Bancinsurance is a specialty property insurance holding company incorporated in the State of Ohio in 1970. The Company has two reportable business segments: (1) property/casualty insurance; and (2) insurance agency. Until August 31, 2006, the Company also had a municipal code publishing business segment. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described in “Overview-Sale of Affiliate” below and in Note 1 to the Consolidated Financial Statements. These segments are described in more detail below.
Our unemployment compensation (“UC”) products are utilized by qualified entities that elect not to pay the unemployment compensation taxes and instead reimburse state unemployment agencies for benefits paid by the agencies to the entities’ former employees. Through our UCassure® and excess of loss products, we indemnify the qualified entity for liability associated with its reimbursing obligations. In addition, we underwrite surety bonds that certain states require employers to post in order to obtain reimbursing status for their unemployment compensation obligations. Our bonded service program was discontinued at the end of 2003 and replaced by our UCassure® program.
In connection with the Sale and the Investment, the Company recorded a net realized gain of approximately $2.5 million ($1.7 million after tax) for the period ended December 31, 2006.
The decrease in loss and LAE reserves from $19.6 million at December 31, 2005 to $6.4 million at December 31, 2006 was primarily due to loss payments made by the Company during 2006 in connection with the Aegis and Sirius settlements and the Harco Final Order.
Discontinued bond program losses and LAE were $1.8 million, $0.4 and $20.2 million during the years ended December 31, 2006, 2005 and 2004, respectively. The 2006 loss of $1.8 million was primarily attributable to the Harco Final Order combined with our increase in Harco’s reported losses. The $0.4 million loss recorded during 2005 was primarily attributable to an increase in reported losses from Harco which was partially offset by a decrease in losses for Aegis due to a favorable ruling by the Aegis arbitration panel.
Given the uncertainties of the outcome of the Highlands arbitration, uncertainties in the future loss information provided by Harco and Highlands, and the inherent volatility in assumed reinsurance, actual losses incurred for the discontinued bond program could be materially different from our estimated reserves. As a result, future loss development on the discontinued bond program could have a material effect on the Company’s results of operations and/or financial condition.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In accordance with FIN 48, the Company must adjust its financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. The effective date of FIN 48 for the Company is January 1, 2007. The adoption of FIN 48 is not expected to have a material impact on the Company’s Consolidated Financial Statements.
See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for a description of the Company’s discontinued bond program.
Net income (loss) for 2005 was $6,294,074, or $1.26 per diluted share, compared to $(8,500,620), or $(1.72) per diluted share, in 2004. The most significant factor contributing to the increase in net income was a decrease in losses and LAE of approximately $19.7 million for the discontinued bond program. In addition, the Company benefited from an increase in profitability for its CPI, GAP, UC and WIP product lines and an increase in investment income when compared to 2004. These positive factors were partially offset by an increase in legal, auditing and federal income tax expenses incurred during 2005 when compared to 2004.
The combined ratio, which is the sum of the loss ratio and the expense ratio, is the traditional measure of underwriting experience for property/casualty insurance companies. The Company’s specialty insurance products are underwritten by Ohio Indemnity, whose results represent the Company’s combined ratio. The statutory combined ratio is the sum of the ratio of losses to premiums earned plus the ratio
ULI net premiums earned decreased 10.5%, or $3,056,573, to $26,017,984 in 2006 from $29,074,557 in 2005. ULI premiums decreased due primarily to a general agent transferring half of its production to other insurance carriers in the second half of 2005 (the “Transferred Business”), combined with lower lending volumes for certain financial institution customers and the cancellation of a ULI customer at the end of second quarter 2006.
Net premiums earned for CPI decreased 29.6%, or $683,650, to $1,623,494 in 2006 from $2,307,144 in 2005 primarily due to a decline in volume for certain financial institution customers.
Net premiums earned for GAP grew 15.3%, or $1,488,113, to $11,240,520 in 2006 from $9,752,407 in 2005. This growth was primarily due to rate and volume increases with existing customers.
Discontinued bond program net premiums earned declined $145,317 in 2006 compared to a year ago due to the discontinuation of this program in the second quarter of 2004. See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for additional information concerning the discontinued bond program.
