As of December 31, 2007, we believe all of our facilities are suitable and adequate for use.
In 2005, we contributed a total of $24.9 million into our insurance company subsidiaries, net of dividends received, of which $6.8 million, $5.6 million, $7.5 million and $5.0 million was contributed to North Pointe
the inability to successfully integrate the Capital City entities could have a negative effect on our expenses and results of operations;
Our revenues are principally derived from premiums earned from our insurance operations. Other revenues are primarily generated through investment income and fees associated with our personal and commercial policies. Our expenses consist primarily of losses and loss adjustment expenses, agents’ commissions and other underwriting and administrative expenses. We report consolidated financial information in four business segments: commercial lines insurance, personal lines insurance, administrative services and agency services.
The $3.7 decrease in net income for the year ended December 31, 2006 was primarily attributable to a $18.1 million decrease in net premiums earned, partially offset by a $13.1 million decrease in net loss and loss adjustment expenses and a $2.7 million decrease in policy acquisition costs.
The decrease in net premiums earned primarily resulted from cancellations and non-renewals in our commercial lines segment and increased reinsurance costs. The cancellations and non-renewals were the result of our prompt reduction of our wind exposure in Florida when it became evident that we could not obtain catastrophe reinsurance coverage for the 2006 hurricane season. We made the decision to reduce our exposure in early June, which was substantially implemented by July 2006 by the cancellation or non-renewal of all policies included in specific classes within our Florida small business line. This reduced total annualized gross premiums written in our Florida small business line by approximately $18.0 million, or 40.0%, and total insurable value with wind exposure by approximately 75.0%.
In October 2007, the Company signed an agreement to sell Home Pointe Insurance. On January 23, 2008, the Company through its wholly owned subsidiary, North Pointe Financial, completed the sale of Home Pointe Insurance to American Capital Assurance Corp., a subsidiary of Safe Harbour Holdings, LLC, a Florida domiciled insurance holding company. Home Pointe conducted all of the Company’s Florida homeowners and dwelling fire operations in 2007.
In June 2006, we entered into a Second Amended and Restated Credit Agreement which replaced a previous Amended Credit Agreement. The Credit Agreement provides for a revolving credit line in the aggregate amount of $25.0 million.
We use actuarial methodologies to assist us in establishing these estimates, including estimates of the severity and frequency of future claims, the length of time to obtain an ultimate resolution, outcomes of litigation and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, our ultimate liability may differ from our original estimate. Our reserve estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. See “Results of Operations - Losses and Loss Adjustment Expenses,” “Business - Unpaid Losses and Loss Adjustment Expenses,” and Note 9 to our consolidated financial statements, all of which are included elsewhere in this annual report on Form 10-K.
individual securities in their investment portfolios to determine whether a decline in the value of a security is other than temporary. A review for other-than-temporary impairment (“OTTI”) requires companies to make certain forward-looking judgments regarding the materiality of the decline, its effect on the financial statements, and the probability, extent and timing of a valuation recovery, and the Company’s ability and intent to hold the security. The scope of this review is broad and requires a forward-looking assessment of the fundamental characteristics of a security, as well as market-related prospects of the issuer and its industry.
Reinsurance recoverables represent (1) amounts currently due from reinsurers on paid losses and LAE, (2) amounts recoverable from reinsurers on case basis estimates of reported losses and LAE, and (3) amounts recoverable from reinsurers on actuarial estimates of IBNR losses and LAE. Such recoverables, by necessity, are based upon estimates. Reinsurance does not legally discharge us from our legal liability to our insureds, but it does make the assuming reinsurer liable to us to the extent of the reinsurance ceded. Instead of being netted against the appropriate liabilities, ceded unearned premiums and reinsurance recoverables on paid and unpaid losses and LAE are reported separately as assets in our consolidated balance sheets. Reinsurance recoverable balances are also subject to credit risk associated with the particular reinsurer. In our selection of reinsurers, we continually evaluate their financial stability. While we believe our reinsurance recoverables are collectible, the ultimate recoverable may
Gross premiums written in our commercial lines segment for 2007 were $108.5 million as compared to $81.9 million for 2006, an increase of $26.6 million, or 32.5%. This increase was primarily attributable to $29.2 million of gross premiums written by Capital City Insurance which was acquired in July 2007. This increase was offset by a $10.7 million decrease in the Crop program which was discontinued for 2007. Offsetting the decrease from the Crop program were other small increases throughout the rest of our commercial programs.
