The following table summarizes our consolidated financial information for the periods indicated.
The information as of December 31, 2006, 2005, 2004, 2003 and 2002 and for the years ended December 31, 2006, 2005, 2004 and 2003 and the period from June 26, 2002 through December 31, 2002 was derived from our audited consolidated financial statements. We purchased our initial operating subsidiaries on June 26, 2002, and our holding company had minimal activity prior to the acquisition of our subsidiaries. The information as of and for the period ended June 25, 2002 was derived from the predecessor companies’ audited combined financial statements.
As of December 31, 2004, combined statutory capital and surplus included $15.0 million for North Pointe Casualty, which was acquired in February 2004 utilizing a combination of holding company funds and new debt.
Loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred divided by the sum of net premiums earned, installment fees and other income.
possible assessments for guaranty funds, other insurance-related assessments and mandatory reinsurance arrangements and our ability to recover such assessments through future surcharges or other rate changes;
the cyclical and seasonal nature of the industries within which we operate;
existing and future regulations by the local, state and federal governments;
our limited history writing homeowners insurance policies to homeowners in Florida;
The $826,000 increase in net income for the year ended December 31, 2006 was primarily attributable to a $5.7 million after-tax decrease in net loss and loss adjustment expenses, partially offset by a $3.0 million after-tax decrease in net premiums earned. In addition, 2006 net income includes an after-tax charge of $1.8 million related to a FIGA assessment.
Net income for 2004 includes an extraordinary gain of $2.9 million related to the recognition of negative goodwill resulting from the acquisition of North Pointe Casualty for less than the aggregate fair value of its net assets. Net income for 2004 also includes after-tax expenses of $4.8 million attributable to four hurricanes which
struck Florida in 2004 and $2.8 million after-tax gain primarily attributable to the sale of the renewal rights of our non-standard automobile line of business in October 2004.
In 2005, our gross premiums written grew to $112.1 million from $96.5 million in 2004, an increase of $15.6 million, or 16.2%. Our commercial lines gross premiums written increased by $5.2 million, or 7.0% and our personal lines gross premiums written increased by $10.4 million or 45.0%. We experienced continued expansion in our Florida small business line which accounted for most of the growth in our commercial lines segment. We entered the Florida homeowners market in December 2004 which accounts for the growth in our personal lines segment. The growth in the Florida homeowners line of business was partially offset by a decrease in writings in our personal automobile insurance line, which we exited in October 2004.
In August 2006, our Board of Directors authorized the repurchase of up to $5.0 million of the Company’s outstanding common stock. The repurchase program has a twenty-four month time limit, and the timing and actual number of shares to be repurchased will depend on a variety of factors, including corporate and regulatory requirements, price, and other market conditions. During the year ended December 31, 2006, we had not repurchased any shares under the program.
Our analyses are critical not only for the purpose of establishing accurate financial reporting data but also for evaluating pricing and the effectiveness of various product lines or coverages.
We use actuarial methodologies to assist us in establishing these estimates, including estimates of the severity and frequency of future claims, the length of time to obtain an ultimate resolution, outcomes of litigation and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, our ultimate liability may differ from our original estimate. Our reserve estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. See “Results of Operations - Losses and Loss Adjustment Expenses,” “Business - Unpaid Losses and Loss Adjustment Expenses,” and Note 7 to our consolidated financial statements, all of which are included elsewhere in this annual report on Form 10-K.
SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” and Staff Accounting Bulletin 59, “Noncurrent Marketable Equity Securities,” require companies to perform periodic reviews of individual securities in their investment portfolios to determine whether a decline in the value of a security is other than temporary. A review for other-than-temporary impairment (“OTTI”) requires companies to make certain forward-looking judgments regarding the materiality of the decline, its effect on the financial statements, and the probability, extent and timing of a valuation recovery, and the Company’s ability and intent to hold the security. The scope of this review is broad and requires a forward-looking assessment of the fundamental characteristics of a security, as well as market-related prospects of the issuer and its industry.