Investment Income. We seek to invest in investment-grade obligations of states and political subdivisions because the majority of the interest income from such investments is tax-exempt and such investments have generally resulted in more favorable net yields. Net investment income increased 16.4%, or $542,405, to $3,845,064 in 2006 from $3,302,659 a year ago. This improvement was primarily due to growth in average investments in 2006 compared to 2005 combined with higher yields.
Management Fees. Pursuant to the terms of certain surety bonds issued by the Company that guarantee the payment of reimbursable unemployment compensation benefits, certain monies are held by the Company in contract funds on deposit and are used for the payment of benefit charges. The Company has agreements with cost containment service firms designed to control the unemployment compensation costs of the employers enrolled in the program. Any remaining funds after the payment of all benefit charges are shared between the Company and the cost containment firms as management fees. Management fees are recognized when earned based on the development of benefit charges. Our management fees increased 16.3%, or $116,632, to $830,329 in 2006 from $713,697 a year ago as a result of favorable unemployment experience and pricing actions. We expect management fees to vary from period to period depending on unemployment levels and benefit charges.
Losses and Loss Adjustment Expenses. Losses and LAE represent claims associated with insured loss events and expenses associated with adjusting and recording policy claims, respectively. Losses and LAE increased 9.6%, or $2,238,623, to $25,574,243 in 2006 from $23,335,620 a year ago primarily due to an increase in losses and LAE of $1,344,763 for the discontinued bond program. See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for additional information concerning the discontinued bond program. Excluding the discontinued bond program, losses and LAE increased 3.9%, or $893,860, to $23,806,747 in 2006 from $22,912,887 a year ago primarily due to an increase in losses and LAE for our ULI and GAP business, which was partially offset by a decrease in losses and LAE for our CPI, UC and WIP business.
ULI losses and LAE increased 7.6%, or $1,189,422, to $16,874,524 in 2006 from $15,685,102 a year ago. The increase was due primarily to favorable loss development during 2005 as a result of fewer loan defaults, bankruptcies and automobile repossessions among our ULI customers.
GAP losses and LAE increased 5.8%, or $294,848, to $5,383,325 in 2006 from $5,088,477 a year ago principally due to growth in the business.
Losses and LAE for our UC products decreased 35.9%, or $305,110, to $545,295 in 2006 from $850,405 a year ago primarily due to a decrease in losses for the bonded service program which was cancelled at the end of 2003.
Net Premiums Earned. Net premiums earned increased 3.3%, or $1,652,760, to $51,716,945 in 2005 from $50,064,185 in 2004. Net premiums earned benefited from growth in our CPI, GAP, UC and WIP product lines, which was partially offset by premium decreases in ULI and the discontinued bond program.
ULI net premiums earned decreased 15.6%, or $5,373,145, to $29,074,557 in 2005 from $34,447,702 in 2004. The decline was due to decreased lending volume for certain of our financial institution customers, a decrease from the Transferred Business and an increase in experience rating adjustments. The experience rating adjustment is primarily influenced by ULI policy experience-to-date and premium growth. A decrease in experience rating adjustments results in a positive impact to net premiums earned whereas an increase in experience rating adjustments results in a decrease to net premiums earned. Experience rating adjustments increased for 2005 when compared to 2004 primarily due to favorable loss experience for the ULI product line. Management anticipates that experience rating adjustments will fluctuate in future periods based upon loss experience and premium growth. These decreases in ULI net premiums earned were partially offset by an increase in lending volume by several of our other financial institution customers.
Discontinued bond program net premiums earned declined $672,897 in 2005 compared to 2004 due to the discontinuation of this program in the second quarter of 2004. See “Overview-Discontinued Bond Program” above and Note 16 to the Consolidated Financial Statements for additional information concerning the discontinued bond program.
concerning impairment charges, see “Critical Accounting Policies-Other-Than-Temporary Impairment of Investments” below.
Codification and Subscription Fees. ALPC’s codification and subscription fees decreased 13.3%, or $530,747, to $3,474,668 in 2005 from $4,005,415 in 2004. In 2004, ALPC engaged in a one-time project which generated additional fees that were not received in 2005.
Management Fees. Our management fees increased to $713,697 in 2005 from $33,710 in 2004 as a result of pricing actions, favorable unemployment experience during 2005 and cancellation of a poor performing account at the end of 2004. We expect management fees to vary from period to period depending on unemployment levels and benefit charges.
