The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and, in management’s belief, conform to general practices within the insurance industry. The following is an explanation of the Company’s accounting policies and the resultant estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management’s estimates determined using these policies. Atlantic American does not expect that changes in the estimates determined using these policies will have a material effect on the Company’s financial condition or liquidity, although changes could have a material effect on its consolidated results of operations.
Future policy benefits comprised 32% of the Company’s total liabilities at December 31, 2013. These liabilities relate primarily to life insurance products and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Deferred acquisition costs comprised 9% of the Company’s total assets at December 31, 2013. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to expense in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any previous calendar year.
Receivables are amounts due from reinsurers, insureds and agents, and any sales of investment securities not yet settled, and comprised 7% of the Company’s total assets at December 31, 2013. Insured and agent balances are evaluated periodically for collectibility. Annually, the Company performs an analysis of the creditworthiness of the reinsurers with whom the Company contracts using various data sources. Failure of reinsurers to meet their obligations due to insolvencies, disputes or otherwise could result in uncollectible amounts and losses to the Company. Allowances for uncollectible amounts are established, as and when a loss has been determined probable, against the related receivable. Losses are recognized by the Company when determined on a specific account basis and a general provision for loss is made based on the Company’s historical experience.
The Company determines the fair values of certain financial instruments based on the fair value hierarchy established in Accounting Standards Codification (“ASC”) 820-10-20, Fair Value Measurements and Disclosures (“ASC 820-10-20”). The fair values of fixed maturities and equity securities are largely determined by either independent methods prescribed by the National Association of Insurance Commissioners, which do not differ materially from nationally quoted market prices, when available, or independent broker quotations. See Note 2 and Note 15 of the accompanying notes to consolidated financial statements with respect to assets and liabilities carried at fair value and information about the inputs used to value those financial instruments, by hierarchy level, in accordance with ASC 820-10-20.
Gross written premiums at American Southern increased $14.5 million, or 33.2%, during 2013 as compared to 2012. The increase in gross written premiums was primarily attributable to an increase in commercial automobile written premiums of which $13.7 million resulted from a new state contract awarded to American Southern in the second quarter of 2013 through a competitive bidding process.
Ceded premiums decreased slightly during 2013 as compared to 2012. American Southern’s ceded premiums are determined as a percentage of earned premiums and generally will increase when earned premiums increase. However, the change in ceded premiums during 2013 was disproportionate to the increase in related earned premiums due to a separate reinsurance agreement with different terms to reinsure the commercial automobile business from the new state contract referenced previously.
Net earned premiums increased $8.4 million, or 22.4%, during 2013 as compared to 2012. The increase in net earned premiums during 2013 was primarily attributable to the increase in commercial automobile earned premiums from the new state contract referenced previously. Also contributing were increases in general liability and property earned premiums resulting from new programs. In 2013, American Southern’s five principal states in terms of premium revenue were Alabama, Florida, Georgia, South Carolina, and Texas, which accounted for approximately 67% of total earned premiums for 2013.
Net losses and loss adjustment expenses at American Southern increased $2.9 million, or 10.5%, during 2013 as compared to 2012. As a percentage of premiums, net losses and loss adjustment expenses were 65.9% in 2013 compared to 73.0% in 2012. The decrease in the loss ratio during 2013 was due to more favorable loss experience in significantly all lines of business. During 2012, American Southern experienced increases in the frequency and severity of claims in the commercial automobile line of business and higher claims in the general liability line of business which did not recur in 2013. The improvement in the loss ratio was primarily attributable to actions taken in prior periods to better rationalize American Southern’s book of business and to strengthen the underwriting guidelines with respect to new and renewal business.
