Our principal executive offices are located in leased premises of approximately 32,536 square feet in North Palm Beach, Florida. We also lease a total of approximately 72,977 square feet of office space in 10 states. We believe that there is sufficient office space available at favorable leasing terms both to replace existing office space and to satisfy any additional needs we may have as a result of future expansion.
(2) Includes favorable loss reserve development for the years ended December 31, 2005, 2004, 2003 and 2002 of $24.7 million, $8.3 million, $1.0 million and $0.4 million, respectively, and unfavorable loss reserve development for the year ended December 31, 2001 of $11.1 million.
(3) Beginning in the third quarter of 2005, the second injury fund assessment in South Carolina was doubled, which resulted in a pre-tax charge of $3.3 million in the third quarter of 2005.
(7) Policy acquisition expenses including: commissions, assessments, premium tax and general and administrative expenses directly associated with policy acquisition divided by net premiums earned, after the effects of reinsurance.
THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE ACCOMPANYING NOTES APPEARING ELSEWHERE IN THIS REPORT. IN ADDITION TO HISTORICAL INFORMATION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS IN FUTURE PERIODS MAY DIFFER FROM THOSE REFERRED TO HEREIN DUE TO A NUMBER OF FACTORS, INCLUDING THE RISKS DESCRIBED IN THE SECTIONS ENTITLED "RISK FACTORS" AND "FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS" AND ELSEWHERE IN THIS REPORT.
AmCOMP Incorporated, a Delaware corporation, is a holding company engaged through its wholly-owned subsidiaries, including AmCOMP Preferred and AmCOMP Assurance, in the workers' compensation insurance business. Our long-term source of consolidated earnings is principally the income from our workers' compensation insurance business and investment income from our investment portfolio. Workers' compensation insurance provides coverage for the statutorily prescribed wage replacement and medical care benefits that employers are required to make available to their employees injured in the course of employment. We are licensed to provide workers' compensation insurance in 22 states, but currently focus our resources in 11 states that we believe provide the greatest opportunity for near-term profitable growth.
o other operating and general expenses, which include general and administrative expenses such as salaries, rent, office supplies and depreciation and other expenses not otherwise classified separately;
o assessments and premium surcharges related to our insurance activities, including assessments and premium surcharges for state guaranty funds and other second injury funds; and
o interest expense under our bank credit facility and surplus notes issued to third parties.
When claims are reported to one of our insurance subsidiaries, its claims personnel establish "case reserves" that represent an estimate of the amount (including LAE) that we will have to pay in respect of these claims. The amount of the reserve is primarily based upon a case-by-case evaluation of the claims involved, the circumstances surrounding each claim, historical loss experience and the policy provisions relating to the type of losses. The estimate reflects the informed judgment of our claims personnel based on general insurance reserving practices, as well as the experience and knowledge of the claims personnel. Our claims professionals continually monitor all open claims. As new information becomes available about the claims, the case reserves may be updated.
result of factors such as inflation, claims settlement patterns, legislative activity and litigation trends. Our IBNR estimates are affected by the results of nine separate actuarial reserving methods, our assumptions regarding the adequacy of case reserves, the impact of future wage and medical inflation, litigation trends, the quality of recent underwriting standards and actuarial judgment. Consistent with industry practices, the actuarial judgment of our management plays a significant part in the reserving process. Actuarial judgment takes into account our assumptions regarding future claims emergence, the number of claims to be closed in the future with or without payment, amounts that may be collected from subrogation and any other changes expected to occur in the future. Changes in the assumptions we employ or our estimates associated with such assumptions could result in materially different amounts being reported as reserves. If necessary, we will increase or decrease the level of our reserves, with a corresponding change in our expenses in the period in which the increase or decrease occurs, as experience develops or new information becomes known in the period in which changes to the estimates are determined. As of December 31, 2005, our case reserves and IBNR, net of reinsurance were $151.3 million and $79.9 million, respectively. Gross of reinsurance, these amounts were $177.4 million and $132.5 million, respectively.
The range of estimates for IBNR as of December 31, 2005 produced by the various separate actuarial reserving methods we reviewed ranged from $1.0 million below the point estimate (for the paid loss Bornhuetter Ferguson method) and $26.7 million below the point estimate (for the paid loss development method). This range does not necessarily constitute a range of reasonable estimates and does not imply that each of these loss estimates is equally likely. No one actuarial reserving method has consistently been found to be more predictive than any other.
The state-specific assumptions regarding the claim payment and claim reporting patterns are established by considering loss development patterns for the industry, as well as our loss development patterns for the state being examined and Florida, the state in which we have the most extensive loss experience. The state-specific assumptions regarding the expected net loss ratios are established by examining historic pricing levels in that state for that accident year and our and the consulting firm's judgment on the expected difference between our net loss ratio and that of the workers' compensation insurance industry given the same pricing structure. Claim cost and claim averages are based on AmCOMP's history and our judgment and that of the independent actuarial firm regarding trends.
We believe the weightings displayed above are appropriate for a long-tailed line of business such as workers' compensation insurance. Initially, when loss experience is very immature and the ultimate payout of our largest claims is still unknown, the expected loss ratio should carry relatively more weight than after experience has developed more fully. As loss experience matures, the initial expected loss ratio becomes less important as it does not consider all of the new loss information that has become available. As a result, the weighting of the Bornhuetter-Ferguson methods decreases from 25% to 0% after five years and the weighting of the loss development methods increases from 25% to 50% after 5 years. The 0% weight of the Bornhuetter-Ferguson methods for accident years older than five years should not suggest that the Bornhuetter-Ferguson methods are not considered, but rather that they are typically not given significant weight when selecting our estimate of ultimate losses for older accident years. In the future, as we compare the actual losses with the different estimates of losses for recent accident years, we may change the relative weightings of these and other actuarial methods.
Change in Net Loss Change in Assumptions Reserves ---------------------------------------------------- ------------------- Improve Expected Loss Ratio by 10% $ (7,134) Deteriorate Expected Loss Ratio by 10% 7,134 Improve Paid Loss Development Pattern by 10% (7,695) Deteriorate Paid Loss Development Pattern by 10% 7,066 Improve Incurred Loss Development Pattern by 10% (2,578) Deteriorate Incurred Loss Development Pattern by 10% 2,395 Improve Expected Loss Ratio by 10% and Improve Loss Development Patterns by 10% (17,023) Improve Expected Loss Ratio by 10% and Deteriorate Loss Development Patterns by 10% 1,968 Deteriorate Expected Loss Ratio by 10% and Improve Loss Development Patterns by 10% (3,524) Deteriorate Expected Loss Ratio by 10% and Deteriorate Loss Development Patterns by 10% 16,955
SENSITIVITY OF GROSS LOSS RESERVES TO CHANGES IN ACTUARIAL ASSUMPTIONS as of December 31, 2005 (all dollar amounts in thousands)
The impact of recording the net reserve for losses at the lowest value from the sensitivity analysis above would be to increase net income by $4.5 million and to increase stockholders' equity at December 31, 2005 by 6.3%. The impact of recording the net reserves for losses at the highest value from the sensitivity analysis above would be to reduce net income by $4.5 million and decrease stockholders' equity at December 31, 2005 by 6.3%. Such changes in the net reserves for losses and loss adjustment expense would not have an immediate impact on our liquidity, but would affect cash flow in future periods as the incremental or reduced amount of losses is paid.
Our reserves are driven by a number of important assumptions including litigation and regulatory trends, legislative activity, social and economic patterns and claims inflation assumptions. Our reserve estimates reflect expected inflation in legal claims settlements and assume we will not be subject to losses from significant new legal liability theories. Our reserve estimates also assume that we will not experience significant losses from mass torts and that we will not incur losses from future mass torts not known to us today. While it is not possible to predict the impact of changes in this environment, if new mass torts or expanded legal theories of liability emerge, our IBNR claims may differ substantially from our IBNR reserves. Our reserve estimates assume that there will not be significant changes in the regulatory and legislative environment. The impact of potential changes in the regulatory or legislative environment is difficult to quantify in the absence of specific, significant new regulation or legislation. In the event of significant new regulation or legislation, we will attempt to quantify its impact on our business. These estimates also assume that the inflation assumption implicitly built into our reserving philosophy, expected loss ratio, and loss payment and reporting patterns will continue into the future. Unexpected changes in loss cost inflation can occur through changes in general inflationary trends, changes in medical technology and procedures, changes in wage levels and general economic conditions in particular geographic areas and changes in legal theories of liability.
