2002 2003 2004 2005 2006 Statement of Operations Data: (In thousands except per share data and ratios)
GAAP Underwriting Ratios: Loss and loss adjustment expense ratio (1) 57.1% 60.2% 68.6% 61.4% 62.9% Expense ratio (2) 44.2% 36.6% 34.2 % 37.3% 35.7% Combined ratio (3) 101.3% 96.8% 102.8% 98.6% 98.6%
The following information is presented on the basis of accounting principles generally accepted in the United States of America (“GAAP”) and should be read in conjunction with “Business” and “Risk Factors,” and our consolidated financial statements and the related notes included elsewhere in this report. All amounts and percentages are rounded.
The following table sets forth the Company’s consolidated premium and total revenue information:
2005 2006 to to 2004 2005 2006 2004 2005 (Dollars in thousands) Net premiums written:
Excess and Surplus: Environmental $ 35,024 $ 41,477 $ 37,746 18.4% (8.9)% Construction 77,462 77,639 92,530 0.2 19.2 Non-Construction - - 1,524 - 100.0 Excess 432 387 670 (10.4) 73.1 Surety 1,174 1,345 3,042 14.6 126.2 114,092 120,848 135,512 5.9 11.2 Alternative Risk Transfer: Specialty Programs 17,273 19,712 21,756 14.1 10.4 Runoff 299 - - (100.0) - Total net premiums written $131,644 $138,515 $157,268 5.2% 13.6% ======== ======== ======== ====== =====
Excess and Surplus: Environmental $ 32,152 $ 38,081 $ 35,138 18.4% (7.7)% Construction 79,559 81,908 88,612 2.9 8.2 Non-Construction - - 653 - 100.0% Excess 222 457 532 105.9 16.4 Surety 1,138 1,148 2,566 0.9 123.5 113,071 121,137 127,501 7.1 5.3 Alternative Risk Transfer: Specialty Programs 16,516 18,297 19,255 10.8 5.2 Runoff 6,715 (1,854) - (127.6) 100.0 Total net premiums earned 136,302 137,580 146,756 0.9 6.7
Total Expenses: Loss and loss adjustment expenses incurred $ 93,503 $ 84,406 $ 92,329 (9.7)% 9.4% Acquisition expenses 26,649 28,752 27,378 7.9 (4.8) Payroll expenses 10,297 12,130 14,896 17.8 22.8 Real estate expenses 55,480 2,439 381 (95.6) (84.4) Interest expense 1,076 1,257 3,376 16.8 168.6 Other expenses 8,560 11,901 12,106 39.0 1.7 Minority interest 988 515 (1,873) (47.9) (463.6) Rescission expenses (229) (1,334) - (482.5) (100.0) Income taxes 3,696 1,392 2,314 (62.3) 66.2 Total expenses $200,020 $141,458 $150,907 (29.3)% 6.7% ======== ======== ========= ======= ======
Year Ended December 31, 2004 2005 2006 Insurance operations Loss & loss adjustment expense ratio 68.6% 61.4% 62.9% Expense ratio 34.2 37.3 35.7 Combined ratio 102.8% 98.6% 98.6% ====== ===== =====
Environmental. Net premiums earned decreased 7.7% to $35.1 million for the year ended December 31, 2006 compared to $38.1 million for 2005. Net earned premiums decreased due to the $3.7 million accrual of reinstatement premium to reinstate excess limit reinsurance coverage as a result of three large claims, a decline in the Company’s middle market business due to increased competition, and an expected decline in the Company’s book of environmental contractor and consultant premiums in the State of New York. The decline in the New York business is the result of changes in the underwriting process .
Excess. Net premiums earned increased 16.4% to $532,000 for the year ended December 31, 2006 compared to 2005. The Company experienced strong submission activity and production continued to increase. The Company’s excess product offering is focused primarily in the construction and products liability area. The addition of the new underwriting team in Middletown, StateNew Jersey has allowed the Company to expand its excess liability product to write over other carriers’ primary policies and to offer umbrella liability coverage. The Company also increased the available policy limits up to $5.0 million during 2006.