Gross premiums written in our commercial lines segment for 2006 were $81.9 million as compared to $78.6 million for 2005, an increase of $3.3 million, or 4.2%. This increase was primarily attributable to $11.0 million in gross premiums written in our crop fronting program and flood program, which we began in 2006, and a $2.3 million increase in our bowling centers and roller skating centers lines. The crop fronting program was discontinued for 2007. These increases were partially offset by an $8.6 million decrease in gross written premiums in our Florida small business line, which resulted from cancellations and non-renewals, and a $2.2 million decrease in our Restaurant Bar Tavern, or RBT lines. The cancellations and non-renewals were the result of our prompt reduction of our wind exposure in Florida when it became evident that we could not obtain catastrophe reinsurance coverage for the 2006 hurricane season. We made the decision to reduce our exposure in early June which was substantially implemented by July 2006 by the cancellation or non-renewal of all policies included in specific classes within our Florida small business line. This reduced total annualized gross premiums written in our Florida small business line by approximately $18.0 million, or 40.0%, and total insurable value with wind exposure by approximately 75.0%. The decrease in our RBT line was attributable to a reduction in policy count resulting from a more competitive market.
While we did not cancel the bowling centers line written in Florida, we have reduced our exposure to catastrophe losses in the bowling line through a combination of certain non-renewals, higher deductibles and other increased underwriting restrictions. In addition, we took measures to substantially increase rates on the bowling line, as well as our other Florida commercial lines which we retained, including contractor and RBT lines.
Gross premiums written in our personal lines segment for 2006 were $8.3 million as compared to $32.5 million for 2005, a decrease of $24.2 million or 74.5%. This decrease was primarily attributable our Florida homeowners insurance line which was written in North Pointe Casualty in 2005 but transferred to Home Pointe in 2006 and therefore is excluded from continuing operations (see Note 3). Home Pointe had gross premiums written of $24.4 million and $1.1 million for 2006 and 2005, respectively.
Net premiums written is the amount of our gross premiums written less the amount of premiums that we transfer, or cede, to our reinsurers based upon the risks they accept pursuant to our reinsurance treaties. We relate our net premiums written to gross premiums written to measure the amount of premium we retain after cessions to reinsurers. Our primary reinsurance agreement is a multi-line, excess of loss treaty covering substantially all lines
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Net premiums written for 2007 were $107.4 million as compared to $61.1 million in 2006, an increase of $46.3 million, or 75.8%. This increase is primarily due to an increase in gross premiums written (discussed above) and a decrease in premiums ceded to reinsurers. Ceded premiums written for 2007 were $11.9 million as compared to ceded premiums written of $29.1 million for 2006, an $17.2 million decrease, or 59.1%. The decrease in ceded premiums written was primarily due to decreased ceding rates. For example, in our master reinsurance treaty agreement, which provides 100% coverage up to $1.0 million, we ceded 10.7% of gross premiums written in 2006 and we ceded 3.0% and 3.3% of gross premium written in 2007 on property and casualty lines of business, respectively. Additionally, we are no longer writing the crop program in which we ceded 98% of our gross premiums written in 2006.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Net premiums earned for 2007 were $94.2 million as compared to $66.7 million for 2006, an increase of $27.5 million, or 41.2%. The increase in net premiums earned was consistent with the increase in net premiums written discussed above.
Our premiums earned by segment, for the years ended December 31, 2007, 2006 and 2005, are as follows:
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Net investment income for 2006 was $5.7 million as compared to $3.9 million for 2005, an increase of $1.8 million, or 46.2%. The increase in net investment income was attributable to a combination of an increase in our average cash and invested assets balance and an increase in the annualized yield on our portfolio. The increase in average cash and invested assets resulted primarily from the issuance of $20.0 million, mandatorily redeemable trust preferred securities during the first quarter of 2006. Pre-tax yield on our portfolio increased to 4.2% in 2006 from 3.1% in 2005. This increase in pre-tax yield is primarily attributable to an increase in prevailing market interest rates. For example, the three-year U.S. Treasury notes increased to 4.7% in 2006 from 3.9% in 2005, which we believe reflected the trend in market interest rates for debt securities with durations similar to our cash and securities mix. The average duration of our debt securities portfolio was 3.5 and 3.3 years as of December 31, 2006 and 2005, respectively.
Net realized gains (losses) on investments are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities we hold as investments.