Reinsurance premiums, losses, and LAE are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance ceding commissions received are deferred and amortized over the effective period of the related insurance policies.
Reinsurance contracts that do not transfer insurance risk are accounted for using deposit accounting. At inception, a deposit asset or liability is recognized based on the consideration paid or received, less any explicitly identified premiums or fees to be retained by the insurer or reinsurer, irrespective of the experience of the contract. Accounting for such fees is based on the terms of the contract. The deposit assets and liabilities are reported on a gross basis. Cash recoveries reduce the carrying amount of the deposit. The amount of the deposit asset or liability is adjusted at subsequent reporting dates by calculating the effective yield on the deposit to reflect actual payments to date and expected future payments with a corresponding credit or charge to interest income.
All premium revenue is recognized over the period of the contract in proportion to the amount of insurance protection provided. The insurance premiums we charge are billed to our policyholders either annually or under various installment plans based on the estimated annual premium under the policy terms. We recognize the premium revenue for the proportionate share of the risks assumed from the NWCRP on a quarterly basis. At the end of the policy term, payroll-based premium audits are performed on substantially all policyholder accounts to determine earned premiums for the policy year. Earned but unbilled premiums include estimated future audit premiums. Estimates of future audit premiums are based on our historical experience. These estimates are subject to changes in policyholders' payrolls due to growth, economic conditions and seasonality. Although considerable variability is inherent in such estimates, management believes that the accrual for earned but unbilled premiums is reasonable. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations. The reserve for unearned premiums is determined on a daily pro rata basis.
Fixed maturity investments are designated at purchase as held-to-maturity or available-for-sale. Held-to-maturity investments are reported at amortized cost. Securities classified as available-for-sale are reported at fair value with unrealized appreciation and depreciation, net of deferred taxes, on our balance sheet in accumulated other comprehensive income as a separate component of stockholders' equity. We have generally held until maturity those securities designated as held-to-maturity and intend to maintain our investment guidelines so that we would do so in the future.
An estimated provision for our dividends to policyholders is accrued as the related premiums are earned. We offer dividend programs to our policyholders in Florida and Wisconsin, where rates are set by state insurance regulators. These dividends are not guaranteed and are required to be approved by the boards of directors of our insurance subsidiaries. The boards of directors may base their decisions to pay dividends on many factors, including (1) an individual policyholder's net loss ratio, (2) the insurance subsidiary's overall net loss ratio and (3) the terms of the individual policyholder's dividend plan. The type of dividend plan is stated in the policy and, other than with respect to flat dividend policies in Wisconsin, has a direct relationship to the amount of losses incurred under that policy. The prior loss experience of the policyholder is a key element in the estimation of our dividend liability.
NET PREMIUMS WRITTEN. Net premiums written is the sum of direct premiums written and assumed premiums written less ceded premiums written. Ceded premiums written is the portion of our direct premiums that we cede to our reinsurers under our reinsurance contracts. We use net premiums written, primarily in relation to gross premiums written, to measure the amount of business retained after cession to reinsurers.
NET LOSS RATIO. The net loss ratio is a measure of the underwriting profitability of an insurance company's business. Expressed as a percentage, this is the ratio of net losses and LAE incurred to net premiums earned.
An accident year loss ratio is calculated by dividing the losses and LAE, regardless of when such losses and LAE are incurred, for insured events that occurred during a particular year by the premiums earned for that year. An accident year net loss ratio is calculated using premiums and losses and LAE that are net of amounts ceded to reinsurers. An accident year loss ratio for a particular year can decrease or increase when recalculated in subsequent periods as the reserves established for insured events occurring during that year develop favorably or unfavorably, respectively, whereas the calendar year loss ratio for a particular year will not change in future periods. This ratio is an operating ratio based on our statutory financial statements and is not derived from our GAAP financial information.
Year Ended December 31, ------------------------------------ Increase Increase (decrease) (decrease) 2005 over 2004 over 2005 2004 2003 2004 2003 --------- --------- --------- --------- --------- (Dollars in thousands)
SELECTED FINANCIAL DATA: Gross premiums written $ 277,095 $ 270,981 $ 239,484 2.3% 13.2% Net premiums written 267,652 217,472 144,952 23.1 50 Gross premiums earned 276,117 259,445 226,289 6.4 14.7
Net premiums earned 256,603 181,186 164,287 41.6 10.3 Net investment income 10,798 6,077 4,803 77.7 26.5 Net realized investment (loss) gain (385) 982 2,644 NA (62.9) Other income (loss) 285 332 (2,464) (14.2) N/A --------- --------- --------- Total revenue $ 267,301 $ 188,577 $ 169,270 41.7% 11.4% ========= ========= ========= Losses and loss adjustment expenses 143,663 119,121 109,518 20.6 8.8 Policy acquisition expenses 51,508 19,499 21,735 164.2 (10.3) Underwriting and other expenses 34,447 32,280 30,244 6.7 6.7 Dividends to policyholders 8,612 6,983 5,796 23.3 20.5 Interest expense 2,960 1,389 410 113.1 238.8 Federal and state income taxes 9,326 4,275 632 118.2 576.4 --------- --------- --------- --------- ------- Net income $ 16,785 $ 5,030 $ 935 233.7% 438.0% ========= ========= ========= ========= =======
---------- DEPOSIT ACCOUNTING. Two of our reinsurance treaties, one from 2001 and one from 2002, did not transfer sufficient risk to the assuming reinsurer to be accounted for as reinsurance and were accounted for using deposit accounting. We terminated these agreements in December 2003 and received $34.1 million in cash from the reinsurer and recorded a pre-tax charge of $2.1 million for 2003 which is reflected in other income (loss) in the Statement of Operations. This charge equaled the difference between the proceeds received from the reinsurer and the carrying value of the deposit on our balance sheet. Under deposit accounting, all net payments made to the reinsurer are recorded as insurance deposits and ceding commissions received are recorded as reductions of these deposits. All future receipts of recoveries for reinsurance claims reduce the amount of the deposit recorded. An implied interest rate is applied to the deposit balance and recorded as investment income. The interest rate is calculated based on the amount of estimated future net cash flows for each of the treaties.
We intentionally reduced our writings during 2003 in Florida because of rate uncertainty and the regulatory environment in Florida. New legislation, effective October 1, 2003, made changes primarily related to compensability of claims, disability benefits and attorney fees. One of the intended outcomes of the legislation was a reduction in the overall costs associated with delivering workers' compensation benefits in Florida. The Florida OIR increased rates 13.7% as of April 1, 2003, and then as a result of the legislative changes mentioned above, offset the earlier increase with a rate decrease of 14%, effective October 1, 2003. As underwriting profitability is one of our primary goals and given the uncertainty of the impact of the new legislation and rates, we were cautious about renewing certain policyholders or writing policies for prospective policyholders. We have since resumed normal underwriting operations in Florida as the legislative environment and pricing have become more certain.
NET PREMIUMS WRITTEN is significantly impacted by the changes in our quota share reinsurance arrangements. In 2004, we terminated our quota share reinsurance arrangement for new and renewal business effective July 1, 2004. The premium associated with quota share reinsurance was completely run off by July 1, 2005. The increase in the retention in our 2005 excess-of-loss reinsurance program also reduced our ceded premiums written for the $1.0 million excess of $1.0 million layer. Therefore, net premiums written increased by $50.2 million to $267.7 million in 2005 and $72.5 million to $217.5 million in 2004.
