The following management's discussion and analysis ("MD&A") should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements appearing elsewhere in this report. The consolidated financial statements include the results of all of our wholly owned subsidiaries. Except for the historical information contained here, the discussions in the MD&A contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under Item 1A. Risk Factors.
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. Through our insurance subsidiaries, we are the largest provider of MPL insurance in Florida. Based on the latest available premium data published by A.M. Best, Florida is the third largest market for MPL insurance in the United States. We have chosen to focus on selected markets where we believe we have advantages in terms of our market knowledge, well-established reputation, meaningful market presence and resources.
Our former insurance management operations, which provided insurance management services in New York and Pennsylvania, were discontinued in September 2006 in connection with the sale of these operations to a private investor. Our former TPA operations, which provided administrative and claims management services to employers, primarily in Florida, were sold in 2005. For additional information on our discontinued operations, see Note 17, Discontinued Operations to the consolidated financial statements included elsewhere herein.
During February 2007, our subsidiary, First Professionals, commuted, effective January 1, 2007, all assumed reinsurance treaties with PRI under which First Professionals acted as a reinsurer. In connection with the commutation, First Professionals recognized an after-tax gain of $9.7 million. For additional information on the commutation, see Note 5, Reinsurance to the consolidated financial statements included elsewhere herein and the management’s discussion and analysis that follows.
The number of professional liability policyholders insured by our insurance subsidiaries remained essentially level with a total of 13,372 policyholders as of December 31, 2007 compared with a total of 13,402 policyholders as of December 31, 2006.
During 2007, we repurchased 1,232,482 shares of our common stock, on a settlement date basis, at an average price per share of $41.00; as of February 25, 2008, we have repurchased an additional 202,573 of our shares on a settlement date basis, under our Rule 10b5-1 plan, at an aggregate cost of $8.4 million, or $41.50 per share, and had remaining authority from our Board of Directors to repurchase 237,770 more shares as of that date.
Our discussion and analysis of financial condition, results of operations and liquidity and capital resources is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. We generally base our estimates on historical experience or other appropriate assumptions that we believe are reasonable and relevant under the circumstances and evaluate them on an ongoing basis. The results of these estimation processes form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Liability for Losses and LAE - 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 98 percent of our total consolidated liability for losses and LAE for both 2007 and 2006.
IBNR as a component of our total reserves has increased in recent years as a result of higher estimates of LAE, such as legal defense and related costs, driven by the stricter claims philosophy we adopted in 2001, which focuses on aggressively defending non-meritorious claims in order to lower overall claims costs. While we believe this approach has been beneficial to our results in total, it has increased our estimates for LAE costs as an individual component. Establishing case reserves for LAE is inherently difficult since the level of costs ultimately necessary to resolve a case tends to increase over time and can vary significantly based on factors such as whether and when a case is taken to trial. Therefore, a substantial portion of total LAE reserves is reflected in our estimates for case reserve development. Additionally, our stricter claims philosophy has resulted in a relatively lower number of cases with an indemnity case reserve, which has also resulted in an increase in IBNR as a component of total reserves.
We establish loss and LAE reserves taking into account the results of multiple actuarial techniques applied as well as other assumptions and factors regarding our business. The actuarial techniques we use that are material to our evaluation of loss and LAE reserves include the following:
Allocated Loss Adjustment Expense (“ALAE”) Development Methods (Incurred and Paid Development);
Using internal actuarial staff, we analyze and develop projections of ultimate losses that are utilized in establishing our carried reserves. In performing our review, we separate reserves by line of business, coverage type, layer of coverage, geography and accident year. By doing so, we are able to evaluate the unique patterns of development and trends for each line of business. We then select a point estimate for each line of business with due regard for the age, characteristics and volatility of the portion of the business, the volume of data available for review and past experience with respect to the accuracy of estimates for business of a similar type. This series of selected point estimates, along with other relevant quantitative and qualitative information, is then evaluated by management to produce our best estimate of our total liability for losses and LAE.
