Loss and loss adjustment expenses ratio: The loss and loss adjustment expenses ratio, expressed as a percentage of loss and loss adjustment expenses to net earned premiums.
Debt to total capitalization ratio: The debt to total capitalization ratio, is the ratio, expressed as a percentage, of total debt to the sum of total debt and shareholders’ equity. The Company’s total debt consists solely of trust preferred loans payable.
In our ART division, specialty programs facilitate the offering of insurance to homogeneous niche groups through third party program managers. Our fully funded business allows insureds to self-insure their risks where collateral is required for which we generate fee income. We are paid a fee to front this business.
In our Assumed Re division, the Company provides traditional specialty property and casualty reinsurance for unaffiliated specialty insurers and reinsurers with a focus on small specialty insurers, risk retention groups and captives focused on medical malpractice, general liability, professional liability, and one property catastrophe program.
The Other segment consists of the Company’s investment in real estate which was essentially completed in 2005, and lines of business that we have placed in run-off, such as workers’ compensation, excess liability insurance for municipalities and certain commercial lines.
Net earnings for the year of $30.5 million, or $2.87 per diluted share, includes a $2.1 million tax benefit primarily due to the reversal of the remaining valuation allowance established in 2008. Loss and loss adjustment expenses of $120.3 million include unfavorable development on prior years’ loss reserves totaling approximately $0.4 million and includes: favorable development of $2.4 million in E&S, unfavorable development of $2.7 million in ART, unfavorable development of $1.5 million in assumed reinsurance, and favorable development of $1.4 million in run-off.
Net earnings for 2009 of $24.3 million, or $2.30 per diluted share, includes net favorable development recognized in 2009 with respect to prior accident years of $4.5 million. The E&S division recognized favorable development of $12.6 million, which was partially offset by adverse development in ART of $1.5 million and the assumed reinsurance unfavorable development of $5.7 million Additionally, the tax provision includes a $0.9 million benefit representing a partial reversal of the valuation allowance established in 2008 for realized investment losses.
Fee income earned decreased 15% to $4.6 million for the year ended December 31, 2010 compared to $5.4 million for 2009 due to less opportunity in the risk transfer market and the sale of a wholly owned agency subsidiary in 2010 that produced fee income during all of 2009.
Net investment income increased 5.2% to $32.1 million for the year ended December 31, 2010 compared to $30.6 million for 2009 due to increased average invested assets generated by operating cash flow of $59.6 million. Yield compression during 2010 impacted investment income as cash flow and portfolio maturities were reinvested at lower rates. Average invested assets increased to $784.4 million as of December 31, 2010 from $712.1 million as of December 31, 2009. The average pre-tax investment yield decreased to 4.1% for 2010 from 4.3% for 2009.
Net realized gains for the period ended December 31, 2010 were $2.3 million as compared to $.2 million in 2009.
Losses and loss adjustment expenses totaled $120.3 million, or 59.9%, of net earned premiums for the year ended December 31, 2010 compared to $97.6 million and 57.9% in 2009. 2010 results include $0.4 million of development to prior year loss reserves as shown below.
Favorable development recognized in 2009 with respect to prior accident years was primarily in the E&S division. Construction general liability business, excluding construction defect, for accident years 2006 and prior, recognized favorable development of $14.1 million, which was offset by adverse development in the ART and Reinsurance division. The development within the ART division was primarily attributable to a discontinued program. The development for the Assumed Re division was primarily attributable to one D&O contract written in 2007 that we terminated in 2008.
Income tax expense totaled $(2.1) million, or (6.9%), and $0.5 million, or 2.2%, of pre-tax earnings for the years ended December 31, 2010 and 2009, respectively. In 2010, $1.6 million of the remaining valuation allowance established in 2008 was reversed. Additionally, as shown below, a larger percentage of our earnings for 2010 were generated in Bermuda.
Net Earnings. Net earnings from Bermuda operations increased to $29.6 million for the year ended December 31, 2010, compared to $20.3 million for 2009, due to improved loss ratios in the Bermuda operations. The U.S. operations net earnings of $0.9 million for the year ended December 31, 2010, compared to $4.0 million for 2009. In 2010, the U.S. operations incurred a $2.2 million charge related to reinsurance balances recoverable in addition to the loss reserve development in the ART division.