Reinsurance recoverables represent (1) amounts currently due from reinsurers on paid losses and LAE, (2) amounts recoverable from reinsurers on case basis estimates of reported losses and LAE, and (3) amounts recoverable from reinsurers on actuarial estimates of IBNR losses and LAE. Such recoverables, by necessity, are based upon estimates. Reinsurance does not legally discharge us from our legal liability to our insureds, but it does make the assuming reinsurer liable to us to the extent of the reinsurance ceded. Instead of being netted against the appropriate liabilities, ceded unearned premiums and reinsurance recoverables on paid and unpaid losses and LAE are reported separately as assets in our consolidated balance sheets. Reinsurance recoverable balances are also subject to credit risk associated with the particular reinsurer. In our selection of reinsurers, we continually evaluate their financial stability. While we believe our reinsurance recoverables are collectible, the ultimate recoverable may be greater or less than the amount accrued. At December 31, 2006 and 2005, reinsurance recoverables on paid and unpaid losses and loss adjustment expenses, and pre-paid reinsurance premiums were $49.4 million and $84.9 million, respectively.
We evaluate the performance of our operations by monitoring key measures of growth and profitability. We measure our growth by examining our gross premiums written. We measure our profitability by examining our net income, loss ratio, expense ratio and combined ratio. The following table provides financial results and key measures that we use to evaluate our results. In discussing the trends in our financial results, we refer principally to the information contained in the following table:
Gross premiums written in our commercial lines segment for 2006 were $81.9 million as compared to $78.6 million for 2005, an increase of $3.3 million or 4.2%. This increase was primarily attributable to $11.0 million in gross premiums written in our crop fronting program and flood program, which we began in 2006, and a $2.3 million increase in our bowling centers and roller skating centers lines. The crop fronting program was discontinued for 2007. These increases were partially offset by an $8.6 million decrease in gross written premiums in our Florida small business line, which resulted from cancellations and non-renewals, and a $2.2 million decrease in our Restaurant Bar Tavern, or RBT lines. The cancellations and non-renewals were the result of our prompt reduction of our wind exposure in Florida when it became evident that we could not obtain catastrophe reinsurance coverage for the 2006 hurricane season. We made the decision to reduce our exposure in early June which was substantially implemented by July 2006 by the cancellation or non-renewal of all policies included in specific classes within our Florida small business line. We expect this will reduce total annualized gross premiums written in our Florida small business line by approximately $18.0 million, or 40.0%, and total insurable value with wind exposure by approximately 75.0%. The decrease in our RBT line was attributable to a reduction in policy count resulting from a more competitive market.
Net premiums written is the amount of our gross premiums written less the amount of premiums that we transfer, or cede, to our reinsurers based upon the risks they accept pursuant to our reinsurance treaties. We relate our net premiums written to gross premiums written to measure the amount of premium we retain after cessions to reinsurers. Our primary reinsurance agreement is a multi-line, excess of loss treaty covering substantially all lines and a variety of other reinsurance treaties, including catastrophe, corporate clash, and facultative coverage. See “Business - Reinsurance,” incorporated elsewhere within this Annual Report on Form 10-K.
Year Ended December 31, 2005 as Compared to Year Ended December 31, 2004. Net premiums written for 2005 were $87.1 million as compared to $80.5 million in 2004, an increase of $6.6 million, or 8.2%. The increase in net premiums written resulted from an increase in gross premiums written, partially offset by a decrease in the percentage of premiums retained after cessions to reinsurers. Net premiums written as a percentage of gross premiums written were 77.7% in 2005 and 83.4% in 2004. The decrease in the percentage of net premiums written that we retained in 2005 as compared to 2004 was primarily attributable to the shift in the mix of business to personal property insurance policies in Florida which resulted in higher catastrophe reinsurance premiums. Also,
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Net premiums earned for 2006 were $80.2 million as compared to $84.7 million for 2005, a decrease of $4.5 million, or 5.3%. The decrease in net premiums earned was consistent with the decrease in net premiums written discussed above.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Net investment income for 2006 was $6.5 million as compared to $4.0 million for 2005, an increase of $2.5 million, or 62.5%.
U.S. Treasury notes increased to 4.7% in 2006 from 3.9% in 2005, which we believe reflected the trend in market interest rates for debt securities with durations similar to our cash and securities mix. The average duration of our debt securities portfolio was 3.5 and 3.3 years as of December 31, 2006 and 2005, respectively.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Other income for 2006 was $1.9 million, consistent with 2005 results.
