The following table sets forth selected consolidated financial information for the periods ended and as of the dates indicated. We derived the data as of December 31, 2005, 2004, 2003, 2002 and 2001, and for each of the five years in the period ended December 31, 2005, from our consolidated financial statements that have been audited by Deloitte & Touche LLP, an independent registered public accounting firm.
On October 21, 2003 and December 8, 2003, respectively, we entered into two additional replacement carrier agreements with Sentry Insurance and Met P&C, whereby we agreed to become the replacement carrier for the personal lines business of each entity in New Jersey. We received $0.9 million and have received an additional $2.6 million in 2004 and $0 in 2005 from Sentry Insurance, $2.8 million of which has been recorded as deferred revenue as of December 31, 2003 and $0.7 million recorded as replacement carrier revenue for the year ended December 31, 2003. We received $20.1 million ($9.5 million recorded as deferred revenue as of December 31, 2003, $0.6 million recorded as replacement carrier revenue from a related party for the year ended December 31, 2003, and $10.0 million in the form of a capital contribution) from Met P&C in 2004 and $0 in 2005. In connection with these transactions we recorded $0 million of replacement carrier transaction revenue for the year ended December 31, 2005 as we continued the process of fulfilling our obligations under the terms of each of these respective contracts.
2005 was a transitional year for National Atlantic. The $62 million in net proceeds raised through our IPO in April 2005 strengthened our Company’s financial position, which we believe put us in a position to become a much more aggressive competitor in the New Jersey marketplace. We perceive that the New Jersey auto insurance market migrated from an essentially non-competitive to a highly competitive environment during 2005. In addition, personal lines automobile business has historically made up the largest percentage of our overall business, however we began a transition in 2005 from writing predominantly mono-line automobile business to writing increasing amounts of package personal lines policies that include homeowners, umbrella, boat and specialty coverages in addition to the automobile coverage. Our plan for future growth relates to capturing a larger share of our Partner Agents business and cross-selling our automobile, homeowners and business insurance products to their existing customers.
As of December 31, 2004, our insurance subsidiary, Proformance Insurance Company (“Proformance”), was the ninth largest and the fastest growing provider of private passenger auto insurance in New Jersey, based on direct written premiums of companies writing more than $5 million of premiums annually over the past three years, according to A.M. Best. From 2001 through 2005, we experienced a 41.2% compound annual growth rate, as our direct written premiums for all lines of business we write, including homeowners and commercial lines, increased from $49.8 million in 2001 to $198.0 million in 2005. As of December 31, 2005, our shareholders’ equity was $138.2 million, up from shareholders’ equity of $(4.0) million as of December 31, 2001, reflecting a 142.4% compound annual growth rate. For the year ended December 31, 2005 the increase in shareholders equity is primarily due to the capital received in connection with the completion of the Company’s initial public offering on April 21, 2005 in the amount of $62.2 million.
As a result of New Jersey’s “take all comers” requirement, we are obligated to underwrite a broad spectrum of personal automobile insurance risks. To address this potential problem, since 1998 Proformance has utilized a tiered rating system to price its policies, which includes five (5) rating tiers based upon the driving records of the policyholders. The purpose of the rating tiers is to modify the premiums to be charged for each insured vehicle on the personal automobile policy so that the premiums charged accurately reflect the underwriting exposures presented to Proformance. As of December 31, 2005, the rating tier modifiers and the distribution of risks within the tiers were as follows:
the recent rise in gasoline prices may serve to decrease the number of miles driven by our policyholders and result in lower frequency of automobile claims; and
an evolving set of legal standards by which we are required to pay claims may result in significant variability in our loss reserves over time.
We believe that proper recognition of emerging trends, and an active response to those trends, is essential for our business. In addition, we believe that the recent entrants to the New Jersey personal automobile insurance marketplace, such as Mercury General, GEICO and Progressive, will provide a new level of competition not previously experienced by us or by our long-term competitors, which could have a material effect on our ability to meet sales goals or maintain adequate rates for our insurance products.
Since we operate in a coastal state and we underwrite property insurance, we are subject to catastrophic weather events, which may have significant impact upon our claims expense or our ability to collect the proceeds from our third party reinsurers. We also underwrite commercial insurance business and we expect that the rate increases on those policies that we have experienced over the last three years will moderate and that rate level reductions may ensue, impacting our ability to maintain our underwriting margins on this business.
