(4) Acquisition costs and other underwriting expenses also include salary and benefits and other insurance general and administrative expenses which represent other costs that are directly attributable to insurance activities.
(6) The foreign currency gain from discontinued operations relates to our wholly-owned subsidiary, AmTrust Pacific Limited, a New Zealand real estate operating company (“APL”). Income (loss) from discontinued operations reflects the results of operations of APL and AFS Capital Corp., a premium finance company. The real estate in the balance sheet reflects the carrying value of real estate held by APL in 2004. The mortgage notes in the balance sheet reflect mortgage debt on this real estate. All of these real estate assets were liquidated as of November 2005.
(10) Net combined ratio is calculated by adding net loss ratio and net expense ratio together.
(11) Calculated by dividing net income, by the average stockholders’ equity for the period.
Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Form 10-K. This discussion and analysis includes forward-looking statements that are subject to risks, uncertainties and other factors described under the caption “Risk Factors” beginning on page 41. These factors could cause our actual results in current and future periods to differ materially from those expressed in, or implied by, those forward-looking statements.
Overview The Company is a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. We provide insurance coverage for small businesses and products with high volumes of insureds and loss profiles which we believe are predictable. We target lines of insurance that we believe generally are underserved by larger insurance carriers. The Company has grown by hiring teams of underwriters with expertise in our specialty lines and through acquisitions of distribution networks and renewal rights to established books of specialty insurance business and Companies. We have operations in three business segments:
• Small commerical business insurance, which includes workers’ compensation, commercial package and other commercial lines produced by retail agents and brokers in the United States;
• Specialty middle-market property and casualty insurance. We write commercial insurance for homogeneous, narrowly defined classes of insureds, requiring an in-depth knowledge of the insured’s industry segment, through general and other wholesale agents.
• AIIC, which underwrites workers’ compensation insurance in the United States;
• MCIC, SNIC, TUIC, and TLIC which underwrite small commercial business coverages in the United States;
Insurance, particularly workers’ compensation, is, generally, affected by seasonality. The first quarter generally produces greater premiums than subsequent quarters. Nevertheless, the impact of seasonality on our small commercial business and specialty middle market segments has not been significant. We believe that this is because we serve many small businesses in different geographic locations. In addition, we believe seasonality may be muted by our acquisition activity.
One of the key financial measures that we use to evaluate our operating performance is return on average equity. Our return on average equity was 21.2%, 24.7% and 21.3% for the years ended December 31, 2008, 2007 and 2006, respectively. Our overall financial objective is to produce a return on average equity of 15.0% or more over the long term. In addition, we target a net combined ratio of 95.0% or lower over the long term, while seeking to maintain optimal operating leverage in our Insurance Subsidiaries commensurate with our A.M. Best rating objectives. Our net combined ratio was 74.4%, 83.2% and 91.9% for the years ended December 31, 2008, 2007 and 2006, respectively. A key factor in achieving our targeted net combined ratio is improvement of our net expense ratio. Our strategy across our segments is to maintain premium rates, deploy capital judiciously, manage our expenses and focus on the sectors in which we have expertise, which we believe will provide opportunities for greater returns.
Investment income is an important part of our business. Because the period of time between our receipt of premiums and the ultimate settlement of claims is often several years or longer, we are able to invest cash from premiums for significant periods of time. As a result, we are able to generate more investment income from our premiums as compared to insurance companies that operate in many other lines of business. Our net investment income was $57.6 million, $50.9 million and $27.6 million for the years ended 2008, 2007 and 2006, respectively. The Company held 14.2% and 11.5% of total invested assets in cash and cash equivalents as of December 31, 2008 and 2007, respectively. This relatively high concentration of cash and cash equivalents represents our reaction to the relatively flat debt yield curve and should enable the Company to quickly redeploy substantial assets should the interest rate environment change.
unearned premium. The $78.2 million consisted of $59.8 million of unearned premium related to the four acquired insurance companies at acquisition date and $18.4 million of unearned premium related to non acquired Unitrin businesses. As a result, the Company has included $18.4 million of the non acquired Unitrin businesses’ unearned premium in the Company’s written premium in 2008.
