We operate in the MPL insurance sector of the property and casualty insurance industry. Our primary insurance products provide protection for physicians, dentists and other healthcare providers as individual practitioners or as members of practice groups. Our insurance protects policyholders against losses arising from professional liability claims and the related defense costs with respect to injuries alleged to have been caused by medical error or malpractice. Optional coverage is available for professional corporations under which physicians or dentists practice. We are the largest provider of MPL insurance in Florida, the fourth largest provider in Texas and have top five market positions in Georgia and Arkansas. In all, we currently write MPL insurance in 14 states and are licensed to write in 32 states. Based on 2009 premiums reported by SNL Financial LC, Florida and Texas are the fifth and eighth largest markets, respectively, for MPL insurance in the United States in terms of DPW. We focus on selected markets where we believe we have advantages in terms of our market knowledge, well-established reputation, meaningful market presence and resources.
In November 2009, we acquired all of the issued and outstanding stock of Advocate, MD, which then became a wholly owned subsidiary of First Professionals. In connection with the acquisition, we paid cash consideration of $33.6 million at closing, and may pay up to $12.0 million in additional consideration depending on the performance of Advocate, MD during the two-year period following closing. In connection with the transaction, we also retired all of Advocate, MD's outstanding bank debt, totaling $9.0 million. Advocate, MD is the fourth largest provider of MPL insurance in Texas and also writes MPL insurance in Mississippi. Advocate, MD's operations are located in Austin, Texas. In January 2011, we made our first payment under the earnout agreement between FPIC and Advocate, MD. In connection with the agreement, we made a payment of $4.4 million based on Advocate, MD's attainment of targets with respect to direct written premiums, combined ratio and underwriting profits. For additional information on the acquisition of Advocate, MD, see Note 3, Acquisition of Advocate, MD, to the consolidated financial statements included elsewhere herein.
On January 15, 2010, we declared a three-for-two stock split of our common shares in the form of a 50 percent stock dividend payable on March 8, 2010 to shareholders of record as of the close of business on February 8, 2010 (the record date). Fractional shares were settled in cash based on the average of the high and low sale prices for FPIC common stock reported on the Nasdaq Stock Market on the record date. The common stock issued and outstanding as of December 31, 2009 and the basic and diluted earnings per common share for periods prior to 2010 have been retroactively restated to reflect the stock split.
Income from continuing operations and net income decreased 12 percent and 13 percent (1 percent and 2 percent, respectively, on a per diluted common share basis), respectively for the year ended December 31, 2010 compared to 2009. Our 2009 consolidated results include $0.5 million in income from continuing operations and net income from the operations of Advocate, MD after its acquisition on November 13, 2009. Our 2009 net income also includes $0.4 million in discontinued operations related to the resolution of a contingency related to certain consolidated tax returns that included the discontinued operations (2005 and prior), and the expiration of federal and state statutes of limitations for those tax years. The decline in consolidated income from continuing operations is primarily attributable to lower net investment income, higher losses and LAE incurred, other underwriting expenses and other expenses offset by growth in net premiums earned and an increase in net
The number of professional liability policyholders, excluding policyholders under alternative risk arrangements, increased 2 percent to 18,374 policyholders at December 31, 2010 compared to 18,003 policyholders at December 31, 2009 mainly as a result of an increase in Texas policyholders. Our national policyholder retention was 94 percent and 95 percent for 2010 and 2009, respectively. Florida policyholder retention was 96 percent for 2010 and 95 percent for 2009.
Net premiums earned increased 7 percent for 2010 compared to 2009 as a result of the acquisition of Advocate, MD. Excluding the impact of the Advocate, MD acquisition, net premiums earned declined 7 percent, primarily as the result of a prior rate decrease in our Florida market that was reflected in net premiums earned during 2010, a higher level of tail premiums written during 2009 and differences in business mix.