GROSS PREMIUMS EARNED increased $16.7 million, or 6.4%, to $276.1 million for 2005 from $259.4 million for 2004. This increase is the result of consistent overall growth each quarter throughout 2004 and 2005. During 2004, gross earned premium increased $33.2 million, or 14.7%, from $226.3 million in 2003.
NET PREMIUMS EARNED increased $75.4 million or 41.6% to $256.6 million from $181.2 million. The increase in net premiums earned is greater than the increase in gross premiums earned due to the elimination of quota share reinsurance on all new and renewal business since July 1, 2004 and the reduction in excess-of-loss reinsurance premiums from 7.4% of gross premiums earned in
Percent of Percent of Percent of Gross Gross Gross Premiums Premiums Premiums 2005 Earned 2004 Earned 2003 Earned -------- -------- --------- --------- --------- --------- (Dollars in thousands)
Gross premiums earned $276,117 100.0% $259,445 100.0% $226,289 100.0% Excess reinsurance premiums (12,224) (4.5%) (19,322) 7.5 (18,305) 8.1 Quota share reinsurance premiums (7,290) (2.6%) (58,937) 22.7 (43,697) 19.3 -------- -------- --------- --------- -------- --------- Net premiums earned $256,603 92.9% $181,186 69.8% $164,287 72.6% ======== ======== ========= ========= ======== =========
NET REALIZED (LOSS) GAINS were a $0.4 million loss in 2005, a $1.0 million gain in 2004, and $2.6 million gain in 2003. In 2005 we sold two bonds due to credit issues, which accounted for the majority of our realized loss. In 2004 and 2003, due to a decline in interest rates, we sold securities in our investment portfolio and recognized gains of $1.0 million and $2.6 million, respectively.
LOSSES AND LOSS ADJUSTMENT EXPENSES were $143.7 million, or 56.0% of net premiums earned in 2005, $119.1 million in 2004, or 65.7% of net premiums earned, and $109.5 million in 2003, or 66.7% of net premiums earned. The IBNR from years prior to 2005 showed redundancy of $24.7 million, net of reinsurance, which is reflected in our losses and LAE in 2005. The IBNR from years prior to 2004 showed redundancy of $8.3 million, net of reinsurance, which is reflected in our losses and LAE in 2004. The IBNR from years prior to 2003 showed redundancy of $1.0 million, net of reinsurance, which is reflected in our losses and LAE in 2003. The loss development we have experienced in recent years has been significantly lower than our selected development factors. Because of the Company's extensive history in Florida, Florida loss development factors significantly influence the results of our actuarial reserving methods. The results of these methods, in turn, influence the IBNR estimate. In recent years, Florida loss development experience has decreased from previous levels.
In 2004, excluding ULAE and the NWCRP Pool, Florida experienced $17.9 million in redundancy. Texas experienced prior accident year redundancy of $3.7 million, while all other states experienced adverse development in prior year reserves of $13.3 million. In addition, the 2004 accident year net loss ratios increased in South Carolina, Georgia and Tennessee from the 2003 accident year net loss ratios. In 2004, NWCRP pool losses of $8.2 million were allocated to us, representing 82.4% of net premiums earned from that pool during 2004.
In 2003, losses and LAE were $109.5 million, or 66.7% of net premiums earned. The decrease in losses and LAE as a percentage of net premiums earned was primarily due to rate increases, and redundancies in our loss reserves that reduced our calendar year losses incurred. NWCRP pool losses of $5.4 million were allocated to us, representing 78.3% of net premiums earned from that pool during 2003. Overall, the 2003 accident year net loss ratio was 62.8% at December 31, 2003.
DIVIDENDS TO POLICYHOLDERS increased $1.6 million, to $8.6 million in 2005 from $7.0 million in 2004 and increased $1.2 million from $5.8 million in 2003. This is due to an increase in gross premiums earned in Wisconsin and Florida, the states in which policyholders are eligible for dividend plans. Additionally, the percentage of direct written premiums in Florida on a dividend plan increased to 36.8% in 2005 from 32.3% in 2004. Wisconsin's direct written premiums on dividend plans decreased to 86.4 % from 89.4% in 2004. The company wide direct premiums written on a dividend plan increased to 24.9% from 21.1% in 2004.
INTEREST EXPENSE increased $1.6 million in 2005 from 2004 and $1.0 million in 2004 from 2003 due to interest paid on $32.0 million of surplus notes issued to third parties in 2004. These surplus notes were issued at various times during the second and third quarters of 2004 and are subject to floating interest rates. The rates have increased in 2005 by approximately 200 basis points.
FEDERAL AND STATE INCOME TAXES were 35.7% of pretax income in 2005, 46.0% of pretax income in 2004, and 40.4% in 2003. The effective tax rate for 2005 includes a 35% federal tax rate. The state of Florida's tax rate is 5.5%. We apportion our pretax income to the State of Florida according to the State's apportionment factors. For 2005, this decreased the effective state tax rate to 3.5%. This was an increase compared to our 2004 apportioned rate used of 2.5%. The tax exempt interest lowered our effective tax rate by 2.2%. The increase in the effective rate for 2004 was due to an adjustment in 2004 in the effective rate used in calculating the value of the deferred tax assets. The rate was adjusted to 34.0% from 35.0% to reflect the current federal tax rate and to 3.5% from 5.5% to reflect the current Florida state tax rate after its apportionment of income. These are the rates at which we expect to be taxed when the deferred tax asset is utilized. The adjustment in the rates caused an additional deferred tax expense of approximately $1.2 million to be recognized in 2004, creating the higher effective tax rate. Federal and state income tax expenses were $10.2 million, $4.3 million, and $0.6 million for 2005, 2004, and 2003 respectively.
NET INCOME increased $11.8 million in 2005 from $5.0 million in 2004 and $4.1 million, from $0.9 million in 2003. Net income was significantly impacted by our losses and LAE relative to the net premiums earned as indicated by net loss ratios of 56.0 %, 65.7%, and 66.7% in 2005, 2004 and 2003, respectively.
NET COMBINED RATIO, INCLUDING POLICYHOLDER DIVIDENDS improved 5.3% to 92.9% in 2005 and 3.6% to 98.2% in 2004. The changes indicate an improvement in our underwriting performance.
We are a holding company and our insurance subsidiaries are the primary source of funds for our operations. We have historically received dividend payments solely from Pinnacle Administrative Company ("Pinnacle Administrative") and Pinnacle Benefits, Inc ("Pinnacle Benefits"). These dividend payments are funded by fee payments under service agreements between Pinnacle Administrative and Pinnacle Benefits and our insurance subsidiaries. Fee payments under the service agreements are subject to review by the Florida OIR, as are dividend payments by our insurance subsidiaries. There are no restrictions on the payment of dividends by our non-insurance subsidiaries, Pinnacle Administrative, Pinnacle Benefits and AmSERV, Inc., other than customary state corporation laws regarding solvency. The cash requirements of these non-insurance subsidiaries are primarily for the payment of salaries, employee benefits and other operating expenses.
We have historically met our cash requirements and financed our growth principally from operations, the proceeds of borrowings, investment income and the sale of our Series A preferred stock in 1996. Cash flow is summarized in the table below.
For statutory purposes, these surplus notes are considered as a component of AmCOMP Preferred's policyholders' surplus. For GAAP and income tax purposes, the surplus notes are considered debt. The issuance of the surplus notes required Florida OIR approval. Additionally, all future principal and interest payments require the approval of the Florida OIR.
We consummated our initial public offering on February 15, 2006 with the sale by the Company of 6,000,000 shares of common stock. Our net proceeds, after deducting underwriting discounts and commissions and other expenses relating to the offering, were approximately $48.0 million. We intend to utilize substantially all of the proceeds to further capitalize our insurance subsidiaries, which will enable us to underwrite additional insurance in the states where we currently operate. We are evaluating a number of states in the near term including Mississippi, Missouri, Arkansas and Minnesota, subject to compliance with applicable licensing requirements. The balance, if any, of the net proceeds we received from the initial public offering will be used for working capital and general corporate purposes.