Year Ended December 31, 2005 as Compared to Year Ended December 31, 2004. Other income for 2005 was $1.9 million as compared to $2.2 million for 2004, a decrease of $300,000, or 13.6%. The decrease was primarily attributable to exiting the personal automobile line of business in October 2004, which business generated a substantial portion of the installment fees in 2004. The decrease in installments fees attributable to the automobile line of business was partially offset by an increase in fees generated from the new Florida homeowners line of business as well as some additional charges and commissions attributable to our bowling center line.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Losses and loss adjustment expenses for 2006 were $35.4 million as compared to $44.0 million for 2005, a decrease of $8.6 million, or 19.5%. Our loss ratio for 2006 was 43.1% as compared to 50.8% in 2005.
The impact of the hurricane losses and reserve development on our loss ratios for our commercial lines for the years ended December 31, 2006, 2005 and 2004 are as follows:
Unfavorable development of prior period reserve estimates increased losses and loss adjustment expenses in our personal lines by $1.5 million in 2006 from $10.2 million to $11.7 million and increased the loss ratios from 48.9% to 55.9% in 2006. We experienced favorable development of $2.0 million in our personal lines segment in 2005, which reduced the loss ratio from 70.8% to 62.5% in 2005.
The impact of the hurricane losses and reserve development on our loss ratios for our personal lines segment for the years ended December 31, 2006, 2005 and 2004 are provided as follows:
The increase in the losses and loss adjustment expenses was primarily attributable to four hurricanes which struck Florida, Texas and the U.S. Gulf coast in 2005, further detailed in the commercial and personal lines discussions, below. Hurricane losses increased our 2005 loss ratio by 15.1 percentage points, from 35.7% to 50.8%. This is compared to an 8.4 percentage point increase in our 2004 loss ratio, from 44.0% to 52.4%, also attributable to hurricane losses.
The loss ratio for our commercial lines for 2005 was 47.8% as compared to 50.9% for 2004. This decrease in our loss ratio was attributable to a combination of fewer hurricane losses incurred in our commercial lines in 2005 as compared to 2004 as well as improved loss experience from the non-catastrophic risks. For the years ended December 31, 2005 and 2004, we incurred $4.8 million and $6.2 million, respectively, of net losses and loss adjustment expenses related to hurricanes as well as $2.0 million and $1.1 million, respectively, of accelerated reinsurance reinstatement charges recorded as a reduction of net premiums earned. Of the $2.0 million of reinstatement charges in 2005, $1.8 million was attributable to hurricane losses and $248,000 was attributable to the Citizens assessments. The losses from the hurricanes and related reinstatement charges increased our commercial lines loss ratio from 38.3% to 47.8% in 2005 and from 38.7% to 50.9% in 2004.
Favorable development of prior period reserve estimates reduced losses and loss adjustment expenses in our personal lines by $2.0 million in 2005 from $16.8 million to $14.8 million. Similar favorable development in 2004 reduced losses and loss adjustment expenses in our personal lines by $552,000, from $13.9 million to $13.3 million. Such favorable development reduced the loss ratio from 70.8% to 62.5% in 2005 and from 64.3% to 61.7% in 2004.
The favorable reserve adjustments in our personal lines were primarily attributable to our personal automobile line (currently in run-off) in which we experienced better than expected loss development in the liability coverages.
Commissions generally represent approximately 70% of our total policy acquisition costs, with the remaining 30% attributable to administrative expenses directly related to the marketing and issuance of insurance policies. Policy acquisition costs are capitalized and amortized over the life of the related policy.
Year Ended December 31, 2005 as Compared to Year Ended December 31, 2004. Policy acquisition costs for 2005 were $21.8 million as compared to $18.7 million for 2004, an increase of $3.1 million, or 16.6%. The increase was primarily attributable to an increase in gross premiums earned.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Other underwriting and operating expenses for the year ended December 31, 2006 were $22.3 million as compared to $17.9 million for the year ended December 31, 2005, an increase of $4.4 million, or 24.6%. The increase was primarily attributable to increased personnel and external services costs associated with being a public company. In addition, in 2006, we incurred $2.8 million of operating expenses attributable to the FIGA assessment which stemmed from the insolvency of POE Financial Insurance Group in early 2006.
Year Ended December 31, 2005 as Compared to Year Ended December 31, 2004. Other underwriting and operating expenses for the year ended December 31, 2005 were $17.9 million as compared to $13.7 million for the year ended December 31, 2004, an increase of $4.2 million, or 30.7%. This increase was primarily attributable to additional personnel and other expenses associated with the expansion in our Florida small business and homeowners operations and increased personnel and external services costs associated with being a public company. In addition, in 2005, we incurred $568,000 of operating expenses attributable to the Citizens’ assessments (for both the imposed and anticipated assessments) relating to hurricane losses in 2004 and 2005, however we incurred no similar expenses in 2004.