Net earned premiums totaled $168.5 million in 2009, compared to $174.5 million in 2008. E&S totaled $92.0 million, a slight decrease from the same period in 2008; ART totaled $40.6 million, a 5% increase over the 2008 period; Assumed Reinsurance totaled $36.2 million, a 15.3% decrease from 2008. The decrease in earned premium for the Excess and Surplus lines division was due to market conditions where pricing was increasingly competitive resulting in reduced gross written premiums. The Alternative Risk Transfer division's increase in earned premium was due to new programs. The Assumed Reinsurance division's decrease in earned premium was due to a business mix shift from quota share to excess of loss. Excess of loss reinsurance generally results in less premium to the reinsurer.
Fee income earned increased 107.0% to $5.4 million for the year ended December 31, 2009 compared to $2.6 million for 2008. The increase is primarily attributable to growth in our fully funded business.
Net realized gains for the period ended December 31, 2009 were $0.2 million. The $14.3 million net realized losses in 2008 included other-than-temporary-impairment charges of $13.7 million and realized losses of $1.4 million partially offset by net realized gains of $0.8 million. All but $0.4 million of the impairment related to securities issued by companies in the financial services sector.
Losses and loss adjustment expenses totaled $97.6 million or 57.9% of net earned premiums for the year ended December 31, 2009 compared to $110.1 million and 63.1% in 2008. 2009 results include $4.5 million net favorable adjustments to prior year loss reserves as shown below. Also during 2009, we recorded a $4.0 million decrease in 2009 ceded losses, thus increasing our net losses by the same amount.
Policy acquisition expenses are commissions paid to our producers, offset by ceding commissions we receive from our reinsurers. Policy acquisition expenses also include premium taxes paid to states in which we are admitted to conduct business. Policy acquisition expenses decreased to $37.2 million for the year ended December 31, 2009 as compared to $43.5 million for the same period of 2008, and, as a percentage of net premiums earned, decreased to 22.1% for the year ended December 31, 2009 compared to 24.9% for the same period of 2008. The decrease year over year is the result of less gross written premium in 2009 as compared to 2008 while the percentage decrease is primarily due to lower acquisition costs in our assumed reinsurance business resulting from a shift in business mix.
Corporate and other underwriting expenses increased 21.8% to $41.4 million for the year ended December 31, 2009, compared to $34.0 million for the same 2008 period. Payroll expense increased primarily due to the 2009 incentive compensation expense of $2.5 million. In 2008 management did not accrue any incentive compensation. Other underwriting expenses increased to $15.4 million due to a $1.6 million bad debt write-off related to a legacy program. The increase in corporate and other expenses to $3.4 million was due to an adjustment made in 2008 for $2.8 million, reducing a warranty liability established in 2004 associated with our former real estate project in Florida.
The Company operates through its subsidiaries in the U.S. and Bermuda. Significant differences exist in the regulatory environment in each country. The table below describes the Company’s operations by geographic location for the years ended December 31, 2009 and 2008 (dollars in thousands):
Net Earnings. Net earnings from Bermuda operations increased to $20.3 million for the year ended December 31, 2009, compared to $7.2 million for 2008, due primarily to 2008 realized losses on investments of $7.3 million, as well as lower underwriting profit in 2008. The U.S. operations had net earnings of $4.0 million for the year ended December 31, 2009, compared to a net loss of $6.9 million for 2008, primarily due to realized gains on investments in 2009 of $2.7 million, compared to 2008 realized losses of $7.0 million.
The Company meets its cash requirements and finances its growth principally through cash flows generated from operations. The Company’s primary sources of short-term cash flow are premium writings and investment income. The Company has experienced both a reduction in premium rates due to competition and overall market conditions and a reduction in investment yields due to declines in interest rates. Short-term cash requirements relate to claims payments, reinsurance payments, commissions, salaries, employee benefits and other operating expenses. Due to the uncertainty regarding the timing and amount of settlements of unpaid claims, the Company’s future liquidity requirements may vary; therefore, the Company has structured its investment portfolio maturities to mitigate the variations in those factors. The Company believes its current cash flows are sufficient for the short-term needs of its business and its invested assets are sufficient for the long-term needs of its insurance business.
Our ability to pay future dividends to shareholders will depend, to a significant degree, on the ability of our subsidiaries to generate earnings from which to pay dividends. The jurisdictions in which we and our insurance and reinsurance subsidiaries are domiciled place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect the solvency of insurers. The Company has not paid dividends in the past and does not anticipate paying dividends on the common shares in the near future.