AmCOMP Assurance is currently subject to maximum premium writings in any calendar year of $9.0 million in Illinois. Effective July 6, 2005, the North Carolina Department of Insurance removed the $12.0 million maximum previously applicable in that state. Historically, the regulatory authorities' primary concern was the capitalization of AmCOMP Assurance and its reliance on an inter-company pooling arrangement with AmCOMP Preferred, which is not licensed to do business in those states. Should we choose to expand our operations in Illinois, we would be required to negotiate an increase in the current limit on premium writing and there is no assurance that we would be able to do so.
As a result of raising $32.0 million from surplus notes issued by one of our insurance subsidiaries, we have eliminated the need for quota share reinsurance on new and renewal business since July 1, 2004. In addition, we increased our retention in our excess of loss reinsurance program to $2.0 million in 2005 and 2006 from $1.0 million in 2004.
In early 2003, as a result of appreciation in our fixed maturity securities caused by the declining interest rates experienced in prior years and our investment committees' belief that interest rates were likely to increase in the near term, we sought to adjust the duration of our portfolio in response to the interest rate environment. We believed that by reducing the duration of our investment portfolio, we would be better positioned to take advantage of increases in interest rates that we expected would soon begin. We sold a small portion of our bond portfolio, recognizing income in the current period, and reinvested those proceeds in shorter-duration bonds in accordance with our revised strategy. As a result of the investment of those proceeds and the subsequent increase in our investment portfolio in shorter-duration bonds, our duration decreased from 3.4 years at December 31, 2002 to 2.6 years at December 31, 2003 and, as market rates increased, we allowed our duration to increase to 3.2 years by December 31, 2004. In 2005, as our yield to maturity increased to 4.9%, we increased our average duration slightly to 3.5 years. However, with an investment portfolio increase of $98.8 million from $128.5 million at December 31, 2002 to $227.3 million at December 31, 2004 during a period when market rates were below the yield on our existing portfolio, our overall investment portfolio yield declined. The investment portfolio was $327.5 million at December 31, 2005. In the future, we may sell securities due to changes in the investment environment, our expectation that fair value may deteriorate further, our desire to reduce our exposure to an issuer or an industry and changes in the credit quality of the security. In addition, depending on changes in prevailing interest rates, our investment strategy may again shift toward long-term securities, and we may adjust that portion of our investment portfolio that is held-to-maturity rather than available-for-sale. Except for recognizing other-than-temporary impairments, our held to maturity portfolio is not subject to mark to market accounting because we have the ability and intent to hold those securities to maturity. The repositioning of our portfolio during 2004 resulted in net realized gains of $1.0 million. In 2005 we sold two bonds due to credit issues, which account for the majority of our realized loss. As of December 31, 2005, approximately 90.3% of our entire portfolio was classified as available-for-sale.
Our insurance subsidiaries employ AmSouth Bank to act as their independent investment advisor. AmSouth Bank follows the insurance subsidiaries' written investment guidelines based upon strategies approved by our insurance subsidiaries' board of directors. Our insurance subsidiaries have no investments in common stock (other than AmCOMP Preferred's investment in AmCOMP Assurance and certain institutional money market accounts), preferred stock, real estate, asset-backed securities (other than mortgages) or derivative securities. AmSouth Bank has discretion to enter into investment transactions within our insurance subsidiaries' investment guidelines. In the case of sales of securities prior to maturity or the acquisition of securities that differ from the types of securities already present in the portfolio, AmSouth Bank routinely consults with our insurance subsidiaries' executive officers, who report regularly to our insurance subsidiaries' investment committees. AmSouth Bank's fee is based on the amount of assets in the portfolio and is not dependent upon investment results or portfolio turnover.
Carrying Yield to Percentage of Amount(1) Maturity Carrying Amount (1) ----------------- -------- -------------------------- (Dollars in thousands)
Mortgage-backed securities 43,177 4.5 13.0 ----------------- -------- -------------------------- Total Bonds $327,457 4.9% 98.6% ----------------- -------- -------------------------- Cash and cash equivalents and short-term investments $4,739 3.6 1.4% ----------------- -------- -------------------------- Total $332,196 4.9% 100.0% ================= ======== ==========================
(1) Carrying amount is amortized cost for bonds held-to-maturity and short-term investments. Carrying value is market value for bonds available-for-sale and common stock. As of December 31, 2005, $295.7 million of our bonds was classified as available-for-sale and $31.8 million was classified as held-to-maturity.
1 year or less $ 32,308 $ 32,028 More than 1 year, through 5 years 164,041 160,734 More than 5 years, through 10 years 83,582 81,756 More than 10 years 8,753 9,762 Mortgage backed securities 43,383 42,710 -------- -------- Total $332,067 $326,990 ======== ========
Unrealized Number of Fair Value Losses Issues -------- -------- -------- (In thousands) Less than 12 months: U.S. Treasury securities $ 18,860 ($ 209) 9 Agency 9,965 (84) 6 Municipalities 30,461 (509) 19 Corporate debt securities 109,539 (2,199) 76 Mortgage-backed securities 25,359 (328) 16 -------- -------- -------- Total $194,184 ($ 3,329) 126 ======== ======== ======== Greater than 12 months: U.S. Treasury securities $ 9,514 ($ 427) 14 Agency 19,095 (496) 15 Municipalities 13,221 (272) 10 Corporate debt securities 52,248 (1,379) 57 Mortgage-backed securities 11,906 (359) 6 -------- -------- -------- Total $105,984 ($ 2,933) 102 ======== ======== ======== Total fixed maturity securities: U.S. Treasury securities $ 28,374 ($ 636) 23 Agency $ 29,060 ($ 580) 21 Municipalities $ 43,682 ($ 781) 29 Corporate debt securities $161,787 ($ 3,578) 133 Mortgage-backed securities $ 37,265 ($ 687) 22 -------- -------- -------- Total fixed maturity securities $300,168 ($ 6,262) 228 ======== ======== ========
At December 31, 2005, there were no investments in fixed maturity securities with individual material unrealized losses, nor any other-than-temporarily impaired fixed maturity securities. Additionally, all the unrealized losses on the fixed maturity securities are interest rate related.
We believe our future cash flow generated by operations, our cash and investment balances and the net proceeds from our initial public offering will be sufficient to fund continuing operations, service our outstanding obligations and provide for required capital expenditures for at least the next 12 months.
Prior to 2001, no material amounts due from reinsurers were written off as uncollectible, because most of our reinsurance was recoverable from large, well-capitalized reinsurance companies. On October 3, 2001, the Commonwealth Court of Pennsylvania approved an Order of Liquidation for Reliance Insurance Company in response to a petition from the Pennsylvania Department of Insurance. In 2001, we wrote off all balances due from Reliance. The write off resulted in an increase in underwriting and other expenses of approximately $8.3 million. We are continuing to pursue the collection of amounts recoverable from Reliance in its liquidation proceeding.
In August 1998, in an effort to expand its customer base, AmCOMP Assurance began selling insurance policies for a third party insurance company that had an "A" rating from A.M. Best at the time. This arrangement included insurance policies with effective dates of August 1, 1998 through November 1, 2000. Pinnacle Administrative performed marketing, underwriting, loss prevention and other administrative functions, and Pinnacle Benefits provided claim adjusting services, including the payment of claims, related to these policies. This arrangement also provided for a reinsurance agreement between AmCOMP Assurance as the reinsurer and this insurance company as the reinsured. At December 31, 2005, the amount to be recovered from this insurance company on these claims and LAE expenses paid by us was $1.9 million.
