Certain information included in this report and other statements or materials published or to be published by us are not historical facts but are forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new and existing products, expectations for market segment and growth, and similar matters. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we provide the following cautionary remarks regarding important factors which, among others, could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, and results of our business, and the other matters referred to below include, but are not limited to:
Changes in the business environment in which we operate, including inflation and interest rates;
The Commercial Lines Underwriting Group has underwriting responsibility for the commercial multi-peril package, commercial automobile, specialty property and inland marine and the antique/collector car insurance products;
The Specialty Lines Underwriting Group, has underwriting responsibility for the professional and management liability insurance products; and
The Personal Lines Group, which has underwriting responsibility for personal property insurance products for the homeowners and manufactured housing markets in Florida, and the National Flood Insurance Program for both Personal and Commercial policyholders.
We operate solely within the United States through our 13 regional and 32 field offices.
We generate most of our revenues through the sale of commercial property and casualty insurance policies. The commercial insurance policies are sold through our five distribution channels which include direct sales, retail insurance producers/open brokerage, wholesalers, preferred agents and “Firemark producers,” and the Internet. We believe that consistency in our field office representation has created excellent relationships with local insurance agencies across the country.
During 2007, we experienced strong gross written premium growth for our commercial and specialty lines segments due to an increase in policy counts resulting from continued expansion of marketing efforts through our field organization and preferred agents, and the introduction of several new niche product offerings. This strong premium growth occurred despite realized average rate decreases for commercial and specialty lines renewal business of (3.6)% and (1.8)%, respectively. We currently anticipate that these average rate decreases will continue through 2008, and may be higher than experienced during 2007. For our personal lines segment, gross written premiums declined during 2007 due to a restriction of business production which included non-renewing all
We also generate revenue from our investment portfolio, which approximated $3.0 billion as of December 31, 2007, and generated $117.2 million in pre-tax investment income during 2007. We utilize external independent professional investment managers with the objective of realizing relatively high levels of investment income while generating competitive after-tax total rates of return within specific objectives and guidelines.
The following table illustrates the 2007 calendar year and accident year loss ratios by segment.
We believe our core strategy of adhering to an underwriting philosophy of sound risk selection and pricing discipline have enabled us to produce loss ratios that have been well below industry averages. We monitor certain measures of growth and profitability for each business segment, including, but not limited to:
We regularly perform impairment reviews with respect to our investments. There are certain risks and uncertainties inherent in our impairment methodology. These include, but are not limited to, the financial condition of specific industry sectors and the resultant effect on any underlying collateral values, and changes in accounting, tax and/or regulatory requirements which may have an effect on either, or both, the investor and/or the issuer.
For investments other than interests in securitized assets, these reviews include identifying any security whose fair value is below its cost, and an analysis of securities meeting predetermined impairment thresholds to determine whether such decline is other than temporary. If we do not intend to hold a security to maturity or determine a decline in value to be other than temporary, the cost basis of the security is written down to its fair value. The amount of the write down is included in earnings as a realized investment loss in the period the impairment arose (See Investments). Gross unrealized losses for investments excluding interests in securitized assets were $26.2 million as of December 31, 2007.
The liability for unpaid loss and loss adjustment expenses reflects our best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. The process of establishing the liability for property and casualty unpaid loss and loss adjustment expenses is a complex and imprecise process, requiring the use of informed estimates and judgments. The liability includes an amount determined on the basis of claim adjusters’ evaluations with respect to insured events that have been reported to us, and an amount for losses incurred that have not yet been reported to us. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of it to us.
Estimates for unpaid loss and loss adjustment expenses are based on our assessment of known facts and circumstances, review of past loss experience and settlement patterns, and consideration of other internal and external factors. These factors include, but are not limited to,
We review these estimates regularly and any resulting adjustments are made in the accounting period in which the adjustment arose.
The table below classifies the components of our reserve for gross losses and loss adjustment expenses (“loss” or “losses”) with respect to major lines of business, as of December 31, 2007:
In general, this assumption is considered fully valid across our lines of business for older, more mature accident years. Most claims in these years have been reported, fully adjusted and settled, and any remaining unpaid claims are not anticipated to result in incurred loss activity at levels significant enough to cause material deviation in ultimate losses as projected by generally accepted actuarial methods that rely upon this assumption.
Loss reserve indications from generally accepted actuarial methods that rely upon this assumption are utilized where this assumption is considered fully valid. Where this assumption is considered to have less than full validity, those indications receive partial or no weight.
Our estimation procedures employ several generally accepted actuarial methods to determine loss reserves, each of which has its own strengths and weaknesses. These methods generally fall into one of the categories described below, or they are hybrids of one or more of them (e.g., the Bornhuetter-Ferguson method which blends development and expected methods). The predictive accuracy of any of these methods may vary by line of business, age of development, and credibility of underlying historical experience data. Loss development methods tend to be more accurate where claims data are relatively stable and for older accident years within most lines of business. Expected loss methods and hybrid methods can be more appropriate for more recent accident years. Adjusted historical loss development methods may be employed where volatile claims data can be largely attributed to discernable events, such as changes in claim handling procedures. Accordingly, more or less weight is placed on a particular method based on the facts and circumstances at the time the actuarially determined loss reserve estimates are made.
These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods assume that factors which have affected paid losses in the past, such as claim settlement patterns, inflation, or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods that use incurred losses in situations where there are significant changes in how case reserves are established by claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses, because cumulative loss payments can take much longer to converge on the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
For most lines of business, given the high level of case reserve adequacy observed in recent calendar periods and the consistent claim reserving practices employed by our claim staff, loss reserves for older accident years are generally set in accordance with ultimate projections from incurred loss development methods. Projections from paid loss development methods may be selected for these older accident years where very few claims remain open and case reserves held for those claims are low relative to observed historical average severities of similar claims.
Data for the current accident year are often too limited to provide fully reliable indications using standard loss development methods due to the delays in reporting claims and the limited time that has elapsed for adjusting the known claims. For longer-tail coverages and lines experiencing exposure growth, data may be somewhat limited in the more recently completed accident years, as well, for similar reasons. In such situations, ultimate loss is assessed by weighting results from standard paid and incurred loss development methods, with results from expected loss ratio and hybrid methods. The judgmental weights assigned are based upon the partial validity that can be attributed to the traditional methods, given the stability of underlying claim activity and exposures, with the complement of that partial validity given to the indications from expected loss ratio methods. The actuarially determined estimates by line of business are often based upon a weighted average of these results.