In establishing reserves, American Southern initially reserves for losses at the higher end of the reasonable range if no other value within the range is determined to be more probable. Selection of such an initial loss estimate is an attempt by management to give recognition that initial claims information received generally is not conclusive with respect to legal liability, is generally not comprehensive with respect to magnitude of loss and generally, based on historical experience, will develop more adversely as time and information develops. However, as a result, American Southern generally experiences reserve redundancies when analyzing the development of prior year losses in a current period. At December 31, 2013, the range of estimates developed in connection with the loss reserves for American Southern indicated that reserves could be as much as 13.1% lower or as much as 10.4% higher. Development from prior years’ reserves has historically reduced the current year loss ratio; however, such reduction in the current year loss ratio is generally offset by the reserves established in the current year for current period losses. American Southern’s estimated net reserve redundancies for the years ended December 31, 2013 and 2012 were $2.5 million and $1.7 million, respectively. To the extent reserve redundancies vary between years, there is an incremental impact on the results of operations of American Southern and the Company. The indicated redundancy in 2013 was $0.8 million more than that in 2012. After considering the impact on contingent commissions and other related accruals, the $0.8 million increase in the redundancy resulted in an increase in income from operations before tax of approximately $0.5 million in 2013 as compared to 2012. Management believes that such differences will continue in future periods but is unable to determine if or when incremental redundancies will increase or decrease, until the underlying losses are ultimately settled.
Benefits and losses increased $7.7 million, or 12.3%, during 2013 as compared to 2012. As a percentage of premiums, benefits and losses were 70.3% in 2013 compared to 70.0% in 2012. The slight increase in the loss ratio was primarily attributable to higher claims associated with the continued aging of the existing life business. Partially offsetting the increase in the loss ratio was more favorable loss experience in the Medicare supplement line of business in 2013 as compared to 2012. The company continues to implement rate increases on its Medicare supplement line of business which have helped mitigate the impact of higher medical costs.
Underwriting expenses increased $4.9 million, or 18.8%, during 2013 as compared to 2012. As a percentage of earned premiums, these expenses were 30.7% in 2013 compared to 28.9% in 2012. The increase in the expense ratio was primarily attributable to increases in advertising and agency related expenses as well as development of worksite products to broaden overall product offering. Advertising expenses in 2013 increased $0.7 million as compared to 2012 and included charges for television commercials and social media initiatives. Expenses related to the development of worksite products increased $0.7 million in 2013 as compared to 2012.
The Company had net realized investment gains of $8.7 million in 2013 compared to net realized investment gains of $1.4 million in 2012. The net realized investment gains in 2013 were primarily due to the sale of a number of the Company’s investments in longer-term fixed maturities discussed previously. The net realized investment gains in 2012 also resulted from the disposition of several of the Company’s investments in fixed maturities, although in lesser amounts. Management continually evaluates the Company’s investment portfolio and, as may be determined to be appropriate, makes adjustments for impairments and/or will divest investments. See Note 2 of Notes to Consolidated Financial Statements.
Interest expense decreased $0.7 million, or 27.9%, in 2013 as compared to 2012. The decrease in interest expense was primarily due to the termination of the Company’s zero cost interest rate collar with Wells Fargo Bank, National Association (“Wells Fargo”) on March 4, 2013, the stated maturity date, by its terms. The interest rate collar had a London Interbank Offered Rate (“LIBOR”) floor of 4.77%. As a result of interest rates remaining below the LIBOR floor, the Company was required to make payments to Wells Fargo under the interest rate collar through the maturity date.
The primary differences between the effective tax rate and the federal statutory income tax rate resulted from the dividends-received deduction (“DRD”), the small life insurance company deduction (“SLD”) and the change in deferred tax asset valuation allowance. The current estimated DRD is adjusted as underlying factors change and can vary from estimates based on, but not limited to, actual distributions from investments as well as the amount of the Company’s taxable income. The SLD varies in amount and is determined at a rate of 60 percent of the tentative life insurance company taxable income (“LICTI”). The SLD for any taxable year is reduced (but not below zero) by 15 percent of the tentative LICTI for such taxable year as it exceeds $3.0 million and is ultimately phased out at $15.0 million. The change in deferred tax asset valuation allowance was due to the unanticipated utilization of certain capital loss carryforward benefits that had been previously reduced to zero through an existing valuation allowance reserve.
Cash flows at the Parent are derived from dividends, management fees, and tax-sharing payments, as described below, from the subsidiaries. The cash needs of the Parent are for the payment of operating expenses, the acquisition of capital assets and debt service requirements, as well as the repurchase of shares and payments of any dividends as may be authorized and approved by the Company’s board of directors from time to time. At December 31, 2013, the Parent had approximately $32.0 million of unrestricted cash and investments.