The following table identifies our long-term debt and contractual obligations as of December 31, 2005:
Long Term Debt Obligations(1) $119,667 $ 5,116 $ 9,620 $ 8,360 $ 96,571 Operating Leases 6,478 2,302 3,474 702 -- Loss Reserves(2) 309,857 105,971 89,508 20,110 94,268 -------- -------- -------- -------- -------- Total Contractual Obligations $436,002 $113,389 $102,602 $ 29,172 $190,839 ======== ======== ======== ======== ========
are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB Opinion No. 25, and requires instead that such transactions be accounted for using a fair-value-based method. In January 2005, the SEC issued SAB No. 107, which provides supplemental implementation guidance for SFAS No. 123R. SFAS No. 123R will be effective for the Company beginning in the first quarter of its fiscal 2006. The Company's assessment of the estimated stock-based compensation expense is affected by the Company's stock price as well as assumptions regarding a number of complex variables and the related tax impact. These variables include, but are not limited to, the Company's stock price, volatility, and employee stock option exercise behaviors and the related tax impact. The Company will recognize stock-based compensation expense on all awards on a straight-line basis over the requisite service period using the modified prospective method. Depending on the future use of share-based payments, the adoption of SFAS No. 123R could have a material effect on the Company's results of operations, future changes to various assumptions used to determine the fair-value of awards issued or the amount and type of equity awards granted create uncertainty as to whether future stock-based compensation expense will be similar to the historical SFAS No. 123 pro forma expense.
We have audited the accompanying consolidated balance sheets of AmCOMP Incorporated and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules presented in Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
AMCOMP INCORPORATED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2005 AND 2004 (IN THOUSANDS)
2005 2004 2003 --------- --------- --------- REVENUE: Net premiums earned ...................................................... $ 256,603 $ 181,186 $ 164,287 Net investment income .................................................... 10,798 6,077 4,803 Net realized investment (losses) gains ................................... (385) 982 2,644 Loss on commutation ...................................................... -- -- (2,062) Interest expense on insurance deposit .................................... -- -- (691) Other income ............................................................. 285 332 289 --------- --------- --------- Total revenue .......................................................... 267,301 188,577 169,270 --------- --------- --------- EXPENSES: Losses and loss adjustment expenses ...................................... 143,663 119,121 109,518 Dividends to policyholders ............................................... 8,612 6,983 5,796 Underwriting and acquisition expenses .................................... 85,955 51,779 51,979 Interest expense ......................................................... 2,960 1,389 410 --------- --------- --------- Total expenses ......................................................... 241,190 179,272 167,703 --------- --------- --------- Income before income taxes ................................................. 26,111 9,305 1,567 Income taxes expense ....................................................... 9,326 4,275 632 --------- --------- --------- Net income ................................................................. $ 16,785 $ 5,030 $ 935 ========= ========= ========= Earnings per common share--basic ........................................... $ 3.13 $ 0.94 $ 0.17 ========= ========= ========= Earnings per common share--diluted ......................................... $ 1.76 $ 0.53 $ 0.10 ========= ========= ========= Pro forma earnings per common share--basic (Notes 1 and 17) ................ $ 1.72 ========= Pro forma earnings per common share--diluted (Notes 1 and 17) .............. $ 1.72 ========= Weighted average number of common shares outstanding Basic ................................................................. 5,367 5,368 5,368 ========= ========= ========= Diluted ............................................................... 9,562 9,564 9,562 ========= ========= =========
AMCOMP INCORPORATED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (IN THOUSANDS)
Net income ....................................................................... $ 16,785 $ 5,030 $ 935 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .................................................. 2,144 2,403 2,258 Amortization of investment premiums/discounts .................................. 3,069 2,415 1,239 Provision for deferred income taxes ............................................ (1,434) 2,661 (5,880) Net realized losses (gains) on investments ..................................... 385 (989) (2,648) Gain on sale of fixed assets ................................................... -- -- -- Policy acquisition costs deferred .............................................. (47,673) (28,938) (11,301) Policy acquisition costs amortized ............................................. 42,955 19,145 22,548 Change in operating assets and liabilities: Restricted cash ................................................................ -- 944 533 Accrued investment income ...................................................... (962) (1,217) 186 Premiums receivable ............................................................ (2,884) (4,820) (2,685) Reinsurance balances ........................................................... 41,888 948 (39,825) Other assets ................................................................... (2,015) (1,657) 1,541 Unpaid losses and loss adjustment expenses ..................................... 12,159 46,576 23,408 Unearned and advance premiums and policyholder deposits ........................ 1,339 10,487 12,921 Policyholder retention dividends payable ....................................... 351 (1,482) (2,699) Accounts payable and accrued expenses .......................................... 13,464 4,936 108 Income taxes recoverable ....................................................... 1,959 (1,683) 225 --------- --------- --------- Net cash provided by operating activities .................................... 81,530 54,759 864 INVESTING ACTIVITIES: Securities available-for-sale: Purchases ...................................................................... (152,524) (150,070) (95,138) Sales and maturities ........................................................... 63,531 59,952 90,172 Securities held-to-maturity: Purchases ...................................................................... (22,814) (10,069) -- Redemptions and maturities ..................................................... 3,224 265 60 Purchases of property and equipment .............................................. (1,193) (2,041) (2,369) Regulatory restricted deposit .................................................... 899 (899) -- Sale of other assets ............................................................. -- -- 15 --------- --------- --------- Net cash used in investing activities ........................................ (108,877) (102,862) (7,260) FINANCING ACTIVITIES: Insurance deposits--net .......................................................... -- -- $ 42,524 Proceeds from borrowings ......................................................... -- 32,000 5,531 Payment of note payable .......................................................... (1,785) (1,786) (1,362) Purchase of treasury stock ....................................................... (4) -- (13) --------- --------- --------- Net cash (used in) provided by financing activities .......................... (1,789) 30,214 46,680 --------- --------- --------- Net (decrease) increase in cash and cash equivalents ......................... (29,136) (17,889) 40,284 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ..................................... 33,865 51,754 11,470 --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR ........................................... $ 4,729 $ 33,865 $ 51,754 ========= ========= ========= SUPPLEMENTAL CASH FLOW DATA: Cash paid--interest .............................................................. $ 2,872 $ 1,232 $ 391 Cash paid (received)--income taxes ............................................... $ 8,795 $ 3,288 $ (6,289)
o AmServ Incorporated ("AmServ"), a wholly owned company established to provide administrative services to external customers.
using the retrospective method. Prepayment assumptions are obtained from dealer surveys or internal estimates and are based on the current interest rate and economic environment.
Debt and equity securities are exposed to various risks such as interest rate, market, and credit risk. Fair values of securities fluctuate based on the magnitude of changing market conditions; significant changes in market conditions could materially affect portfolio value in the near term. The Company continually monitors its portfolio for pricing changes, which might indicate potential impairments and performs detailed reviews of securities with unrealized losses based on predetermined criteria. When a security in the Company's investment portfolio has an unrealized loss in fair value that is deemed to be other-than-temporary, the Company reduces the book value of such security to its current market value, recognizing the decline as a realized loss in the accompanying consolidated statements of operations. Any future increases in the fair value of securities previously written down are recorded and presented as changes in unrealized gains (losses) as part of accumulated other comprehensive income within stockholders' equity.
PROPERTY AND EQUIPMENT--Property and equipment is stated on the basis of cost. Depreciation is computed using the straight-line method over the estimated useful lives, generally 3 to 5 years for financial reporting purposes. Depreciation expense was $2,144,000, $2,403,000 and $2,258,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Accumulated depreciation was $14,285,000 and $12,164,000 at December 31, 2005 and 2004 respectively.
REINSURANCE--Reinsurance premiums, losses, and loss adjustment expenses ("LAE") are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance ceding commissions received are deferred and amortized over the effective period of the related insurance policies.
DEPOSIT ACCOUNTING--Reinsurance contracts that do not transfer insurance risk are accounted for using deposit accounting. At inception, a deposit asset or liability is recognized based on the consideration paid or received, less any explicitly identified premiums or fees to be retained by the insurer or reinsurer, irrespective of the experience of the contract. Accounting for such fees is based on the terms of the contract. The deposit assets and liabilities are reported on a gross basis. Cash recoveries reduce the carrying amount of the deposit. The amount of the deposit asset or liability is adjusted at subsequent reporting dates by calculating the effective yield on the deposit to reflect actual payments to date and expected future payments with a corresponding credit or charge to interest income.