CPI losses and LAE increased 14.0%, or $98,070, to $798,465 in 2005 from $700,395 in 2004 which is consistent with the growth in the business.
GAP losses and LAE increased 22.7%, or $941,850, to $5,088,477 in 2005 from $4,146,627 in 2004 principally due to growth in the business.
Losses and LAE for our UC products increased 98.6%, or $422,214, to $850,405 in 2005 compared to $428,191 in 2004 due to favorable loss development in 2004 on an excess of loss policy that was cancelled at the end of 2003 as well as unfavorable loss development on our bonded service program during 2005.
WIP losses and LAE increased 129.2%, or $272,771, to $483,925 in 2005 from $211,154 in 2004. This increase is consistent with the growth in WIP net premiums earned as the Company records loss and LAE reserves for WIP using an expected loss ratio reserving method, which is based on a certain percentage of net premiums earned.
GAAP Combined Ratio. For 2005, the combined ratio decreased to 93.6% from 129.7% a year ago. The loss ratio improved to 45.8% in 2005 from 95.1% in 2004 due principally to the decrease in losses and LAE for the discontinued bond program. Excluding the discontinued bond program losses and LAE, the Company’s loss ratio was 45.0% in 2005 compared to 54.8% in 2004. This improvement was attributable to the performance of our ULI, CPI, GAP and WIP product lines. The expense ratio increased to 47.8% in 2005 from 34.6% in 2004 primarily due to an increase in commission expense and other insurance operating expenses as described above.
During the third quarter of 2005, one of our managing general agents moved a portion of its ULI and GAP premium in an effort to more evenly distribute its business with existing insurance carriers. As a result, the Company expects a decline in premiums earned of $1.6 million and a decline in losses, commissions and premium taxes incurred of approximately $1.3 million for this managing general agent for fiscal year 2007 when compared to fiscal year 2006. In addition, a ULI financial institution customer cancelled its policy at the end of second quarter 2006. As a result, the Company expects a decline in premiums earned of $1.9 million and a decline in losses, commission and premium taxes incurred of approximately $1.8 million for this customer for fiscal year 2007 when compared to fiscal year 2006.
If the rate of loan defaults, bankruptcies and automobile repossessions increase for our ULI customers, we would anticipate an increase in the frequency of losses for this product line. Incentives being offered on new cars by dealers and manufacturers have depressed the value of the used car market. In addition, the higher level of gas prices could lower the market value of less fuel-efficient vehicles. If used car prices continue to decline, the “gap” between the value of the vehicle and the outstanding loan balance would increase and thus the severity of our GAP losses would increase. The Company has taken pricing actions to help mitigate the effect of these trends.
Effective January 1, 2007, the Company entered into a producer-owned reinsurance arrangement with a new CPI customer whereby 100% of that customer’s premiums (along with the associated risk) were ceded to its PORC. For this program, the CPI coverage is voluntary and is primarily for tractors and residential/commercial mowers as opposed to automobiles. The Company receives a ceding commission based on a percentage of the premiums ceded. For this reinsurance arrangement, the Company obtains collateral in the form of funds held and a letter of credit to secure its obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and the Company has immediate access to such collateral if necessary. If the customer’s premium projections for 2007 are accurate, this program should reduce our commission expense by approximately $0.2 million to $0.3 million during 2007.
Since the Company began participating in the waste surety bond program in 2004 there have not been any claims to date. If the Company were to have claims experience on this program during 2007, such claims experience could have an impact to our financial performance if our reserves prove to be deficient.
As discussed above in “Risk Factors - Automobile Service Contract Program”, this program could have an impact to our 2007 financial performance if the Company is required to pay claims under the program and it is unable to draw on the letter of credit and cannot collect on the reinsurance.
During 2006, 2005 and 2004, ALPC had pretax income of approximately $0.3 million, $0.7 million and $0.5 million, respectively, which is included in our results of operations. As the Company sold ALPC on August 31, 2006, the operations of ALPC are no longer included in our consolidated financial statements, other than our equity investment in the Purchaser. As a result of this transaction, we do not expect our 2007 operations to include the same level of profit that was contributed by ALPC in previous years.