The primary factors affecting our estimates of ultimate reserves for insurance claims, defense, and other related costs, including how much we pay for a given claim, include the following:
Frequency and severity trends (numbers of claims and how much we will pay for each claim on average);
Frequency of claims closed with indemnity payments (the percentage of claims received that ultimately result in a loss payment versus those that are settled and closed without a loss payment); and
In 2007, we paid a total of $61.5 million in loss payments (indemnity only), excluding the impact of commuted reinsurance agreements, on 311 claims.
The following table rolls forward our consolidated liability for losses and LAE, net of reinsurance.
Effective January 1, 2007, First Professionals commuted all assumed reinsurance treaties with PRI under which First Professionals acted as a reinsurer. Under the terms of the commutation agreements, First Professionals paid cash and delivered securities with an aggregate value of $87.7 million to PRI as full settlement of all past and future obligations for policy risks previously reinsured by First Professionals. The corresponding net liabilities related to these agreements carried by First Professionals totaled $103.4 million. First Professionals recognized a decrease in incurred losses of $14.0 million and an after-tax gain of $9.7 million as a result of the commutation.
Effective December 31, 2006, First Professionals commuted its net account quota share reinsurance agreement with Hannover Re. Under the terms of the commutation agreement, First Professionals assumed loss and LAE reserves previously ceded of approximately $84.0 million and in exchange Hannover Re released to First Professionals the funds withheld under the agreement of $84.0 million. No gain or loss was recognized on the transaction.
Losses and LAE related to the current year decreased approximately 15 percent for 2007 compared to 2006. As noted in our discussion of results of operations below, our net premiums earned declined 12 percent for 2007 compared to 2006. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) related to the current year declined to 67.3 percent for the year ended December 31, 2007 compared to 69.0 percent for the same period in 2006 as a result of favorable claims trends, including the level of newly reported claims and incidents. Severity of claims also continued to be within our expectations.
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, 2007, 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 set aside 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, 2007, there was $30.0 million of favorable development for accident year 2006 reserves, including all accident years leading up to 2006. This favorable development consists of $23.0 million of favorable development for accident years 2005 and earlier and $7.0 million of favorable development for accident year 2006. Further, the net cumulative redundancy / (deficiency) shown in the table below also includes development for multiple calendar years. For example, the $5.7 million cumulative redundancy in 2004 consists of $3.5 million of favorable development during calendar year 2007 and $2.2 million of favorable development during calendar year 2006.
Data presented in 1997 reflects only loss and LAE reserves of First Professionals, which primarily related to MPL insurance business written in Florida. Claim results for this period were generally favorable and resulted in lower reserve estimates.
Beginning in 1998, the composition of our business and our reserves changed because of acquisitions, geographic expansion and increased writings in other lines of insurance, such as accident and health and assumed reinsurance. These events resulted in additional volatility to our reserve estimates.
For accident years 1998 through 2001, we 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 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 decreased overall loss costs, it had an adverse affect on older report years where higher loss adjustment expenses were not entirely offset by lower indemnity expenses.
Data presented in the table above represents consolidated information of all our insurance subsidiaries commencing from their respective dates of acquisition. Data presented in 1997 reflects only First Professionals’ liability for losses and LAE. The 1998 year reflects losses and LAE data for First Professionals and APAC. The data presented from 1999 to 2007 reflects all of our insurance subsidiaries.