FEDERAL AND STATE INCOME TAXES--The Company provides deferred federal and state income taxes for certain differences between the financial statement amounts and tax basis of assets and liabilities.
These estimates are subject to the effects of trends in payroll audit adjustments. Although considerable variability is inherent in such estimates, management believes that the accrual for earned but unbilled premiums is reasonable. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations. The reserve for unearned premiums is determined on a daily pro rata basis.
FLORIDA WORKERS' COMPENSATION INSURANCE GUARANTY ASSOCIATION ASSESSMENTS--The Company accrues a liability for the Florida Workers' Compensation Insurance Guaranty Association assessments as net premiums are written and defers these costs and recognizes them as an expense as the related premiums are earned. Assessments were $2,115,000, $1,734,000 and $743,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The Company has deferred approximately $873,000 and $791,000 as of December 31, 2005 and 2004, respectively, which is included in deferred policy acquisition costs. The assessment accrual rate for the Florida Workers' Compensation Insurance Guaranty Association for policies written in 2005 and 2004 was 2% of written premiums and in 2003 was 1% of written premiums.
EARNINGS PER SHARE--The Company computes earnings per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128. In the calculation of basic earnings per share, the dilutive effects of options, warrants, and convertible securities are excluded from the calculation. Diluted earnings per share consider the effects of dilutive convertible securities and stock options.
STOCK-BASED COMPENSATION--The Company accounts for stock-based compensation to employees using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. Accordingly, compensation cost for stock options issued to employees is measured as the excess, if any, of the estimated market price of the Company's stock at the date of grant over the amount an employee must pay for the stock. Compensation cost related to restricted stock or deferred stock units granted is recognized in the period the compensation is earned and measured using the quoted market price on the effective grant date.
RECLASSIFICATIONS--Certain 2004 and 2003 amounts have been reclassified to conform to the 2005 presentation.
NEW ACCOUNTING PRONOUNCEMENTS-- In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS No. 123R), SHARE-BASED PAYMENT, which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB Opinion No. 25, and requires instead that such transactions be accounted for using a fair-value-based method. In January 2005, the SEC issued SAB No. 107, which provides supplemental implementation guidance for SFAS No. 123R. SFAS No. 123R will be effective for the Company beginning in the first quarter of its fiscal 2006. The Company's assessment of the estimated stock-based compensation expense is affected by the Company's stock price as well as assumptions regarding a number of complex variables and the related tax impact. These variables include, but are not limited to, the Company's stock price, volatility, and employee stock option exercise behaviors and the related tax impact. The Company will recognize stock-based compensation expense on all awards on a straight-line basis over the requisite service period using the modified prospective method. Depending on the future use of share-based payments, the adoption of SFAS No. 123R could have a material effect on the Company's results of operations, future changes to various assumptions used to determine the fair-value of awards issued or the amount and type of equity awards granted create uncertainty as to whether future stock-based compensation expense will be similar to the historical SFAS No. 123 pro forma expense.
AmCOMP Preferred and AmCOMP Assurance are required to periodically submit financial statements prepared in accordance with prescribed or permitted statutory accounting practices ("SAP") to the Florida Department of Financial Services ("FDFS"). Such practices vary from GAAP. Prescribed SAP includes state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). Permitted SAP encompasses all accounting practices that are not prescribed; such practices may differ from company to company and may not necessarily be permitted in subsequent reporting periods.
Statutory-basis capital and surplus for AmCOMP Preferred and AmCOMP Assurance as of December 31, 2005 and 2004 is as follows (in thousands):
Under Florida insurance regulations, the maximum dividend to stockholders that may be paid without prior approval by the FDFS is specifically defined by the Florida insurance laws and regulations and is generally based on operating results and capital and surplus. For AmCOMP Preferred and AmCOMP Assurance, no dividends were paid during 2005 and 2004. As of December 31, 2005 and 2004, AmCOMP Preferred had $9,617,000 and $8,050,000, respectively, available to pay dividends without prior approval. As of December 31, 2005, AmCOMP Assurance had $1,370,000 available to pay dividends without prior approval. As of December 31, 2004, AmCOMP Assurance could not pay any dividends without prior approval.
workers' compensation insurers, which are based on a percentage of net workers' compensation premiums written. Assessments were $4,772,000, $3,901,000 and $3,356,000 for the years ended December 31, 2005, 2004 and 2003, respectively, of which $1,974,000, $1,788,000 and $1,429,000 are deferred.
The SDTF currently has significant unfunded liabilities. It is not possible to predict how the SDTF will operate, if at all, in the future after further legislative review. Changes in the SDTF's operations could decrease the availability of recoveries from the SDTF, increase SDTF assessments payable by AmCOMP Preferred and/or result in the discontinuation of the SDTF and thus could have an adverse effect on AmCOMP Preferred's business, financial condition, and its operations. Under current law, future assessments are capped at 4.52% of net written premiums, and no recoveries can be made for losses incurred by the SDTF after January 1, 1998.
The Company's investments in available-for-sale securities and held-to-maturity securities are summarized as follows at December 31, 2005 and 2004 (in thousands):
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value -------- -------- -------- --------
Available-for-sale securities at December 31, 2004: U.S. Treasury securities ........................................ $ 28,049 $ 1,021 $ 324 $ 28,746 Agency .......................................................... 35,755 50 358 35,447 Municipalities .................................................. 26,833 78 80 26,831 Corporate debt securities ....................................... 109,237 674 717 109,194 Mortgage-backed securities ...................................... 17,273 52 81 17,244 -------- -------- -------- -------- Total fixed maturity securities ............................... $217,147 $ 1,875 $ 1,560 $217,462 ======== ======== ======== ======== Held-to-maturity securities at December 31, 2004: Mortgage-backed securities ...................................... $ 9,792 $ -- $ 29 $ 9,763 ======== ======== ======== ========
The amortized cost and estimated fair values of investments in fixed maturity securities, segregated by available-for-sale and held-to-maturity, at December 31, 2005 are summarized by maturity as follows (in thousands):
At December 31, 2005 and 2004, bonds with an amortized cost of $19,245,000 and $37,157,000 and a fair value of $20,186,000 and $37,962,000, respectively, were on deposit with various states' departments of insurance in accordance with regulatory requirements. Additionally, at December 31, 2005 and 2004, bonds with an amortized cost of $6,000,000 and $9,792,000, respectively, were held in a reinsurance trust to the benefit of members of the Orion Insurance Group in accordance with the terms of a reinsurance agreement between the Company and the Orion Companies.
The Company continuously monitors its portfolio to preserve principal values whenever possible. All securities in an unrealized loss position are reviewed to determine whether the impairment is other-than-temporary. An investment in fixed maturity security is impaired if its fair value falls below its book value. Factors considered in determining whether an impairment is considered to be other-than-temporary include length of time and the extent to which fair value has been below cost, the financial condition and near-term prospects of the issuer, and the Company's ability and intent to hold the security until its expected recovery.
The following table summarizes, for all fixed maturity securities in an unrealized loss position at December 31, 2005, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position (in thousands):
2005 2004 --------- --------- Direct billed premiums receivable ................ $ 18,197 $ 20,292 Estimated future audit premiums .................. 11,759 10,668 Collateralized premiums receivable ............... 132 70 Premiums receivable deferred installments ........ 79,321 76,608 --------- --------- 109,409 107,638 Less allowance for doubtful accounts ............. (4,887) (6,000) --------- --------- Net premiums receivable .......................... $ 104,522 $ 101,638 ========= =========
Certain premiums and losses are ceded to other insurance companies under quota share reinsurance arrangements and various aggregate and specific excess of loss reinsurance agreements. The ceded reinsurance agreements are intended to provide the Company with the ability to maintain its exposure to loss within its capital resources. Losses ceded under these treaties are estimated based on ultimate losses. These estimates are subject to the effects of trends in loss severity. Although considerable variability is inherent in such estimates, management believes that their estimates of losses ceded under these treaties are reasonable. These estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations.