On February 21, 2006 the Company announced that Proformance had entered into a replacement carrier transaction with Hanover Insurance Group (“Hanover”) whereby Hanover will transfer its renewal obliga-
tions for New Jersey auto, homeowners, dwelling fire, personal excess liability and inland marine policies sold through independent agents to Proformance. Under the terms of the transaction, Proformance will offer renewal policies to approximately 16,000 qualified policyholders of Hanover. The Company and Proformance received approval of this transaction from the NJDOBI on February 16, 2006.
On September 27, 2005 the Company announced that Proformance had entered into a replacement carrier transaction with The Hartford whereby certain subsidiaries of The Hartford (Hartford Fire Insurance Company, Hartford Casualty Insurance Company, and Twin City Fire Insurance) will transfer their renewal obligations for New Jersey homeowners, dwelling fire, and personal excess liabilities policies sold through independent agents to Proformance. Under the terms of the transaction, Proformance will offer a renewal policies to approximately 8,500 qualified policyholders of The Hartford. NAHC and Proformance received preliminary approval of this transaction when they received a draft of the final consent order from the NJDOBI on September 27, 2005. We received final approval of this transaction from the NJDOBI on November 22, 2005.
The Hartford is not liable for any fees and or other amounts to be paid to Proformance and, as such, Proformance will not recognize any Replacement carrier revenue from this transaction. The revenue that will be recognized as part of this transaction will be from the premium generated by the policies that renew with Proformance.
Prior to the Company’s initial public offering, the Company limited the amount of business that Partner Agents could write with Proformance because of its limited capital. However, following the Company’s initial public offering on April 21, 2005, the Company contributed additional capital to Proformance. Accordingly, on June 13, 2005, the Company held a meeting with Partner Agents to inform them that the limitations historically placed on them with respect to placing new business with Proformance were no longer applicable due to Proformance’s enhanced capital adequacy.
On March 15, 2005, the Board of Directors of the Company discussed extending the exercise period of stock options to purchase 73,100 shares of the Company’s common stock granted under its Nonstatutory Stock Option Plan (the “Plan”) on June 15, 1995 to three individuals, two of whom are currently executive officers and one of whom is currently a director of the Company. These stock options were scheduled to expire on June 14, 2005, ten years after the date of issuance. The Board of Directors discussed extending the expiration date of these stock options from June 14, 2005 until December 31, 2005, with the effective date of the extension being June 14, 2005. This proposal to extend the exercise period for such stock options was approved by the Board of Directors at its meeting held on June 13, 2005, subject to shareholder approval. The extension of these options was approved by the Company’s shareholders at the Company’s Annual Meeting of Shareholders which was held on September 19, 2005.
Approval of the extension of the options granted during 1995 and the grant of new stock options to the estate of Mr. Campion was received at the Company’s Annual Meeting of Shareholders on September 19,
2005. The fair market value of the Company’s stock on September 19, 2005 was $11.47; therefore, the Company recognized $749,802 as compensation expense related to the extension of options in its consolidated statement of income for the year ended December 31, 2005. The Company also recognized $1,937,198 as compensation expense related to the grant of new options in its consolidated statement of income for the year ended December 31, 2005.
The revenue we earned from replacement carrier transactions relates to the funds that we received to assume the renewal obligations of those books of business. Revenues from replacement carrier transactions are recognized pro-rata over the period that we complete our obligations under the terms of the agreement, typically ranging from six months to a year, determined by the renewal option period of the policyholders. Certain replacement carrier contracts require additional consideration to be paid to us based on an evaluation of the ratio of premiums written to surplus. The calculation is performed and related revenue is recognized as earned annually, pursuant to the terms of the contract. Certain other transactions, such as the Hanover and Hartford transactions described above, require us to pay additional consideration in the future. We did not record any replacement carrier revenue for the year ended December 31, 2005. Our strategy includes entering into additional replacement carrier transactions as opportunities arise. However, due to improvements in the New Jersey insurance market during 2005, it is not likely that we will enter into replacement carrier transactions which have as significant an impact on the Company’s operations, or are comparable in size to those entered into prior to 2005.
Investment income consists of the income we earn on our fixed income and equity investments as well as short term investments. The “other income” we earn consists of service fees charged to insureds that pay on installment plans, commission received by National Atlantic Insurance Agency from third party business, and revenue from our contract with AT&T under which we provide claims handling and risk data reporting on general liability, automobile liability and physical damage and household move claims.
Our expenses consist primarily of three types: losses and loss adjustment expenses, including estimates for losses and loss adjustment expenses incurred during the period and changes in estimates from prior periods, less the portion of those insurance losses and loss adjustment expenses that we cede to our reinsurers; and acquisition expenses, which consist of commissions we pay our agents. In addition, underwriting, acquisition and insurance related expenses include premium taxes and company expenses related to the production and underwriting of insurance policies, less ceding commissions that we receive under the terms of our reinsurance contracts, and other operating and general expenses which include general and administrative expenses.
When reviewing reserves, we analyze historical data and estimate the impact of various loss development factors, such as our historical loss experience and that of the industry, trends in claims frequency and severity, our mix of business, our claims processing procedures, legislative enactments, judicial decisions, legal developments in imposition of damages, and changes and trends in general economic conditions, including the effects of inflation. A change in any of these factors from the assumptions implicit in our estimate can cause
our actual loss experience to be better or worse than our reserves, and the difference can be material. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves and currently established reserves may not prove adequate in light of subsequent actual experience. To the extent that reserves are inadequate and are strengthened, the amount of such increase is treated as a charge to earnings in the period that the deficiency is recognized. To the extent that reserves are redundant and are released, the amount of the release is a credit to earnings in the period that redundancy is recognized.
For the year ended December 31, 2005, we increased reserves for prior years by $10.1 million. This increase was due to (i) increases in average severity for Personal Injury Protection (No-fault) losses of $9.4 million (ii) higher Commercial Auto Liability projected loss ratios for 2002-2004 due to the fact that actual loss development was higher than expected for those years, resulting in an increase of $1.8 million and (iii) Homeowners losses of $0.6 million and Other Liability losses of $1.6 million. This development was partially offset by continued favorable trends in loss development for Property Damage losses ($1.6 million), Auto Physical Damage losses ($1.2 million), and Bodily Injury losses of ($0.5 million), as reported claims frequency has dropped significantly and we have reduced our projected loss ratios in recognition of this trend. For the year ended December 31, 2004, we reduced reserves for prior years by $0.7 million because our actual loss experience observed during the period, especially during the fourth quarter of 2004, was slightly lower than expected due to a reduction in the frequency of claims reported during the fourth quarter of 2004. In addition, as more fully described in Note 4 Reinsurance Activity to our consolidated financial statements, the commutation referred to for 2004 had no impact on our consolidated unpaid loss and loss adjustment expense reserves as of December 31, 2004. In addition, we increased reserves by $0.1 million for the year ended December 31, 2003. The incurred losses related to prior years of $0.1 million in 2003 included a commutation of a reinsurance agreement of $0.2 million which was offset by favorable loss development on prior accident year reserves.
The table below sets forth the types of reserves we maintain for our lines of business and indicates the amount of reserves as of December 31, 2005 for each line of business.
The amount of reported losses and reported claim frequency for the accident year 2005 are at a lower rate than prior periods, especially for personal auto liability. If this development continues, reserves for accident year 2005 could be redundant.
Loss trends (both frequency and severity) have been declining in recent years in the New Jersey personal auto insurance market. If loss trends become unfavorable, our reserves could be deficient. In addition, the Diprospero v. Penn. decision of the New Jersey Supreme Court, discussed above, which potentially increases a claimant’s right to sue for serious injury, could impact future claims frequency.
We experienced considerable growth in our business commencing in early 2002 and continuing throughout 2003. Specifically, on December 18, 2001 we entered into an agreement with OCIC and OCNJ to become a replacement carrier pursuant to which OCNJ transferred to Proformance the obligation to offer renewals for all of OCNJ’s New Jersey private passenger automobile business effective March 18, 2002. In connection with this transaction our direct written premiums, net written premiums and net earned premiums increased from $49.8 million, $25.5 million and $25.4 million, respectively, for the year ended December 31, 2001, to $163.2 million, $147.0 million and $143.2 million, respectively, for the year ended December 31, 2003, increases of 227.7%, 476.5% and 463.8%, respectively, during that period. In addition total assets, losses
and loss adjustment expense reserves and total shareholders’ equity increased from $78.3 million, $56.7 million and $(4.0) million as of December 31, 2001 to $266.7 million, $134.2 million and $49.8 million, respectively, as of December 31, 2003, increases of 240.6% to total assets, and 136.7% to losses and loss adjustment expense reserves during that period. Also as part of this transaction we recorded replacement carrier revenue in the amount of $4.4 million, $12.7 million and $21.7 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Direct written premiums for the year ended December 31, 2005 decreased by $9.3, or 4.5%, to $198.0 million from $207.3 million in the comparable 2004 period.