Reserve for Extended Reporting Endorsements - A portion of the coverage that physicians purchase under claims-made policies is for an additional death, disability and retirement (“DD&R”) insurance benefit. Coverage is provided to the physician for any prior incidents occurring during the claims-made policy period that are reported after his or her death, disability or retirement. The loss exposure associated with this product is known as extended reporting endorsement claims. The reserve for extended reporting endorsement claims is recorded during the term of the original claims-made policy, based on the present value of future estimated benefits, including assumptions for morbidity, mortality, retirement, interest and inflation, less the present value of expected future premiums associated with this DD&R coverage. The reserves for these claims fluctuate based on the number of physicians who are eligible for this coverage and their age. These liabilities, which possess elements of both loss reserves and pension liabilities, are carried within unearned premiums. Once an endorsement is issued because of a triggering event, a liability is established as part of the reserve for losses and LAE. Any changes in the DD&R reserves are reflected as income or expense in the period in which we become aware that an adjustment is necessary. At December 31, 2007 and 2006, our carried DD&R reserves were $23.6 million and $81.0 million, respectively, which include a discount related to the present value calculation of approximately $10.8 million and $31.4 million, respectively. A one percentage point change in our discount rate of 5 percent related to our DD&R reserves as of December 31, 2007, would result in an approximate addition or reduction in our reserve of approximately $2.8 million. Effective January 1, 2007, we commuted our assumed DD&R reserves, which were $54.5 million. Excluding these reserves, our carried DD&R reserves at December 31, 2006 were $26.6 million. For additional information, see Note 5, Reinsurance to the consolidated financial statements presented elsewhere herein.
The occurrence of a significant economic event that may affect the industry in which an issuer participates; and
The U.S. residential mortgage market is experiencing a decline due to credit quality deterioration in a significant portion of loans originated, primarily to sub-prime borrowers. The slowing U.S. residential mortgage market has caused many sub-prime borrowers to be unable to refinance their mortgage loans, particularly those customers who had adjustable rate mortgages that reset at a higher rate than the rate at the origination of their mortgage. As a result, there has been a significant increase in delinquency and foreclosure rates within the United States. We do not engage in subprime residential mortgage lending, which is the origination of residential mortgage loans to customers with weak credit profiles including the use of relaxed mortgage underwriting standards to provide affordable mortgage products. Our exposure to sub-prime residential mortgage lending is through investments within our fixed income investment portfolio that contain securities collateralized by mortgages that have characteristics of sub-prime lending. These investments are in the form of asset-backed securities supported by sub-prime mortgage loans. The collective carrying value of these investments is approximately $3.3 million, representing less than 1 percent of our total fixed income investments, and all of these securities had a Standard & Poor’s credit rating of AAA. We also hold investments collateralized by Alt-A mortgage loans, which are in the form of mortgage-backed securities. The collective carrying value of these investments is approximately $3.6 million, representing less than 1 percent of our total fixed income investments, and all of these securities had a Standard & Poor’s credit rating of AAA. None of our subprime or Alt-A investments were other than temporarily impaired as of December 31, 2007. We manage our sub-prime and Alt-A risk exposure by maintaining high credit quality investments, limiting our holdings in these types of instruments and utilizing investment advisors who perform ongoing analyses of cash flows, prepayment speeds, default rates and other stress variables. While our exposure to subprime and Alt-A investments is not significant to our total investment portfolio, if the residential mortgage market continues to decline and / or the decline expands beyond the U.S. sub-prime and Alt-A residential mortgage market, such events could ultimately have an impact on other mortgage-backed securities held within our investment portfolio.
A valuation allowance against deferred tax assets is estimated and recorded if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized. Valuation allowances are based on estimates of taxable income and the period over which deferred tax assets will be recoverable. In the event that actual results differ from our estimates or those estimates are adjusted in future periods, we may need to establish a valuation allowance, which would impact our financial position and results of operations. We have not established any material valuation allowance, as we believe it is more likely than not that our deferred tax assets will be fully realized. For additional information concerning our income taxes, see Note 8, Income Taxes to the consolidated financial statements included elsewhere herein.
Share-Based Payment - On January 1, 2006, we adopted the provisions of FAS 123(R), Share-Based Payment, using the modified prospective method. Prior period financial statements have not been restated to reflect fair value share-based compensation expense. Prior to the adoption of FAS 123(R), we followed the intrinsic value method in accordance with Accounting Principles Board (“APB”) 25 to account for our employee stock options. Accordingly, no compensation expense was recognized in connection with the issuance of stock options under our share-based compensation plans. However, compensation expense was recognized in connection with the issuance of restricted stock.