Net premiums earned were zero for the year ended December 31, 2006 compared to negative $1.9 million for 2005. The negative net premiums earned was due to an accrual of $2.0 million for reinstatement reinsurance premiums on discontinued lines. The Company’s excess municipality and workers’ compensation businesses were put in runoff in 2004.
Net investment income increased 57.7% to $21.8 million for the year ended December 31, 2006 from $14.3 million for 2005 due to an increase in the Company’s invested assets and higher investment yields. The increase in invested assets was due to $70.7 million of cash flow from operations and $53.0 million of net proceeds from the Company’s secondary equity offering completed in June 2006. Average invested assets increased to $483.6 million as of December 31, 2006 from $371.3 million as of December 31, 2005. The average pre-tax investment yield increased from 3.9% to 4.5% from 2005 to 2006.
The effective tax rate increased to 10.1% for the year ended December 31, 2006 from 8.7% for 2005. In 2005, American Safety RRG, reversed $555,000 of its deferred tax asset reserve due to expected profitability. The effects of this reversal are reflected in minority interest on the Company’s consolidated financial statements. Included in tax expense for 2006, is the establishment of a valuation allowance for American Safety RRG for $1.1 million and 2005 provision to return adjustments for permanent differences in the 2005 federal and state income tax returns of $483,000. The establishment of the valuation allowance is reflected in minority interest on the consolidated financial statements. Absent this adjustment, the effective tax rate for 2006 would have been 5.1%. The reduction in the effective rate is due to lower earnings from U.S. operations from the impact of reinstatement premiums and prior-year loss development For 2005 and 2006, the reversal and establishment of the valuation allowance has been included in income tax expense with a corresponding offset in minority interest.
Significant differences exist in the regulatory environment in each country. The table below describes the Company’s operations by geographic segment for the years ended December 31, 2005 and 2006 (in thousands):
December 31, 2006 U.S. Bermuda Total Income Tax $ 2,314 $ - $ 2,314 Net earnings 3,491 17,041 20,532 Assets 509,552 337,579 847,131 Equity $ 66,896 $ 129,254 $ 196,150
Total revenues for the year ended December 31, 2005 decreased 27.4% to $155.9 million compared to 2004 as a result of lower real estate income. Net premiums earned for the year ended December 31, 2005 increased 1.6% to $138.5 million from 2004 due to increased production in the Company’s core business lines. Investment income increased 46.5% to $14.3 million compared to 2004 as a result of increased invested assets of $88.5 million. Net cash flow from operations decreased to $70.4 million for the year ended December 31, 2005 from $89.8 million for 2004 as a result of increased loss payments, which were anticipated as a result of the long-tail nature of the risks that the Company insures, where, with the maturity of the Company’s business, loss payments are expected to continue to increase.Net book value per share increased 9.4% to $17.54 for the year.
Construction. Net premiums earned increased 2.9% to $81.9 million for the year ended December 31, 2005 compared to $79.6 million for 2004. During 2005, the Company had $14.3 million of gross premiums written generated as a result of audits. Premium rates on the residential construction business have remained relatively stable year to year. However, during 2005 the Company started to experience a slight decline in premium rates on its renewal book of commercial construction business due to increased competition and a general softening of pricing in the market place. The changing market conditions resulted in a decline in the Company’s renewal retention rates and new business volume in 2005. See “Business- Our Market-Excess and Surplus Lines” for a description of these changing conditions. The Company remained committed to its disciplined underwriting approach and the Company also did broaden its policy terms and conditions. During 2005, the Company continued to focus on construction risks in its new business efforts as it believed this area continued to offer modest growth opportunities in selected geographic areas. Effective July 1, 2005, the Company discontinued purchasing reinsurance on the primary PersonNamegeneral liability portion of this business line. The Company made this decision after performing a loss cost and dynamic financial analysis, concluding that its reinsurance purchases were uneconomical. The Company believes retaining this exposure will enhance its financial results and returns on capital.