Liquidity and capital resources demonstrate the Company’s ability to generate sufficient cash flows from its operations and borrow funds at competitive rates to meet operating and growth needs. As of December 31, 2006, the Company’s capital structure consists of trust preferred debt issued to affiliates and shareholders’ equity and is summarized in the following table:
In December 2002, we organized BIC Statutory Trust I (“BIC Trust I”), a Connecticut special purpose business trust, which issued $8,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust I also issued $248,000 of floating rate common securities to Bancinsurance. In September 2003, we organized BIC Statutory Trust II (“BIC Trust II”), a Delaware special purpose business trust, which issued $7,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust II also issued $217,000 of floating rate common securities to Bancinsurance. BIC Trust I and BIC Trust II (collectively, the “Trusts”) were formed for the sole purpose of issuing and selling the floating rate trust preferred capital securities and investing the proceeds from such securities in junior subordinated debentures of the Company. In connection with the issuance of the trust preferred capital securities, the Company issued junior subordinated debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC Trust II, respectively. The floating rate trust preferred capital securities and the junior subordinated debentures have substantially the same terms and conditions. The Company has fully and unconditionally guaranteed the obligations of the Trusts with respect to the floating rate trust preferred capital securities. The Trusts distribute the interest received from the Company on the junior subordinated debentures to the holders of their floating rate trust preferred capital securities to fulfill their dividend obligations with respect to such trust preferred securities. BIC Trust I’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred basis points (9.37% and 8.44% at December 31, 2006 and 2005, respectively), are redeemable at par on or after December 4, 2007 and mature on December 4, 2032. BIC Trust II’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred and five basis points (9.41% and 8.58% at December 31, 2006 and 2005, respectively), are redeemable at par on or after September 30, 2008 and mature on September 30, 2033. The proceeds from the junior subordinated debentures were used for general corporate purposes and provided additional financial flexibility to the Company. The terms of the junior subordinated debentures contain various restrictive covenants. As of December 31, 2006, the Company was in compliance with all such covenants.
Because of the nature of the risks we insure on a direct basis, losses and LAE emanating from the insurance policies that we issue are generally characterized by relatively short settlement periods and quick development of ultimate losses compared to claims emanating from other types of insurance products. Therefore, we believe we can estimate our cash needs to meet our policy obligations and utilize cash flows from operations and cash and short-term investments to meet these obligations. The Company considers the relationship between the duration of our policy obligations and our expected cash flows from operations in determining our cash and short-term investment position. We maintain a level of cash and liquid short-term investments which we believe will be adequate to meet our anticipated cash needs without being required to liquidate intermediate-term and long-term investments. At December 31, 2006, total cash and short-term investments were approximately $10.1 million and gross loss and LAE reserves, excluding the discontinued bond program, were approximately $7.5 million.
Given the Company’s historic cash flows and current financial condition, management believes that the cash flows from operating and investing activities over the next year will provide sufficient liquidity for the operations of the Company. Our line of credit provides us with additional liquidity that could be used for short-term cash requirements if cash from operations and investments is not sufficient.
The preparation of the Consolidated Financial Statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, revenues, liabilities and expenses and related disclosures of contingent assets and liabilities. We regularly evaluate these estimates, assumptions and judgments. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates, assumptions and judgments under different assumptions or conditions. Set forth below are the critical accounting policies that we believe require significant estimates, assumptions and judgments and are critical to an understanding of our Consolidated Financial Statements .
We continually monitor the difference between the cost and the estimated fair value of our investments, which involves uncertainty as to whether declines in value are temporary in nature. If we believe a decline in the value of a particular available for sale investment is temporary, we record the decline as an unrealized loss in our shareholders’ equity. If we believe the decline in any investment is “other-than-temporarily impaired,” we write down the carrying value of the investment and record a realized loss. Our assessment of a decline in value includes our current judgment as to the financial position and future prospects of the entity that issued the investment security. If that judgment changes in the future, we may ultimately record a realized loss after having originally concluded that the decline in value was temporary.
In addition to the monthly valuation procedures described above, we continually monitor developments affecting our invested assets, paying particular attention to events that might give rise to impairment write-downs. There were $7,310, $0 and $535,487 in impairment charges included in net realized gains on investments for the years ended December 31, 2006, 2005 and 2004, respectively. Included in impairment charges for 2004 is a write down of $334,136 related to a private equity investment due to its financial uncertainty. Impairments within the portfolio during 2007 are possible if current economic and financial conditions worsen. See Note 2 to the Consolidated Financial Statements for additional information with respect to securities in an unrealized loss position at December 31, 2006 and 2005.