On a trade date basis, we repurchased 1,393,541 shares of our common stock during 2010 at an average price of $30.13 per share and as of December 31, 2010, had remaining authority from our Board of Directors to repurchase 761,270 more shares under our stock repurchase program. Through February 22, 2011, we have repurchased an additional 347,000 shares of our common stock, on a trade date basis, at an average price of $36.58 per share and had remaining authority from our Board of Directors to repurchase an additional 414,270 shares as of that date.
Book value per common share increased 12 percent to $30.84 as of December 31, 2010 compared to $27.58 as of December 31, 2009. We received $41.9 million in dividends from our insurance subsidiaries during 2010. The
For a discussion of our business strategy, see Item 1. Business - Business Strategy.
We believe the critical accounting policies discussed in the remainder of this section of our MD&A affect our more significant judgments and estimates used in preparation of our consolidated financial statements. These may be further commented on in applicable sections under discussions that follow in Consolidated Results of Operations and Liquidity and Capital Resources. Information about the significant accounting policies we use in the preparation of our consolidated financial statements is included in Note 2, Significant Accounting Policies to the consolidated financial statements included elsewhere herein.
Our liability for losses and LAE (also referred to as our loss and LAE reserves) is our largest liability and represents the financial statement item most sensitive to estimation and judgment. MPL insurance is our primary line of business and accounted for nearly 100 percent of our total consolidated liability for losses and LAE for both 2010 and 2009.
IBNR represents a significant component of our total reserves given the nature of MPL claims and the inherent difficulty in establishing such reserves. For example, a significant portion of total LAE reserves is reflected in IBNR given the difficulty in determining the ultimate costs necessary to resolve a case. LAE costs tend to increase over time and can vary significantly based on factors such as whether and when a case is taken to trial. Additionally, in establishing our best estimate of reserves, we consider other factors, such as potential exposure to claims in excess of policy limits, which is generally contemplated within our IBNR reserves.
We also utilize and evaluate calculations contained in actuarial studies performed by our independent actuarial firms to corroborate the adequacy of our carried reserves. Our best estimate may differ from the selected reserve estimate of our independent actuaries because of differences in evaluating such things as the impact of historical experience, legal and regulatory changes, expectations about future claim results and trends and certain other factors as discussed below. While our best estimate may differ, our carried reserves remain within a reasonable actuarial range of the independent actuaries' selected reserve estimate. The independent reviews of our reserves plays an important role in our overall assessment of the adequacy of our reserves. A typical range of reasonable values for MPL business is considered to be as wide as 15 percent. Therefore, in addition to the performance of the business itself, our financial condition, results of operations and cash flows are sensitive to our reserve estimates and judgments. Our range developed for our loss and LAE reserves, net of reinsurance, at December 31, 2010 was $329.4 million to $401.3 million, with management's best estimate of loss and LAE reserves at $386.3 million. Our independent actuaries' indicated reserve was $363.0 million as of December 31, 2010. The reserve opinions of our independent actuaries for the years ended December 31, 2010 and 2009 have been filed with the respective state insurance regulators along with the statutory financial statements of our insurance companies.
Frequency and severity trends (the numbers of claims and how much we expect to ultimately pay for such claims);
Frequency of claims closed with indemnity payments (the percentage of claims received that ultimately result in a loss payment versus those that are resolved and closed without a loss payment); and
The higher average indemnity payment per claim in 2010 resulted from First Professionals resolving two related claims from the 2002 accident year against an insured with payments in excess of each claim's $1.0 million policy limit. The amount paid by First Professionals in excess of the policy limit was $10.0 million for each of the two claims, net of applicable reinsurance of $2.0 million per claim. Such amounts were fully contemplated in previously established reserves. Excluding the impact of these payments, the average indemnity payment per claim declined 16 percent in 2010.
Given the magnitude of our reserves and the characteristics noted above, even relatively small changes in our estimates for factors such as the number of claims we expect to pay or the amount we expect to ultimately pay for such claims could have a significant impact on our reserves and, correspondingly, our financial position, results of operations and cash flows. This is the case for other key assumptions as well, such as the frequency of reported claims and incidents that will
In November 2009, we acquired all of the issued and outstanding stock of Advocate, MD, which then became a wholly owned subsidiary of First Professionals.
