Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
limits prescribed by statute, municipal or other regulatory requirements. The majority of our policyholders are individual owners or small fleet operators. In certain jurisdictions like Illinois, Nevada and New York, we have also been successful working with larger operators who retain a meaningful amount of their own risk of loss through higher retentions, self-insurance or self-funded captive insurance entity arrangements. In these cases, we provide support in the areas of day to day policy administration and claims handling consistent with the value proposition we offer to all of our insureds, generally on a fee for service basis. We may also provide excess coverage above the levels of risk retained by the insureds where a better than average loss ratio is expected. Through these arrangements, we are able to effectively utilize the significant specialized operating infrastructure we maintain to generate revenue from business segments that may otherwise be more price sensitive in the current market environment.
The other line of business is comprised of Gateway's truck and workers' compensation programs (currently in run off), American Services' non-standard personal lines business (currently in run off ), Atlas' workers' compensation related to taxi, other liability and assigned risk business.
Non-standard automobile insurance is principally provided to individuals who do not qualify for standard automobile insurance coverage because of their payment history, driving record, place of residence, age, vehicle type or other factors. Such drivers typically represent higher than normal risks and pay higher insurance rates for comparable coverage.
We approach investment and capital management with the intention of supporting insurance operations by providing a stable source of income to supplement underwriting income. The goals of our investment policy are to protect capital while optimizing investment income and capital appreciation and maintaining appropriate liquidity. We follow a formal investment policy and the Board of Directors reviews the portfolio performance at least quarterly for compliance with the established guidelines. The Investment Committee of the Board of Directors provides interim guidance and analysis with respect to asset allocation, as deemed appropriate.
The combined ratio improved by 3.7 percentage points to 90.7% on a full year basis and was 88.4% in the fourth quarter
Operating income was $4.0 million or $0.33 diluted earnings per common share in the fourth quarter of 2014
Net income for the full year was $17.7 million, compared to net income of $6.2 million in the prior year
Diluted earnings per common share was $1.56, inclusive of the reduction of the valuation allowance for deferred tax assets
The following financial data is derived from Atlas’ consolidated financial statements for the for the years ended December 31, 2014 and December 31, 2013.
other items. These amounts are more heavily influenced by market opportunities and other external factors. Operating income should not be viewed as a substitute for U.S. GAAP net income.
We achieved substantial premium growth primarily through organic vertical expansion of core lines of business written in our target markets. There was an increase in gross premium written related to core commercial lines of 35.0% for the year ended December 31, 2014 as compared to the year ended December 31, 2013. When excluding our excess taxi program, which experienced a modest increase in gross premium written, for the year ended December 31, 2014, gross premium written on our traditional core lines increased by 40.6% as compared to the prior year. The pricing activity and claims initiatives were the primary drivers for loss ratio improvement in 2014. The overall loss ratio for the year ended December 31, 2014 improved to 62.3% as compared to 63.9% in the year ended December 31, 2013.
Fair values for marketable bonds and equity securities are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or values obtained from independent pricing services through a bank trustee.
security's credit worthiness using both quantitative tools and qualitative review. At the issuer level, this includes reviews of past financial data, trends in financial stability, projections for the future, reliability of the management team in place, market data (credit spread, equity prices, trends in this data for the issuer and the issuer's industry). Reviews also consider industry trends and the macro-economic environment. This analysis is continuous, integrating new information as it becomes available. As of December 31, 2014, this process did not generate any significant difference in the rating assessment between Atlas' review and the rating agencies.