Fees and other income is generated from commissions earned for policies written by one of our wholly-owned managing general agents for unrelated insurance companies, policy or inspection fees charged on our personal homeowners and commercial policies, and premium finance charges.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Fees and other income for 2007 was $6.6 million as compared to $1.4 million for 2006, an increase of $5.2 million, or 371.4%. This increase is due to the acquisition of Capital City Holdings which generated $5.2 million in fees and other income for 2007, primarily from their Davis-Garvin Agency subsidiary.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Losses and loss adjustment expenses for 2007 were $53.5 million as compared to $30.9 million for 2006, an increase of $22.6 million, or 73.1%. Our loss ratio for 2007 was 53.1% as compared to 45.4% in 2006.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Losses and loss adjustment expenses for 2006 were $30.9 million as compared to $44.0 million for 2005, a decrease of $13.1 million, or 29.8%. Our loss ratio for 2006 was 45.4% as compared to 50.8% in 2005.
Favorable development of prior period estimates reduced losses and loss adjustment expenses in our commercial lines by $4.0 million in 2006 from $28.0 million to $24.0 million. Such favorable development reduced our commercial lines loss ratios from 46.5% to 39.9% in 2006.
Reserve development occurs primarily in our liability lines which rely more on estimations in establishing reserves than do property lines and require more years to fully develop. The favorable reserve adjustments were primarily attributable to lower actual loss development as compared to our originally estimated loss development factors.
Unfavorable development of prior period reserve estimates increased losses and loss adjustment expenses in our personal lines by $1.6 million in 2006 from $5.6 million to $7.2 million and increased the loss ratios from 78.5% to 99.0% in 2006. We experienced favorable development of $2.0 million in our personal lines segment in 2005, which reduced the loss ratio from 70.8% to 62.5% in 2005.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Other underwriting and operating expenses for the year ended December 31, 2007 were $28.0 million as compared to $21.8 million for the year ended December 31, 2006, an increase of $6.2 million, or 28.4%. The increase was primarily attributable to costs incurred by Capital City, which was acquired in 2007.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Interest expense for 2006 was $1.7 million as compared to $959,000 for 2005, an increase of $752,000, or 78.4%. The increase in interest expense was primarily attributable to the $20.6 million junior subordinated note, bearing interest at 8.7% per annum, and issued in concert with the trust preferred securities in February 2006.
Year Ended December 31, 2007. Federal income tax expense on income from continuing operations for 2007 was $1.8 million, representing an effective tax rate of 27.5%. The statutory rate is 34.0%. The decrease in the statutory rate is primarily due to $356,000 favorable tax position from tax exempt income.
Our primary assets are the stock of North Pointe Financial (a non-insurance company) and the stock of our insurance companies. Our ability to pay dividends to shareholders, meet our debt payment obligations and pay our general and administrative expenses is largely dependent on cash dividends we receive from North Pointe Financial. In turn, North Pointe Financial’s primary source of revenue, from which dividends to us have been paid, is the service fees and commissions it receives from our insurance companies pursuant to various servicing, marketing and management agreements in effect between those entities. In addition, it is possible that North Pointe Financial could receive dividends from our insurance companies paid out of their retained earnings, which North Pointe Financial could then pay to us as dividends. However, we traditionally have not issued dividends from our insurance companies to fund our general expenses and debt payment obligations. Moreover, holding company laws regulate dividends and other payments by our insurance companies.
Our non-insurance companies provide management and administrative services to our insurance company subsidiaries pursuant to intercompany service agreements. These services include providing management, marketing, offices and equipment, and premium collection, for which our insurance companies pay our non-insurance companies fees primarily based on a percentage of gross premiums written. In exchange for providing these intercompany services, our non-insurance companies recorded revenues of $23.2 million, $20.5 million, and $19.3 million, for the years ended December 31, 2007, 2006 and 2005, respectively. Our non-insurance companies also derive nonaffiliated revenues from installment fees, commissions from nonaffiliated insurance carriers, premium financing and other income which totaled $6.6 million, $1.9 million, and $1.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. There were no material non-cash components of our non-
insurance company revenues. All of the agreements between our regulated insurance company subsidiaries and our non-insurance company subsidiaries have been approved by the applicable regulators.
Net cash used in investing activities for the year ended December 31, 2007 was $12.4 million and was attributable to $27.7 million in cash used in the acquisition of Capital City, offset by $15.8 million in investment portfolio sales and other dispositions in excess of cash used in investment portfolio purchases.