Warrantech In February of 2007, the Company participated with H.I.G. Capital, a Miami-based private equity firm, in financing H.I.G. Capital’s acquisition of Warrantech Corporation (“Warrantech”) in a cash merger. The Company contributed $3.8 million for a 27% equity interest Warrantech. Warrantech is an independent developer, marketer and third party administrator of service contracts and after-market warranty primarily for the motor vehicle and consumer product industries. The Company currently insures a majority of Warrantech’s business, which produced gross premium written of approximately $86.5 million and $41.3 million in 2008 and 2007, respectively.
Principal Revenue and Expense Items Gross Premium Written. Gross premium written represents estimated premiums from each insurance policy that we write, including as part of an assigned risk plan, during a reporting period based on the effective date of the individual policy. Certain policies that are underwritten by the Company are subject to premium audit at that policy’s cancellation or expiration. The final actual gross premiums written may vary from the original estimate based on changes to the final rating parameters or classifications of the policy.
Net Premium Earned. Net premium earned is the earned portion of our net premiums written. Insurance premiums are earned on a pro rata basis over the term of the policy. At the end of each reporting period, premiums written that are not earned are classified as unearned premiums and are earned in subsequent periods over the remaining term of the policy. Our workers’ compensation insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2007 for an employer with a constant payroll during the term of the policy, we would earn half of the premiums in 2007 and the other half in 2008. Our
specialty risk and extended warranty coverages are earned over the estimated exposure time period. The terms vary depending on the risk and have an average duration of approximately 32 months, but range in duration from one month to 84 months.
Net Investment Income and Realized Gains and (Losses). We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity and equity securities. Our net investment income includes interest and dividends earned on our invested assets. Net realized gains and losses on our investments are reported separately from our net investment income. Net realized gains occur when our investment securities are sold for more than their costs or amortized costs, as applicable. Net realized losses occur when our investment securities are sold for less than their costs or amortized costs, as applicable, or are written down as a result of other-than-temporary impairment. We classify equity securities and most of our fixed maturity securities as available-for-sale and the remainder of our fixed maturity securities as held-to-maturity. Net unrealized gains (losses) on those securities classified as available-for-sale are reported separately within accumulated other comprehensive income on our balance sheet.
Commission and Fee Income. We recognize commission and fee revenue as a servicing carrier for the Arkansas, Indiana, Illinois, Georgia and Virginia assigned risk plans. In addition, we also offer claims adjusting and loss control services for fees to unaffiliated third parties. We also recognize fee income associated with the issuance of workers’ compensation policies for installment fees, in jurisdictions where it is permitted and approved, and reinstatement fees, fees charged to reinstate a policy after it has been cancelled for non-payment, in jurisdictions where it is permitted and approved. Our specialty risk and extended warranty business generates fee revenue for product warranty registration and claims handling services provided to unaffiliated third parties. We also recognize brokerage and asset management fees in association with our reinsurance agreement with Maiden.
Loss and Loss Adjustment Expenses Incurred. Loss and loss adjustment expenses (“LAE”) incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expenses related to estimates of future claim payments based on case-by-case valuations and statistical analyses. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our insurance policies is a critical factor in our profitability.
Net Expense Ratio. The net expense ratio is a measure of an insurance company’s operational efficiency in administering its business. Expressed as a percentage, this is the ratio of the sum of acquisition costs and other underwriting expenses less ceding commission to net premiums earned.
Premiums. Insurance premiums, other than specialty risk and extended warranty, are recognized as earned on the straight-line basis over the contract period. Insurance premiums on specialty risk and extended warranty are earned based on estimated program coverage periods. These estimates are based on the expected distribution of coverage periods by contract at inception, because a single contract may contain multiple coverage period options and these estimates are revised based on the actual coverage periods selected by the insured. Unearned premiums represent the portion of premiums written which is applicable to the unexpired term of the contract or policy in force. Premium adjustments on contracts and audit premiums are based on estimates made over the contract period. The Company also estimates an allowance for doubtful accounts based on a percentage of premium. The Company reviews its bad debt write-offs at least annually and adjusts its premium percentage as required. Allowance for doubtful accounts were approximately $8,131 and $7,828 at December 31, 2008 and 2007, respectively.