In the year ended December 31, 2014, gross premium written from commercial automobile was $119.5 million, representing a 35.0% increase relative to the year ended December 31, 2013. This substantial increase is primarily the result of the planned expansion of the commercial auto business. Removing the impact of the excess taxi program, our traditional commercial automobile gross premium written was $106.5 million, an increase of 40.6% versus the year ended December 31, 2013. Gross premium written attributable to the Gateway acquisition and subsequent organic growth related to that subsidiary in 2014, was approximately $17.3 million and $12.6 million for the years ended December 31, 2014 and 2013, respectively. As a percentage of the insurance subsidiaries’ overall book of business, commercial auto gross premium written represented 97.6% of gross, and 99.6% of net, premium written in the year ended December 31, 2014 compared to 95.2% and 105.9%, respectively, during the year ended December 31, 2013.
heavily reinsured. The percentage of premium ceded is driven by the business mix within our total premium base. As of July 1, 2014, Atlas implemented a quota share reinsurance agreement for its commercial auto and general liability lines of business which provides the Company with financial flexibility to manage expected growth and the timing of potential future capital raising activities. With the exception of this quota share reinsurance agreement, all of our reinsurance partners have remained consistent since 2013.
Premiums are earned ratably over the term of the underlying policy. Net premium earned was $98.1 million in the year ended December 31, 2014, a 37.5% increase compared with $71.3 million in the year ended December 31, 2013. The increase in net premiums earned is attributable to the combined effects of the issues cited in the ‘Gross Premium Written’ and ‘Ceded Premium Written’ sections above.
The loss ratio relating to the claims incurred in the year ended December 31, 2014 was 62.3% compared to 63.9% in the year ended December 31, 2013. Loss ratios improved in the year ended December 31, 2014 relative to prior periods primarily due to the increased percentage of commercial auto, which has historically had a better overall underwriting result, relative to total written premium. In both years, the excess taxi program contributed significantly to favorable loss results in the year as we expect better than average claim experience from this program. We believe that our extensive experience and expertise with respect to underwriting and claims management in all our commercial lines will allow us to continue this decreasing trend since we expect 100% of net premium earned to be related to core lines of business moving forward. The Company is committed to retain this claim handling expertise as a core competency as the volume of business increases.
The other underwriting expense ratio was 14.1% in the year ended December 31, 2014 compared to 16.0% in the year ended December 31, 2013. We expect our underwriting expense ratio to continue trending lower as a result of the growth of our core lines and our increasing operational scale. Approximately 1.0% of the full year 2013 other underwriting expense ratio was attributed to Gateway integration costs. There were no Gateway related integration costs in 2014.
The other underwriting expense ratio in 2014 excludes $694,000 in transaction costs incurred in conjunction with the acquisition of Global Liberty. The other underwriting expense ratio in 2013 excludes $406,000 in transaction costs incurred in conjunction with the acquisition of Gateway.
Investment income (excluding net realized gains) net of investment expenses increased by 45.3% to $3.1 million in the year ended December 31, 2014, compared to $2.1 million in the year ended December 31, 2013. These amounts are primarily comprised of interest income. This increase is primarily due to higher return on certain securities in our investment portfolio.
Net realized investment gains in the year ended December 31, 2014 were $382,000 compared to $529,000 in the year ended December 31, 2013. The difference is the result of management's decision not to sell fixed income securities due to unfavorable market conditions.
Atlas recorded other income in the year ended December 31, 2014 of $2,000 compared to other income of $13,000 for the year ended December 31, 2013. Other income was primarily comprised of miscellaneous balances recovered.
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and loss adjustment expense (LAE) ratio, the acquisition cost ratio and the underwriting expense ratio. Atlas’ combined ratio for the years ended December 31, 2014 and 2013 are summarized in the table below. The underwriting income is attributable to the factors described in the ‘Claims Incurred’, ‘Acquisition Costs’, and ‘Other Underwriting Expenses’ sections above.
1 - Underwriting expenses are the combination of claims incurred, acquisition costs, and other underwriting expenses and, for 2013, does include the Gateway integration costs. However, underwriting expenses does not include the transaction costs incurred in conjunction with the acquisitions mentioned in the 'Other Underwriting Expenses' section' above.
Our combined ratio improvement in 2014 is attributed to the combined effects of the issues cited in the ‘Claims Incurred’, ‘Acquisition Costs’, 'Other Underwriting Expenses' and 'Net Premium Earned' sections above.