We have a loss reserve review committee consisting of senior members of our actuarial, corporate, claims, underwriting, marketing and financial management groups. Our committee generally meets monthly to review and discuss the various monthly and quarterly actuarial analyses which are performed, as well as to discuss any other factors or trends that may influence our claims activity. Generally, loss reserves are recorded in accordance with the actuarially determined estimates by line of business. However, based upon the review performed by the loss reserve committee, the committee may make a “management adjustment” to an actuarially determined estimate for a line of business if, in the committee’s collective judgment, factors affecting ultimate losses in a line have not been fully captured or considered by actuarial methods. This may be the case with newer product lines, lines that are growing, and/or lines which may be exposed to claims with latent emergence patterns that extend beyond the credible historical period that we have experienced to date. Any such “management adjustment” is documented and reported to our audit committee. Our loss reserve committee did not establish a management adjustment as of December 31, 2007 or 2006. Accordingly, the loss reserves recorded in the financial statements as of December 31, 2007 and 2006 are equal to the actuarially determined estimate for each line of business.
Due to numerous factors including, but not limited to, trends affecting loss development factors and pricing adequacy, our key actuarial assumptions may change. The quantification referred to in the next paragraph of the impact that changes to the actuarial assumptions could have are stated without any adjustment for reinsurance and before the effects of taxes.
For each of the key actuarial assumptions, the median difference was calculated from the historical differences between actual data and the assumptions, with the reasonably likely range identified as a 40% statistical range around the median. Therefore, the “High” (or “Low”) end of the reasonably likely range of changes for each assumption is roughly equal to the median difference plus (or minus) the amount of difference observed 40% of the time when the differences are above (or below) the median. In statistical terms, this is equivalent to taking the 30th and 70th percentiles of the assumption differences. The resulting reasonably likely changes for each of the actuarial assumptions are displayed in the second chart below.
Adjustments were not made to accident years aged beyond 10 years (i.e. 1997 and prior).
obtain collateral for balances due from reinsurers that are not approved by the Pennsylvania and/or Florida Insurance Departments due to their foreign domiciliary status; and
seek to collect the obligations of our reinsurers on a timely basis through the regular monitoring of reinsurance receivables.
Reinsurance receivables are reported net of an allowance for estimated uncollectible reinsurance receivables. The allowance is based upon our regular review of amounts outstanding, length of collection period, changes in reinsurer credit standing and other relevant factors. As of December 31, 2007, reinsurance receivables amounted to $280.1 million. Based upon our continual monitoring, analysis and evaluation, we estimate that an allowance for estimated uncollectible reinsurance receivables is not necessary as of December 31, 2007.
Our 210 preferred agents are eligible to receive profit sharing based upon achieving minimum premium production thresholds and profitability results for their business placed for a contact year with us. The ultimate amount of profit sharing may not be known until the final contractual loss evaluation of the profit sharing is completed 6.5 years after the contract year business has been written. We estimate the liability for this profit sharing based upon the contractual provisions of the profit sharing agreements and our actual historical profit sharing payout. As of December 31, 2007, we have accrued a liability for profit sharing of $33.7 million, of which $32.7 million relates to business written for contract years commencing January 1, 2004 and subsequent. We have estimated the profit sharing liability to be 2.85% of the preferred agent business written for contract years commencing January 1, 2004 and subsequent. In our judgment, it is reasonably likely that the actual profit sharing payout as a percentage of the preferred agent business could increase by up to 75 basis points or decrease by up to 50 basis points from the currently estimated 2.85%. An increase of 75 basis points would decrease our net income and financial position by approximately $7.2 million. A decrease of 50 basis points would increase our net income and financial position by approximately $4.8 million. These changes would not have a material impact on our liquidity. The maximum potential ultimate profit sharing payout is 5.0% of preferred agent business written for contract years commencing January 1, 2003 and thereafter.
Compensation expense for the share-based payment awards granted subsequent to December 31, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).
In conjunction with the adoption of SFAS 123(R), the Company elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for its pro forma information required under SFAS 123.
Since share-based compensation expense recognized in our Consolidated Statement of Operations and Comprehensive Income for the year ended December 31, 2007 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant, and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. In our pro-forma information required under SFAS 123 for the periods prior to January 1, 2006, forfeitures were estimated based upon historical experience. If factors change and different assumptions are employed in the application of SFAS 123(R) in future periods, the actual compensation expense under SFAS 123(R) may differ significantly from what was recorded in the current period.
As of December 31, 2007, there was $30.4 million of total unrecognized compensation costs related to stock options, SARS and restricted stock granted under our stock compensation plan. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.0 years.
Premiums: Premium information for the years ended December 31, 2007 and 2006 for each of our business segments is as follows (dollars in millions):
Prospecting efforts by marketing personnel in conjunction with long term relationships formed by our marketing Regional Vice Presidents continue to result in additional prospects and increased premium writings in existing product offerings, most notably for our condominium and homeowners associations, non-profit, specialty schools, and golf and country clubs products in the commercial package product grouping as well as the inland marine product in the specialty property product grouping. These product offerings accounted for approximately $123.3 million of the $218.8 million total Commercial Lines segment gross written premiums increase.
Our “Firemark producer” program, which promotes our product offerings and underwriting philosophy in selected producers’ offices.
A $3.0 million increase in gross written premium by the personal lines segment for the National Flood Insurance Program (“NFIP”) for the year ended December 31, 2007, compared to 2006. Gross written premiums for the NFIP accounted for 59.2% and 33.1% of the total personal lines segment gross written premiums for the years ended December 31, 2007 and 2006, respectively.
Restriction of personal lines business production which consisted of non-renewing all homeowners and rental dwelling policies providing windstorm coverage which expired between June 15, 2007 and December 31, 2007. This restriction was imposed to reduce our exposure to catastrophe wind losses.
In addition, on January 4, 2008, we provided the Florida Office of Insurance Regulation (“FOIR”) with the required statutory notification of our intention to non-renew all of our Florida personal lines policies, other than policies issued pursuant to the NFIP, beginning with policies expiring on or about July 15, 2008. In February 2008, we received preliminary notification from the FOIR
that they have no objection to our intention to non-renew the noted policies. We currently expect the non-renewal process to be completed by July 15, 2009. As of December 31, 2007, there were approximately 4,100 in-force policies with an aggregate in-force premium of approximately $3.2 million which expire between July 15, 2008 and December 31, 2008, which we will not renew during 2008.
A decrease in the lawyers professional liability gross written premium of $11.6 million to $0.2 million for the year ended December 31, 2007 as a result of non-renewing policies due to unacceptable underwriting results.
We believe our mixed marketing platform is a strength in that it provides us the flexibility to quickly deploy our marketing efforts from soft market segments to market segments with emerging opportunities. However, we will “walk away” from writing business that does not meet our established underwriting standards and pricing guidelines.
The respective net written premiums, and net earned premiums for our commercial lines, specialty lines and personal lines segments for the years ended December 31, 2007 and 2006, were as follows (dollars in millions):
For our commercial lines segment, we experienced rate decreases on our annual January 1, 2007 renewal of our casualty excess of loss and property excess of loss reinsurance agreements compared to the rates on our January 1, 2006 renewals of these agreements.