Losses and LAE incurred related to the current year increased approximately 8 percent in 2010 and decreased approximately 5 percent in 2009. The increase in loss and LAE incurred during 2010 is primarily the result of higher net premiums earned resulting from the acquisition of Advocate, MD. As noted in our discussion of results of operations below, our net premiums earned increased 7 percent in 2010 and decreased 9 percent in 2009. The growth in net premiums earned in 2010 is primarily the result of the inclusion of a full year of activity for Advocate, MD, which was
acquired in November 2009. The decrease in net premiums earned in 2009 is the result of lower premium rates in our Florida market and a prior shift in business mix. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) related to the current year (excluding prior year development) was 71.6 percent, 71.0 percent, and 67.5 percent for 2010, 2009 and 2008, respectively. Our current year loss ratio has increased in recent years primarily as a result of lower premium rates, following several years of overall favorable claims trends.
Losses and LAE for claims related to prior years represent the total net change in estimates charged or credited to earnings in the current year with respect to liabilities established in prior years. Information regarding losses and LAE is accumulated over time and the estimates of the liability are revised accordingly, with the change recognized in the period revisions are made. During 2010, our loss and LAE reserve estimates for prior years decreased $23.0 million compared to $19.0 million in 2009. The favorable prior year loss development reflects a decline in expected ultimate losses for prior years, primarily the 2005 through 2008 accident years, as the result of changes in our previous estimates of incident to claim development, payment frequency and / or payment severity for the respective accident years.
Loss Reserve development table - The following table sets forth on a calendar year basis, the development of our liability for losses and LAE, net of amounts recoverable under reinsurance arrangements, for the ten-year period preceding the year ended December 31, 2010, and the cumulative amounts paid with respect to such reserves. Development reflects the difference between the amount we previously established as loss reserves and the re-estimated liability as of the end of each succeeding year. Favorable development, or redundancy, means that we now believe we will have to pay less for related claims than we had previously established in reserves and have revised our reserve estimates accordingly. Adverse development, or deficiency, means that we now believe we will have to pay more for related claims and have increased our reserve estimates. The table also provides a reconciliation of our liability net of reinsurance to the gross liability before reinsurance, as it is shown on our consolidated statement of financial position.
The net cumulative redundancy / (deficiency) shown in the table below for each year end includes accident year development for all years leading up to that year. For example, for the year ended December 31, 2010, there was $23 million of favorable development for calendar year 2009 reserves, including all accident years leading up to and including 2009. This favorable development consists of $10 million of favorable development for accident years 2007 and earlier and $13 million of favorable development for accident years 2008 and 2009 (for purposes of the ten-year table below, $3 million of favorable development is reflected in 2009 as a result of the acquisition of Advocate, MD and the inclusion of all of Advocate, MD's reserves in the 2009 calendar year). Further, the net cumulative redundancy / (deficiency) shown in the table below also includes development for multiple calendar years. For example, the $39 million cumulative redundancy in 2008 consists of $20 million of favorable development during calendar year 2010 and $19 million of favorable development during calendar year 2009.
As the table below indicates, our reserve estimates can vary over time based on actual results and our assessment of the impact of recent conditions and trends. For example, the cumulative net reserves carried at the end of calendar years 2000 through 2004 have been lower than subsequent payments and re-estimates and have developed upward (i.e., deficiently). In contrast, net reserves at the end of calendar years 2005 through 2009 have decreased from the amounts initially carried and have developed downward (i.e., redundantly). Improvements in recent years have resulted in a redundancy in the cumulative net reserves carried at the end of 2010 as compared to our prior estimates.
For accident years 2000 through 2002, we experienced higher than expected claims trends in Missouri. We also experienced adverse development in our core Florida book primarily due to increases in ALAE for those report years as a result of the stricter claims handling philosophy we implemented in 2001. This philosophy resulted in increases in ALAE costs for open claims including claims for prior accident years. Although our claims handling philosophy has positively impacted our overall loss costs, it had an adverse affect on older accident years where higher LAE were not entirely offset by lower indemnity expenses for those years.