Atlas generated pre-tax income of $11.9 million in the year ended December 31, 2014, compared to pre-tax income of $6.3 million in year ended December 31, 2013.
For the year ended December 31, 2014, there were 10,937,181 weighted average common shares outstanding used to compute basic earnings per common share and 11,341,588 were used for the diluted earnings per common share computation. For the year ended December 31, 2013, there were 8,007,458 weighted average common shares outstanding used to compute basic earnings per common share and 10,840,868 used for the diluted earnings per common share computation.
Atlas held securities with a fair value of $143.4 million at December 31, 2014, which was primarily comprised of fixed income securities. The securities held by the insurance subsidiaries must comply with applicable regulations that prescribe the type, quality and concentration of securities. These regulations in the various jurisdictions in which the insurance subsidiaries are domiciled permit investments in government, state, municipal and corporate bonds, preferred and common equities, and other high quality investments, within specified limits and subject to certain qualifications.
The amortized cost, gross unrealized gains and losses and fair value for Atlas’ investments in fixed maturities, equity, and other investments by type and sector are as follows (all amounts in '000s):
Credit risk is defined as the risk of financial loss due to failure of the other party to a financial instrument to discharge an obligation. Atlas is exposed to credit risk principally through its investments and balances receivable from policyholders and reinsurers. It monitors concentration and credit quality risk through policies designed to limit and monitor its exposure to individual issuers or related groups (with the exception of U.S. government bonds) as well as through ongoing review of the credit ratings of issuers in the securities portfolio. Credit exposure to any one individual policyholder is not material. The Company's policies, however, are distributed by agents who may manage cash collection on its behalf pursuant to the terms of their agency agreement. Atlas has policies to evaluate the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurers’ insolvency.
The following table summarizes the composition of the fair value of the fixed income securities portfolio (excluding the bond which has been classified in Level 3 within the fair value hierarchy in 2013), excluding cash and cash equivalents, as of the dates indicated, by ratings assigned by Fitch, S&P or Moody’s Investors Service. The fixed income securities portfolio consists of predominantly very high quality securities in corporate and government bonds with 87.4% rated ‘A’ or better at December 31, 2014 compared to 88.3% at December 31, 2013.
The length of time securities may be held in an unrealized loss position may vary based on the opinion of the appointed investment manager and their respective analyses related to valuation and to the various credit risks that may prevent us from recapturing the principal investment. In cases of securities with a maturity date where the appointed investment manager determines that there is little or no risk of default prior to the maturity of a holding, Atlas would elect to hold the security in an unrealized loss position until the price recovers or the security matures. In situations where facts emerge that might increase the risk associated with recapture of principal, Atlas may elect to sell securities at a loss. Atlas had no material gross unrealized losses in its portfolio at December 31, 2014 or at December 31, 2013.
For Atlas’ available-for-sale fixed income securities held at December 31, 2014, a 100 basis point increase in interest rates on such held fixed income securities would have increased net investment income and income before taxes by approximately $100,000. Conversely, a 100 basis point decrease in interest rates on such held fixed income securities would decrease net investment income and income before taxes by $102,000.
Atlas generally purchases reinsurance to limit net exposure to a maximum amount on any one loss of $500,000 with respect to commercial automobile liability claims. Atlas also purchases reinsurance to protect against awards in excess of its policy limits. Atlas continually evaluates and adjusts its reinsurance needs based on business volume, mix, and supply levels. As a result, the Company has entered into a quota share reinsurance contract with Swiss Reinsurance America Corporation ("Swiss Re"), a highly accredited global reinsurer. Our initial cession is 5% of subject written premiums which can be increased at our election should we want to utilize it as a means of deleveraging. This new facility gives us flexibility in terms of the timing and approach to potential future capital raising activities in light of anticipated increased operating leverage.
Reinsurance ceded does not relieve Atlas of its ultimate liability to its insured in the event that any reinsurer is unable to meet their obligations under its reinsurance contracts. Therefore, Atlas enters into reinsurance contracts with only those reinsurers deemed to have sufficient financial resources to provide the requested coverage. Reinsurance treaties are generally subject to cancellation by the reinsurers or Atlas on the anniversary date and are subject to renegotiation annually. Atlas regularly evaluates the financial condition of its reinsurers and monitors the concentrations of credit risk to minimize its exposure to significant losses as a result of the insolvency of a reinsurer. Atlas believes that the amounts it has recorded as reinsurance recoverables are appropriately established. Estimating amounts of reinsurance recoverables, however, is subject to various uncertainties and the amounts ultimately recoverable may vary from amounts currently recorded. Atlas had $20.7 million recoverable from third party reinsurers (exclusive of amounts prepaid) and other insurers at December 31, 2014 as compared to $19.1 million at December 31, 2013.
Atlas has the following total net operating loss carryforwards at December 31, 2014:
On May 22, 2012, Atlas closed the sale of the headquarters building to 150 Northwest Point, LLC, a Delaware limited liability company. Atlas recognized a gain on the sale of this property of $213,000, which will be deferred and recognized over the 5 year lease term. Atlas recognized $43,000 as an offset to rent expense for both the years ended December 31, 2014 and 2013. Total rental expense recognized on the headquarters building was $707,000 and $699,000 for the years ended December 31, 2014 and 2013, respectively. There are two properties located in Alabama which are for sale. These properties are listed for sale for amounts greater than carried values.
The table below shows the amounts of total case reserves and incurred but not reported (“IBNR”) claims provision at December 31, 2014 and at December 31, 2013. The provision for unpaid claims increased by 1.0% to $102.4 million at December 31, 2014 compared to $101.4 million at December 31, 2013. During the year ended December 31, 2014, case reserves decreased by 18.2% compared to December 31, 2013, while IBNR reserves increased by 56.3% generally due to the consolidation of its reserve balances and the increase in premiums earned in our core commercial lines of business.
The Gateway truck and workers' compensation programs were put into run-off during 2012. The workers' compensation program is 100% reinsured retrospectively and prospectively to an unrelated third party.
Claims liabilities - The changes in the provision for unpaid claims, net of amounts recoverable from reinsurers, for the years ended December 31, 2014 and December 31, 2013 were as follows ($ in '000's):
The process of establishing the estimated provision for unpaid claims is complex and imprecise, as it relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provision necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made. The change to the provision for unpaid claims is consistent with the changes in written premium. However, because the establishment of reserves is an inherently uncertain process involving estimates, current provisions may not be sufficient. Adjustments to reserves, both positive and negative, are reflected quarterly in the statement of income as estimates are updated.
As of December 31, 2014, Atlas has the following cash obligations related to its operating leases:
The table below identifies changes in shareholders’ equity for the years ended December 31, 2014 and December 31, 2013:
As of March 5, 2015, there were 11,646,130 ordinary common shares outstanding and 132,863 restricted common shares outstanding, and 2,000,000 preferred shares issued and outstanding.
All of the issued and outstanding restricted voting common shares are beneficially owned or controlled by Kingsway America, Inc. ("KAI"), or its affiliated entities. The restricted voting common shares will convert to ordinary voting common shares in the event that these KAI owned shares are sold to non-affiliates of KAI. As of December 31, 2014, KAI's ownership of AFH common stock was less than 2%.
In our opinion, Atlas Financial Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We have audited the accompanying consolidated statement of financial position of Atlas Financial Holdings, Inc. as of December 31, 2014 and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for the year ended December 31, 2014. In connection with our audit of the consolidated financial statements, we have also audited the financial statements schedules listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Atlas Financial Holdings, Inc. as of December 31, 2013, and the results of its consolidated operations and its cash flows for the year ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements as a whole, present fairly, in all material respects, the information set forth therein.
Classification of assets and liabilities - It is not customary in the insurance and financial services industries to classify assets and liabilities as current (settled in 1 year or less) and non-current (settled beyond 1 year). Assets and liabilities that could otherwise be classified as current include cash and cash equivalents, accrued investment income, accounts receivable and other assets, certain amounts due from reinsurers and other insurers, income tax receivable, deferred policy acquisition costs, assets held for sale, accounts payable and accrued expenses, due to reinsurers and other insurers. Balances that would otherwise be classified as non-current include deferred tax assets and office equipment. All other assets and liabilities include balances that are both current and non-current.
Financial instruments - Financial instruments are recognized and derecognized using trade date accounting, since that is the date Atlas contractually commits to the purchase or sale with the counterparty.
Available for sale (“AFS”) - Investments in fixed income securities are classified as available for sale. Securities are classified as available-for-sale when Atlas may decide to sell those securities due to changes in market interest rates, liquidity needs, changes in yields or alternative investments, and for other reasons. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of income tax, included as a separate component of accumulated other comprehensive income (loss) in shareholder’s equity.
For equity securities, the Company evaluates its ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence considered to determine anticipated recovery are analysts' reports on the near-term prospects of the issuer and the financial condition of the issuer or the industry, in addition to the length and extent of the market value decline. If OTTI is identified, the equity security is adjusted to fair value through a charge to earnings.
Atlas employs specific control processes to determine the reasonableness of the fair value of its financial assets. These processes are designed to supplement those performed by Atlas' investment advisor to ensure that the values received from them are accurately recorded and that the data inputs and the valuation techniques utilized are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. For example, on a continuing basis, Atlas assesses the reasonableness of individual security values which have stale prices or whose changes exceed certain thresholds as compared to previous values received from Atlas' investment advisor or to expected prices. The portfolio is reviewed routinely for transaction volumes, new issuances, any changes in spreads, as well as the overall movement of interest rates along the yield curve to determine if sufficient activity and liquidity exists to provide a credible source for market valuations. When fair value determinations are expected to be more variable, they are validated through reviews by members of management or the Board of Directors who have relevant expertise and who are independent of those charged with executing investment transactions.
When anticipated losses, loss adjustment expenses, commissions and other acquisition costs exceed recorded unearned premium and any future installment premiums on existing policies, a premium deficiency reserve is recognized by recording a reduction to DPAC with a corresponding charge to operations. Atlas utilizes anticipated investment income as a factor in its premium deficiency calculation. Atlas concluded that no premium deficiency adjustments were necessary in either of the years ended December 31, 2014 and December 31, 2013.
Deferred taxes are recognized using the asset and liability method of accounting. Under this method the future tax consequences attributable to temporary differences in the tax basis of assets, liabilities and items recognized directly in equity and the financial reporting basis of such items are recognized in the financial statements by recording deferred tax liabilities or deferred tax assets.
Share-based payments - Atlas has a stock-based compensation plan which is described fully in Note 12 of the Consolidated Financial Statements. Under U.S. GAAP, the fair-value method of accounting is used to determine and account for equity settled transactions and to determine stock-based compensation awards granted to employees and non-employees using the Black-Scholes option pricing model. Compensation expense is recognized over the period that the stock options vest, with a corresponding increase to additional paid in capital.
Except for rules and interpretative releases of the SEC under authority of federal securities laws and a limited number of grandfathered standards, the Financial Accounting Standards Board ("FASB") ASC is the sole source of authoritative U.S. GAAP recognized by the FASB that is applicable to the Company. All recently issued accounting pronouncements with effective dates prior to January 1, 2015 have been adopted by the Company. There were no adoptions in 2014 that had a material impact on the Consolidated Financial Statements. All other recently issued accounting pronouncements with effective dates after December 31, 2014 are not expected to have a material impact on the Consolidated Financial Statements.
In the first quarter of 2015 (having received regulatory approval on March 4, 2015), we anticipate consummating the acquisition of Anchor Holdings Group, Inc., a privately owned insurance holding company, and its wholly owned subsidiary, Global Liberty Insurance Company of New York, along with its affiliated entities, Anchor Group Management, Plainview Premium Finance Company, Inc. and its wholly owned subsidiary Plainview Premium Finance Company of California, Inc., or collectively "Global Liberty", from an unaffiliated third party. Global Liberty provides specialized commercial insurance products, including commercial automobile insurance to niche markets such as taxi, black car and sedan service owners and operators primarily in the New York market.
Global Liberty is a New York-based insurance company that was writing approximately $40.0 million of annual taxi and limousine net written premium in states deemed favorable to Atlas at the time of our acquisition. Global Liberty is an admitted carrier in 13 states plus the District of Columbia. Atlas' acquisition of Global Liberty will expand our distribution channel for core commercial automobile lines.
The total purchase price for all of Camelot Services’ outstanding shares was $14.3 million, consisting of a combination of cash and Atlas preferred shares. Consideration consisted of a $6.0 million dividend paid by Gateway immediately prior to the closing, $2.0 million of Atlas preferred shares (consisting of a total of 2 million preferred shares) and $6.3 million in cash. The agreement includes contractual protections to offset up to $2.0 million of future reserve development. We have also agreed to provide the sellers up to $2.0 million in additional consideration in the event of favorable reserve development.
Earnings per ordinary and restricted common share (collectively, the "common shares") for the years ended December 31, 2014 and December 31, 2013 are as follows ($ in '000's except for share and per share amounts):
Diluted earnings per common share is computed by dividing net income attributable to Atlas by the weighted average number of common shares outstanding for each period plus the incremental number of shares added as a result of converting dilutive potential ordinary shares, calculated using the treasury stock method (or, in the case of the convertible preferred shares, using the "if-converted" method).
As of December 31, 2014 there were no outstanding warrants. On August 1, 2013, 18,000,000 preferred shares were repurchased. Atlas’ dilutive potential ordinary shares consist of outstanding stock options to purchase ordinary common shares and 2,000,000 preferred shares potentially convertible to ordinary common shares at the option of the holder at any date after December 31, 2015 at the rate of 0.1270 ordinary common shares for each preferred share. The effects of these convertible instruments are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive. Convertible preferred shares are anti-dilutive when the amount of dividend declared or accumulated in the current period per common share obtainable upon conversion exceeds basic earnings per share. For the years ended December 31, 2014 and 2013, convertible preferred shares and stock options were deemed to be dilutive.
The amortized cost, gross unrealized gains and losses and fair value for Atlas’ investments in fixed maturities, equities and other investments are as follows (all amounts in '000s):
As a result of the above analysis performed by management to determine declines in fair value that may be other than temporary, there was an impairment related to an equity position that was recorded in 2013. The Company reduced the fair value of its equity position by $311,000 and recorded an adjustment through the Consolidated Statements of Income and Comprehensive Income to account for this other than temporary impairment.
The following table summarizes the components of net investment income for the years ended December 31, 2014 and 2013 (all amounts in '000s):
not material. Atlas has policies requiring evaluation of the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvency.
Equity price risk - This is the risk of loss due to adverse movements in equity prices. Atlas' investment in equity securities comprises a small percentage of its total portfolio, and as a result, the exposure to this type of risk is minimal.
Atlas employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The hierarchy is comprised of quoted prices in active markets (Level 1), third party pricing models using available trade, bid and market information (Level 2) and internal models without observable market information (Level 3). The following table summarizes Atlas' investments at fair value as of December 31, 2014 and December 31, 2013 (all amounts in '000s):
The Company's investments in fixed income securities that are classified as Level 2 in the two preceding tables consist of investments in corporate bonds, states and political subdivisions bonds and mortgage-backed securities of U.S. government agencies and other asset-backed bonds. The Company's other investments that are classified as Level 2 consist of a limited partnership that invests in equities.
For securities classified as Level 3, the Company uses valuations provided by third party fund managers. These valuations are typically the audited net book value for each limited partnership. These limited partnerships invest in income-producing real estate or catastrophe bonds.
Though Atlas believes its valuation methods are appropriate, the use of different methodologies or assumptions to determine its fair value could result in a different fair value as of December 31, 2014. Management does not believe that reasonable changes to the inputs to its valuation methodology would result in a significantly higher or lower fair value measurement.
Information by security type pertaining to the changes in fair value of the Company's investments classified as Level 3 for the years ended December 31, 2014 and 2013 are presented below (all amounts in '000s):
Net income computed under statutory-basis accounting was $2.0 million, $4.0 million and $1.7 million for American Country, American Service and Gateway, respectively, for the year ended December 31, 2014. Net income for the year ended December 31, 2013 was $1.6 million, $3.6 million and $2.1 million for American Country, American Service and Gateway, respectively. The combined statutory capital and surplus of the insurance subsidiaries was $63.0 million and $53.1 million as of December 31, 2014 and December 31, 2013, respectively.
Atlas did not declare or pay any dividends to its common shareholders during the year ended December 31, 2014 or in the year ended December 31, 2013.
The effective tax rate was (48.3)% and 1.2% for the years ended December 31, 2014 and 2013, respectively, compared to the U.S. statutory income tax rate of 34% as shown below ($ in '000s):
Income tax expense consists of the following for the years ended December 31, 2014 and 2013:
The components of deferred income tax assets and liabilities as of December 31, 2014 and December 31, 2013 are as follows (all amounts in '000s):
Atlas established a valuation allowance of $0 and $9.4 million for its gross deferred tax assets as of December 31, 2014 and as of December 31, 2013, respectively. Based on Atlas’ expectations of future taxable income, its ability to change its investment strategy, as well as reversing gross future tax liabilities, management believes it is more likely than not that Atlas will fully realize the net future tax assets. The Company, therefore, has released its remaining valuation allowance at December 31, 2014.
Atlas accounts for uncertain tax positions in accordance with the income taxes accounting guidance. Atlas has analyzed filing positions in the federal and state jurisdiction where it is required to file tax returns, as well as the open tax years in these jurisdictions. Atlas believes that its federal and state income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. Therefore, no reserves for uncertain federal and state income tax positions have been recorded. Atlas would recognize interest and penalties related to unrecognized tax benefits as a component of the provision for federal income taxes. Atlas did not incur any federal income tax related interest income, interest expense or penalties for the years ended December 31, 2014 and 2013. Tax years 2009 through 2014 are subject to examination by the Internal Revenue Service ("IRS"). The Company's 2012 tax year is currently under examination.
Claims liabilities - The changes in the provision for unpaid claims, net of amounts recoverable from reinsurers, for the years ended December 31, 2014 and 2013 were as follows (all amounts in '000s):
The process of establishing the estimated provision for unpaid claims is complex and imprecise, as it relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provision necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made. Atlas experienced favorable prior year development during 2014 of $352,000 on its core lines and $250,000 on its non-core lines, reflected as incurred related to prior years in the table above. Atlas experienced minimal unfavorable prior year development in 2013, reflected as incurred related to prior years in the table above, on its non-core lines.
1 - Options granted in Canadian dollars will be exercised at the appropriate conversion rate at the date of exercise.
In the second quarter of 2013, a new Equity Incentive Plan was approved by the Company's common shareholders at the Annual General Meeting. Atlas ceased to grant new stock options under the preceding Stock Option Plan. The Equity Incentive Plan is a new securities based compensation plan, pursuant to which Atlas may issue restricted stock grants for ordinary voting common shares, restricted units, stock grants for ordinary voting common shares, stock options and other forms of equity incentives to eligible persons as part of their compensation. The Equity Incentive Plan is considered an amendment and restatement of the Stock Option Plan, although outstanding stock options issued pursuant to the Stock Option Plan will continue to be governed by the terms of the Stock Option Plan.
The Black-Scholes option pricing model was used to estimate the fair value of compensation expense using the following assumptions - risk-free interest rate 1.88% to 3.18%; dividend yield 0.00%; expected volatility 38.00% to 100.00%; expected life of 6 to 10 years .
Warrants - On November 1, 2010, 1,327,840 subscription receipts were issued in a private placement for ordinary voting common shares of Atlas as well as warrants to purchase 1,327,840 ordinary voting common shares of Atlas for C$6.00 per share. The subscription receipts were converted to Atlas ordinary common shares at Atlas' formation. During 2013, all outstanding warrants were exercised prior to their expiration on December 31, 2013.
Defined Contribution Plan - In January 2011, Atlas formed a defined contribution 401(k) plan covering all qualified employees of Atlas and its subsidiaries. Employees can choose to contribute up to 60% of their annual earnings but not more than $17,500 for 2014 to the plan. Qualifying employees age 50 and older can contribute an additional $5,500 in 2014. Effective April 2014, Atlas matches 100% of the employee contribution up to 2.5% of annual earnings plus 50% of additional contributions up to 2.5% of annual earnings for a total maximum expense of 3.75% of annual earnings per participant. Atlas' matching contributions are discretionary. Employees are 100% vested in their own contributions and vest in Atlas contributions based on years of service with 100% vested after five years. Company contributions were $204,000 and $118,000, for the years ended December 31, 2014 and December 31, 2013, respectively.
On December 7, 2012, a shareholder meeting was held where a one-for-three reverse stock split was unanimously approved. When the reverse stock split took effect on January 29, 2013, it decreased the authorized and outstanding ordinary common shares and restricted common shares at a ratio of one-for-three. The primary objective of the reverse stock split was to increase the per share price of Atlas' common shares to meet certain listing requirements of the NASDAQ Capital Market. The share capital for the common shares is as follows:
On May 13, 2014, an aggregate of 2,000,000 Atlas ordinary shares were offered in a subsequent public offering in the United States at a price of $12.50 per share. Atlas also granted the underwriters an option to purchase up to an aggregate of 300,000 additional shares at the public offering price of $12.50 per share to cover over-allotments, if any. On May 27, 2014, the underwriters exercised this option and purchased an additional 161,000 shares. After underwriting and other expenses, total proceeds of $25.0 million were realized on the issuance of the shares. A portion of the net proceeds from the offering will be used to support the acquisition of Anchor Holdings Group, Inc. and its affiliated entities.
The cumulative amount of dividends to which the preferred shareholders are entitled upon liquidation or sooner, if Atlas declares dividends, is $184,000 as of the year ended December 31, 2014, or $0.02 per common share.
The business of Atlas is carried on through its insurance subsidiaries. Atlas’ insurance subsidiaries have been a party to various transactions with affiliates in the past, although activity in this regard has diminished over time. Related party transactions, including services provided to or received by Atlas’ insurance subsidiaries, are carried out in the normal course of operations and are measured at the amount of consideration paid or received as established and agreed upon by the parties. Such transactions
typically include claims handling services, marketing services and commission payments. Management believes that consideration paid for such services approximates fair value.
Atlas has the following future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year as of December 31, 2014 (all amounts in '000s):
The Loan Agreement requires us to comply with customary affirmative and negative covenants, including those governing indebtedness, liens, investments, sales of assets, issuance of securities, and distributions. The Loan Agreement also requires us to comply with certain financial covenants, including the Operating Subsidiaries (defined below) maintaining a combined statutory net worth in an amount not less than $50 million. The revolving loan facility is secured by all of the outstanding shares of American Country, American Service and Gateway, which are wholly-owned direct or indirect subsidiaries of American Acquisition (collectively, the “Operating Subsidiaries”). As of December 31, 2014, no funds were accessed from the line of credit nor were there letters of credit issued under the terms of this Loan Agreement.