Our projection of ultimate loss and LAE reserves are estimates of future events, the outcomes of which are unknown to us at the time the projection is made. Considerable uncertainty and variability are inherent in the estimation of loss and LAE reserves. As a result, it is possible that actual experience may be materially different than the estimates reported. The Company continually refines reserve estimates as experience develops and further claims are reported and resolved. The Company reflects adjustments to reserves in the results of the periods in which such adjustments are made.
Assumed Business. Assumed reinsurance is a line of business with inherent volatility. Since the length of time required for the losses to be reported through the reinsurance process can be quite long, unexpected events are more difficult to predict. Ultimate loss reserve estimates for assumed reinsurance are dependent upon and based primarily on reports received by the Company from the underlying ceding insurers. These reports are the primary basis for the Company’s reserving estimates.
As discussed in “Overview-Discontinued Bond Program” above and in Note 16 to the Consolidated Financial Statements , discontinued bond program loss and LAE reserves were $6.4 million at December 31, 2006. Given the uncertainties of the outcome of the Highlands arbitration, uncertainties in the future loss information provided by Harco and Highlands, and the inherent volatility in assumed reinsurance, actual losses incurred for the discontinued bond program could be materially different from our estimated reserves. As a result, future loss development on the discontinued bond program could have a material effect on the Company’s results of operations and/or financial condition.
The Company calculates a reserve range for its lender/dealer product lines (ULI, CPI and GAP) and calculates point estimates for UC, WIP and other specialty product lines. As of December 31, 2006, our indicated gross loss and LAE reserve range for lender/dealer products was $3.6 million to $5.8 million and our recorded loss and LAE reserves were $5.2 million.
During 2006, reserves for incurred losses and LAE attributable to insured events of prior years increased by approximately $0.1 million as a result of re-estimation of unpaid losses and LAE principally on the Company’s discontinued bond program. An analysis of this increase is provided below.
GAP experienced reserve redundancies of approximately $0.6 million during 2006. The improvement in loss experience primarily related to the 2005 accident year. At December 31, 2006 and 2005, the Company’s ultimate selected loss ratio for the 2005 accident year was 58.2% and 62.3%, respectively. Changes in this key assumption occurred primarily during the first half of 2006 as the majority of our GAP losses are settled within six months from the date of loss. When estimating the ultimate loss ratio at December 31, 2005, the Company selected an ultimate loss ratio for the 2005 accident year that was comparable to previous accident years’ ultimate loss ratios. During the first half of 2006, our 2005 accident year loss experience was more favorable than previously estimated at December 31, 2005.
ULIN experienced reserve redundancies of approximately $0.3 million during 2006. The improvement in loss experience primarily related to the 2005 accident year. At December 31, 2006 and 2005, the Company’s ultimate selected loss ratio for the 2005 accident year was 48.2% and 48.5%, respectively. Changes in this key assumption occurred primarily during the first half of 2006 as the majority of our ULIN losses are settled within four months from the date of loss. When estimating the ultimate loss ratio at December 31, 2005, the Company selected an ultimate loss ratio for the 2005 accident year that was comparable to previous accident years’ ultimate loss ratios. During the first half of 2006, our 2005 accident year loss experience was more favorable than previously estimated at December 31, 2005. In accordance with SFAS No. 60, the Company recorded this change in reserves as a change in estimate during 2006.
Revenue from municipal code contracts is recognized on the percentage-of-completion method: completion is measured based on the percentage of direct labor costs incurred to date compared to estimated direct labor costs for each contract. While we use available information to estimate total direct labor costs on each contract, actual experience may vary from estimated amounts. Under this method, the costs incurred and the related revenues are included in the income statement as work progresses. Adjustments to contract cost estimates are made in the periods in which the facts which require such revisions become known. If a revised estimate indicates a loss, such loss is provided for in its entirety. The amount by which revenues are earned in advance of contractual collection dates is an unbilled receivable and the amount by which contractual billings exceed earned revenues is deferred revenue which is carried as a liability. As the Company sold ALPC on August 31, 2006, this is a critical accounting policy through that date only. See “Overview-Sale of Affiliate” above and Note 1 to the Consolidated Financial Statements for information concerning this transaction.