First Professionals resolved two related claims from the 2002 accident year during 2010 against an insured with payments in excess of each claim's $1.0 million policy limit. The amount paid by First Professionals in excess of the policy limit was $10.0 million for each of the two claims, net of applicable reinsurance of $2.0 million per claim.
U.S. Treasuries include those securities issued by the U.S government or a U.S. Agency. These securities have an average credit quality of Aaa and represent approximately 7 percent of our fixed income securities.
Commercial mortgage-backed securities ("CMBS") reflect structured securities issued based on underlying commercial mortgages (such as on hotels, malls, or offices) and are from the vintage years 2002 and 2005 through 2008. These securities have an average credit quality of Aa3 and represent approximately 6 percent of our fixed income securities.
Preferred equity securities that trade in less active markets are classified within Level 2, as fair values are based on valuation methodologies, the significant inputs into which may include, but are not limited to, benchmark yields, reported trades, broker / dealer quotes and issuer spreads.
Other invested assets - includes investments held as part of our deferred compensation plan and an investment in a small limited partnership.
Our invested assets comprise our largest single asset class and consist primarily of investment securities in the form of fixed income securities. Our fixed income securities, equity investments and short-term investments are carried at their fair values and accounted for $639.2 million or 99 percent of our total investments and 65 percent of our total assets as of December 31, 2010, compared to $676.9 million or 99 percent of our total investments and 66 percent of our total assets as of December 31, 2009. Unrealized gains or losses in their fair values are recorded directly in shareholders' equity, net of tax effects, as a component of accumulated other comprehensive income (loss). Gross unrealized investment gains were $27.6 million and gross unrealized investment losses were $2.2 million as of December 31, 2010 compared to $24.3 million and $6.3 million, respectively, as of December 31, 2009.
Issuer-specific considerations, including an event of missed or late payment or default, adverse changes in key financial ratios, an increase in nonperforming loans, a decline in earnings substantially below that of the investee's peers, downgrading of the investee's debt rating or suspension of trading in the security;
The occurrence of a significant economic event that may affect the industry in which the investee participates, including a change that might adversely impact the investee's ability to achieve profitability in its operations;
With regard to CMBS, we also evaluate key statistics such as breakeven constant default rates and credit enhancement levels. The breakeven constant default rate indicates the percentage of the pool's outstanding loans that must default each and every year for a CMBS class/tranche to experience its first dollar of principal loss. Credit enhancements indicate how much protection, or “cushion,” exists to absorb losses in a particular deal before an actual loss would impact a specific security.
Reinsurance represents insurance bought by an insurance company. In a reinsurance contract the reinsurer agrees to indemnify another insurance or reinsurance company, the ceding company, against all or a portion of the insurance or reinsurance risks underwritten by the ceding company under one or more policies. Reinsurers do not pay policyholder claims. Instead, they reimburse insurers for claims paid. Reinsurance does not relieve us from our primary obligations to policyholders. Therefore, the failure of reinsurers to honor their obligations could result in losses to us. The amounts recoverable from reinsurers on our unpaid losses and LAE are calculated by applying the terms of the respective reinsurance contracts to our estimates of the underlying loss and LAE reserves that are subject to reinsurance. Thus, to the extent our reinsured reserves change or are adjusted, so will the related reinsurance recoverable and our exposure.
We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk with respect to the individual reinsurers that participate in our ceded programs to minimize our exposure to significant losses from reinsurer insolvencies. We hold collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not designated as authorized reinsurers by the applicable departments of insurance of the states that have jurisdiction over the underlying business. For additional information concerning our reinsurance, see Note 9, Reinsurance to the consolidated financial statements included elsewhere herein.
The accounting for defined benefit plans is dependent on actuarial estimates, assumptions and calculations that result from a complex series of judgments about future events and uncertainties. The assumptions and actuarial estimates required to estimate the employee benefit obligations for our defined benefit plans include discount rate; expected compensation increases; certain employee-related factors, such as turnover, retirement age and mortality (life expectancy); and expected return on plan assets. Our assumptions reflect our historical experiences and our best judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our defined benefit plans may impact our results of operations. Consequently, we often obtain assistance from actuarial experts to aid in developing reasonable assumptions and cost estimates.