Beginning January 1, 2006, we recognized share-based compensation expense for (i) all share-based payments granted prior to, but not vested as of, January 1, 2006, based on the grant date fair value originally estimated in accordance with the provisions of FAS 123 and (ii) all share-based payments granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of FAS 123(R). We recognize share-based compensation expense under FAS 123(R) ratably using the straight-line attribution method over the expected vesting period. In addition, pursuant to FAS 123(R), we are required to estimate the amount of expected forfeitures when calculating share-based compensation costs, instead of accounting for forfeitures as incurred, which was allowed under previous guidance. As of January 1, 2006, the cumulative effect of adopting the estimated forfeiture method was not significant as the amount related solely to our January 2005 restricted stock awards and our financial statements already reflected an appropriate adjustment to compensation expense for forfeitures. In determining the pool of windfall tax benefits for purposes of calculating assumed proceeds under the treasury stock method, we exclude the impact of pro forma deferred tax assets. We elected to use the short-cut method in determining our pool of windfall tax benefits upon adoption of FAS 123(R).
We use historical data and projections to estimate expected employee behaviors related to stock option exercises and forfeitures. We estimate the fair value of each stock award on the grant date using the Black-Scholes valuation model incorporating the assumptions noted in the following table. Stock valuation models require the input of highly subjective assumptions, and changes in assumptions used can materially affect the fair value estimate.
Pension Benefits - In September 2006, the FASB issued FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). In accordance with FAS 158, we recognized a liability for the under-funded status of our defined benefit plans for the difference between the plans’ projected benefit obligation and the fair value of plan assets. We also recorded all unrecognized prior service costs and credits, unrecognized actuarial gains and losses and any unrecognized transition obligations or assets in accumulated other comprehensive (loss) income. Such amounts are reclassified into earnings as components of net periodic benefit cost pursuant to the current recognition and amortization provisions of FAS 106, Employers’ Accounting for Postretirement Benefits Other than Pensions. FAS 158 requires us to measure plan assets and benefit obligations as of the date of our statement of financial position. As allowed by the standard, we will adopt the measurement date requirement in 2008. We currently use a measurement date of October 1 for our pension plans. The impact of adopting the measurement date requirement is expected to approximate $0.2 million as a reduction to retained earnings as of January 1, 2008. The incremental effect of applying FAS 158 on individual line items in the consolidated statement of financial position is presented in the table below.
Our assumption for the expected long-term rate of return-on-assets in our pension plans, which impacts net periodic benefit cost, is 6.8% for 2007 and 7.0% for 2006. The assumption for the expected return on assets for our defined benefit plans reflects our actual historical return experience and our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans.
For additional information on our defined benefit plan, see Note 13, Employee Benefit Plans to the consolidated financial statements included elsewhere herein.
Commitments and Contingencies - For information concerning contingencies, to which we are subject, including assessments related to insolvencies in the states we operate, see Note 16, Commitments and Contingencies to the consolidated financial statements included elsewhere herein.
Consolidated income from continuing operations was $51.1 million for 2007, or $5.23 per diluted common share, an increase of 55 percent and 69 percent, respectively, compared to $32.9 million, or $3.09 per diluted common share, for 2006. The increase in income from continuing operations for 2007 was primarily due to lower net losses and LAE, other expenses and other underwriting expenses, partially offset by lower net premiums earned. The lower net losses and LAE include favorable prior year loss development of $16.0 million, excluding the impact of the PRI commutation, during 2007 compared to $5.1 during 2006. Income from continuing operations for 2007 also includes an after-tax gain of $9.7 million on the reinsurance commutation between First Professionals and PRI. Other underwriting expenses for 2007 include a $4.2 million ($2.6 million after-tax) charge for a state levied guaranty fund assessment with respect to the insolvency of the subsidiaries of Poe Financial Group. Other underwriting expenses for 2006 include a $9.4 million ($5.8 million after-tax) charge for two separate assessments with respect to the same insolvency. The lower net premiums earned for 2007 resulted from lower rates in our Florida market, a change in business mix to lower risk specialties and a small decline in professional liability policyholders.