For our personal lines segment, our property catastrophe costs were lower for the year ended December 31, 2007 compared to December 31, 2006. For our June 1, 2007 personal lines segment property catastrophe reinsurance renewal, we experienced lower reinsurance rates, reduced our catastrophe loss retention, and purchased decreased catastrophe coverage limits due to lower exposures, compared to our June 1, 2006 renewal.
years ended December 31, 2007 and 2006, we accrued $5.0 million ($2.1 million for the commercial lines segment and $2.9 million for the specialty lines segment) and $5.3 million ($2.2 million for the commercial lines segment and $3.1 million for the specialty lines segment) respectively, of reinstatement or additional reinsurance premium under our casualty excess of loss reinsurance treaties, as a result of changes in ultimate loss estimates. The reinstatement premium increased ceded written and earned premiums and reduced net written and earned premiums.
Effective for the two-year period beginning March 1, 2007, we purchased Terrorism Catastrophe Excess of Loss reinsurance coverage for our commercial lines segment which provides, on an annual basis, in the aggregate, $50.0 million of coverage for losses arising from acts of terrorism incurred in excess of $10.0 million, after all applicable inuring reinsurance coverages. The agreements providing this coverage allows one reinstatement on an annual basis at the same cost as the initial coverage. We did not purchase similar reinsurance coverage in the prior year.
The percentage of the fixed maturity portfolio allocated to municipal security investments was increased; and
The percentage of the investment portfolio allocated to common stock investments was increased.
The taxable equivalent book yield on our fixed income holdings approximated 5.5% as of December 31, 2007, compared to 5.4% as of December 31, 2006.
For the year ended December 31, 2006, we realized net investment gains (losses) of $(1.5) million and $0.4 million from the sale of fixed maturity and equity securities, respectively, and $4.6 million and $4.2 million in realized investment losses for fixed maturity and equity securities, respectively, as a result of our impairment evaluations. The $4.6 million in realized investment losses for fixed maturities resulting from our impairment evaluations included approximately $4.2 million of realized investment losses on available for sale fixed maturity investments that were recognized as of September 30, 2006 and subsequently sold during the fourth quarter of 2006 as a result of tax planning and investment portfolio management strategies.
Net Loss and Loss Adjustment Expenses: Net loss and loss adjustment expenses increased by $150.8 million (32.2%) to $619.0 million for the year ended December 31, 2007 from $468.2 million for the year ended December 31, 2006. The loss and loss adjustment expense ratio increased to 44.9% in 2007 from 40.0% in 2006.
Professional liability, management liability, and commercial general liability coverages due to better than expected case incurred loss development primarily as a result of claim severity emergence being less than anticipated.
51.1% was estimated for the 2007 accident year. During the year ended December 31, 2006, a net ultimate loss and loss adjustment expense ratio of 47.6% was estimated for the 2006 accident year. The increase in the 2007 accident year loss and loss adjustment expense ration is principally attributable to:
Establishing loss reserve estimates is a complex and imprecise process. Our estimation procedures employ several generally accepted actuarial methods to determine net unpaid loss and loss adjustment expenses. Some of these methods are based on actual loss development, while others are based on expected loss development, and still others use a blend of both. Over time, more reliance is placed on actuarial methods based on actual loss development, and accordingly, over time, less reliance is placed on actuarial methods based on expected loss development.
Acquisition Costs and Other Underwriting Expenses: Acquisition costs and other underwriting expenses increased $74.8 million (22.1%) to $413.1 million for the year ended December 31, 2007 from $338.3 million for the year ended December 31, 2006. The expense ratio increased to 30.0% in 2007 from 28.9% in 2006. The increase in acquisition costs and other underwriting expenses was due primarily to the 18.0% growth in net earned premiums.
The increase in the expense ratio for the year ended December 31, 2007 was due primarily to:
A $3.0 million change in the net reduction to expenses related to assessments from Citizen’s Property Insurance Corporation (“Citizens”). During 2007, we recognized a net reduction to expense of $0.4 million related to the Citizens assessments, compared to a net reduction to expense of $3.4 million related to Citizens assessments during 2006. The expense reduction during 2007 is attributable to recoupments recognized from our policyholders.
Income Tax Expense: Our effective tax rate for the years ended December 31, 2007 and 2006 was 32.7% and 33.5%, respectively. The effective rates for 2007 and 2006, respectively, differed from the 35% statutory rate principally due to investments in tax-exempt securities and the relative proportion of tax exempt income to our income before tax. The decrease in the effective tax rate during 2007 is due principally to increased investments in tax exempt securities.
Prospecting efforts by marketing personnel in conjunction with long term relationships formed by our marketing Regional Vice Presidents continue to result in additional prospects and increased premium writings in existing product offerings, most notably for our non-profit, condominium association and sports leagues commercial package product lines. These product offerings accounted for approximately $105.3 million of the $209.1 million total Commercial Lines segment gross written premiums increase.
Continued expansion of marketing efforts relating to Commercial Lines and Specialty Lines products through our field organization and preferred agents.
An increase to in-force policy counts as of December 31, 2006 versus December 31, 2005 of 57.3% for the Commercial Lines segment. The introduction of the antique/collector vehicle program accounted for 22.3% of the 57.3% total policy count increase. The other factors discussed above accounted for the remaining 35.0% increase in the policy counts.
A decrease in mobile homeowners gross written premium of $13.7 million from Liberty’s continuing shift in product mix as a result of reducing mobile homeowners product policies and increasing homeowners product policies. This $13.7 million decrease was offset in part by a $4.9 million increase in homeowners gross written premium.
Restricting new personal lines business production of Liberty due to the significant increase in catastrophe reinsurance rates and restricted availability of reinsurance catastrophe coverage experienced at the June 1, 2006 catastrophe reinsurance renewal.
A decrease in in-force policy counts for the personal lines segment of 27.2%, resulting from a decrease to the in-force counts for the mobile homeowners product and the homeowners product of 76.6% and 19.0%, respectively, due to the factors noted above.
Realized average rate decreases on renewal business approximating 0.5% for the specialty lines segment.
Certain of our reinsurance contracts have reinstatement or additional premium provisions under which we must pay reinstatement or additional reinsurance premiums to reinstate coverage provisions upon utilization of initial reinsurance coverage. During the years ended December 31, 2006 and 2005, we accrued $5.3 million ($2.2 million for the commercial lines segment and $3.1 million for the specialty lines segment) and $3.7 million ($1.6 million for the commercial lines segment and $2.1 million for the specialty lines segment) respectively, of reinstatement or additional reinsurance premium under our casualty excess of loss reinsurance treaties, as a result of changes in ultimate loss estimates. The reinstatement premium increased ceded written and earned premiums and reduced net written and earned premiums.