We believe this method, which tracks the development of claims incurred in a particular time period, is the best method for projecting our ultimate liability. These factors are dependent on a number of elements, including frequency and severity of claims, length of time to achieve ultimate settlement of claims, projected inflation of medical costs and wages (for workers’ compensation), insurance policy coverage interpretations, judicial determinations and existing laws and regulations. The predictive ability of loss development factors is dependent on consistent underwriting, claims handling, and inflation, among other factors, and predictable legislatively and judicially imposed legal requirements. If all things remain equal, losses incurred in 2008 should develop similarly to losses incurred in 2007 and prior years. Thus, if the Net Loss Ratio for premiums written in year one is 55.0% we expect that the Net Loss Ratio for premiums written in year two also would be 55.0%. However, due to the inherent uncertainty in the loss development factors, our actual liabilities may differ significantly from our original estimates.
Notwithstanding the inherent uncertainty, the Company has not experienced material variability in its loss development factors. We believe that it is reasonably likely that we could experience a 5% deviation in our loss and loss adjustment expense reserves due to changes in the elements that underlie loss development, such as claims frequency or severity. As of December 31, 2008, the average cost per workers compensation claim was $10,484, which was a 6% increase over the claims severity from 2001-2007 of $9,929. In 2008, claims frequency (number of claims per $1.0 million of payroll) increased to .965 from 0.944, an increase of 2.2%, for the period between 2001 and 2007.
On a quarterly basis, and in some cases more frequently, we review our reserves to determine whether they are consistent with our actual results. In the event of a discrepancy, we would seek to determine the causes (underwriting, claims, inflation, regulatory) and would adjust our reserves accordingly. For example, if the development of our total incurred losses were 5% greater than the loss development factors would have predicted, we would adjust our reserves for the periods in question. In 2006, we recognized a $0.5 million deficiency in the prior year’s reserves. In 2007, we recognized a $2.1 million deficiency in prior year’s reserves, related to our mandatory participation in the reinsurance pools which reinsure state assigned risk plans for workers compensation insurance. In 2008, we recognized a $0.5 million redundancy. We do not anticipate that we will make any material reserve adjustments, but will continue to monitor the accuracy of our loss development factors and adequacy of our reserves. Additional information regarding our reserves for loss and loss adjustment expenses can be found in “Risk Factors” and “Business - Loss Reserves.”
Reinsurance. Reinsurance premiums, losses and LAE are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums earned and losses incurred ceded to other companies have been recorded as a reduction of premium revenue and losses and LAE. Commissions allowed by resinsurers on business ceded have been accounted for as ceding commission revenue. Reinsurance recoverables are reported relating to the portion of reserves and paid losses and LAE that are ceded to other companies. The Company remains contingently liable for all loss payments, in the event of failure to collect from the reinsurer.
Deferred Policy Acquisition Costs. We defer commission expenses, premium taxes and assessments as well as certain marketing, sales, underwriting and safety costs that vary with and are primarily related to the acquisition of insurance policies. These acquisition costs are capitalized and charged to expense ratably as premiums are earned. The Company may realize deferred policy acquisition costs only if the ratio of loss and loss adjustment expense reserves (calculated on a discounted basis) to the premiums to be earned is less than 100%, as it historically has been. If, hypothetically, that ratio were to be above 100%, the Company could not continue to record deferred policy acquisition costs as an asset and may be required to establish a liability for a premium deficiency reserve.
As of December 31, 2008, if the actual results of the future premiums audits were 1% lower than the historical results used in calculating EBUB, the result would be a decrease in EBUB and net earned premium of $2.0 million or $1.2 million after tax. If the actual results of the future premiums audits were 1% higher
Fixed-maturity securities and equity securities are reported at their estimated fair values based on quoted market prices or a recognized pricing service, with unrealized gains and losses, net of tax effects, reported as a separate component of comprehensive income in stockholders’ equity. Realized gains and losses are determined on the specific identification method.
• any reduction or elimination of dividends, or nonpayment of scheduled interest payments; and
Income Taxes - The Company joins its domestic subsidiaries in the filing of a consolidated Federal income tax return and is party to a Federal income tax allocation agreement. Under the tax sharing agreement, the Company pays to or receives from its subsidiaries the amount, if any, by which the group’s Federal income tax liability was affected by virtue of inclusion of the subsidiary in the consolidated Federal return.