The discount rate used in calculating our pension benefit obligations as of December 31, 2010 and 2009, is 5.5 percent and 6.0 percent, which represents a 0.8 and 0.4 percentage-point decrease, respectively, from our December 31, 2008 rate of 5.9 percent. The discount rate for our defined benefit plans is based on a yield curve constructed from a portfolio of high quality corporate bonds for which the timing and amount of cash flows approximate the estimated payouts of the plans.
The following table illustrates the sensitivity to a change in the discount rate for our defined benefit plans as of December 31, 2010:
For information concerning commitments and contingencies to which we are subject, see Note 19, Commitments and Contingencies to the consolidated financial statements included elsewhere herein.
Comparison for the Years Ended Ended December 31, 2010 and 2009
Includes $5.3 million, and $4.8 million of DPW related to our initiative to provide management services for alternative risk arrangements for the years ended December 31, 2010 and 2009, respectively. Management fees of $0.2 million for both the years ended December 31, 2010 and 2009, for such arrangements are included in other income.
Consolidated net income was $29.6 million for 2010, or $3.03 per diluted common share, a decrease of 13 percent and 2 percent, respectively, compared to $34.0 million, or $3.09 per diluted common share, for 2009. Our net income for 2009 included a gain from discontinued operations of $0.4 million. Other changes in net income are due to the factors discussed in the paragraph above with regard to consolidated income from continuing operations.
Net premiums earned increased 7 percent for 2010 compared to 2009, primarily as the result of the acquisition of Advocate, MD. Excluding the impact of the Advocate, MD acquisition, net premiums earned declined 7 percent, primarily as the result of a prior rate decrease in our Florida market that was reflected in net premiums earned during 2010, a higher level of tail premiums written during 2009 and differences in business mix.
Net investment income declined 10 percent for 2010 compared to 2009, primarily as the result of lower average invested assets and a decline in yields on fixed income securities and cash and cash equivalents due to lower prevailing interest rates.
Net realized investment gains were $4.1 million for 2010 up from $2.6 million for 2009. Our 2010 and 2009 investment results include $0.9 million and $2.1 million, respectively, in other-than-temporary impairments on investments. As of December 31, 2010, we had a total of $707.1 million in cash and investments, of which 89 percent were fixed income securities, 2 percent were equity securities, 8 percent were cash and 1 percent were other invested assets. Our fixed income portfolio had an overall average credit quality of Aa3, based on the lower of the available credit ratings from Moody's and S&P.
the recognition of $23.0 million of favorable prior year development for 2010 compared to $19.0 million for 2009. The favorable development recognized in 2010 reflects lower than expected ultimate losses related to the 2005 through 2008 accident years as the result of changes in our previous estimates of incident to claim development, payment frequency and / or payment severity for the respective accident years. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) related to the current accident year (excluding prior year development) has increased in recent years as a result of lower premium rates, following several years of overall favorable claims trends and was 71.6 percent and 71.0 percent for 2010 and 2009, respectively. Our calendar year loss ratio was 57.9 percent for 2010 compared to 58.9 percent for 2009.
The claims with indemnity payment (“CWIP”) ratio is defined as the ratio of total professional liability claims with
indemnity payment to the sum of total professional liability claims with indemnity payment and total professional liability claims closed without indemnity payment.
Our business is comprised of our insurance operations through insurance subsidiaries domiciled in Florida, Missouri and Texas. We currently engage only in insurance operations. Financial and selected other data, including professional liability claims data, related to our operations as of December 31 and for the years then ended is summarized in the table below. FPIC pre-acquisition business represents our insurance operations conducted through insurance subsidiaries domiciled in Florida and Missouri and exclude the operations of Advocate, MD.
Includes $4.8 million and $2.9 million of direct premiums written related to our initiative to provide management services for alternative risk arrangements for the years ended December 31, 2009 and 2008, respectively. Management fees of $0.2 million and $0.1 million for the years ended December 31, 2009 and 2008, respectively, for such arrangements are included in other income.