At December 31, 2005 the Company experienced a significant increase in shareholder equity, as compared to the amount at December 31, 2004, primarily due to the capital received in connection with the completion of the Company’s initial public offering on April 21, 2005 in the amount of $62.2 million.
The table below shows certain of our selected financial results for the twelve months ended December 31, 2005, 2004 and 2003:
For the Twelve months ended December 31, 2005 Compared to the Twelve months ended December 31,
Net Earned Premiums. Net earned premiums for the twelve months ended December 31, 2005 decreased by $6.9 million, or 3.8%, to $172.8 million from $179.7 million in the comparable 2004 period.
Replacement Carrier Revenue. Replacement carrier revenue for the twelve months ended December 31, 2005 decreased by $18.0 million to $0.0 million from $18.0 million in the comparable 2004 period. The decrease was due to the completion of the revenue recognition process associated with the Met P&C and
Sentry Insurance replacement carrier transactions that began in the fourth quarter of 2003 and were completed during 2004.
Net Realized Investment Gain (Loss). Net realized investment gain (loss) for the twelve months ended December 31, 2005 and 2004 were $0.4 million and $1.9 million, respectively.
Losses and Loss Adjustment Expenses. Loss and loss adjustment expenses for the twelve months ended December 31, 2005 decreased by $2.2 million, or 1.6%, to $132.8 million from $135.0 million in the comparable 2004 period. For the year ended December 31, 2005, we increased reserves for prior years by $10.1 million. This increase was due to (i) increases in average severity for Personal Injury Protection (No-fault) losses of $9.4 million (ii) higher Commercial Auto Liability projected loss ratios for 2002-2004 due to the fact that actual loss development was higher than expected for those years, resulting in an increase of $1.8 million and (iii) Homeowners losses of $0.6 million and Other Liability losses of $1.6 million. This development was partially offset by continued favorable trends in loss development for Property Damage losses ($1.6 million), Auto Physical Damage losses ($1.2 million), and Bodily Injury losses of ($0.5 million), as reported claims frequency has dropped significantly and we have reduced our projected loss ratios in recognition of this trend. As a percentage of net earned premiums, losses and loss adjustment expenses incurred for the year ended December 31, 2005 was 76.9% as compared to 75.1% for the year ended December 31, 2004. The ratio of net losses, excluding loss adjustment expenses, to net earned premiums during the year ended December 31, 2005 was 65.6% compared to 59.5% for the comparable 2004 period.
Underwriting, Acquisition and Insurance Related Expenses.. Underwriting,acquisition and insurance related expenses for the twelve months ended December 31, 2005 decreased by $4.5 million, or 9.6%, to $42.3 million from $46.8 million in the comparable 2004 period. As a percentage of net written premiums, our underwriting, acquisition and insurance related expense ratio for the twelve months ended December 31, 2005 was 22.4% as compared to 24.2% for the comparable 2004 period. The decrease in underwriting, acquisition and insurance related expenses is due to the decrease in net written premium and the related policy acquisition expenses incurred (principally the commission paid to agents) to produce and underwrite that premium, offset by the amount of deferred acquisition costs amortized.
Net Income. Net income after tax for the twelve months ended December 31, 2005 and 2004 was $6.4 million and $17.4 million, respectively. The decrease in net income after tax is a result of the factors discussed above.
Direct Written Premiums. Direct written premiums for the year ended December 31, 2004 increased by $44.1 million, or 27.0%, to $207.3 million from $163.2 million in the comparable 2003 period. The increase was primarily due to new business generated by our Partner Agents less attrition of existing business of $6.1 million, the Sentry Insurance replacement carrier transaction of $7.8 million and the Met P&C replacement carrier transaction of $24.3 million.