Net cash used in investing activities for the year ended December 31, 2006 was $12.6 million and was attributable to $10.3 million of net cash used in investment portfolio purchases in excess of investment portfolio sales and other dispositions, $620,000 of cash used for the capital contribution to NP Capital Trust I (an unconsolidated Delaware trust used to issue trust preferred securities), and $1.7 million of cash used to purchase fixed assets.
In 2007, contributions of $5.0 million, $1.0 million, $3.0 million and $3.0 million by North Pointe Insurance, North Pointe Casualty, Davis-Garvin Agency and Midfield, respectively, were made to the parent company to provide funds for the acquisition of the Capital City entities and to pay down a portion of the outstanding debt.
North Pointe Insurance’s gross premiums written to statutory capital and surplus ratios were 1.59 to 1.0 and 1.27 to 1.0 as of December 31, 2007 and 2006, respectively. North Pointe Casualty’s net premiums written to statutory capital and surplus ratios were 1.26 to 1.0 and 0.77 to 1.0, as of December 31, 2007 and 2006, respectively.
Dividends or distributions falling below these thresholds are not subject to prior approval by the Florida insurance regulator. Florida’s insurance law does not allow North Pointe Casualty to pay any dividends without prior regulatory approval in 2008.
Under the South Carolina Insurance Holding Company Regulatory Act, our South Carolina company, Capital City Insurance Company, is required to report all dividends within five business days following the declaration and at least fifteen days before payment. The declaration of a dividend confers no rights until the department either has approved the payment of the dividend or has not disapproved the payment within fifteen days after receiving notice of the declaration. Accordingly, prior approval would be sought for any dividend distributions from Capital City Insurance Company.
On July 2, 2007, the Company entered into Amendment Number 2 to the Second Amended and Restated Credit Agreement (the “Credit Agreement”) with Comerica Bank (“Comerica”), as agent. This Credit Agreement expires July 1, 2010 and provides a revolving credit line of $35,000,000. At December 31, 2007, there was an outstanding balance of $21.3 million on the revolving credit line bearing interest of 6.41%.
The Credit Agreement requires that the Company comply with various financial and other covenants, including requirements that it maintain an A.M Best rating of no less than “B+” for certain of its insurance company subsidiaries, and that the Company maintain the following financial ratios for each insurance company subsidiary including the Capital City acquired entities:
Mortgage Obligation. On August 18, 2005, we assumed the mortgage on the office building in Southfield, Michigan after acquiring Northwest Zodiac. The mortgage loan terms include monthly principal and interest payments of $22,000 and a balloon payment of $1.9 million due in June 2011. As of December 31, 2007, the mortgage debt obligation had an outstanding balance of $2.4 million.
On February 22, 2006, we issued $20.0 million of 30-year, mandatorily redeemable trust preferred securities (the “Trust Preferreds”) through a newly formed, unconsolidated wholly-owned subsidiary, NP Capital Trust I (the “Trust”).
The proceeds of the Trust Preferreds received by the Trust, along with proceeds of $620,000 paid by us to the Trust from the issuance of common securities by the Trust to us, were used to purchase $20.6 million of our junior subordinated debt securities (the “Debt Securities”) under terms which mirror those of the Trust Preferreds.
We primarily invested the $19.3 million of proceeds, which is net of $690,000 of issuance costs, in high-grade debt securities which will remain available to fund future contributions to our subsidiaries, acquisition activities as they may arise, and other capital uses. In June 2006 and September 2006, we contributed $3.0 million and $2.0 million of the funds, respectively, to North Pointe Casualty to meet the minimum statutory capital and surplus of $15.0 million required by many states for surplus lines carriers. In December 2006, we contributed $4.0 million to Home Pointe Insurance to meet statutory capital and surplus levels required by A.M. Best for their initial rating.
We obtained consents and waivers from our senior lenders acknowledging that the purchase of our equity interest in and issuance of subordinated debt securities to NP Trust and the guaranty of the NP Trust’s preferred securities would not constitute an event of default under the senior credit facility.
The following table summarizes information about our contractual obligations. The minimum future payments, including anticipated interest, under these agreements as of December 31, 2007 are as follows:
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which redefines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The effects of adoption will be determined by the types of instruments carried at fair value in the Company’s financial statements at the time of adoption as well as the method utilized to determine their fair values prior to the adoption. Based on our current use of fair value measurements, the adoption of SFAS No. 157 on January 1, 2008 did not have a material effect on the results of operations or financial position of the Company.