Other underwriting expenses includes a guaranty fund assessment of $1.2 million offset by $1.2 million in recoveries in 2009, and recoveries of $2.7 million in 2008 related to previous assessments.
Consolidated income from continuing operations was $33.6 million for 2009, or $3.05 per diluted common share, an increase of 5 percent and 24 percent, respectively, compared to $32.1 million, or $2.46 per diluted common share, for 2008. Consolidated income from continuing operations for 2009, includes $0.5 million (excluding acquisition related costs) contributed by the operations of Advocate, MD from its acquisition in November 2009. The remainder of the increase in income from continuing operations is primarily due to net realized investment gains compared with net realized
investments losses in the prior period, partially offset by lower net premiums earned and net investment income, a higher combined ratio in the current year and an increase in other expenses primarily as a result of transaction costs incurred in connection with the acquisition of Advocate, MD. Share repurchases under our stock repurchase program were a major contributor to the growth in earnings per common share during 2009. For further information, see the discussion below.
Net investment income declined 8 percent for 2009 compared to 2008. Excluding the impact of the Advocate, MD acquisition, net investment income declined 10 percent as the result of a decline in average invested assets due to share repurchases under our stock repurchase program, and a lower yield on cash and cash equivalents partially offset by a slight increase in the average yield on fixed income securities. In addition, during 2009 we held cash in contemplation of the Advocate, MD acquisition, which was completed November 13, 2009, that would have otherwise been invested in higher yielding securities.
Net losses and LAE declined 8 percent for 2009 compared to 2008. Excluding the impact of the Advocate, MD acquisition, net losses and LAE declined 10 percent. The declines in net losses and LAE are primarily related to the declines in net premiums earned and an increase in the amount of favorable reserve development over the prior year period. The continuation of favorable claims results as compared to previous estimates resulted in the recognition of $19.0 million of favorable prior year development for 2009, compared to $17.0 million for 2008. The favorable development recognized in
2009 primarily reflects reductions in our estimates of incident to claim development, payment frequency and payment severity for accident years 2005 through 2007 as compared to previous estimates. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) was 58.9 percent for 2009 compared to 57.7 percent for 2008.
Other underwriting expenses increased 9 percent for 2009 compared to 2008. Excluding the impact of the Advocate, MD acquisition, other underwriting expenses increased 7 percent primarily as a result of lower recoveries on prior guaranty fund assessments and an additional guaranty fund assessment levied in November 2009, lower ceding commissions and higher bad debt expense, partially offset by lower variable costs for agent commissions and premium taxes due to lower premiums earned.
The claims with indemnity payment (“CWIP”) ratio is defined as the ratio of total professional liability claims with indemnity payment to the sum of total professional liability claims with indemnity payment and total professional liability claims closed without indemnity payment.
Selected professional liability insurance claims data. Net paid losses and LAE, excluding assumed reinsurance contracts in run-off, was relatively level for 2009 compared with the same period in 2008 with an increase in net paid indemnity being almost entirely offset by a decline in paid LAE. The increase in net indemnity paid is primarily due to a higher number of claims with an indemnity payment. The average payment severity of our claims remains within our expectations. For the year ended December 31, 2009, the CWIP ratio was 37 percent and the CWIP ratio, including incidents, was 19 percent, compared to 36 percent and 19 percent, respectively, for the same period in 2008. The slightly higher CWIP ratios, excluding incidents, is the result of a lower number of reported claims in recent years. Excluding claims reported at Advocate, MD, claims and incidents reported decreased 2 percent. As claims frequency decreases, there is a general expectation that the CWIP ratio will be higher. The CWIP ratios remain within our expectations. Our inventory of open claims and incidents increased during 2009 due to the acquisition of Advocate, MD and inclusion of Advocate, MD's open claims as of December 31, 2009. Excluding open claims and incidents of Advocate, MD, professional liability claims and incidents that remained open declined 2 percent. It is not unusual for our claims data to fluctuate from period to period, and our claims data remains within our expectations.