Investment Income. Investment income for the year ended December 31, 2004 increased by $2.8 million, or 65.1%, to $7.1 million from $4.3 million in 2003. The increase was due primarily to an increase in invested assets to $237.5 million from $170.6 million for the comparable 2003 period. The increase in invested assets was primarily due to the receipt of $10.1 million in connection with the commutation of our reinsurance agreement with Odyssey America Reinsurance Company in early 2004 and the increase in net written premiums during the period. Our average book yield to maturity for the years ended December 31, 2004 and 2003 was 4.0% and 3.9%, respectively. The increase in yield was due to the decrease in our cash instruments and our ability to purchase securities with higher yields.
Other Income. Other income for the years ended December 31, 2004 and 2003 was $2.0 million and $0.9 million, respectively. The increase in other income of $1.1 million is primarily related to an increase in claims services income of $0.5 million and an increase in finance and service charges of $0.3 million.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the year ended December 31, 2004 increased by $26.9 million, or 24.9%, to $135.0 million from $108.1 million in the comparable 2003 period. Losses and loss adjustment expenses for the year ended December 31, 2004 increased by $27.6 million for the 2004 accident year as a result of the growth in the Company’s net earned premiums. For the year ended December 31, 2004, we reduced reserves for prior years by $0.7 million due to the fact that the actual loss experience observed during the period, especially during the fourth quarter of 2004, was slightly lower than expected. Excluding the reserve decrease for prior years, the 2004 accident year loss ratio increased to 75.2% from 75.1% for accident year 2003. As a percentage of net earned premiums, losses and loss adjustment expenses incurred during 2004 was 75.1% compared to 75.5% for the comparable 2003 period. The ratio of net incurred losses, excluding loss adjustment expenses, to net earned premiums during 2004 was 59.2% compared to 65.1% for the comparable 2003 period.
Underwriting, Acquisition and Insurance Related Expenses. Underwriting, acquisition and insurance related expenses for the year ended December 31, 2004 increased by $20.7 million, or 79.3%, to $46.8 million from $26.1 million in the comparable 2003 period. As a percentage of net written premiums, our underwriting, acquisition and insurance related expense ratio for the year ended December 31, 2004 was 24.2% compared to 17.8% for the comparable 2003 period. The increase in underwriting, acquisition and insurance related expenses is due to the increase in net written premiums and the related acquisition expenses incurred (principally the commission paid to agents) to produce and underwrite that premium, for the year ended December 31, 2004 compared to the comparable period in 2003. The increase in underwriting, acquisition and insurance related expenses is due primarily to the increase in commissions of $8.6 million, due to the increase in direct written premiums for the period, as well as expenses of approximately $0.8 million incurred to process the renewal offers in connection with the Met P&C and Sentry Insurance replacement carrier transactions. Also included in underwriting, acquisition and insurance related expenses are New Jersey Automobile Insurance Risk Exchange, or NJAIRE, expenses, which increased $3.2 million (of which $1.4 million reflected a “true-up” settlement with respect to 2003), an increase in the allowance for uncollectible premiums receivable of $1.5 million and increases in salaries of $1.1 million at certain subsidiaries.
Other Operating and General Expenses. Other operating and general expenses for the years ended December 31, 2004 and 2003 were $0.6 million and $0.5 million, respectively. Other operating and general expenses remained constant as professional fees for the years ended December 31, 2004 and 2003 were $0.1 million and $0.1 million, respectively. Stock based compensation expense for the twelve months ended December 31, 2004, increased $0.1 million to $0.5 million from $0.4 million in the comparable 2003 period. The increase in stock based compensation expense for the year ended December 31, 2004 is due to the stock options granted during 2002 and 2003 being amortized over a full year.
Income Tax Expense. Income tax expense for the years ended December 31, 2004 and 2003 were $8.9 million and $9.9 million, respectively. The decrease of $1.0 million in income tax expense for the year ended December 31, 2004 was due to the decrease in income before tax for the same period.
On April 21, 2005, an initial public offering of 6,650,000 shares of our common stock (after the 43-for-1 stock split) was completed. We sold 5,985,000 shares resulting in net proceeds (after deducting issuance costs and the underwriters discount) of $62,198,255. We contributed $43,000,000 to Proformance, which increased its statutory surplus. The additional capital will permit us to reduce our reinsurance purchases and to retain more of the direct written premiums produced by our Partner Agents. In addition, we intend to increase the capital of our other operating subsidiaries by approximately $10,000,000 to facilitate the execution of their business plans as opportunities arise. Currently, these funds are being held by NAHC. The remainder of the capital raised by us will be used for general corporate purposes, including but not limited to possible additional increases to the capitalization of our existing subsidiaries.