During the year ended December 31, 2005, we experienced catastrophe losses attributable to Hurricanes Dennis, Katrina, Rita and Wilma. These multiple hurricane events resulted in the recognition of reinstatement and accelerated catastrophe reinsurance premium expense of $3.9 million ($0.6 million for the Commercial Lines Segment and $3.3 million for the Personal Lines Segment) during the year ended December 31, 2005 due to the utilization of certain of our catastrophe reinsurance coverages. This recognition of reinstatement and accelerated reinsurance premium expense increased reinsurance ceded written and earned premiums and reduced net written and earned premiums. We experienced no such catastrophe losses during 2006.
Net Investment Income: Net investment income approximated $91.7 million in 2006 and $63.7 million in 2005. Total investments grew to $2,433.6 million at December 31, 2006 from $1,935.0 million at of December 31, 2005. The growth in investment income is primarily due to increased investments which arose from investing net cash flows provided from operating activities, during a period in which the general level of interest rates increased and in which we increased the average duration of our fixed income portfolio. Our average duration of our fixed maturity portfolio was 4.6 years and 4.0 years at December 31, 2006 and December 31, 2005, respectively. The decision to increase the average duration of our fixed maturity portfolio was based upon enterprise risk management analyses completed during 2006. The analyses indicated the capacity to further refine the risk/return profile of the investment portfolio. Based upon the analyses, the following actions were implemented:
The total pre-tax return, which includes the effects of both income and price returns on securities, of our fixed income portfolio was 4.57% and 2.34% for the years ended December 31, 2006 and 2005, respectively, compared to the Lehman Brothers Intermediate Aggregate Bond Index (“the Index”) total pre-tax return of 4.63% and 2.01% for the same periods, respectively. We expect some variation in our portfolio’s total return compared to the Index because of the differing sector, security and duration composition of its portfolio as compared to the Index.
For the year ended December 31, 2005, we realized net investment gains of $3.5 million and $11.5 million from the sale of fixed maturity and equity securities, respectively, and $0 million and $2.2 million in non-cash realized investment losses for fixed maturity and equity securities, respectively, as a result of our impairment evaluation. The $11.5 million net realized gains from the sale of equity securities included approximately $11.0 million of net realized gains as a result of the liquidation of certain of our equity portfolios following our decision to change four of our common stock investment managers. Net realized investment gain for the year ended December 31, 2005 was reduced by $3.2 million due to the recognized loss of the change in fair value of a cash flow hedge we entered into for which the anticipated transaction did not occur.
For accident year 2005, the decrease in estimated net unpaid loss and loss adjustment expenses was principally due to lower estimates for commercial coverages due to better than expected case incurred loss development. The incurred frequency emergence on general liability coverages, and the incurred severity emergence on property and auto coverages, were less than anticipated.
For accident year 2003, the decrease in estimated net unpaid loss and loss adjustment expenses was principally due to lower estimates for professional liability coverages and rental/leasing auto coverages due to better than expected case incurred loss development. The incurred severity emergence on professional liability E&O and D&O coverages, and the incurred frequency emergence on rental/leasing auto coverages, were less than anticipated.
A $24.7 million reduction in hurricane catastrophe losses incurred. During the year ended December 31, 2005, we incurred $24.7 million of net loss and loss adjustment expenses related to Hurricanes Dennis, Katrina, Rita and Wilma. We incurred no such catastrophe losses during the year ended December 31, 2006.
An $18.3 million reduction in ceded loss and loss adjustment expenses pursuant to a 10% quota share agreement (See Premiums). Ceded loss and loss adjustment expenses pursuant to this quota share agreement for the year ended December 31, 2005 were $18.3 million; however, due to our decision to terminate this agreement on a run-off basis effective December 31, 2004, there were no losses ceded to this agreement during 2006.
$7.2 million of share-based compensation expense allocated to underwriting and acquisition expenses which was recognized under SFAS 123(R), which we adopted on January 1, 2006.
A $21.3 million decrease in ceding commission earned pursuant to our quota share agreements (See “Premiums”). During the year ended December 31, 2006, we earned no ceding commissions related to quota share agreements, as compared to $21.3 million of ceding commissions earned during 2005. There were no ceded earned premiums pursuant to these quota share agreements for the year ended December 31, 2006 as compared to $43.7 million for 2005 due to our decision to terminate its 10% quota share agreement on a run-off basis effective December 31, 2004.
Citizens was established by the State of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. Citizens assessments may be recouped through future insurance policy surcharges to Florida insureds. These surcharges are recorded in our consolidated financial statements as the related premiums are written.
Other Operating Expenses: Other operating expenses decreased by $4.5 million to $12.6 million for the year ended December 31, 2006 from $17.1 million for the same period of 2005. Of this decrease, $2.0 million is due to a bonus accrual for the year ended December 31, 2005 related to the terms of an employment agreement with our founder and Chairman. There was no such bonus accrual for 2006.
Of our total investments in fixed maturity securities, asset backed, mortgage pass-through, and collateralized mortgage obligation securities, on a cost basis, amounted to $199.3 million, $604.3 million and $329.5 million, respectively, as of December 31, 2007, and $202.1 million, $425.5 million and $293.1 million, respectively, as of December 31, 2006.
The following table identifies the period of time securities with an unrealized loss as of December 31, 2007 have continuously been in an unrealized loss position. None of the amounts shown in the table include unrealized losses due to non-investment grade fixed maturity securities. No issuer of securities or industry represents more than 3.8% and 19.9%, respectively, of the total estimated fair value, or 9.0% and 20.5%, respectively, of the total gross unrealized loss included in the table below:
The industry concentration as a percentage of total estimated fair value represents investments in a geographically diversified pool of investment grade Municipal securities issued by states, political subdivisions, and public authorities under general obligation and/or special district/purpose issuing authority. The unrealized losses on these securities are generally attributable to spread widening. The primary factor underlying the spread widening is the increasing market risk aversion to issues surrounding the monoline financial guarantors, given the monolines’ significant participation in the Municipal sector through their financial guarantee insurance.
The contractual repayment of the Municipal securities is backed either by the general taxing authority of the state or political subdivision or by general or specific revenues of the public authorities. Additionally, a portion of the securities are backed by financial guarantee insurance issued by the monoline financial guarantors. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized costs of the investments. Given the investment grade credit quality of the issuers represented in the Municipal portfolio, without considering any monoline financial guarantee, we believe we will be able to collect all amounts due according to the contractual terms of the investments. At the present time, we have the ability and intent to hold these securities until a recovery of fair value, which may be maturity; therefore, we do not consider these investments to be other than temporarily impaired as of December 31, 2007.
The unrealized losses on our Aaa/AAA rated investments in U.S. Treasury Securities and Obligations of U.S. Government Agencies are attributable to interest rate fluctuations since the date of purchase. Of the 30 investment positions held, approximately 26.7% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments.
