cancelled after January 1, 2005. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered, that were outstanding as of January 1, 2005, are being recognized as the requisite service is rendered on or after January 1, 2005 (generally over the remaining option vesting period). The compensation cost for that portion of awards has been based on the grant-date fair value of those awards as calculated previously for pro forma disclosures. Prior to the fourth quarter of 2005, the Company accounted for compensation expense related to such transactions using the “intrinsic value” based method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and its related interpretations. Midland’s equity compensation plans are described more fully in Note 13.
The fair values of the 2005, 2004 and 2003 option grants were estimated on the date of the grant using the Black Scholes option-pricing model with the following (weighted average) assumptions:
New Accounting Standards - In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Correction,” which replaces Accounting Principles Board (“APB”) Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless determination of either the period specific effects or the cumulative effect of the change is impracticable or otherwise promulgated. SFAS No. 154 is effective for fiscal years beginning after December 15, 2005. SFAS No. 154, upon adoption, is not expected to have a material effect on the Company’s Consolidated Financial Position or Results of Operations.
Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. Internal replacement contracts are those that are substantially changed from the replaced contract and are accounted for as an extinguishment of the replaced contract. Nonintegrated contract features are accounted for as separately issued contracts. Modifications resulting from the election of a feature or coverage within a contract or from an integrated contract feature generally do not result in an internal replacement contract subject to SOP 05-1 provided certain conditions are met. The provisions of SOP 05-1 are effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The SOP is not expected to have a material impact on the Company’s Consolidated Financial Position or Results of Operations.
Accounts receivable at December 31, 2005 and 2004 are generally due within one year and consist of the following (amounts in 000’s):
Depreciation expense recorded in 2005, 2004 and 2003 was (amounts in 000’s): $10,250, $10,043 and $8,956, respectively.
Long-term debt at December 31, 2005 and 2004 is summarized as follows (amounts in 000’s):
* In 2002, an interest rate swap agreement was entered into with a consortium of three banks. This agreement fixed the interest rate of this credit facility at 5.57% through December 1, 2005. The fair value of this agreement as of December 31, 2004 was $(0.4) million and is included in Other Payables and accruals.
The aggregate amount of repayment requirements on long-term debt for the five years subsequent to 2005 are (amounts in 000’s): 2006 - $1,258; 2007 - $15,183; 2008 - $6,125; 2009 - $36,562; 2010 - $593; thereafter-$8,045.
At December 31, 2005 and 2004, the carrying value of the Company’s long-term debt, excluding the fair value of the interest rate swap agreement disclosed separately above, approximated its fair value.
Wholly-owned subsidiary trusts of Midland have issued preferred trust securities and, in turn, purchased a like amount of subordinated debt which provides interest and principal payments to fund the trusts’ obligations. The preferred trust securities are mandatorily redeemable upon maturity or redemption of the subordinated debt and are an obligation of Midland. The interest rate related to these securities is based on the 90 day LIBOR rate plus 3.5%, not to exceed 12.5% through the optional redemption dates in April and May 2009, respectively. The interest rates were 7.9% and 5.8% at December 31, 2005 and 2004, respectively. The junior subordinated debentures are due in 2034. They consist of $12 million issued in April 2004 and $12 million issued in May 2004 that are redeemable at the Company’s option any time after April and May 2009, respectively.
The federal income tax provision for the years ended December 31, 2005, 2004 and 2003 is different from amounts derived by applying the statutory tax rates to income before federal income tax as follows (amounts in 000’s):
For 2005, 2004 and 2003, $455, $1,114 and $182, respectively, of income tax benefits applicable to deductible compensation related to stock options exercised and restricted stock issued were credited to shareholders’ equity.
Premium income in the accompanying consolidated statements of income include (amounts in 000’s) $53,343, $54,088 and $56,184 of earned premiums on assumed business and is net of $112,777, $69,444, and $62,677 of earned premiums on ceded business for 2005, 2004, and 2003, respectively. Written premiums consist of the following (amounts in 000’s):
The net earned premium for the property and casualty group for 2005, 2004 and 2003 was $621,235, $661,579 and $623,971, respectively.
The more significant decrease in net written premium and net earned premium was due partially to a $14.7 million increase in reinstatement premiums in 2005 compared to 2004. Reinstatement premiums, which are netted against net written premium and net earned premium but do not impact gross written premium, related to purchasing additional reinsurance in response to the severe hurricane season experienced in 2005. In addition to the increased reinstatement premiums, the Company experienced growth in several accounts where premium is ceded back to the producing agent.