Deferred income taxes reflect the impact of “temporary differences” between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax asset primarily consists of the book versus tax differences for premiums earned, loss and loss adjustment expense reserve discounting, policy acquisition costs, earned but unbilled premiums, and unrealized holding gains and losses on marketable equity securities. Changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income, primarily unrealized investment gains and losses and foreign currency translation gains and losses, are recorded directly to other comprehensive income. Otherwise, changes in deferred income tax assets and liabilities are included as a component of income tax expense.
cessions of $247.3 million and $376.5 million to Maiden Insurance for the years ended 2007 and 2008, respectfully, under the terms of the Reinsurance Agreement, which was entered into during the third quarter of 2007. The increase before cessions by segment was: small commercial business - $119.8 million; specialty risk and extended warranty - $102.1 million; and specialty middle market property and casualty - $42.3 million.
Net Premium Earned. Net premium earned decreased $5.1 million or 1.1% from $444.2 million to $439.1 million for the year ended December 31, 2007 and 2008, respectively. Net earned premium for the years ended 2007 and 2008, respectively, reflected cessions of $110.2 million and $285.1 million to Maiden Insurance under the terms of the Reinsurance Agreement, which was entered into during the third quarter of 2007. The increase by segment before cessions was: small commercial business - $44.2 million; specialty risk and extended warranty - $95.4 million; and specialty middle market property and casualty - $30.3 million.
Income Tax Expense (Benefit). Income tax expense for the year ended December 31, 2008 was $20.6 million and resulted in an effective tax rate of 19.9%. Income tax expense for year ended December 31, 2007 was $36.7 million and resulted in an effective tax rate of 28.9%. The decrease in the effective tax rate in 2008 resulted primarily from Company subsidiaries, domiciled in the United States, recognizing net realized losses on investments. Thus a higher percentage of income was earned by Company subsidiaries not subject to U.S. taxation. Additionally, the Company earned federal tax-exempt investment income during 2008.
Net Premium Earned. Net premium earned increased $115.2 million or 35.0% from $329.0 million to $444.2 million for the year ended December 31, 2006 and 2007, respectively. The increase of $115.2 million was net of earned premium ceded to Maiden Insurance during the second half of 2007 under the terms of a reinsurance agreement entered into during the third quarter of 2007. Before cessions to Maiden Insurance, earned premium increased $225.4 million for 2007 compared 2006. The increase by segment before cessions was: small commercial business - $64.0 million; specialty risk and extended warranty - $86.5 million; and specialty middle market property and casualty - $74.9 million.
Ceding Commission. Ceding commission represents commission earned primarily through its quota share agreement with Maiden Insurance, whereby AmTrust receives a 31% ceding commission on ceded written premiums to Maiden. The ceding commission earned in 2007 was $62.8 million.
Ceding Commission Revenue. Ceding commission revenue increased $22.6 million or 62.2% from $36.4 million in 2007 to $59.0 million in 2008. The increase resulted from the impact of the Reinsurance Agreement with Maiden Insurance being in effect for a full year in 2008.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses decreased $49.1 million or 35.3% from $139.1 million to $90.0 million for the years ended December 31, 2007 and 2008, respectively. The improvement of the loss and loss adjustment ratio resulted from the effect of the Company’s actual loss experience, which has continued to develop more favorably than the Company’s actuarially projected ultimate losses as well as a reduction of a approximately $8 million in loss reserves related to prior accident years.
Net Premiums Earned Less Expenses Included in Combined Ratio (Underwriting Income). Underwriting income increased $0.7 million to $44.2 million for the year ended December 31, 2008 from $43.5 million for the year ended December 31, 2007. The increase is attributable to an increase in premium writings in the fourth quarter of 2008.
Small Commercial Business Segment Results of Operation 2007 Compared to 2006 Gross Premium Written. Gross premiums written increased $49.9 or 19.3% from $258.9 million to $308.8 million for the year ended December 31, 2006 and 2007, respectively. The increase in the Small commercial business segment related primarily to $17.1 million of additional premiums resulting from the acquisition from Muirfield Underwriters, Ltd. of its distribution network and the renewal rights to its existing business during the second quarter of 2006, additional premiums of $17.7 million related to the acquisition of AIIC in the third quarter of 2007 and $15.1 million from organic growth.