The fair value of options granted by the Company are estimated on the date of grant using the Black-Scholes option pricing model (“Black-Scholes model”). The Black-Scholes model is utilized by the Company to calculate equity-based compensation expense and it uses various assumptions such as risk-free rate, expected life, expected volatility and dividend yield. The risk-free rate is based on the United States Treasury strip curve at the time of the grant with a term approximating that of the expected option life. The Company analyzes historical data regarding option exercise behaviors, expirations and cancellations to calculate the expected life of the options granted, which represents the length of time in years that the options granted are expected to be outstanding. Expected volatilities are based on historical volatility over a period of time using the expected term of the option grant and using weekly stock prices of the Company; however for options granted after February 4, 2005, the Company excludes the period from February 4, 2005 through January 25, 2006 (the period in which shareholders could not obtain current financial information for the Company and could not rely on the Company’s 2003, 2002 and 2001 financial statements) as the Company believes that its stock price during that period is not relevant in evaluating expected volatility of its common shares in the future. Dividend yield is based on historical dividends. See Note 11 to the Consolidated Financial Statements for information concerning the Company’s equity-based compensation expense.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
Notes to Consolidated Financial Statements - December 31, 2006, 2005 and 2004
Bancinsurance Corporation (“Bancinsurance”) is a specialty property insurance holding company incorporated in the State of Ohio in 1970. Bancinsurance and its subsidiaries (collectively, the “Company”) have two reportable business segments: (1) property/casualty insurance; and (2) insurance agency. Until August 31, 2006, the Company also had a municipal code publishing business segment. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described in “Sale of Affiliate” below. These segments are described in more detail below.
The Company has certain other specialty products which consist primarily of service contracts and other surety products. In addition, from 2001 until the end of the second quarter of 2004, the Company participated in a bail and immigration bond program. This program was discontinued in the second quarter of 2004. For a more detailed description of this program, see Note 16 to the Consolidated Financial Statements.
The Company sells its insurance products through multiple distribution channels, including three managing general agents,
In connection with the Sale and the Investment, the Company recorded a net realized gain of approximately $2.5 million ($1.7 million after tax) for the year ended December 31, 2006.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” This Statement defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. The Statement clarifies the rule that fair value be based on the assumptions that market participants would use when pricing an asset or liability, and establishes a fair value hierarchy that prioritizes the framework and information used to develop those assumptions. The Company is required to adopt the provisions of SFAS No. 157 for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157 is not expected to have a material impact on the Company’s Consolidated Financial Statements .
Investments in held to maturity fixed maturities where we have the ability and intent to hold to maturity, are carried at amortized cost. Investments in fixed maturities held as available for sale, which include debt securities and redeemable preferred stock, are carried at fair value. The unrealized holding gain or loss, net of applicable deferred taxes and reclassification adjustment, is reflected in other comprehensive income.
Accounts receivable was comprised of ALPC’s municipal code contract billings. We estimated our allowance for doubtful accounts and bad debts based upon our assessment of the collectibility of receivables and prior experience. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described above in “Sale of Affiliate.”
Revenue from ALPC municipal code contracts was recognized on the percentage-of-completion method. Completion was measured based on the percentage of direct labor costs incurred-to-date compared to estimated direct labor costs for each contract. While we used available information to estimate total direct labor costs on each contract, actual experience may vary from estimated amounts. Revenue from code supplements was recognized on the completed-contract method because the typical supplement is completed in a few months. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described above in “Sale of Affiliate.”
See Note 11 to the Consolidated Financial Statements for more information concerning equity-based compensation.
Certain prior year amounts have been reclassified in order to conform to the 2006 presentation.
The proceeds from sales of available for sale securities were $43,604,109, $47,636,072 and $28,255,910 for the years ended December 31, 2006, 2005 and 2004, respectively.
Amortization expense related to amortizable intangible assets was $49,679, $74,518 and $74,517 during 2006, 2005 and 2004, respectively. On August 31, 2006, the Company sold its municipal code publishing segment as more fully described above in Note 1 to the Consolidated Financial Statements.