For the years ended December 31, 2005, 2004 and 2003, our consolidated cash flow provided by operations was $28.1 million, $73.6 million and $75.3 million, respectively. The decrease in cash flow provided by operations for the year ended December 31, 2005 as compared to December 31, 2004 was due primarily to the conversion of six-month to twelve-month policies and the related increases on premiums receivable and the deferred acquisition cost asset. Accrued interest income also increased during the period as a result of the increase in fixed income securities. The decrease in cash flow provided by operations for the year ended December 31, 2004 as compared to the year ended December 31, 2003 was due primarily to the reduction of reinsurance receivables in connection with the commutation of the Multiple Line Loss Ratio Excess of Loss Treaty between Proformance and Odyssey America Reinsurance Company and the receipt of funds from Sentry Insurance in connection with the replacement carrier transaction offset by an increase in premiums receivable and an increase in reinsurance recoverables.
For the years ended December 31, 2005, 2004 and 2003, our consolidated cash flow used for investing activities was $66.5 million, $67.2 million and $97.0 million, respectively. Net cash used in investing activities for the year ended December 31, 2005 was consistent with the same period in the prior year as the capital received in connection with the Company’s initial public offering which was completed on April 21, 2005 was used to purchase additional investments. The primary use of cash for investing activities for the periods ended December 31, 2004 and 2003 relate to the purchase of investments in connection with the funds received as part of our replacement carrier transactions as well as the respective increases in premium writings for those periods.
The effective duration of our investment portfolio was 6.0 years as of December 31, 2005. By contrast, our liability duration was approximately 3.5 years as of December 31, 2005. We do not believe this difference in duration adversely affects our ability to meet our current obligations because we believe our cash flows from operations are sufficient to meet those obligations. Pursuant to our tax planning strategy, we invested the $40.6 million received from the OCIC replacement carrier transaction in long-term bonds in accordance with Treasury Ruling Regulation 1.362-2, which allows us to defer the payment of income taxes on the associated replacement carrier revenue until the underlying securities are either sold or mature. The effective duration of our investment portfolio, when excluding these securities, is reduced from 6.4 years to 3.5 years.
The Company has entered into a seven-year lease agreement for the use of office space and equipment. The most significant obligation under the lease terms other than the base rent are the reimbursements of the Company’s share of the operating expenses of the premises, which include real estate taxes, repairs and maintenance, utilities, and insurance. Net rent expense for 2005, 2004 and 2003 was $945,391, $919,058 and $743,200, respectively.
The Company entered into a four-year lease agreement for the use of additional office space and equipment commencing on September 11, 2004. Rent expense for the year ended December 31, 2005 was $212,400 as compared to $70,800 for the comparable period in 2004.
Aggregate minimum rental commitments of the Company as of December 31, 2005 are as follows:
In connection with the lease agreement, the Company obtained a letter of credit in the amount of $300,000 as security for payment of the base rent.
Proformance’s historic trends of net paid losses compared to net premiums collected for calendar years 2005, 2004, 2003 reflect ratios of 60.8%, 43.3%, 43.3%, respectively. Each of the replacement carrier transactions with OCIC, Met P&C and Sentry Insurance created an unusual influx of premium, particularly in calendar years 2002 and 2003, causing a reduction in net paid loss ratios. In the 2000 and 2001 calendar years in which we did not have any replacement carrier transactions, our ratio of net paid losses to net written premiums averaged 65.3%. The ratio in 2001 was 73.4% due to the fact that the Company’s loss ratio deteriorated compared to the 2000 loss ratio, resulting in an increase in net paid losses for the same period. For the years ended December 31, 2005, 2004 and 2003 the same ratio averaged 49.1%. The reduction in this ratio was due to increase in the influx of net written premiums as a result of the replacement carrier transactions outlined above and time lag between when the net premium was written and the Actual Net Losses were paid in connection with that business. We expect this ratio to return to levels consistent with ratios achieved in 2000 and 2001 as the business written in connection with the replacement carrier transactions entered into in 2002 and 2003 is on our books for several underwriting cycles. We began to see this return in the latter portion of 2005 and we expect this to continue during 2006. Proformance’s asset/liability match has been established based on the average duration of its claims payments, which we estimate to be approximately 3.5 years as of December 31, 2005. Not including the invested replacement carrier revenue associated with the OCIC replacement carrier transaction, the existing investment portfolio has an effective duration of 3.5 years. The long term investments associated with the OCIC replacement carrier transaction ($40.6 million) represents replacement carrier revenue received to support the premium to surplus leverage in connection with the offers of renewal to those policyholders. The liquidation of securities to retire outstanding claim payments could affect liquidity and future income negatively.