Net Premium Written. Net premiums written decreased $45.9 million or 19.2% from $239.5 million to $193.6 million for the year ended December 31, 2006 and 2007, respectively. The decrease of $45.9 million was net of $86.4 million of premium written ceded to Maiden Insurance during the second half of 2007 under the terms of a reinsurance agreement entered into during the third quarter of 2007. Before cessions to Maiden Insurance, net premium written increased $40.5 million in 2007 compared 2006 and was the result of an increase in gross premium written.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $6.3 million or 4.7% from $132.8 million to $139.1 million for the years ended December 31, 2006 and 2007, respectively. The Company’s loss ratio for the segment for 2007 decreased to 58.5% from 60.1% for 2006. Before cessions to Maiden, loss and loss adjustment expense would have been $166.3 million and its loss ratio would have been 58.3%. The decrease in the overall loss ratio resulted from positive trends the Company experienced in its loss development in both current and prior accident years (with the exception of losses attributable to the NCCI Pools). These trends allowed the Company to reduce its ultimate loss projections.
Net Premium Written. Net premium written increased $71.6 million or 52.0% from $137.6 million to $209.2 million for the years ended December 31, 2007 and 2008, respectively. Net written premium reflected cessions of $131.6 million and $101.1 million to Maiden Insurance for the years ended 2008 and 2007, respectively, under the terms of the Reinsurance Agreement, which was entered into during the third quarter of 2007. Before cessions to Maiden Insurance, net premium written increased $102.1 million in 2008 compared to 2007 and was the result of an increase in gross premium written.
Ceding Commission Revenue. Ceding commission revenue increased $15.5 million or 134.8% from $11.5 million in 2007 to $27.0 million in 2008. The increase resulted from the full year impact of the Reinsurance Agreement with Maiden Insurance being in effect for a full year in 2008.
Specialty Risk and Extended Warranty Segment Results of Operation 2007 Compared to 2006 Gross Premium Written. Gross premium written increased $173.6 million or 130.6% from $132.8 million to $306.4 million for the year ended December 31, 2006 and 2007, respectively. The increase in premium consisted, primarily, of $79.4 million and $36.0 million from new coverage plans in the United States and Europe, respectively, and $58.2 million from an acquisition of IGI in the second quarter of 2007. $30.6 million of the premium increase in the United States in 2007 was generated by two customers, including Warrantech.
Acquisition Costs and Other Underwriting Expenses. Acquisition Costs and Other Underwriting Expenses increased $13.8 million or 142.3% from $9.7 million to $23.5 million for the year ended December 31, 2006 and 2007, respectively. The increase resulted from incurring policy and acquisition expenses and additional salary and benefits expense from the acquisition of IGI in 2007.
Specialty Middle Market Segment Result of Operations 2008 Compared to 2007 Gross Premium Written. Gross premium written increased $11.6 million or 5.2% from $224.2 million to $235.8 million for the years ended 2007 and 2008, respectively. The increase resulted primarily from the growth of existing worker’s compensation programs and commercial auto liability programs. The increase was offset by a decline in the credit business, which the Company writes on behalf of HSBC Insurance Company of Delaware, pursuant to a 100% fronting arrangement entered into in connection with its acquisition of WIC in 2006. The gross premium written pursuant to the arrangement have begun to wind down.
Ceding Commission Revenue. Ceding commission revenue increased $14.5 million or 97.3% from $14.9 million in 2007 to $29.4 million in 2008. The increase resulted from the impact of the Reinsurance Agreement with Maiden Insurance being in effect for a full year in 2008.
Acquisition Costs and Other Underwriting Expenses. Acquisition Costs and Other Underwriting Expenses increased $17.9 million from $40.4 million for the year ended December 31, 2007 to $58.3 million for the year ended December 31, 2008. The increase related primarily to higher policy acquisition costs during 2008.