Activity in the liability for unpaid insurance losses and loss adjustment expenses (excluding claim checks issued but not yet paid) for the property and casualty companies is summarized as follows (amounts in 000’s):
The Company has a qualified defined benefit pension plan which provides for the payment of annual benefits to participants upon retirement. Such benefits are based on years of service and the participant’s highest compensation during five consecutive years of employment. The Company’s funding policy is to contribute annually an amount sufficient to satisfy ERISA funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for benefits expected to be earned in the future. During 2000, the participants of the qualified pension plan were given a one-time election to opt out of the qualified pension plan and enroll in a qualified self-directed defined contribution retirement plan. All employees hired subsequent to that election are automatically enrolled in the qualified self-directed defined contribution retirement plan. The Company contributed $2.3 million, $1.9 million and $2.0 million to the qualified self-directed retirement plan for the years 2005, 2004 and 2003, respectively.
The Company has a qualified 401(k) savings plan, a funded non-qualified savings plan and a funded non-qualified self-directed retirement plan. The Company contributed (amounts in 000’s) $1,256, $1,118 and $960 to the qualified 401(k) savings plan and $250, $228 and $211 to the non-qualified savings plan for the years 2005, 2004 and 2003, respectively.
The Company also has an unfunded non-qualified defined benefit pension plan.
The assumptions used relative to the plans are evaluated annually and updated as necessary. The discount rate assumption is based on average bond yields for high quality corporate bonds. The expected long-term rate of return assumption was based on actuarial recommendations, economic conditions and the historical performance of the plan’s investment portfolio over the past ten years.
The Company’s qualified defined benefit pension plan had projected benefit obligations, accumulated benefit obligations and fair value of plan assets amounting to (in 000’s) $29,213, $24,869 and $19,741 in 2005 and $26,022, $21,734 and $18,793 in 2004, respectively. The Company’s non-qualified defined benefit plan had projected benefit obligations, accumulated benefit obligations and fair value of plan assets amounting to (in 000’s) $1,740, $1,614 and $0 in 2005 and $1,698, $1,365 and $0 in 2004, respectively.
The Company made its required cash contribution of $0.6 million for the 2005 plan year in 2005. The Company’s expected pension benefit payments, which reflect expected future service, for the next ten years are as follows (amounts in 000’s): 2006 - $1,091; 2007 - $1,264; 2008 - $1,310; 2009 - $1,357; 2010 - $1,483; 2011 through 2015 - $9,256.
The Company implemented a restricted stock award program during 1993. Under this program, restricted grants of the Company’s common stock will vest after a five-year incentive period, conditioned upon the recipient’s employment throughout the period. During the vesting period, shares issued are nontransferable, but the shares are entitled to all of the other rights of outstanding shares. In 2004, 202,000 shares were distributed relating to the 1999 grant. At December 31, 2005 and 2004, no restricted stock awards were outstanding.
In 2000, the Company established a performance stock award program. Under this program, shares vest after a three-year performance measurement period and will only be awarded if pre-established performance levels have been achieved. Shares are awarded at no cost and the recipient must have been employed throughout the entire three-year performance period. In 2005, 39,000 shares were issued under this program, 57,000 shares have been earned and are scheduled for distribution in 2006, and a maximum of 75,000 and 64,000 shares could potentially be issued in 2007 and 2008, respectively, related to this program. The expected fair value of these awards is charged to compensation expense over the performance period. Compensation expense for 2005, 2004 and 2003 amounted to (amounts in 000’s) $2,215, $1,852 and $1,035, respectively.
The insurance subsidiaries are subject to state regulations which limit by reference to statutory net income and policyholders’ surplus the dividends that can be paid to their parent company without prior regulatory approval. Dividend restrictions vary between the companies as determined by the laws of the domiciliary states. Under these restrictions, the maximum dividends that may be paid by the insurance subsidiaries in 2006 without regulatory approval total (amounts in 000’s): $64,474; such subsidiaries paid cash dividends of $23,030 in 2005, $2,600 in 2004 and $5,000 in 2003.
The Company operates in several industries and Company management reviews operating results by several different classifications (e.g., product line, legal entity, distribution channel). Reportable segments are determined based upon revenues and/or operating profits and are based on significant product groups, which include residential property, recreational casualty, financial institutions, all other insurance and transportation.
Revenues reported above, by definition, exclude investment income and realized gains. For income before taxes reported above, insurance investment income is allocated to the insurance segments while realized gains and losses are included in Unallocated Insurance Amounts. The Company allocates insurance investment income to the segments based primarily on written premium volume. The Company does not allocate realized gains or losses to the segments as the Company evaluates the performance of the segments exclusive of the impact of realized gains or losses due to potential timing issues. Certain other amounts are also not allocated to segments by the Company.
No single customer contributed in excess of 10% of consolidated revenues in 2005, 2004 or 2003.