In December 2002, we organized BIC Statutory Trust I (“BIC Trust I”), a Connecticut special purpose business trust, which issued $8,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust I also issued $248,000 of floating rate common securities to Bancinsurance. In September 2003, we organized BIC Statutory Trust II (“BIC Trust II”), a Delaware special purpose business trust, which issued $7,000,000 of floating rate trust preferred capital securities in an exempt private placement transaction. BIC Trust II also issued $217,000 of floating rate common securities to Bancinsurance. BIC Trust I and BIC Trust II were formed for the sole purpose of issuing and selling the floating rate trust preferred capital securities and investing the proceeds from such securities in junior subordinated debentures of the Company. In connection with the issuance of the trust preferred capital securities, the Company issued junior subordinated debentures of $8,248,000 and $7,217,000 to BIC Trust I and BIC Trust II, respectively. The floating rate trust preferred capital securities and the junior subordinated debentures have substantially the same terms and conditions. The Company has fully and unconditionally guaranteed the obligations of BIC Trust I and BIC Trust II with respect to the floating rate trust preferred capital securities. BIC Trust I and BIC Trust II distribute the interest received from the Company on the junior subordinated debentures to the holders of their floating rate trust preferred capital securities to fulfill their dividend obligations with respect to such trust preferred securities. BIC Trust I’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred basis points (9.37% and 8.44% at December 31, 2006 and 2005, respectively), are redeemable at par on or after December 4, 2007 and mature on December 4, 2032. BIC Trust II’s floating rate trust preferred capital securities, and the junior subordinated debentures issued in connection therewith, pay dividends and interest, as applicable, on a quarterly basis at a rate equal to three month LIBOR plus four hundred and five basis points (9.41% and 8.58% at December 31, 2006 and 2005, respectively), are redeemable at par on or after September 30, 2008 and mature on September 30, 2033. Interest on the junior subordinated debentures is charged to income as it accrues. Interest expense related to the junior subordinated debentures for the years ended December 31, 2006, 2005 and 2004 was $1,427,241, $1,148,431and $862,256, respectively. The terms of the junior subordinated debentures contain various restrictive covenants. As of December 31, 2006, the Company was in compliance with all such covenants.
The Ohio Indemnity Company Employee 401(k) and Profit Sharing Plan (the “401(k) Plan”) is available to full-time employees who meet the 401(k) Plan’s eligibility requirements. Under the 401(k) Plan, we match 100% of the qualified employee’s contribution up to 3% of salary and 50% of the qualified employee’s contribution between 3% and 5% of salary. The total cost of the matching contribution was $130,075, $126,640 and $224,548 for the years ended December 31, 2006, 2005 and 2004, respectively.
The Company has stock options outstanding and exercisable at December 31, 2006 under two equity compensation plans, each of which has been approved by our shareholders.
The 1994 Stock Option Plan (the “1994 Stock Option Plan”) provided for the grants of options, covering up to an aggregate of 500,000 common shares, with a 100,000 common share maximum for any one participant. Key employees, officers and directors of, and consultants and advisors to, the Company were eligible to participate in the 1994 Stock Option Plan. The 1994 Stock Option Plan is administered by the Company’s Compensation Committee which determined to whom and when options were granted along with the terms and conditions of the options. Under the 1994 Stock Option Plan, options for 266,500 common shares were outstanding at December 31, 2006 and expire at various dates from 2007 to 2013 and range in option price per share from $3.88 to $6.25. Of the options for 266,500 common shares outstanding, 32,000 have been granted to our non-employee directors and 234,500 have been granted to employees. All of the options outstanding were granted to employees and directors for compensatory purposes. No new options can be granted under the 1994 Stock Option Plan and the plan remains in effect only with respect to the outstanding options.
The 2002 Stock Incentive Plan (the “2002 Plan”) provides for awards, including grants of options, covering up to an aggregate of 600,000 common shares. Key employees, officers and directors of, and consultants and advisors to, the Company are eligible to participate in the 2002 Plan. The 2002 Plan is administered by the Compensation Committee which determines to whom and when awards will be granted as well as the terms and conditions of the awards. Under the 2002 Plan, options for 561,000 common shares were outstanding at December 31, 2006 and expire at various dates from 2012 to 2016 and range in option price per share from $4.50 to $8.00. Of the options for 561,000 common shares outstanding, 12,000 have been granted to our non-employee directors and 549,000 have been granted to employees. All of the options outstanding were granted to employees and directors for compensatory purposes. As of December 31, 2006, there were 35,000 shares available for future grant under the 2002 Plan.