A summary of specific and aggregate reinsurance retention limits follows (in thousands):
Specific Aggregate Accident Year Retention Retention ------------- --------- --------- 1987................................................ $500 $2,070 1988................................................ 500 2,080 1989 and 1990....................................... 500 Unlimited 1991 through 1993................................... 500 Unlimited 1994................................................ 400 Unlimited 1995................................................ 400 28,000 1996................................................ 500 Unlimited 1997................................................ 500 Unlimited 1998................................................ 500 Unlimited 1999................................................ 250 Unlimited 2000................................................ 250 Unlimited 2001................................................ 250 Unlimited 2002(a)............................................. 500 Unlimited 2003................................................ 1,000 Unlimited 2004(b)............................................. 1,000 Unlimited 2005................................................ 2,000 Unlimited
Effective January 1, 2004, the Company entered into a 30% quota share reinsurance agreement with a company rated A++ by A.M. Best. Under the agreement, the Company ceded 30% of the subject written premium (defined as gross written premium less specific excess reinsurance premiums) in 2004, with a provisional ceding commission of 31%. The reinsurer's liability is limited to 130% of the gross earned reinsurance premium under any agreement year. In addition, the reinsurer's liability shall not exceed the reinsurer's portion of the estimated net loss as evaluated and reported by the Company 24 months after the inception of each agreement year. This treaty was terminated for new and renewal business on or after July 1, 2004. Furthermore, the remaining exposures for claims occurring prior to June 30, 2004 were commuted. Effective July 1, 2005, the Company terminated the 2004 quota share reinsurance that was maintained on a run-off basis for policies written prior to June 30, 2004.
Insurance premiums for the years ended December 31, 2005, 2004 and 2003 are summarized as follows (in thousands):
2005 2004 2003 ---------------------- ---------------------- ----------------------- Written Earned Written Earned Written Earned -------- -------- -------- -------- -------- --------
Direct................................. $270,331 $267,809 $260,173 $249,526 $231,083 $219,400 Assumed................................ 6,764 8,308 10,808 9,919 8,401 6,889 Ceded.................................. (9,442) (19,514) (53,509) (78,259) (94,532) (62,002) -------- -------- -------- -------- -------- -------- Net.................................... $267,652 $256,603 $217,472 $181,186 $144,952 $164,287 ======== ======== ======== ======== ======== ========
Incurred losses and loss adjustment expenses for the years ended December 31, 2005, 2004 and 2003 are summarized as follows (in thousands):
Direct losses and loss adjustment expenses incurred....................... $144,832 $162,250 $132,758 Assumed losses and loss adjustment expenses incurred...................... 8,164 8,750 5,332 Ceded losses and loss adjustment expenses incurred........................ (9,333) (51,879) (28,572) -------- -------- -------- Net losses and loss adjustment expenses incurred.......................... $143,663 $119,121 $109,518 ======== ======== ========
Effective January 1, 2001, the Company entered into a 50% quota share reinsurance agreement with a company rated A- by A.M. Best. The Company determined this agreement did not transfer insurance risk and accounted for this agreement using deposit accounting. Under this agreement, the Company ceded 50% of premiums written net of premiums ceded for specific excess and facultative reinsurance on Florida business on or after January 1, 2001 for a ceding commission of 47%. The Company ceded 50% of losses and LAE net of losses and LAE ceded for excess and facultative reinsurance until a net loss and LAE ratio of 60%. The Company retained all losses and LAE in a corridor between 60% and 63.5%, and the Company resumed ceding 50% of net losses and LAE after 63.5% up to a cap of 75.5%. All losses and LAE, in excess of the cap, are retained by the Company. This agreement was amended to cede 65% of the Florida business written on or after July 1, 2001.
Activity in the insurance deposits account during 2003 was as follows (in thousands):
The effective federal income tax rates on income before income taxes differ from the maximum statutory rates as follows for the years ended December 31, 2005, 2004 and 2003 (in thousands):
The following table provides a reconciliation of the beginning and ending balances for unpaid losses and LAE, reported in the accompanying consolidated balance sheets as of December 31, 2005 and 2004 (in thousands):
Unpaid losses and LAE, gross of related reinsurance recoverables at beginning of period .. $ 297,698 $ 251,122 Less reinsurance recoverables on unpaid losses and LAE at beginning of period ............ 107,155 94,427 --------- --------- Unpaid losses and LAE, net of related reinsurance recoverables at beginning of period .... 190,543 156,695 --------- --------- Add provision for losses and LAE, net of reinsurance, occurring in: Current period ......................................................................... 168,355 127,458 Prior periods .......................................................................... (24,692) (8,337) --------- --------- Incurred losses during the current period ................................................ 143,663 119,121 --------- --------- Deduct payments for losses and LAE, net of reinsurance, occurring in: Current period ......................................................................... 48,299 25,951 Prior periods .......................................................................... 54,709 59,322 --------- --------- Payments for losses and LAE during the current period, net of reinsurance ................ 103,008 85,273 --------- --------- Unpaid losses and LAE, net of related reinsurance recoverables at end of period .......... 231,198 190,543 Reinsurance recoverables on unpaid losses and LAE at end of period ....................... 78,659 107,155 --------- --------- Unpaid losses and LAE, gross of reinsurance recoverables on unpaid losses at end of period $ 309,857 $ 297,698 ========= =========
The Company's liabilities for unpaid losses and LAE, net of related reinsurance recoverables, at December 31, 2004 and 2003 decreased during the years ended December 31, 2005 and 2004 by $24,692,000 and $8,337,000, respectively, as a result of actual loss development emerging more favorably than expected. Management believes the historical experience of the Company is a reasonable basis for estimating future losses. However, future events beyond the control of management, such as changes in law, judicial interpretations of law, and inflation may favorably or unfavorably impact the ultimate settlement of the Company's loss and loss adjustment expenses.
Certain policyholders have entered into agreements that provide the opportunity for dividends. The amount that will ultimately be payable as dividends is determined by management, based on the overall profitability of the Company. Once the amount of the total dividend that will be paid for a policy year is determined, the dividend is accrued and allocated ratably to the participating policies, based on the policyholders' loss experience. Approximately 25%, 22% and 18% of the total business was subject to dividend participation during the years ended December 31, 2005, 2004 and 2003, respectively. The dividends are ultimately paid at the sole discretion of the Board of Directors (the "Board") and must be approved by the Board prior to payment.
LITIGATION--AmCOMP along with AmCOMP Preferred and AmCOMP Assurance are collectively defendants in identical actions commenced in Pennsylvania and Florida courts by the Insurance Commissioner of Pennsylvania, acting in the capacity as liquidator of Reliance Insurance Company. The complaints in those actions allege that preferential payments were made by Reliance Insurance Company under the formerly existing reinsurance agreement with AmCOMP Preferred and AmCOMP Assurance and seek damages in the amount of approximately $2.3 million. AmCOMP, along with AmCOMP Preferred and AmCOMP Assurance, has made various motions addressed to these complaints. The Company, based on the advice of counsel, believes that it has a variety of factual and legal defenses, including a right of offset related to the statement of claim filed by the Company and Preferred in the Reliance Insurance Company liquidation proceeding for the recovery of approximately $9.9 million under the reinsurance agreement. Although the ultimate results of these legal actions and related claims cannot presently be determined, the Company accrued $1.3 million as of December 1, 2005 related to those matters ($0.8 million was accrued in the fourth quarter of 2005).