The unrealized losses on our investments in long term tax exempt securities which have ratings of A1/A+ to AAA/Aaa are generally caused by spread widening. Of the 873 investment positions held, approximately 32.8% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments.
The unrealized losses on our investments in Asset Backed Securities which have ratings from A2/A to Aaa/AAA are generally caused by spread widening. Of the 116 investment positions held, approximately 40.5% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments.
The unrealized losses on our investments in Collateralized Mortgage Obligations which have ratings of Aa2/AA+ to Aaa/AAA are generally caused by spread widening. Of the 172 investment positions held, approximately 41.3% were in an unrealized loss
position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments.
Our impairment evaluation as of December 31, 2007 for equity securities resulted in the conclusion that we do not consider the equity securities to be other than temporarily impaired. Of the 2,674 investment positions held, approximately 38.4% were in an unrealized loss position.
first to pay or among the first cash flow tranches of their respective transactions;
Our ALT-A and sub-prime loan portfolio has paid down to $27.6 million as of December 31, 2007 from $35.7 million as of September 30, 2007 and from $42.0 million as of June 30, 2007.
As of December 31, 2007, we hold no investments in Collateralized Debt Obligations or Net Interest Margin securities.
Each municipal bond is evaluated prior to purchase to ensure that the issuer and underlying revenue pledge/collateral supporting the municipal bond is sufficient, ignoring the presence of the “financial guarantee” insurance. We consider the “financial guarantee” insurance to be “extra” protection. As of December 31, 2007, we had no impairments or surveillance issues related to these insured municipal bonds.
The following table identifies the period of time securities with an unrealized loss as of December 31, 2006 have continuously been in an unrealized loss position. None of the amounts displayed in the table are due to non-investment grade fixed maturity securities. No issuer of securities or industry represents more than 3.5% and 23.6%, respectively, of the total estimated fair value, or 2.8% and 28.7%, respectively, of the total gross unrealized loss included in the table below. The industry concentration represents investments in “AAA” rated mortgage backed securities issued by agencies of the U.S. Government which are collateralized by pools of residential mortgage loans. As previously discussed, there are certain risks and uncertainties inherent in our impairment methodology, including, but not limited to, the financial condition of specific industry sectors and the resultant effect on the underlying collateral values and changes in accounting, tax, and/or regulatory requirements which may have an effect on either, or both, the investor and/or the issuer. Should we subsequently determine a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included in our earnings as a realized loss for the period such determination was made.
The unrealized losses on our Aaa/AAA rated investments in U.S. Treasury Securities and Obligations of U.S. Government Agencies are attributable to interest rate increases. Of the 32 investment positions held, approximately 71.9% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
The unrealized losses on our investments in Asset Backed Securities which have ratings of Aaa/AAA are generally caused by interest rate increases. Of the 132 investment positions held, approximately 49.2% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
The unrealized losses on our investments in Mortgage Pass-Through Securities which have ratings of Aaa/AAA are generally caused by interest rate increases. Of the 130 investment positions held, approximately 58.5% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
There are certain risks and uncertainties inherent in our impairment methodology, including, but not limited to, the financial condition of specific industry sectors and the resultant effect on any underlying security collateral values and changes in accounting, tax, and/or regulatory requirements which may have an effect on either, or both, the investor and/or the issuer. Should we subsequently determine that we do not intend to hold the security until maturity or should we determine that a decline in the fair value below the cost basis to be other than temporary, the security would be written down to its fair value and the difference would be included as a realized loss for the period in which such determination was made, thereby reducing earnings for such period by the amount of such realized loss.
For the year ended December 31, 2007, our gross loss on the sale of fixed maturity and equity securities amounted to $0.3 million and $5.0 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $33.7 million and $39.6 million, respectively. A total of $1.2 million of the $5.0 million gross loss on the sale of equity securities for the year ended December 31, 2007 was a result of the liquidation of one of our equity portfolios following our decision to change one of our common stock investment managers. The $1.2 million realized gross loss on the sale of equity securities was in addition to the $1.6 million impairment loss recognized during the three months ended March 31, 2007 upon our initial decision to change one of our common stock investment managers and no longer hold the securities to recovery.
For the year ended December 31, 2006, our gross loss on the sale of fixed maturity and equity securities amounted to $1.7 million and $7.0 million, respectively. The fair value of the fixed maturity and equity securities at the time of sale was $185.2 million and $40.5 million, respectively.
The table below provides information about our financial instruments that are sensitive to changes in interest rates and shows the effect of hypothetical changes in interest rates as of December 31, 2007 and 2006. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios. The information is presented in U.S. dollar equivalents, which is our reporting currency.
Philadelphia Consolidated Holding Corp. (PCHC), a holding company whose principal assets currently consist of 100% of the capital stock of our subsidiaries. PCHC’s primary sources of funds are payments received pursuant to tax allocation agreements with our Insurance Subsidiaries; dividends from its subsidiaries, and proceeds from the issuance of shares pursuant to our Stock Purchase and
Performance Based Compensation Plans. For the year ended December 31, 2007, payments to PCHC pursuant to such tax allocation agreements totaled $188.1 million. The payment of dividends to PCHC from our Insurance Subsidiaries is subject to certain limitations imposed by the insurance laws of the Commonwealth of Pennsylvania and State of Florida. Accumulated statutory profits of our Insurance Subsidiaries from which dividends may be paid totaled $1,025.1 million as of December 31, 2007. Of this amount, our Insurance Subsidiaries are permitted to pay a total of approximately $299.2 million of dividends in 2008 without obtaining prior approval from the Insurance Commissioner of the Commonwealth of Pennsylvania or State of Florida (see Business Regulation). During 2007, PCHC received $3.5 million in dividend payments from our Insurance Subsidiaries. No capital contributions were made by PCHC to our Insurance Subsidiaries. During 2007, there were no stock repurchases under the stock repurchase authorization. As of December 31, 2007, the remaining stock repurchase authorization is $45.0 million.
We produced net cash from operations of $534.1 million, $506.8 million and $430.7 million in 2007, 2006 and 2005, respectively. Sources of operating funds consist primarily of net premiums written and investment income. Funds are used primarily to pay claims and operating expenses, and to purchase investments. Cash from operations in 2007 was primarily generated from strong premium growth during the year due to new business written and strong renewal business retention. Net loss and loss expense payments were $452.5 million, $313.8 million and $234.7 million in 2007, 2006 and 2005, respectively. Net cash from operations also included cash provided from tax savings from the issuance of shares pursuant to our stock based compensation plans amounting to $0.8 million, $1.5 million and $7.0 million for 2007, 2006 and 2005, respectively. We believe that we have adequate liquidity to pay all claims and meet all other cash needs.