The following table summarizes weighted-average information by range of exercise prices for stock options outstanding and exercisable at December 31, 2006:
As of and for the period ended December 31, Ohio Indemnity’s statutory surplus and net income determined in accordance with statutory accounting practices differed from shareholder’s equity and net income determined in accordance with GAAP by the following:
The Company assumes and cedes reinsurance with other insurers and reinsurers. Such arrangements serve to enhance the Company’s capacity to write business, provide greater diversification, align business partners with the Company’s interests, and/or limit the Company’s maximum loss arising from certain risks. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer. The primary insurer would reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreement. The ability to collect reinsurance is subject to the solvency of the reinsurers and/or collateral provided under the contract.
A reconciliation of direct to net premiums, on both a written and earned basis, for the year ended December 31 is as follows:
The amounts of recoveries pertaining to reinsurance that were deducted from losses and LAE incurred for the years ended December 31, 2006, 2005 and 2004 were $3,390,786, $1,789,439 and $2,465,643, respectively. For the years ended December 31, 2006, 2005 and 2004, ceded reinsurance decreased commission expense incurred by $1,494,873, $1,054,259 and $597,927, respectively.
In the second quarter of 2004, the Company came to believe that the discontinued bond program was not being operated as it had been represented to the Company by agents of the insurance carriers who had solicited the Company’s participation in the program, and the Company began disputing certain issues with respect to the program, including but not limited to: 1) inaccurate/incomplete disclosures relating to the program; 2) improper supervision by the insurance carriers of the bail bond agency in administering the program; 3) improper disclosures by the insurance carriers through the bail bond agency and the reinsurance intermediaries during life of the program; and 4) improper premium and claims administration. Consequently, during the second quarter of 2004, the Company ceased paying claims on the program and retained outside legal counsel to review and defend its rights under the program.
In February 2000, we entered into a Split-Dollar Insurance Agreement for the benefit of another officer in the face amount of $1,000,000. All premiums paid by the Company in accordance with this agreement are to be repaid, in full, without interest, upon the death, retirement or termination of the officer. The Company had paid premiums of $30,000 relating to this agreement; however, the Company is no longer paying premiums under the agreement. At December 31, 2006 and 2005, $30,000 was included in loans to affiliates in the accompanying balance sheet for payment of insurance premiums in accordance with this agreement.
We share Bancinsurance’s executive offices with certain of our consolidated subsidiaries. Certain expenses are allocated among them pursuant to cost sharing agreements.
As described in Note 1 to the Consolidated Financial Statements, the Company has three reportable business segments: (1) property/casualty insurance; (2) municipal code publishing (through August 31, 2006); and (3) insurance agency. There are intersegment management and commission fees. The allocations of certain general expenses within segments are based on a number of assumptions, and the reported operating results would change if different assumptions were applied. Depreciation and capital expenditures are not considered material. Segment results for the years ended December 31, 2006, 2005 and 2004 are as follows:
During 2003, the Company began issuing insurance policies which guarantee the performance of two automobile service contract providers (the “Providers”). The Providers are owned and managed by a common group. The Company issues insurance policies for business produced by the Providers in five states. Our insurance policy guarantees the fulfillment of the Providers’ obligation under the service contract. Under the program, the Providers carry the related assets and reserves and are responsible for the premiums and claims administration. The Company is obligated to pay a claim only if a Provider fails to do so. Under a reinsurance arrangement, the Company cedes 100% of this business to another insurance carrier. In addition, the Company obtained collateral in the form of a letter of credit to secure its obligations under the program. In February 2007, the Company was notified that one of the Providers entered into an assignment for the benefit of creditors liquidation and that no new business is being produced by that Provider. The Company, with the assistance of its outside actuary, has estimated its potential exposure under the program to be approximately $3.0 million as of December 31, 2006. Because our estimated potential exposure is fully collateralized by a $4.3 million letter of credit and the loss exposure is 100% reinsured, we do not believe this event will have a material adverse impact to the Company. However, if the Company is required to pay claims under the program and it is unable to draw on the letter of credit and cannot collect on the reinsurance, then this program could have a material adverse effect on our business, financial condition and/or operating results.