Dividend payments to a parent corporation by its wholly owned insurance subsidiaries are subject to annual limitations and are restricted to 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries. At December 31, 2013, the Parent’s insurance subsidiaries had an aggregate statutory surplus of $73.6 million. Dividends were paid to Atlantic American by its subsidiaries totaling $6.6 million and $7.4 million in 2013 and 2012, respectively.
The Parent provides certain administrative, purchasing and other services to each of its subsidiaries. The amounts charged to and paid by the subsidiaries for these services were $6.3 million and $5.6 million in 2013 and 2012, respectively. In addition, the Parent has a formal tax-sharing agreement with each of its insurance subsidiaries. A net total of $2.6 million and $2.1 million were paid to the Parent under the tax sharing agreements in 2013 and 2012, respectively. As a result of the Parent’s tax loss carryforwards, which totaled approximately $2.4 million at December 31, 2013, it is anticipated that the tax sharing agreements will continue to provide the Parent with additional funds to assist in meeting its cash flow obligations.
At December 31, 2013, the Company had 65,000 shares of Series D preferred stock (“Series D Preferred Stock”) outstanding. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s controlling shareholder. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,629,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. In 2013, the Company redeemed 5,000 shares of the Series D Preferred Stock at the stated value of $100 per share, for an aggregate payment of $0.5 million. As of December 31, 2013 and 2012, the Company had accrued, but unpaid, dividends, on the Series D Preferred Stock of $20,945 and $22,556, respectively. During 2013, the Company paid $0.5 million in Series D Preferred Stock dividends whereas in 2012, the Company paid $1.0 million which included a $0.5 million dividend attributable to 2011.
The Company believes that existing cash balances as well as the dividends, fees, and tax-sharing payments it receives from its subsidiaries and, if needed, additional borrowings from financial institutions, will enable the Company to meet its liquidity requirements for the foreseeable future. Management is not aware of any current recommendations by regulatory authorities, which, if implemented, would have a material adverse effect on the Company’s liquidity, capital resources or operations.
We have audited the accompanying consolidated balance sheets of Atlantic American Corporation and subsidiaries (the “Company”) as of December 31, 2013 and 2012 and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for the years then ended. In connection with our audits of the financial statements, we have also audited Schedules II, III, IV and VI. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
Life insurance premiums are recognized as revenue when due; accident and health insurance premiums are recognized as revenue over the premium paying period and property and casualty insurance premiums are recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. Benefits and expenses are accrued as incurred and are associated with premiums as they are earned so as to result in recognition of profits over the lives of the contracts. For traditional life insurance and long-duration health insurance, this association is accomplished by the provision of a future policy benefits reserve and the deferral and subsequent amortization of the costs of acquiring business, “deferred policy acquisition costs” (principally commissions, premium taxes, and other incremental direct costs of issuing policies). Deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the policy benefits reserve. The Company provides for insurance benefits and losses on accident, health, and property-casualty claims based upon estimates of projected ultimate losses. The deferred policy acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Contingent commissions, if contractually applicable, are ultimately payable to agents based on the underlying profitability of a particular insurance contract or a group of insurance contracts, and are periodically evaluated and accrued as earned. In periods in which revisions are made to the estimated loss reserves related to the particular insurance contract or group of insurance contracts subject to such commissions, corresponding adjustments are also made to the related accruals. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance).
Intangibles consist of goodwill and other indefinite-lived intangibles. Goodwill represents the excess of cost over the fair value of net assets acquired and is not amortized. Other indefinite-lived intangibles represent the value of licenses acquired in the 2013 acquisition of BFAC (Note 17) and are not amortized. As of December 31, 2013 and 2012, intangibles were $2,544 and $2,128, respectively. The Company periodically reviews its goodwill and other indefinite-lived intangibles to determine if any adverse conditions exist that could indicate impairment. Conditions that could trigger impairment include, but are not limited to, a significant change in business climate that could affect the value of the related asset, an adverse action, or an assessment by a regulator. No impairment of the Company’s recorded intangibles was identified during the periods presented.
Basic earnings per common share are based on the weighted average number of common shares outstanding during the relevant period. Diluted earnings per common share are based on the weighted average number of common shares outstanding during the relevant period, plus options and share awards outstanding using the treasury stock method and the assumed conversion of the Series D preferred stock, if dilutive. Unless otherwise indicated, earnings per common share amounts are presented on a diluted basis.