During 2007, $257.6 million of the fixed maturity portfolio principal was received through either maturity, call option, paydown or sinking fund transactions. Our fixed maturity portfolio cash flow profile has been structured such that approximately 10% of the portfolio principal as of December 31, 2007 will be received from maturity, call option, paydown or sinking fund transactions for each of the next five years through 2012, and in varying percentages thereafter. We estimate that approximately $297.0 million will be received from these transactions during 2008.
In the normal course of business, we have entered into various reinsurance contracts with unrelated reinsurers. We participate in such agreements for the purpose of limiting loss exposure and managing capacity constraints. Reinsurance contracts do not relieve us from our obligations to our policyholders. To reduce the potential for a write-off of amounts due from reinsurers, we evaluate the financial condition of our reinsurers and principally contract with large reinsurers that are rated at least “A” (Excellent) by A.M. Best Company. Additionally, we proactively seek to collect the obligations of our reinsurers on a timely basis, and will obtain collateral for balances due from reinsurers that are not approved by the Pennsylvania and/or Florida Insurance Departments due to their foreign domiciliary status. This collection effort is supported through the regular monitoring of reinsurance receivables. As of December 31, 2007, approximately 93.5% of our reinsurance receivables (excluding amounts ceded to voluntary and mandatory pool mechanisms) are either with reinsurers rated “A” (Excellent) or better by A.M. Best Company or are fully collateralized.
The NAIC’s risk-based capital method is designed to measure the acceptable amount of capital and surplus an insurer should have based on the inherent specific risks of each insurer. The adequacy of a company’s actual capital and surplus is evaluated by a comparison to the risk-based capital results. Insurers failing to meet minimum risk-based capital requirements may be subject to scrutiny by the insurer’s domiciliary insurance department, and may ultimately be subjected to be placed in rehabilitation or liquidation. As of December 31, 2007, our Insurance Subsidiaries exceeded their minimum risk-based capital requirements as follows (dollars in millions):
Represents open commitments under certain limited partnership agreements, information technology development agreements, corporate sponsorship, renewal rights acquisitions and Profit Sharing and Savings Incentive Plan arrangements.
As of December 31, 2007, we have recorded a $2.0 million liability for a bonus amount due to our founder and Chairman under the terms of his employment agreement. This payment is due to be paid six months after the date of the termination of his employment. Since his date of termination is uncertain, this liability has been excluded from the above table.
reliable estimate of the period of settlement of the liability with the related taxing authority, the liability has been excluded from the above table.
In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 155 “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). Subsequently, SFAS No. 155 was modified. Under current generally accepted accounting principles, an entity that holds a financial instrument with an embedded derivative, subject to certain scope exceptions, must bifurcate the financial instrument, resulting in the host and the embedded derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities to account for financial instruments with an embedded derivative at fair value thus negating the need to bifurcate the instrument between its host and the embedded derivative. SFAS No. 155 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We adopted SFAS No. 155 on January 1, 2007. The adoption of SFAS No. 155 did not have a material effect on our financial condition or results of operations.
In July 2006, the FASB released Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48, which is effective for fiscal years beginning after December 15, 2006, also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material effect on our financial condition or results of operations. See Note 10 of the Consolidated Financial Statements for additional information regarding the adoption of FIN 48.
The fair value of our investments in government securities and equity securities is primarily measured using a market based valuation methodology primarily using quoted market prices in active markets (Level 1 inputs per SFAS 157).
We do not currently anticipate that the adoption of SFAS No. 157 will have a material effect on our financial position or the results of our operations.
permitted for an entity that has also elected to apply the provisions of SFAS No. 157. An entity is prohibited from retrospectively applying SFAS No. 159, unless it chooses early adoption. SFAS No. 159 also applies to eligible items existing as of November 15, 2007 (or early adoption date). We are currently in the process of evaluating the impact of SFAS No. 159; however we do not currently anticipate electing the fair value option for any of our eligible financial instruments.
In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS No. 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS No. 141R retains the fundamental requirements of SFAS No. 141 in that the acquisition method of accounting is still used, and an acquirer must be identified in all business combinations. SFAS No. 141R applies prospectively to business combinations which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited from applying SFAS No. 141R prior to that date. We are currently in the process of evaluating the impact of SFAS No. 141R.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements. - an amendment of ARB No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for the non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires that the ownership interests and the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS No. 160 also provides consistent accounting principles for changes in a parent controlling ownership interest in a subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured at fair value. SFAS No. 160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively, except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. We are currently in the process of evaluating the impact of SFAS No. 160.
Consolidated Balance Sheets - As of December 31, 2007 and 2006
Consolidated Statements of Cash Flows - For the Years Ended December 31, 2007, 2006 and 2005
Other Than Investments in Related Parties As of December 31, 2007
Reinsurance For the Years ended December 31, 2007, 2006 and 2005
As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in 2006.
Philadelphia Consolidated Holding Corp. (“Philadelphia Insurance”), and its subsidiaries (collectively the “Company”) doing business as Philadelphia Insurance Companies, include:
The consolidated financial statements include the accounts of the Company prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The carrying amount for the Company’s investments approximates their estimated fair value. The Company’s external fixed income investment manager provides pricing of the Company’s investments based on a pricing methodology approved by the investment manager’s pricing committee. Pricing is primarily obtained from market vendors based on a pre-established provider list.
Our total investments include $1.0 million and $3.3 million in securities as of December 31, 2007 and 2006, respectively, for which there is no readily available independent market price.
Investments in fixed maturities are adjusted for amortization of premiums and accretion of discounts to maturity date, except for asset backed, mortgage pass-through and collateralized mortgage obligation securities which are adjusted for amortization of premiums and accretion of discounts over their estimated lives. Certain asset backed, mortgage pass-through and collateralized mortgage obligation security repayment patterns will change based on interest rate movements and, accordingly, could impact future investment income if the reinvestment of the repayment amounts are at lower interest rates than the underlying securities. Asset backed, mortgage pass-through and collateralized mortgage obligation securities, on a cost basis, amounted to $199.3 million, $604.3 million and $329.5 million, respectively, as of December 31, 2007 and 202.1 million, $425.5 million and $293.1 million, respectively, as of December 31, 2006.
Other intangible assets are carried in the Consolidated Balance Sheet as a component of Other Assets. Other intangible assets consist of rights with respect to the renewals of insurance policies and a trade name which were purchased during 2007 and 2006. As of December 31, 2007, total gross intangible assets amounted to $27.0 million, and accumulated amortization amounted to $3.2 million. As of December 31, 2006, total gross intangible assets amounted to $15.3 million, and accumulated amortization amounted to $0.8 million. Renewal rights are being amortized over a period of 10-12 years, and the trade name is being amortized over a period of 3 years. The aggregate amortization expense of other intangible assets was $2.4 million and $0.8 million for the years ended December 31, 2007 and 2006, respectively. The Company anticipates that the aggregate amortization expense of other intangible assets will be approximately $2.2 million per year for each of the next five succeeding years. This amount is subject to change based upon the reviews of recoverability and useful lives performed at least annually.