Consolidated net income was $51.6 million, or $4.83 per diluted common share, for 2006, an increase of 47% and 48%, respectively, compared with $35.0 million, or $3.26 per diluted common share, for 2005. Changes in net income are due to the factors discussed in the paragraph above with regard to consolidated income from continuing operations. In addition, consolidated net income for 2006 included discontinued operations of $18.6 million (including an $11.6 million gain on the disposal of our former insurance management operations and a $0.4 million gain on the disposal of our former TPA operations). Included in consolidated net income for 2005 were discontinued operations of $9.5 million (including a $1.7 million gain on the disposal of our former TPA operations).
Our business is made up of our four insurance subsidiaries and certain other subsidiaries. Prior to the dispositions of our former TPA operations in June 2005 and our former insurance management operations in September 2006, we operated in multiple segments. Currently, we engage only in insurance operations. Financial and selected other data, including professional liability claims data, related to our continuing operations is summarized in the table below.
Selected direct professional liability insurance claims data. There was a 7% decrease in net paid losses and LAE on core professional liability business for 2007 compared with 2006. This decrease corresponds with a decrease in the number of claims on hand and closed during the year, including a decrease in the number of claims with an indemnity payment. The number of reported claims and incidents for 2007 was down slightly compared to 2006 and generally reflects continued lower frequency in newly reported claims and incidents in total in our Florida market that began in the fourth quarter of 2003. The number of professional liability claims with indemnity payment (“CWIP”) declined slightly for 2007 compared to 2006. For 2007, the CWIP Ratio and the CWIP Ratio, including incidents, continued to be within our expectations. Our inventory of open claims and incidents declined further during 2007, which follows declines in the number of claims and incidents reported. It is not unusual for our claims data to fluctuate from period to period, and our claims data remains within our expectations.
Other underwriting expenses decreased for 2007 compared to 2006. Other underwriting expenses for 2007 and 2006 include charges of $4.2 million and $9.4 million, respectively, for state-levied guaranty fund assessments. Other underwriting expenses for 2007 also include a $1.7 million reduction in other underwriting expenses as a result of the PRI reinsurance commutation. Excluding the impact of the assessments and the PRI reinsurance commutation, other underwriting expenses increased 2 percent for 2007 compared to 2006 primarily due to the redeployment of corporate resources previously supporting our former insurance management segment to our insurance operations. Our expense ratio (defined as the ratio of other underwriting expenses to net premiums earned) was 22.6 percent and 22.5 percent for 2007 and 2006, respectively. Excluding the impact of the assessments, including recoveries, and the PRI commutation, our expense ratio was 21.7 percent for 2007 compared to 18.3 percent for 2006. The increase in the expense ratio is driven primarily by lower net premiums earned in 2007 compared to 2006.
During 2006, the IRS commenced an examination of our 2004 federal income tax return. The examination was closed in February 2007 with no significant adjustments. Our income tax returns for 2005 and 2006 have not been examined by the IRS.
Net income increased for 2006 compared to 2005 primarily due to higher net investment income and lower net losses and LAE offset to a certain extent by higher other underwriting expenses and interest expense.
The decreases in direct premiums written and net premiums written for 2006 are primarily the result of a change in business mix to lower risk specialties and to a lesser extent, a continued migration to lower policy limits in Florida, a lower number of policyholders compared with the same period in the prior year and an effective rate decrease of 9.2% at First Professionals beginning December 1, 2006. The number of professional liability policyholders was 13,402 at December 31, 2006, down 5% from 14,055 at December 31, 2005. The policyholder retention rate in our core Florida market was 94% for 2006 and 95% for 2005. National policyholder retention was 92% for 2006, compared to 94% for 2005.
Net premiums earned for 2006 was flat compared to 2005 primarily because of the factors mentioned above, offset by the termination of cessions under the Hannover Re net account quota share reinsurance agreement, under which ceded earned premiums were $8.4 million for 2005.