Net Premium Written. Net premium written increased $5.4 million or 6.5% from $83.3 million to $88.7 million for the years ended 2006 and 2007, respectively. The increase of $5.4 million was net of $59.8 million of written premium ceded to Maiden Insurance during the second half of 2007 under the terms of a reinsurance agreement entered into during the third quarter of 2007. Before cessions to Maiden Insurance, net written premium increased $65.2 million for the year ended 2007 compared to the year ended 2006. The increase of $65.2 million resulted from an increase in gross premium written in 2007.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses increased $28.0 million or 99.6% from $28.1 million to $56.0 million for the years ended December 31, 2006 and 2007, respectively. The loss ratio for the segment for the year ended December 31, 2007 decreased to 61.9% from 62.8% for the year ended December 31, 2006. Before cessions to Maiden, the loss and loss adjustment expense was $73.4 million and the loss ratio was 61.4%. The loss ratio remained consistent year over year.
Our investment portfolio, including cash and cash equivalents, had a carrying value of $1,348.0 million and $1,261.6 million (excluding $13.5 million and $28.0 million of other investments) as of December 31, 2008 and 2007, respectively, and is summarized in the table below by type of investment.
Other investments represented approximately 1.0% and 2.2% of the Company’s total investment portfolio as of December 31, 2008 and 2007, respectively. At December 31, 2008 other investments consisted primarily of limited partnerships or hedge funds totaling $3.6 million, the equity investment in Warrantech of $2.1 million, an annuity of $1.3 million, an equity investment in a company in the amount of $0.9 million in the form of a secured loan and miscellaneous investments totaling $5.6 million. At December 31, 2007, other investments consisted primarily of limited partnerships or hedge funds totaling $16.5 million, the equity investment in Warrantech of $3.1 million, real estate of $1.3 million and miscellaneous investments of $2.1 million. Additionally, the Company had an equity investment in a company in the amount of $5.0 million in the form of a secured loan.
The table below summarizes the credit quality of our fixed maturity securities as of December 31, 2008 and 2007 as rated by Standard and Poor’s.
The table below summarizes the average duration by type of fixed maturity as well as detailing the average yield as of December 31, 2008:
• how long and by how much the fair value of the security has been below its amortized cost;
In addition to non-cash write-downs of $21.4 million the Company took for the impaired equity securities during 2008, at December 31, 2008, the Company had $55.5 million of gross unrealized losses related to marketable equity securities. The Company’s investment in marketable equity securities consist of investments in common stock across a wide range of sectors. The Company evaluated the near-term prospects for recovery of fair value in relation to the severity and duration of the impairment and has determined in each case that the probability of recovery is reasonable. Within the Company’s portfolio of common stocks, 33 equity securities comprised $51 million, or 90% of the unrealized loss. 14 securities in the consumer products sector
represent approximately 25% of the total fair value and 33% of the Company’s unrealized loss. 4 securities in the financial sector represent approximately 8% of the total fair value and 3% of the Company’s total unrealized losses and 12 common stocks in the health care, industrial and technology sectors which have fair values of approximately 25%, 6% and 8%, respectively, and approximately 18%, 17% and 7%, respectively, of the Company’s unrealized losses. Additionally, the Company owns 3 stocks in other sectors which accounts for 10% of the Company’s unrealized losses. The duration of these impairments range from 1 to 23 months. The remaining securities in a loss position are not considered individually significant and accounted for 10% of the Company’s unrealized losses. The Company believes these securities will recover and that we have the ability and intent to hold them until recovery.
For further information on the Company’s investments and related performance, see Note 3. “Investments” in the audited consolidated financial statements included elsewhere in this report.
Our Insurance Subsidiaries principal sources of operating funds are premiums, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund our anticipated growth, by providing capital to increase the surplus of our insurance company subsidiaries as well as for payment of claims and operating expenses, payment of interest and principal on debt facilities and other holding company expenses until at least December 31, 2009. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth.
The Company has coverage for its casualty lines of business under excess of loss reinsurance agreements. The agreement covers losses in excess of $2 million per occurrence up to a maximum $12 million. The agreement also provides “clash” protection for qualifying claims for losses in excess of $12 million up to a maximum of $32 million.
We reevaluate our reinsurance program annually or more frequently and consider a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms. Even if we maintain our existing retention levels, if the cost of reinsurance increases, our cash flow from operations would decrease as we would cede a greater portion of our premiums written to our reinsurers. Conversely, our cash flow from operations would increase if the cost of reinsurance declined relative to our retention.