Other expenses increased 134 percent for 2009 compared to 2008 primarily as a result of $0.7 million of transaction costs incurred in connection with the acquisition of Advocate, MD. Other expenses also includes amortization expense related to our intangible asset for customer relationships recorded as a result of the Advocate, MD acquisition.
We purchase reinsurance from a number of companies to mitigate concentrations of credit risk. Our reinsurance broker assists us in the analysis of the credit quality of our reinsurers. We base our reinsurance buying decisions in part on an evaluation of the then current financial strength and stability of prospective reinsurers. However, the financial strength of our reinsurers and their corresponding ability to pay us may change in the future due to forces or events we cannot control or anticipate. At December 31, 2010 our receivables from reinsurers, net of amounts due, totaled $148.8 million. We have not experienced difficulty in collecting amounts from reinsurers due to the financial condition of the reinsurers. Should future events lead us to believe that any reinsurer is unable to meet its obligation, adjustments to the amounts recoverable would be reflected in the results of current operations. We hold collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not designated as authorized reinsurers by the applicable departments of insurance of the states that have jurisdiction over the underlying business. The table below identifies our reinsurers from which our recoverables (net of amounts due to the reinsurer) are $5.0 million or more as of December 31, 2010 and 2009.
Under the terms of FPIC's management agreements with First Professionals and APAC, FPIC receives management fees equal to 115 percent of the costs incurred. The additional 15 percent provision in the First Professionals and APAC management agreements is intended to cover overhead, corporate expenses and profit and is eliminated in the consolidated financial statements. In the case of the agreement with APAC, the total annual management fees are also limited to an amount not to exceed those that would have been paid under the terms of its former management agreement. The payment of losses and LAE and insurance operating expenses (including reinsurance costs) in the ordinary course of business are the principal needs for our insurance subsidiaries' liquid funds. The principal sources of cash from their operations to meet ongoing liquidity requirements are the premiums collected for the insurance sold and income on the investment of those funds.
Unexpected changes in, or the imposition of, regulatory restrictions on the amount of dividends that can be paid to us;
Failure of one or more of our reinsurers leading to uncollectible reinsurance recoverables; and
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also have items that represent contractual obligations, commitments and contingent liabilities that are not recorded or that are considered to possess off-balance sheet risks beyond their respective amounts otherwise reflected in our consolidated financial statements. These include: (1) derivative financial instruments, which are used to hedge interest rate risk, (2) employee benefit plans (3) guarantees by us and contractual obligations related to the trust-preferred securities issued by separately created, unconsolidated trusts. These items are discussed further below. We were not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2010 that would give rise to previously undisclosed market, credit or financing risk.
Employee benefit plan obligations are comprised of proposed plan contributions and our unfunded obligation as of December 31, 2010.
Includes $9.5 million related to the acquisition of Advocate, MD for a contingent consideration arrangement that provides for additional consideration to be paid by the Company for Advocate, MD based on its attainment of targets with respect to direct written premiums, combined ratio and underwriting profits over a two-year period from the acquisition date. Up to forty percent of the contingent consideration is payable based on the first year of performance, with any remaining amount payable following the second year of performance. The range of undiscounted amounts we could pay under the contingent consideration agreement is between $0.9 million and $12.0 million. We recognized a liability for the estimated fair value of acquisition-related contingent consideration using a discounted cash flow model assuming probability weighted targets to be achieved over the earn-out period. For additional information, see Note 3, Acquisition of Advocate, MD.
The costs and liabilities that we record for our defined benefit plans are significantly affected by changes in assumptions used to calculate those costs and liabilities. The assumptions include discount rates, benefits earned, interest cost, expected return on plan assets and other factors. Significant changes in these factors may result in volatility in pension costs and liabilities. Also, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense in future periods. While we believe that the assumptions used are appropriate, changes in assumptions or differences in actual experience may affect our future pension costs.
The financial statements and supplementary data required to be included in this Item 8 are set forth on the pages indicated in Item 15 of this report.