Our contractual obligations (in thousands of dollars) as of December 31, 2010 were:
Investments. We routinely review our investments that have experienced declines in fair value to determine if the decline is other than temporary. These reviews are performed with consideration of the facts and circumstances of an issuer in accordance with the Securities and Exchange Commission (“SEC”), Accounting for Non-Current Marketable Equity Securities; ASC-320-10-05, Accounting for Certain Investments in Debt and Equity Securities; and Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments; and related guidance. The identification of distressed investments and the assessment of whether a decline is other than temporary, involve significant management judgment and require evaluation of factors including but not limited to:
Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.
ASC 820-10-15 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The Company routinely monitors and evaluates the difference between the cost and fair value of our investments. Additionally, credit analysis and/or credit rating issues related to specific investments may trigger more intensive monitoring to determine if a decline in market value is other than temporary. For investments with a market value below cost, the process includes evaluating the length of time and the extent to which cost exceeds market value, the prospects and financial condition of the issuer, and evaluation for a potential recovery in market value, among other factors. As a result, management concluded that the recoverability of the principal and interest on these investments is reasonably assured and no additional impairments needed to be recognized.
At December 31, 2010, mortgage backed securities comprised 28.3% of the entire portfolio. All mortgage backed securities are issued by agencies of the U.S. Government or government sponsored entities. The Company's investment in corporate debt securities totaled $339.6 million, or 39.6% of the entire portfolio, with $154.4 million in the industrial sector, $121.8 million in the financial sector, $57.2 million in utilities and $6.2 million in other securities. U.S. Government securities were 8.6% of the total portfolio.
Reserves. Claims made policies provide coverage for claims that are incurred and reported during the policy period. Occurrence form policies provide coverage for claims that occur during the policy period regardless of when they are reported. Certain of our insurance policies and reinsurance assumed are occurrence policies and therefore may be subject to claims brought years after an incident has occurred or the policy period has ended. We are required to maintain reserves to cover the unpaid portion of our ultimate liability for losses and loss adjustment expenses with respect to (i) reported claims and (ii) incurred but not reported (IBNR) claims. An actuarial analysis is performed annually to estimate all of our unpaid losses and loss adjustment expenses under the terms of our contracts and agreements. In evaluating whether the reserves are adequate for unpaid losses and loss adjustment expenses, it is necessary to project future losses and loss adjustment expenses payments. It is probable that the actual future losses and loss adjustment expenses will not develop exactly as projected and may, in fact, vary materially from the projections.
Short-tail business is generally characterized by the industry as business for which claims are received and settled within one year. Total net reserves for short tail business as generally defined by the industry, as of December 31, 2010 were approximately 2.5% of total net reserves. In the aggregate, our primary long-tail lines are construction, where we offer general liability insurance to construction contractors and environmental where we offer general liability and professional liability insurance to environmental contractors and consultants.
Construction: In addition to evaluating the loss reserves on all exposures on a combined basis the actuarial staff evaluates reserves for each of the following exclusive categories: (1) construction defect claims in California; (2) construction defect in all other states; (3) commercial and residential contractors claims other than construction defects; (4) claims in New York state; (5) claims from product liability exposures; (6) claims from habitational risks; and (7) claims from miscellaneous risks.
A number of assumptions were made in the determination of the best reserve estimates for each line of business at December 31, 2010. The key assumptions among them were the expected loss ratios and loss development patterns. If the actual future losses and loss adjustment expenses develop materially differently from those key assumptions, there could be a potential for significant variation in the development of loss reserves. The effect of any specific assumptions can vary by accident year and line of business. We performed sensitivity analyses that tested the effects on the loss reserve position of using alternative loss ratios and loss development patterns rather than those actually used in determining the net carried reserve at December 31, 2010. The tests addressed each major line of business for which a material deviation to the overall reserve position is possible and used what we believed was a reasonably likely range of potential deviation for each line of business. If our net carried reserves were to decrease from our best estimate, this would increase our net earnings, while an increase in our net carried reserves would decrease our earnings.
The following table displays the resulting range of possible deviation of the net carried reserves for each division at December 31, 2010 (in thousands of dollars):
Net earnings attributable to American Safety Insurance Holdings, Ltd without reinsurance
See Part I "Ceded Reinsurance" for additional discussion relative to reinsurance coverage.