As of December 31, 2005 and December 31, 2004, Proformance maintained a high quality investment portfolio.
As of December 31, 2005 and December 31, 2004, we did not hold any securities that were not publicly traded, because our investment policy prohibits us from purchasing those securities. In addition, at those dates, we did not have any non-investment grade fixed income securities.
As of December 31, 2005, fixed maturity securities having an unrealized loss of $1,773,955 a fair value of $184,473,102 and an amortized cost of $186,247,057 were in a continuous unrealized loss position for less than twelve months. As of December 31, 2004, fixed maturity securities having an unrealized loss of $328,335, a fair value of $76,477,342 and an amortized cost of $76,805,677 were in a continuous unrealized loss position for less than twelve months.
As of December 31, 2005, gross unrealized losses totaled $3,387,535. This amount was calculated using the following data: $1,756,164 of unrealized losses related to securities of the U.S. Government, government agencies and authorities, $456,673 related to state, local and government agencies, $834,448 related to
Furthermore, if we believe that the yield to maturity determined by the price of the fixed income security can be attained or exceeded by an alternative investment that decreases our interest rate risk and/or duration, we may sell the fixed income security. This may initially increase or decrease our investment income and allow us to reallocate the proceeds to other investments. Our decision to purchase and sell investments is also dependent upon the economic conditions at a particular point in time.
As of December 31, 2005 and as of December 31, 2004, our fixed income portfolio was 62.3% and 57.3%, respectively, concentrated in U.S. government securities and securities of government agencies and authorities that carry an “Aaa” rating from Moody’s, respectively.
The following table summarizes our long-term contractual obligations and credit-related commitments as of December 31, 2005.
As of December 31, 2005 we had property and casualty reserves of $219.4 million. The amounts and timing of these obligations are not set contractually. Nonetheless, based on cumulative property and casualty claims paid over the last ten years, we anticipate that approximately 33.4% will be paid within a year, an additional 48.5% between one and three years, 16.5% between three and five years and 1.6% in more than five years. While we believe that historical performance of loss payment patterns is a reasonable source for projecting future claim payments, there is inherent uncertainty in this payment estimate because of the potential impact from changes in:
claims staffing levels - claims may be settled at a different rate based on the future staffing levels of the claim department.
loss cost trends - increases/decreases in inflationary factors (legal and economic) will influence ultimate claim payouts and their timing.
We do not have any off-balance sheet arrangements (as that term is defined in applicable SEC rules) that have had or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, results of operations, revenues or expenses, liquidity, capital expenditures or capital resources.
In November 2005, the FASB issued FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Applications of Certain Investments”
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which replaces SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and the recording of such expense in the consolidated statements of operations. In March 2005, the Commission issued Staff Accounting Bulletin (“SAB”) 107 which expresses views of the SEC staff regarding the application of SFAS 123R. SAB 107 provides interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations, as well as provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. In April 2005, the Commission amended compliance dates for SFAS 123R to allow companies to implement SFAS 123R at the beginning of their next fiscal year, instead of the next fiscal reporting period that begins after June 15, 2005. We are required to adopt the provisions of SFAS 123R effective January 1, 2006 at which time the pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The Company has determined that adopting SFAS 123R will not have a material effect on the Company’s consolidated financial statements.
In June 2005, the EITF reached consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements (EITF 05-6). EITF 05-6 provides guidance on determining the amortization period for leasehold improvements acquired in a business combination or acquired subsequent to lease inception. The Company has complied with the disclosure requirements of EITF-05-6, which were effective for periods which began after June 29, 2005.
In September 2005, the AICPA issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs in connection with modifications or exchanges of insurance contracts other than those specifically described in FASB 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. The guidance in SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. We are currently evaluating the method of adoption and whether that adoption will have a material impact on the Company’s consolidated financial statements.