The Company sponsors a 401(k) tax-deferred retirement savings plan (the "Plan") for its employees. The Plan is approved by the Internal Revenue Service and is administered by a national financial management service. All employees with at least six months of service are eligible to participate. The Company matches the employee's contribution at 100% for the first 2% of salary and 50% for the next 4% of salary. Expenses relating to the Plan were $570,000, $525,000 and $427,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
On October 12, 2000, the Company entered into a credit facility (the "Loan") with a financial institution whereby the Company borrowed $11,250,000. The Loan calls for monthly interest payments at the 30-day LIBOR rate plus a margin. The expiration date on the loan is April 10, 2010. The Loan is collateralized by $25,500,000 of surplus notes issued by AmCOMP Preferred and AmCOMP Assurance and the stock of AmCOMP Preferred. During 2003, the Loan was refinanced whereby the Company borrowed an additional $5,531,000. At December 31, 2005 and 2004, the principal balance was $8,036,000 and $9,821,000, respectively. The interest rate was 6.86% at December 31, 2005. Interest paid during 2005 and 2004 totaled $495,000 and $418,000, respectively.
On September 14, 2004, the Company issued a $10,000,000 surplus note, in return for $10,000,000 in cash, to Alesco Preferred Funding V, LTD, as part of a pooled transaction. The note matures in 30 years and is callable by the Company after five years. The terms of the note provide for quarterly interest payments beginning on December 15, 2004. The interest rate resets quarterly at a rate of 405 basis points in excess of the then 90-day London Interbank Offered Rate. As of December 31, 2005 the rate in effect was 8.54%. Approved interest paid through December 31, 2005 totals $886,000 of which $735,000 was paid in 2005 and $151,000 was paid in 2004. Unpaid and unapproved interest as of December 31, 2005 and 2004 was $38,000 and $29,000, respectively. Both the payment of interest and repayment of the principal are subject to the prior approval of the FDFS.
CONVERTIBLE PREFERRED STOCK SERIES A--At December 31, 2005 and 2004, 2,400,000 shares of $1.00 par value, voting, participating, convertible preferred stock ("CPS") was authorized, issued, and outstanding. If the Company declares and pays a dividend on the common stock, the CPS stockholders are entitled to a dividend equal to the dividend that would have been payable to such holder if the shares had been converted. The CPS has a liquidation preference of $10 per share and is convertible, at the holder's option, into 1.7464 shares of the Company's common stock for each share of CPS held. The CPS will automatically convert into common stock upon consummation of a qualified public offering.
The following table summarizes the number of shares of common stock issuable and reserved for future issuance at December 31, 2005 (in thousands):
During 1997, the Board approved a director stock option plan (the "Directors Plan") and reserved 87,321 shares of common stock for issuance under this plan. Under the Directors Plan, options vest over a period determined at the time of grant and are exercisable over a five-year period after the date of grant for an exercise price equal to management's estimate of the fair market value of the common stock on the date of grant. Through December 31, 2005, options to purchase 75,969 shares have been granted, 57,632 have been forfeited, and 7,859 have been exercised. All remaining options expired, leaving no options outstanding as of December 31, 2005.
During 1996, the Company approved an employee stock option plan (the "Employee Plan") and reserved 272,878 shares of the Company's common stock for future issuance under this plan. The employee options vest over a period determined at the time of grant and are exercisable over a period of not more than ten years at an exercise price equal to management's estimate of the fair market value of the common stock at the date of grant in the case of incentive options and not less than 80% of such fair market value in the case of nonqualified options. During 2001, the Company increased the number of shares available for future issuance under the Employee Plan to 960,531. At December 31, 2005 and 2004, options to purchase 359,234 and 220,119 shares, respectively, were currently exercisable at an average exercise price of $9.77.
A summary of the Company's stock option activity through December 31, 2005 is as follows:
Employees, Directors, and Executives ----------------------------- Average Exercise Number of Price Shares ---------------- ---------- Outstanding--December 31, 2002 .............. $ 11.36 777,222 Granted ................................... 8.89 70,610 Exercised ................................. -- -- Forfeited ................................. 12.39 (106,531) ---------- ---------- Outstanding--December 31, 2003 .............. 10.97 741,301 Granted ................................... 9.30 43,660 Exercised ................................. -- -- Forfeited ................................. 9.71 (111,258) ---------- ---------- Outstanding--December 31, 2004 .............. 11.09 673,703 Granted ................................... -- -- Exercised ................................. -- -- Forfeited ................................. 10.13 (28,106) ---------- ---------- Outstanding--December 31, 2005 .............. $ 11.12 645,597 ========== ==========
Options Outstanding Options Exercisable ---------------------------------------------- ----------------------------------------- Weighted Average Weighted Remaining Average Number Outstanding at Contractual Exercise Number Exercisable at Weighted Average Range of Exercise Prices December 31, 2005 Life Price December 31, 2005 Exercise Price ------------------------------ --------------------- ----------- -------- --------------------- ----------------
$0.00-$ 8.99 87,114 2.03 $8.83 62,716 $8.84 9.00- 9.99 285,605 1.39 9.32 252,859 9.32 10.00- 14.00 272,878 1.28 13.74 272,878 13.74 --------------------- ----------- -------- --------------------- ---------------- 645,597 1.43 $11.12 588,453 $11.12 ===================== =========== ======== ===================== ================
Numerator: Net income attributable to common stockholders....................................... $ 16,785 $ 5,030 $ 935 ========== ========= ========= Denominator: Weighted-average shares outstanding (denominator for basic earnings per share)....... 5,367 5,368 5,368 Plus effect of dilutive securities: Convertible preferred stock........................................................ 4,191 4,191 4,191 Employee stock options............................................................. 4 5 3 ---------- --------- --------- Weighted-average shares outstanding and assumed conversions (denominator for diluted earnings per share)................................................................ 9,562 9,564 9,562 ========== ========= ========= Basic earnings per share............................................................... $ 3.13 $ 0.94 $ 0.17 Diluted earnings per share............................................................. $ 1.76 $ 0.53 $ 0.10
Earnings per share--Pro forma Basic $ 1.76 Diluted $ 1.76 Weighted-average common shares outstanding--Pro forma Basic 9,558 Diluted 9,562
On February 9, 2006, the Company completed its initial public offering of 10,500,000 shares of its common stock $0.01 par value per share (the "Common Stock"), at a price of $9.00 per share. Of the shares sold in the offering, 6,000,000 were offered by the Company and 4,500,000 were offered by selling shareholders. The Company's net proceeds from the offering were $48.0 million. Additionally, on March 15, 2006, the underwriters of the Company's initial public offering of Common Stock, purchased an additional 274,000 shares of Common Stock at a price of $9.00 per share pursuant to the partial exercise of the over-allotment option granted to them. All of the shares purchased upon exercise of the underwriters' option were sold by selling stockholders and the Company did not receive any sale proceeds. The exercise of the over-allotment increased the size of the offering to 10,774,000 shares of Common Stock, of which 6,000,000 were offered and sold by the Company and 4,774,000 were offered and sold by selling stockholders.
The Company's shares are listed on the NASDAQ National Market under the symbol "AMCP." On February 6, 2006, the Company affected a 1-for-2.2904 reverse stock split and immediately prior to the effectiveness of the stock offering, the Company increased the authorized common stock to 45,000,000 shares. As a result of this reverse stock split, $72,000 representing the par value of the reduction in shares issued, was transferred from common stock to additional paid-in capital. All numbers of common shares and per share data in the accompanying consolidated financial statements and related notes have been retroactively adjusted to give effect to the stock split. At the effective date of the offering, the Company granted five-year options with respect to an aggregate of 758,039 shares at an exercise price equal to the initial public offering price to employees, including officers.
First Second Third Fourth Quarter Quarter Quarter Quarter --------- --------- --------- --------- Revenues $ 63,122 $ 66,759 $ 68,457 $ 68,963 Expenses 54,902 57,659 66,353 62,276 Net income 5,327 5,220 1,579 4,659 Basic earnings per share 0.99 0.97 0.29 0.87 Diluted earnings per share 0.56 0.55 0.17 0.49