Comparison of Years Ended December 31, 2008 and 2007 Net cash provided by operating activities was $64.3 million for the year ended December 31, 2008, compared to $248.2 million for the same period in 2007. For the year ended 2008, major components of cash provided by operating activities were premiums settled of $996.5 million offset by claim payments of $257.2 million, and overall higher level of cessions and operating expenses. For the year ended 2007, major components of cash provided by operating activities were premiums settled of $729.4 million, partially offset by claim payments of $180.1 million.
Net cash used in investing activities was $176.0 million for the year ended December 31, 2008. Net cash used in investing activities was $343.1 million for the year ended December 31, 2007. In 2008, major components of net cash used in investing activities primarily included the acquisition of UBI for $55.9 million and net purchases of investments of $109.9 million. In 2007, major components of net cash used in investing activities primarily included net purchases of equity, fixed maturity securities, other investments and short term investments of $285.8 million and the purchases of Associated and IGI for $35.7 million.
In 2008, premium receivables, net increased $161,821 as a result of a higher overall level of premium writing in 2008, the acquisition of UBI and the entering into a managing general agency relationship in the fourth quarter with CardinalComp in 2008. Reinsurance recoverable increased $302,908 and prepaid reinsurance premium increased $127,346 as a result of increased cessions to Maiden due to higher premium volumes and cessions of unearned premium related to the UBI acquisition. Loss and loss expense reserves increased $238,667 in 2008 as a result of entering into a managing general agency relationship in the fourth quarter with Cardinal Comp as well as increased premium writings in the fourth of 2008 compared to the fourth quarter of 2007.
payments beginning on September 3, 2008 of $3.3 million and ending on June 3, 2011. The loan carries a variable rate and is based on a Eurodollar rate plus an applicable margin. The Eurodollar rate is a periodic fixed rate equal to the London Inter bank Offered Rate “LIBOR” and had a margin rate of 185 basis points and was 4.07% as of December 31, 2008. The Company can prepay any amount of the loan after the first anniversary date without penalty upon prior notice. The term loan contains affirmative and negative covenants, including limitations on additional debt, limitations on investments and acquisitions outside the Company’s normal course of business. The loan requires the Company to maintain a debt to capital ratio of 0.35 to 1 or less. The Company incurred financing fees of $0.1 million related to the agreement.
Note Payable - Collateral for Proportionate Share of Reinsurance Obligation In conjunction with the Reinsurance Agreement between AII and Maiden Insurance, AII entered into a loan agreement with Maiden Insurance during the fourth quarter of 2007, whereby, Maiden Insurance will lend to AII from time to time for the amount of obligation of the AmTrust Ceding Insurers that AII is obligated to secure, not to exceed an amount equal to the Maiden Insurance’s proportionate share of such obligations to such AmTrust Ceding Insurers in accordance with the Reinsurance Agreement. The Company is required to deposit all proceeds from the advances into a sub-account of each trust account that has been established for each AmTrust Ceding Insurer. To the extent of the loan, Maiden Insurance is discharged from providing security for its proportionate share of the obligations as contemplated by the Reinsurance Agreement. If an AmTrust Ceding Insurer withdraws loan proceeds from the trust account for the purpose of reimbursing such AmTrust Ceding Insurer, for an ultimate net loss, the outstanding principal balance of the loan shall be reduced by the amount of such withdrawal. The loan agreement was amended in February 2008 to provide for interest at a rate of LIBOR plus 90 basis points and is payable on a quarterly basis. Each advance under the loan is secured by a promissory note. Advances totaled $168.0 million as of December 31, 2008.
Contractual Obligations and Commitments The following table sets forth certain of our contractual obligations as of December 31, 2008:
(1) The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2008 and actuarial estimates of expected payout patterns and are not contractual liabilities as to a time certain. Our contractual liability is to provide benefits under the policy. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our loss and loss adjustment expense estimate process, see “Business - Loss Reserves.” Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the table above to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See “Risk Factors - Risks Related to Our Business - Our loss reserves are based on estimates and may be inadequate to cover our actual losses” for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
(3) We are required by the terms of certain purchase agreements to pay the seller an annual minimum override payment based on a contractually defined formula. The amount payable to the seller under these agreements could be materially higher if the premiums produced generate a higher payment than the
calculated minimum payment. Additionally, the Company is holding approximately $4.3 million of the purchase price, which will be distributed upon resolution of a pending tax matter.