Net losses and LAE decreased approximately 9% for 2006 compared to 2005. Our calendar year loss ratio (defined as the ratio of net losses and LAE incurred to net premiums earned) decreased to 67% for 2006 compared to 74% for 2005. Our lower loss ratio reflects an improved current year loss ratio and favorable claims trends, including a significant reduction in newly reported claims and incidents during the year and favorable prior year loss development of $5.1 million, primarily as a result of lower expected ultimate losses for accident years 2004 and 2005. Severity of claims continued to be within our expectations.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. As a holding company, we possess assets that consist primarily of the stock of our subsidiaries and of other investments. The sources of liquidity available to us for the payment of operating expenses, taxes and debt-related amounts include management fees and dividends from our insurance subsidiaries. Management fees from our insurance subsidiaries are based upon agreements in place with First Professionals and APAC, pursuant to which we provide substantially all management and administrative services. In accordance with limitations imposed by Florida and Missouri laws, our insurance subsidiaries are permitted, within insurance regulatory guidelines, to pay us dividends of approximately $48.2 million during 2008 without prior regulatory approval.
Under the terms of the management agreements with First Professionals and APAC, we receive management fees equal to 115 percent of the costs incurred. The additional 15 percent provision in the First Professionals and APAC management fees 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 premium revenue due to higher or lower than expected new business or retention of insurance policies in force resulting in unanticipated changes in liquidity provided by our insurance subsidiaries;
Net cash flows provided by investing activities was $11.6 million for 2007 compared to net cash flows used in investing activities of $27.3 million and $130.8 million for 2006 and 2005, respectively. The increase in net cash provided by investing activities is primarily due to transactions involving fixed income securities and short-term investments, which are dependent on our cash flows from operating activities and the management of our investment portfolio. Net sales and maturities of fixed income securities, equity securities and short-term investments, were $15.9 million for 2007, compared to net purchases of $61.0 million and $133.1 for 2006 and 2005, respectively.
Capital resources consist of funds deployed or available to be deployed to support our business operations. We believe our financial strength provides us with the flexibility and capacity to obtain funds externally through debt or equity financing on both a short-term and long-term basis. Our ability to access the capital markets is dependent on, among other things, market conditions. We have accessed the debt market on certain occasions in the past. The following table summarizes the components of our capital resources:
Premiums receivable declined 23 percent to $65.2 million as of December 31, 2007, from $84.2 million as of December 31, 2006. The decline in premiums receivable is primarily associated with the decline in direct premiums written at our insurance subsidiaries.
Deferred policy acquisition costs declined 32 percent to $9.7 million as of December 31, 2007 from $14.2 million as of December 31, 2006. Approximately $3.4 million of the decline in deferred policy acquisition costs is due to the reinsurance commutation between First Professionals and PRI effective January 1, 2007. In addition, deferred policy acquisition costs declined as a result of lower agent commissions driven by lower direct premiums written in 2007.
Deferred income taxes declined 11 percent to $32.6 million as of December 31, 2007 from $36.6 million as of December 31, 2006. The decline in our net deferred tax asset is primarily a result of the PRI commutation and the resulting impact on deferred tax assets associated with unearned premiums and deferred policy acquisition costs.
Paid in advance and unprocessed premiums declined 18 percent to $11.0 million as of December 31, 2007 from $13.4 million as of December 31, 2006. The decline in paid in advance and unprocessed premiums is associated with the decline in direct premiums written at our insurance subsidiaries.
The following table summarizes our significant contractual obligations and commitments as of December 31, 2007, and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. Additional information regarding these obligations is provided in Note 4, Liability for Losses and LAE, Note 8, Income Taxes, Note 10, Long-term Debt, Note 13, Employee Benefit Plans and Note 16, Commitments and Contingencies to the consolidated financial statements included elsewhere herein.
Employee benefit plan obligations are comprised of approved plan contributions and our unfunded obligation as of December 31, 2007.
Reflects amounts recognized in our statement of financial position for unrecognized tax benefits. These items are included in the “other” column as they technically do not meet the definition of a contractual obligation as we are not contractually obligated to pay these amounts to third parties and the amount and timing of their eventual payment is sufficiently uncertain. For additional information, see Note 8, Income Taxes to the consolidated financial statements included elsewhere herein.