The liability for unpaid loss and loss adjustment expenses reflects the Company’s best estimate for future amounts needed to pay losses and related settlement expenses with respect to insured events. The process of establishing the ultimate claims liability is a complex imprecise process, requiring the use of informed estimates and judgments using data currently available. The liability includes an amount determined on the basis of claim adjusters’ evaluations with respect to insured events that have occurred and an amount for losses incurred that have not been reported to the Company. In some cases significant periods of time, up to several years or more, may elapse between the occurrence of an insured loss and the reporting of such to the Company. Estimates for unpaid loss and loss adjustment expenses are based upon management’s assessment of known facts and circumstances, review of past loss experience and settlement patterns and consideration of other internal and external factors. These factors include, but are not limited to, the Company’s growth; changes in the Company’s operations; and legal, social, and economic developments. These estimates are reviewed regularly and any resulting adjustments are made in the accounting period in which the adjustment arose. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2007, the related adjustments could have a material adverse impact on the Company’s financial condition and results of operations.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS 123(R)”) using the modified prospective transition method, which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including stock options, stock settled appreciation rights (“SARS”), restricted stock and employee and director stock purchases related to the Employee Stock Purchase Plan, the Nonqualified Employee Stock Purchase Plan and the Directors Stock Purchase Plan based on fair values. The Company’s financial statements as of and for the years ended December 31, 2007 and 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest.
In July 2006, the FASB released Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48, which is effective for fiscal years beginning after December 15, 2006, also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. The Company adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material effect on the financial condition or results of operations of the Company. See Note 10 of the Consolidated Financial Statements for additional information regarding the adoption of FIN 48.
The fair value of its investments in the remainder of its fixed maturities available for sale is primarily measured using a market based valuation methodology using primarily matrix pricing (Level 2 inputs per SFAS No. 157) and in certain cases, valuation models using its own inputs (Level 3 inputs per SFAS 157)..
The Company does not currently anticipate that the adoption of SFAS No. 157 will have a material effect on its financial position or the results of its operations.
In December 2007, the FASB issued Statement No. 141R, “Business Combinations” (“SFAS No. 141R”), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, “Business Combinations” (“SFAS No. 141”), and broadens the scope of transactions which should be accounted for under this standard. SFAS No. 141R retains the fundamental requirements of SFAS No. 141 in that the acquisition method of accounting is still used, and an acquirer
must be identified in all business combinations. SFAS No. 141R applies prospectively to business combinations which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited from applying SFAS No. 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS No. 141R.
Risk-Based Capital: Risk-based capital is a method developed by the National Association of Insurance Commissioners (“NAIC”) designed to measure the acceptable amount of capital and surplus an insurer should have based on the inherent specific risks of each
The Company invests primarily in investment grade fixed maturities, which possessed a weighted average quality of AAA as of December 31, 2007. In addition, 99.9% of the Insurance Subsidiaries’ fixed maturity securities (cost basis) consisted of U.S. government securities or securities rated “1” (“highest quality”) or “2” (“high quality”) by the NAIC as of December 31, 2007. The cost, gross unrealized gains and losses and estimated market value of investments as of December 31, 2007 and 2006 are as follows (in thousands):
The unrealized losses on the Company’s Aaa/AAA rated investments in U.S. Treasury Securities and Obligations of U.S. Government Agencies are attributable to interest rate fluctuations since the date of purchase. Of the 30 investment positions held, approximately 26.7% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
The unrealized losses on the Company’s investments in Collateralized Mortgage Obligations which have ratings of Aa2/AA+ to Aaa/AAA are attributable to the spread widening. Of the 172 investment positions held the average rating was Aaa/AAA and approximately 41.3% were in an unrealized loss position. The contractual terms of the investments do not permit the issuer to settle the security at a price less than the amortized cost of the investments. Therefore, it is expected that the securities would not be settled at a price less than the amortized cost of the investments.
The Company’s impairment evaluation as of December 31, 2007 for equity securities resulted in the conclusion that the Company does not consider the equity securities to be other than temporarily impaired. Of the 2,674 investment positions held, approximately 38.4% were in an unrealized loss position.
first to pay or among the first cash flow tranches of their respective transactions:,
The Company’s ALT-A and sub-prime loan portfolio has paid down to $27.6 million as of December 31, 2007 from $35.7 million as of September 30, 2007 and $42.0 million as of June 30, 2007.
Given a combination of recent events in the housing and mortgage finance sectors, and the issues surrounding the monoline financial guarantor the Company believes that fixed income and equity markets, in general, may experience more volatility than during recent historical reporting periods. As of December 31, 2007, the Company had no impairments or surveillance issues related to these market conditions. However, the Company expects that ongoing volatility in these sectors, in particular, and in spread related sectors, in general, may impact the prices of securities held in the Company’s overall Aaa/AAA rated investment portfolio.
Each municipal bond is evaluated prior to purchase to ensure that the issuer and underlying revenue pledge/ collateral supporting the municipal bond is sufficient, ignoring the presence of the “financial guarantee” insurance. The Company considers the “financial guarantee” insurance to be “extra” protection. As of December 31, 2007, The Company had no impairments or surveillance issues related to these insured municipal bonds.
The Company had no debt or equity investments in a single issuer in excess of 10% of Shareholders’ Equity at December 31, 2007.
The investment portfolio had no non-income producing fixed maturity securities as of December 31, 2007.
Realized pre-tax investment gains (losses) for the years ended December 31, 2007, 2006 and 2005 are as follows (in thousands):
The following table summarizes property and equipment as of December 31, 2007 and 2006 (dollars in thousands):
The changes in the estimated net unpaid loss and loss adjustment expenses for the prior accident years during 2007 were primarily attributable to the following:
Professional liability and management liability coverages due to better than expected case incurred loss development primarily as a result of claim severity being less than anticipated.
For accident year 2004, the decrease in estimated net unpaid loss and loss adjustment expenses was principally due to lower loss estimates for:
Professional liability and management liability coverages due to better than expected case incurred loss development primarily as a result of claim severity emergence being less than anticipated.
Commercial general liability coverages due to better than expected case incurred loss development primarily as a result of both claim frequency and severity emergence being less than anticipated.
The changes in the estimated net unpaid losses and loss adjustment expenses for prior accident years during 2005 were primarily attributable to the following:
On January 1, 2007 the Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” As a result of the implementation, no adjustment to the beginning balance of retained earnings was deemed necessary. The following table represents a reconciliation of the beginning and ending amount of the Company’s unrecognized tax benefits (dollars in thousands):
Interest and penalties accrued for the underpayment of taxes are recorded as a component of income tax expense. The Company recognized a $0.7 million benefit related to interest and penalties, which reduced income tax expense for the year ended December 31, 2007. The liability for interest and penalties was $0.1 million and $1.7 million as of December 31, 2007 and 2006, respectively.