Net premiums earned decreased to negative $1.9 million for the year ended December 31, 2005 compared to $6.7 million for 2004. The decrease in runoff net premiums earned was attributable to the Company’s exit from specific business lines that did not meet its profit or production expectations. In addition, in 2005 net premiums earned decreased due to an accrual of $2.0 million for reinsurance premiums on its discontinued workers compensation business, which was put into runoff in 2004. See “Business-Our Products-Runoff Lines” for additional information about our runoff segment.
For the year ended December 31, 2005, the Company’s losses and loss adjustment expenses ratio decreased 7.7 percentage points to 60.9% from 68.6% primarily due to improved underwriting results. The table below sets forth the prior year reserve development made for by the Company for the years ended December 31, 2004 and 2005 (in thousands):
Real estate expenses associated with the Harbour Village project decreased to $2.2 million for the year ended December 31, 2005 from $55.5 million for 2004. In 2005, the Company received $980,000 for settlement of roof litigation at Harbour Village, which was applied as a reduction to real estate expenses as it had been expensed previously.
The effective tax rate decreased to 8.7% for the year ended December 31, 2005 from 20.0% for 2004. This decrease was due primarily to the reversal of a deferred tax asset reserve of our non-subsidiary affiliate American Safety RRG of $555,000. Absent this adjustment, the effective tax rate would have been 12.1% for the year ended December 31, 2005. In addition, the effective tax rate was lower due to a decrease in real estate earnings and lower taxable income on the Company’s U.S. insurance subsidiaries.
The Company operates through its subsidiaries in the country-regionU.S. and Bermuda. Significant differences exist in the regulatory environment in each country. The table below describes the Company’s operations by geographic segment for the years ended December 31, 2004 and 2005 (in thousands):
December 31, 2004 U.S. Bermuda Total Income Tax $ 3,696 $ - $ 3,696 Net earnings 5,543 9,214 14,757 Assets 448,366 134,838 583,204 Equity $ 56,126 $ 52,654 $ 108,780
Net Income. Net income from Bermuda operations increased to $10.3 million for the year ended December 31, 2005 compared to $9.2 million for 2004. Net income from Bermuda operations increased in 2005 due to improved underwriting results in the Company’s insurance operations. Net income from U.S. operations decreased to $4.4 million for the year ended December 31, 2005 compared to $5.5 million for 2004. This decrease is due to lower real estate income offset by improved insurance operations. U.S. insurance earnings increased by $6.5 million to $4.2 million at December 31, 2005 compared to a loss of $2.3 million at December 31, 2004. Real estate income decreased to $209,000 at December 31, 2005 compared to $7.8 million for the same period of 2004.
Assets. Assets from Bermuda operations increased to $167.4 million at the end of 2005 compared to $134.8 million at the end of 2004. This increase resulted from an increase in premium writings assumed from growing U.S. operations. Assets from U.S.
operations at the end of 2005 increased to $527.6 million, compared to $448.4 million at the end of 2004. This increase is a result of the Company issuing a trust preferred security in 2005 raising approximately $25 million and the growth in the Company’s core business lines offset by a decrease in real estate assets as the Harbour Village project is substantially complete.
Equity. Equity of the Bermuda operations increased to $59.4 million at the end of 2005 compared to $52.6 million at the end of 2004. This increase was largely due to higher net income offset by a stock repurchase during the second quarter of 2005 and an increase in the net unrealized losses on the Company’s investment portfolio. Equity of the U.S. operations increased to $59.0 million at the end of 2005, compared to $56.1 million at the end of 2004. This increase was a result of higher net income offset by an increase in net unrealized losses on the Company’s investment portfolio.
Our contractual obligations (in thousands of dollars) as of December 31, 2006 were:
Less than 1 1-3 3-5 More than 5 Total year Years Years Years -------------------------------------------------------------------------- Long term debt $ 38,139 $ - $ - $ 38,139 $ Interest (1) 100,640 3,026 6,470 6,653 - 84,491 Operating leases 7,388 877 2,088 1,237 3,186 Gross loss reserves (2) 439,674 97,987 150,399 90,586 100,702 -------------------------------------------------------------------------- Total contractual obligations $585,841 $101,890 $158,957 $136,615 $188,379
For these purposes, routine purchases of services, including insurance, that are expected to be used in the ordinary course of the Company’s business have been excluded. More information about our contractual obligations appears in Note 8 to our consolidated financial statements.
o Percentage decline in value and the length of time during which the decline has occurred, o Recoverability of principal and interest, o Market conditions, o Ability to hold the investment to maturity, o A pattern of continuing operating losses of the issuer, o Rating agency actions that affect the issuer's credit status, o Adverse changes in the issuer's availability of production resources, revenue sources, technological conditions, and o Adverse changes in the issuer's economic, regulatory or political environment.