As of December 31, 2013, securities in an unrealized loss position primarily included certain of the Company’s investments in fixed maturities within the other diversified business, other diversified consumer and financial services sectors. The Company does not currently intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position. Based upon the Company’s expected continuation of receipt of contractually required principal and interest payments and its intent and ability to retain the securities until price recovery, as well as the Company’s evaluation of other relevant factors, including those described above, the Company has deemed these securities to be temporarily impaired as of December 31, 2013.
Level 3 Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Fair value is based on criteria that use assumptions or other data that are not readily observable from objective sources. The Company’s financial instruments valued using Level 3 criteria consist of a limited number of fixed maturities. As of December 31, 2013 and 2012, the value of the Company’s fixed maturities valued using Level 3 criteria was $1,991 and $2,124, respectively. The use of different criteria or assumptions regarding data may have yielded materially different valuations.
The following is a roll-forward of the Company’s financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2012 to December 31, 2013.
The financial structure of each of Atlantic American Statutory Trust I and II, as of December 31, 2013 and 2012, was as follows:
The Company’s rental expense, including common area charges, for operating leases was $1,215 and $1,204 in 2013 and 2012, respectively. The Company’s future minimum base lease obligations under non-cancelable operating leases are as follows:
A summary of the status of the Company’s stock options at December 31, 2013 and 2012 is as follows:
The Company had 65,000 and 70,000 shares of Series D preferred stock (“Series D Preferred Stock”) outstanding at December 31, 2013 and 2012, respectively. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s controlling shareholder. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,629,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. In 2013, the Company redeemed 5,000 shares of the Series D Preferred Stock at the stated value of $100 per share, for an aggregate payment of $500. As of December 31, 2013 and 2012, the Company had accrued, but unpaid, dividends, on the Series D Preferred Stock of $21 and $23, respectively. During 2013, the Company paid $483 in Series D Preferred Stock dividends whereas in 2012, the Company paid $1,015 which included a $508 dividend attributable to 2011.
Under the insurance code of the state in which each insurance subsidiary is domiciled, dividend payments to the Parent by its insurance subsidiaries are subject to certain limitations without the prior approval of the applicable state’s Insurance Commissioner. The Parent received dividends of $6,646 and $7,350 in 2013 and 2012, respectively, from its subsidiaries. In 2014, dividend payments to the Parent by the insurance subsidiaries in excess of $7,112 would require prior approval.
In the normal course of business the Company has engaged in transactions with entities affiliated with the controlling shareholder of the Company. These transactions include the leasing of office space as well as certain investing and financing activities. At December 31, 2013, two members of the Company’s board of directors were considered affiliates of the majority shareholder including our chairman, president and chief executive officer.
The Company leases approximately 49,586 square feet of office and covered garage space from one such controlled entity. During the years ended December 31, 2013 and 2012, the Company paid $864 and $853, respectively, under this lease.
(1) See Note 2 for a description of the fair value hierarchy as well as a disclosure of levels for classes of these financial assets.
The carrying amount approximates fair value due to the short-term nature of the instruments.
As the Company’s only derivative financial instrument was an interest rate collar, changes in valuation were correlated with changes in interest rates and contract maturity date and, accordingly, values were estimated using projected cash flows at current interest rates discounted at a reasonably estimated rate of interest. Fair value quotations were also obtained and considered, as applicable, from the contractual counterparty.
The following table sets forth the balance of each component of accumulated other comprehensive income as of December 31, 2013 and 2012, and the changes in the balance of each component thereof during 2013.
On December 18, 2013, the Company acquired 100% of the outstanding stock of Direct Life Insurance Company (“DLIC”) for $3,857 and changed the name of the company to Bankers Fidelity Assurance Company. The acquisition will allow Bankers Fidelity to offer additional similar products to those it already writes permitting greater diversification of product and pricing as well as opportunity for future expansion in other states. The purchase was not significant to the financial position or results of operations of the Company in 2013 and DLIC had no significant recent operations prior to acquisition. In connection with the acquisition the following assets and liabilities were acquired: