The primary sources of the Company's liquidity are (1) funds generated from insurance operations including net investment income, (2) proceeds from the sale of investments and (3) proceeds from maturing investments. The Company generally experiences positive cash flow resulting from the fact that premiums are collected on insurance policies in advance of the disbursement of funds in payment of claims. Operating costs of the insurance subsidiaries, other than loss and loss expense payments, generally average less than 30% of premiums earned on a consolidated basis and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided. Because losses are often settled in periods different from when they are incurred, at times, operating cash flows may turn negative as loss settlements on claim reserves established in prior years exceed net premium revenue and receipts of investment income. During 2003, positive cash flow from operations totaled $56.9 million compared to $38.1 million in 2002, as market conditions remained positive allowing the Company to continue to expand its market share in all of its major lines of business.
For several years, the Company's investment philosophy has emphasized the purchase of short-term bonds with maximum quality and liquidity. As interest rates have declined and yield curves have not provided a strong incentive to lengthen maturities in recent years, the Company has maintained its short-term position with respect to the vast majority of its fixed maturity investments. The average life of the Company's bond and short-term investment portfolio was 2.8 years and 2.9 years at December 31, 2003 and 2002, respectively. The Company also remains an active participant in the equity securities market using capital which is not considered necessary to fund current operations. The long-term nature of the Company's equity investments allows it to invest in positions where ultimate value, and not short-term market fluctuations, is the primary focus. Investments made by the Company's domestic insurance subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners which are designed to provide protection for both policyholders and shareholders.
Net premiums written by the Company's U.S. insurance subsidiaries for 2003 equaled approximately 40% of the combined statutory surplus of these subsidiaries. Premium writings of 200% to 300% of surplus are generally considered acceptable by regulatory authorities. Further, the statutory capital of each of the insurance subsidiaries substantially exceeds minimum risk based capital requirements set by the National Association of Insurance Commissioners. Accordingly, the Company has the ability to significantly increase its business without seeking additional capital to meet regulatory guidelines.
of minimum statutory capital requirements. However, management believes that these restrictions pose no material liquidity concerns for the Company. The financial strength and stability of the subsidiaries permit ready access by the parent company to short-term and long-term sources of credit. The Company has no long-term or short-term debt outstanding at December 31, 2003.
Premiums assumed from other insurers and reinsurers totaled $11.1 million during 2003, an increase of $3.0 million (37%) from 2002. Improved pricing in this market allowed the Company to increase its participation in existing treaties and, to a lesser extent, add new treaties during 2003. Premium volume for this division is limited by the Company's self-imposed limitation to loss from a single catastrophic event. Further, the Company's participation in reinsurance assumed in the future will be restricted should pricing become less favorable.
After giving effect to changes in unearned premiums, net premiums earned increased 40% to $146.2 million for 2003 from $104.4 million for 2002. Excluding inter-company reinsurance arrangements, net premiums earned from all trucking-related insurance products increased by $29.3 million (48%). Net premiums earned from the Company's private passenger automobile, non-affiliated reinsurance assumed and small workers' compensation programs also increased $6.4 million (20%), $3.0 million (39%) and $2.6 million (76%), respectively.
Including the deficiency noted above for the small business workers' compensation product, the Company produced an overall savings on the handling of prior year claims during 2003 of $13.6 million. This net savings is included in the computation of loss ratios shown in the above table. Because of the high limits provided by the Company to its large trucking fleet insureds, the length of time required to settle larger, more complex claims and the volatility of the trucking liability insurance business, the Company believes it is important to have a high degree of conservatism in its reserving process. As claims are settled in years subsequent to their occurrence, the Company's claim handling process has, historically, tended to produce savings from the reserves provided. The Company believes that favorable loss developments are attributable to the Company's long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Changes in both gross premium volumes and the Company's reinsurance structure for its large trucking fleets can have a significant impact on future loss developments and, as a result, loss and loss expense ratios may not be consistent year to year.
Direct premiums written for 2002 totaled $164.7 million, an increase of $50.4 million (44%) from 2001. This increase is primarily attributable to increases in fleet trucking and independent contractor programs of $35.2 million (86%) and $9.0 million (33%), respectively, from 2001 levels. Direct premium writings from the Company's private passenger automobile and small business workers' compensation programs also increased by $5.4 million (18%) and $2.0 million (46%), respectively. These increases were partially offset by a $1.2 million (10%) decrease in direct premium written for the Company's small trucking fleet program. Large trucking fleet volume increased primarily from the addition of new accounts during 2002. Premium rate increases also contributed to higher large trucking fleet premium in 2002 although rate increases on renewals were not as significant as in 2001. The higher premium volume from the independent contractor program resulted from the addition of contractors by existing accounts. Increases in private passenger automobile and small business workers' compensation were due primarily to geographic expansion, although modest rate increases were implemented in both divisions during 2002. The decrease in small trucking fleet premium resulted from continuing competitive market pressures within that segment.
Premiums assumed from other reinsurers totaled $8.1 million during 2002, an increase of $2.5 million (43%) from 2001. Premiums assumed for 2001 included $1.0 million of reinstatement premiums attributable to losses reported that year. Without these reinstatement premiums, reinsurance assumed volume would have increased 74% from the prior year. Improved pricing in this market allowed the Company to increase its participation via several new treaties since the 2001 period.
Premiums ceded to reinsurers increased $26.2 million (70%) during 2002 to $63.8 million. The percentage of premiums ceded to direct premiums written increased to 39% for 2002 from 33% for 2001 consistent with the increase in direct premiums written for the more heavily reinsured large trucking fleet program discussed above. While the average ceding rate for large fleet trucking was lower in 2002, a significantly higher portion of consolidated premium revenue was concentrated in this product line, resulting in the increase in the overall average ceding rate.
After giving effect to changes in unearned premiums, net premiums earned increased 26% to $104.4 million for 2002 from $83.1 million for 2001. Net premiums earned from all trucking-related insurance products increased by $18.6 million (44%). Net premiums earned from the Company's voluntary reinsurance assumed and small workers' compensation programs increased $2.1 million (37%) and $.7 million (26%), respectively. These increases were partially offset by a $.3 million (1%) decrease in premiums earned from private passenger automobile.
Losses and loss expenses incurred during 2002 decreased $13.8 million (17%) to $68.1 million. Losses and loss expenses for 2001 included $20 million related to the events of September 11, 2001 ("WTC loss"). Adjusting 2001 losses and loss expenses for the WTC loss, losses and loss expenses for 2002 were $6.2 million (10%) higher due mainly to the increased premium volume during 2002. The 2002 consolidated loss and loss expense ratio was 68.5% compared to 74.4% for 2001, after adjustment for the WTC loss. All of the Company's individual product lines contributed to the more favorable loss and loss expense ratio. The improved loss and loss expense ratios for the Company's private passenger automobile, small fleet trucking and
All marketable securities are included in the Company's balance sheet at current fair market value.
decline in value is less than 20% but the amount of the decline is considered significant, a similar objective evaluation is conducted but, in these cases, we will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other than temporary. For any decline which is considered to be other than temporary, we recognize an impairment loss in the current period operating results as an addition to realized capital losses. Declines which are considered to be temporary are recorded as a reduction in shareholders' equity, net of related federal income tax credits.
It is important to note that all investments included in the Company's financial statements are valued at current fair market values. The evaluation process for determination of other than temporary decline in value of investments does not change these valuations but, rather, determines when the decline in value will be recognized in the income statement (other than temporary decline) as opposed to a charge to shareholders' equity (temporary decline). Subsequent recoveries in value of investments which have incurred an other than temporary impairment adjustment are accounted for as unrealized gains until the security is actually disposed. At December 31, 2003, unrealized gains include $4.3 million of appreciation on investments previously adjusted for "other than temporary" impairment. This evaluation process is subject to risks and uncertainties since it is not always clear what has caused a decline in value of an individual security or since some declines may be associated with general market conditions or economic factors which relate to an industry, in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process which results in automatic income statement recognition of any investment which, over a six month period, is unable to recover from a 20% decline in value from our cost basis. However, to the extent that certain declines in value are reported as unrealized at December 31, 2003, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2003, the total gross unrealized loss included in the Company's investment portfolio was less than $1.2 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other than temporary at December 31, 2003, realized capital losses would have increased by $.05 per share for the year. There would, however, have been no impact on total shareholders equity or book value per share since the decline in value of these securities was already recognized as a reduction to shareholders equity at December 31, 2003.
reinsurer's portion of theloss. The financial condition of each of the Company's reinsurers is initially determined upon the execution of a given treaty and only reinsurers with the highest credit ratings available are utilized. However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period. Reviews of the current financial strength of each reinsurer are made continually and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company's additional liability. Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit risk rather than a deficiency associated with the loss reserving process.
Any forward-looking statements in this report including, without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including, without limitation, the
To the extent possible, the Company attempts to recover the costs of inflation by increasing the premiums it charges. A majority of the Company's premiums are charged as a percentage of an insured's gross revenue or payroll. As these charging bases increase with inflation, premium revenues are immediately increased. The remaining premium rates charged are adjustable only at periodic intervals and often require state regulatory approval. Such periodic increases in premium rates may lag far behind cost increases.
The Company operates solely within the property and casualty insurance industry and, accordingly, has significant invested assets which are exposed to various market risks. These market risks relate to interest rate fluctuations, equities market prices and, to a lesser extent, foreign currency rate fluctuations. All of the Company's invested assets are classified as available for sale and are listed as such in Note B to the consolidated financial statements.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Baldwin & Lyons, Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other insurers have been reported as a reduction of premium income. Amounts applicable to reinsurance ceded for unearned premium and claim loss reserves have been reported as reinsurance recoverable assets. Certain reinsurance contracts provide for additional or return premiums and commissions based upon profits or losses to the reinsurer over prescribed periods. Estimates of additional or return premiums and commissions are adjusted quarterly to
EARNINGS PER SHARE: Diluted earnings per share of common stock are based on the average number of shares of Class A and Class B common stock outstanding during the year, adjusted for the effect, if any, of options outstanding. Basic earnings per share are presented exclusive of the effect of options outstanding. See note H.
The reserves for losses and loss expenses, net of related reinsurance recoverables, at December 31, 2002, 2001 and 2000 were decreased by $13,586, $10,008 and $887, respectively, for claims that had occurred on or prior to those dates. These decreases are the result of the settlement of claims at amounts lower than previously reserved and changes in estimates of losses incurred but not reported as part of the normal reserving process. Included in the above developments during 2003 and 2002, are decreases of $1,659 and $1,539, respectively, in reserves outstanding at December 31, 2002 and 2001 for losses and loss expenses related to environmental damage claims. The development during 2001 was insignificant for environmental claims. Reserves for incurred but not reported environmental losses were $2,500 and $3,900 at December 31, 2003 and 2002, respectively. Development during 2003 also included an increase in reinsurance assumed loss and loss expense reserves at December 31, 2002 of $799. Development during 2002 included a decrease in reinsurance assumed loss reserves at December 31, 2001 of $1,305. Development during 2001 included $2,100 of incurred losses and loss expenses on reinsurance assumed reserves outstanding at December 31, 2000 which was partially offset by reinstatement premiums of $1,000. Favorable loss development is influenced by the Company's long-standing policy of reserving for losses realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. Under terms of reinsurance agreements effective June 1, 1998, the Company's exposure on large fleet trucking losses dropped from $1,000 to $100 per occurrence. Effective June 1, 2001, June 1, 2002 and June 1, 2003, terms of replacement reinsurance agreements increased the Company's maximum exposure on large fleet trucking losses to $1,020, $1,400 and $1,625, respectively, per occurrence. The increased net retention per occurrence is reflected in the increase in favorable development during 2003. These trends were considered in the establishment of the Company's reserves at December 31, 2003.
Loss reserves on certain permanent total disability workers' compensation reserves have been discounted to present value at pre-tax rates not exceeding 3.5%. At December 31, 2003 and 2002, loss reserves have been reduced by approximately
$5,549 and $6,396, respectively. Discounting is applied to these claims since the amount of periodic payments to be made during the lifetime of claimants is fixed and determinable.
NOTE E - REINSURANCE The insurance subsidiaries cede portions of their gross premiums written to certain other insurers under excess and quota share treaties and by facultative placements. Risks are reinsured with other companies to permit the recovery of a portion of related direct losses. The Company also serves as an assuming reinsurer under retrocessions from certain other reinsurers. These retrocessions include individual risks as well as aggregate catastrophe treaties. Accordingly, the occurrence of a major catastrophic event can have a significant impact on the Company's operations. In addition, the insurance subsidiaries participate in certain involuntary reinsurance pools which require insurance companies to provide coverages on assigned risks. The assigned risk pools allocate participation to all insurers based upon each insurer's portion of premium writings on a state or national level.
Shareholders' equity at December 31, 2003 includes $310,870 representing GAAP shareholder's equity of insurance subsidiaries, of which $45,654 may be transferred by dividend or loan to the parent company without approval by, or notification to, regulatory authorities. An additional $193,723 of shareholder's equity of such insurance subsidiaries may be advanced or loaned to the Company with prior notification to and approval from regulatory authorities.
NOTE I - REPORTABLE SEGMENTS The Company and its consolidated subsidiaries market and underwrite casualty insurance in five major specialty areas (reportable segments): (1) fleet trucking, (2) nonstandard private passenger automobile, (3) small fleet trucking, (4) the assumption of reinsurance and (5) small business workers' compensation. The fleet trucking segment provides multiple line insurance coverage to large trucking fleets which generally retain substantial amounts of self-insurance and to medium-sized trucking fleets on a first dollar or small deductible basis. The nonstandard private passenger automobile segment provides motor vehicle liability and physical damage coverages to individuals. The small fleet trucking segment provides commercial automobile coverages to small trucking fleets and owner/operators. The reinsurance assumed segment accepts retrocessions from selected reinsurance companies, principally reinsuring against catastrophes. The small business workers' compensation segment provides workers' compensation coverages to small businesses and other entities.
The Company evaluates performance and allocates resources based on gain or loss from insurance underwriting operations before income taxes. Underwriting gain or loss does not include net investment income nor does it include realized gains or losses on the Company's investment portfolio. All investment-related revenues are managed at the corporate level. Underwriting gain or loss for the fleet trucking segment includes revenue and expense from the Company's agency operations since the agency operations serve as an exclusive direct marketing facility for this segment. Underwriting gain or loss also includes fee income generated by each segment in the course of its underwriting operations. Management does not identify or allocate assets to reportable segments when evaluating segment performance and depreciation expense is not material for any of the reportable segments. The accounting policies of each reportable segment are the same as those described in the summary of significant accounting policies.
NOTE I - REPORTABLE SEGMENTS (CONTINUED) The following table provides certain profit and loss information for each reportable segment for the years ended December 31:
The Company maintains stock option plans and has reserved an aggregate of 1,312,500 shares of Class B common stock for the granting of stock options to employees and directors. No options were granted to employees during the three year period ended December 31, 2003. All employee options outstanding at December 31, 2003 are exercisable. Discounted options granted to directors are generally not exercisable for one year from the date of grant. All options expire ten years after the date of grant. All of the Company's option plans have received shareholder approval. Approximately 326,000 of such options are available for future grants.
Acceptable collateral may be provided in the form of letters of credit on Company approved banks, Company approved marketable securities or cash. At December 31, 2003, the Company held collateral in the aggregate amount of $177,847. The amount of collateral required of an insured is determined by the financial condition of the insured, the type of obligations guaranteed by the Company, estimated reserves for incurred losses within the SIR or deductible that have been reported to the insured or the Company, estimated incurred but not reported losses, and estimates for losses that are expected to occur, within the SIR or deductible, prior to the next collateral adjustment date. In general, the Company attempts to hold collateral equal to 100% of the ultimate losses that would be paid by or due the Company in the event of the insured's default. Periodic audits are conducted by the Company to evaluate its exposure and the collateral required. If a deficiency in collateral is noted as the result of an audit, additional collateral is requested immediately. Because collateral amounts contain numerous estimates of the Company's exposure, are adjusted only periodically and are sometimes adjusted based on the financial condition of the insured, the amount of collateral held by the Company at a given point in time may not be sufficient to fully reimburse the Company for all of its guarantees or amounts due in the event of an insured's default. Further, the Company is not fully collateralized for the guarantees made for, or the deductible amounts that may be due from, the Company's largest customer, and in the event of that customer's default, such default may have a material adverse impact on the Company.