The Company did not have any impairment charges during 2006. The Company in conjunction with its investment advisor, monitors its investments for potential impairments. See “Business-Investments” for information as to the credit quality of its investment portfolio. At December 31, 2006, 98.3% of the investment portfolio was rated A or better by S&P and Moody’s, with 72.3% being rated AAA.
Construction: In addition to evaluating the loss reserves on all exposures on a combined basis the actuarial staff evaluated reserves for each of the following exclusive categories: (1) construction defect claims in California; (2) construction defect in all other states; (3) commercial and residential contractors claims other than construction defects; (4) claims in New York state; (5) claims from product liability exposures; (6) claims from habitational risks; (7) claims from miscellaneous risks.
Our experience with construction claims remains limited and prior to the fourth quarter of 2005 our reserve calculations were based upon a combination of industry and Company loss development patterns. During that quarter we retained an actuarial consulting firm that provided us with construction defect claim counts based upon a larger population that we now use to calculate reserves.
Environmental: Most exposures involved common types of bodily injury and property damage claims. These claims tend to be reported sooner but take longer to settle because often times multiple parties are involved in a claim. The loss development patterns and the expected loss ratios are estimated based on our actual emerged losses.
December 31, 2006 Loss Loss Adjustment Total On-Going: Case IBNR Case IBNR Case and IBNR Environmental $ 24,398 23,363 5,517 15,576 $ 68,854 Construction 23,146 114,060 4,322 76,039 217,567 Surety (1,961) 1,109 (1,307) 739 (1,420) Programs * 36,944 52,783 3,951 24,933 118,611 -------------------------------------------------------------------------- 82,527 191,315 12,483 117,287 403,612 Run-Off: 8,955 14,300 9,778 3,028 36,061 -------------------------------------------------------------------------- Total $ 91,482 205,615 22,261 120,315 $ 439,673 ==========================================================================
Due to increasing reinsurance rates and after completing an analysis of our reinsurance structure prepared by our broker, management decided not to purchase reinsurance in connection with its construction and surety lines of business in July 2005 and June 2006, respectively. We also increased our retention levels on certain programs within our specialty program line and on the first excess of loss layer on the environmental line. These actions will increase our net earned premium and related loss and loss adjusted expense. The impact on our financial statements is expected to be an increase to cash and loss reserve and a decrease to reinsurance recoverables. There were no other material changes to our reinsurance strategy during 2006.
In July 2006, the FASB issued a Staff Position Number FIN 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement Number 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company has reviewed the pronouncement and based on its analysis to date will not have a material impact on its operating results.
Our underwriting experience is best indicated by our GAAP combined ratio, which is the sum of (a) the ratio of incurred losses and settlement expenses to net premiums earned (loss ratio) and (b) the ratio of policy acquisition costs and other operating expenses to net premiums earned (expense ratio). A combined ratio below 100% indicates that an insurance company has an underwriting profit, and a combined ratio above 100% indicates an insurer has an underwriting loss. Our reported combined ratio excludes certain holding company expenses such as interest expense as well as real estate and rescission expenses.
In January 2003, the Financial Accounting Standards Board (the ‘FASB”) issued FASB Interpretation No. 46 (“FIN 46”). This interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the expected residual gains, or both, as a result of ownership, contractual or other financial interests in the entity. In December 2003, the FASB issued a revised version of FIN 46, FIN 46(R), which finalized the accounting guidance for VIEs. As a result of adopting FIN 46(R), the Company consolidated its non-subsidiary affiliate American Safety RRG and deconsolidated its trust subsidiaries American Safety Capital Trust, American Safety Capital Trust II and American Safety Capital Trust III.