The following tables presents stock appreciation rights (“SARS”) that were outstanding during the second half of 2007, but were not included in the computation of earnings per share for 2007 because the SARS’ hypothetical option price was greater than the average market prices of the Company’s common shares for 2007:
During 2006, 30,000 SARS, which were granted at a hypothetical option price of $39.95 per SAR, were outstanding during the fourth quarter of 2006, but were not included in the computation of earnings per share for 2006 because the SARS’ hypothetical option price was greater than the average market price of the Company’s common shares for 2006. The SARS, which expire on September 28, 2016, were outstanding as of December 31, 2006.
The total intrinsic value of options exercised during the years ended December 31, 2007 and 2006 was $19.6 million and $29.3 million, respectively.
The aggregate intrinsic value of outstanding and exercisable options as of December 31, 2007 was $157.4 million and $71.8 million, respectively. The total fair value of exercisable options as of December 31, 2007 was $9.6 million. The weighted average remaining contractual life of options outstanding as of December 31, 2007 was 5.3 years.
The following table presents information regarding SARS transactions during the years ended December 31, 2007 and 2006.
As of December 31, 2007, there was $30.4 million of pre-tax unrecognized compensation costs related to stock options, SARS and restricted stock granted under the Company’s Plan. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 3.0 years.
The fair value of each stock option and SAR award is estimated on the date of grant using the Black-Scholes option valuation model based on the assumptions noted in the following table. Expected volatilities are based on the historical volatility of the Company’s common stock. The Company uses historical data to estimate stock option and SAR expected terms and employee terminations that are utilized within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of stock options and SARS granted represents the period of time that granted stock option and SAR awards are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant appropriate for the expected life of the Company’s stock options and SARS. The dividend yield assumption is based on history and expectation of dividend payouts. The ranges given below result from certain groups of employees exhibiting different behavior and from the differing market conditions which existed on the various grant dates.
The Nonqualified Employee Stock Purchase Plan (the “Nonqualified Stock Plan”): The aggregate maximum number of shares that may be issued pursuant to the Nonqualified Stock Plan is 6,000,000. Shares may be purchased under the Nonqualified Stock Plan by eligible employees during designated one-month offering periods established by the Compensation Committee of the Board of Directors at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering
Directors Stock Purchase Plan (“Directors Plan”): The Directors Plan has been established for the benefit of non-employee Directors. The aggregate maximum number of shares that may be issued pursuant to the Directors Plan is 125,000. Non-employee Directors, during monthly offering periods, may designate a portion of his or her fees to be used for the purchase of shares under the terms of the Directors Plan at a purchase price of the lesser of 85% of the fair market value of the shares on the first business day of the offering period or the date the shares are purchased. Under the Directors Plan, the Company issued 7,526 shares and 8,635 shares in 2007 and 2006, respectively. The weighted-average fair value per share of those purchase rights granted in 2007 and 2006 was $7.56 and $6.14, respectively.
During the three years ended December 31, 2007, there were no repurchases under the Company’s stock repurchase authorization. As of December 31, 2007 and 2006, $45.0 million remains available under a $75.3 million stock purchase authorization.
Share-based payment awards granted prior to, but not yet vested as of December 31, 2006 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123, and
Upon adoption of SFAS 123(R), the Company elected to value share-based payment awards granted beginning in 2006 using the Black-Scholes option-pricing model, (the “Black-Scholes model”), which was also previously used for the pro forma information required under SFAS 123. The Black-Scholes model requires the input of certain assumptions. The Company’s stock options and the option component of the Employee Stock Purchase Plan shares have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.
The effect of recording share-based compensation expense for the years ended December 31, 2007 and 2006 is as follows:
The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The percentage of ceded reinsurance receivables (excluding amounts ceded to voluntary and mandatory pool mechanisms) that are with reinsurers rated “A” (Excellent) or better by A.M. Best Company, or are fully collateralized was 93.5% and 92.4% as of December 31, 2007 and 2006, respectively.
Company had a deferred compensation obligation pursuant to the plan amounting to $3.2 million and $3.8 million as of December 31, 2007 and 2006, respectively.
The Company currently leases office space to serve as its headquarters location and 45 regional and field offices throughout the country. In addition, the Company leases certain computer equipment and licenses certain computer software. Rental expense for operating leases was $7.1 million, $5.5 million and $5.1 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2007 were as follows (in thousands):
As of December 31, 2007, the Company has open commitments of $4.1 million under certain limited partnership, information technology and corporate sponsorship agreements.
As of December 31, 2007 and 2006, included in Other Liabilities in the Consolidated Balance Sheets were $13.2 million and $15.1 million, respectively, of liabilities for state insurance guaranty funds. As of December 31, 2007 and 2006, included in Other Assets in the Consolidated Balance Sheets were $0.2 million and $0.2 million, respectively, of related assets for premium tax offsets or policy surcharges. The related asset is limited to the amount that is determined based upon policy surcharges from policies in force.
Among other state insurance facilities, the Company is subject to assessments from Florida Citizens Property Insurance Corporation (“Florida Citizens”), which was created by the state of Florida to provide insurance to property owners unable to obtain coverage in the private insurance market. Florida Citizens, at the discretion and direction of its Board of Governors (“Florida Citizens Board”), can
levy a regular assessment on participating companies for a deficit in any calendar year up to a maximum of the greater of 10% of the deficit or 10% of Florida property premiums industry-wide for the prior year. The portion of the total assessment attributable to the Company is based on its market share. An insurer may recoup a regular assessment through a surcharge to policyholders. If a deficit remains after the regular assessment, Florida Citizens can also fund any remaining deficit through emergency assessments in the current and subsequent years. Companies are required to collect the emergency assessments directly from residential property policyholders and remit to Florida Citizens as collected. In addition, Florida Citizens may issue bonds to further fund a deficit. Participating companies are obligated to purchase any unsold bonds issued by Florida Citizens.
The Specialty Lines Underwriting Group which has underwriting responsibility for professional and management liability products; and
The Personal Lines Group which has underwriting responsibilities for personal property insurance products for homeowners and manufactured housing markets in Florida, and the National Flood Insurance Program for bother personal and commercial policy holders.
Summarized revenue information by product grouping for the Company’s three reportable business segments for the years ended December 31, 2007, 2006 and 2005 is as follows (in thousands):
The Company believes that it has valid defenses to the claims made in the complaint, and that the claims may not be entitled to be brought as a class action. The Company will vigorously defend against such claims. Although there is no assurance as to the outcome of this litigation or as to its effect on the Company’s financial position, the Company believes, based on the facts currently known to it, that the outcome of this litigation will not have a material adverse effect on its financial position.