Year Ended December 31, 2006 as Compared to Year Ended December 31, 2005. Interest expense for 2006 was $1.7 million as compared to $959,000 for 2005, an increase of $751,000, or 78.3%. The increase in interest
Year Ended December 31, 2006. Federal income tax expense for 2006 was $2.4 million, representing an effective tax rate of 33.4%, which approximates the statutory rate of 34.0%. The federal income tax expense calculation included two offsetting items affecting the effective rate, which were: 1) a $46,000 decrease in federal income tax expense attributable to permanent differences between book and tax accounting and 2) a $7,000 increase in federal income tax expense relating to a provision to return variance. In July 2006, the Financial Accounting Standard Board (“FASB”) issued Interpretation No. 48 (“FIN No. 48”) which is effective for fiscal years beginning after December 15, 2006. This Interpretation clarifies the uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS Statement No. 109, Accounting for Income Taxes (“SFAS 109”). FIN No. 48 requires that we evaluate our tax positions within the scope of SFAS 109 in each tax jurisdiction for all open tax years and determine whether our tax positions are more-likely-than-not of being sustained based solely on technical merits. FIN No. 48 then requires that we measure the tax benefit or liability to be recognized and record an adjustment to income and retained earnings according to the Interpretation. We adopted FIN 48 on January 1, 2007 and have determined that it will not have a material effect on our financial condition or results of operation.
As of December 31, 2006, we had an aggregate of $6.7 million in unrealized NOL carryforwards. Federal income tax regulations limit our utilization of these amounts to $960,000 annually in years 2007 through 2010, $909,000 in years 2011 through 2013 and $20,000 in years 2014 through 2020.
North Pointe Holdings Corporation is a holding company with no business operations of its own. Consequently, our ability to pay dividends to shareholders, meet our debt payment obligations and pay our taxes and administrative expenses is dependent on intercompany service agreements with, and dividends from, our subsidiaries, including our insurance company subsidiaries. Our insurance company subsidiaries are subject to extensive regulation by insurance regulatory agencies in each state in which they do business, including restrictions on the amount of dividends they can pay to their shareholder. See “Liquidity and Capital Resources - Capital Constraints,” incorporated elsewhere within this Annual Report on Form-10K.
Our non-insurance companies provide management and administrative services to our insurance company subsidiaries pursuant to intercompany service agreements. These services include providing management, marketing, offices and equipment, and premium collection, for which our insurance companies pay our non-insurance companies fees primarily based on a percentage of gross premiums written. In exchange for providing these intercompany services, our non-insurance companies recorded revenues of $20.5 million, $19.3 million, and $10.9 million, for the years ended December 31, 2006, 2005 and 2004, respectively. Our non-insurance companies also derive nonaffiliated revenues from installment fees, commissions from nonaffiliated insurance carriers, premium financing and other income which totaled $1.9 million, $1.9 million, and $2.2 million for the years ended December 31, 2006, 2005 and 2004, respectively. There were no material non-cash components of our non-insurance company revenues. All of the agreements between our regulated insurance company subsidiaries and our non-insurance company subsidiaries have been approved by the applicable regulators.
The primary obligations of our non-insurance companies are salary and administrative expenses and debt service obligations. Our non-insurance companies incurred salary and administrative expenses of $12.8 million, $10.6 million, and $8.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. Our minimum principal and interest payments on our bank debt were $1.8 million, $4.5 million, and $3.6 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Net cash provided by financing activities for the year ended December 31, 2005 was $26.6 million and was attributable to $44.3 million in net proceeds provided from the initial public offering partially offset by a $17.7 million reduction in net borrowings.
Under the Michigan holding company law, our Michigan insurance company, North Pointe Insurance, can only declare or pay dividends from its earned surplus, unless the Michigan insurance regulator approves the dividend prior to payment. In addition, our Michigan insurance company must obtain prior approval from the Michigan insurance regulator before it may pay extraordinary dividends or distributions to its shareholder, North Pointe Financial. In Michigan, an extraordinary dividend or distribution includes any dividend or distribution of cash or other property if the fair market value of the cash or other property, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (1) 10% of the insurer’s surplus as of December 31 of the preceding year or (2) the net income of the insurer, not including realized capital gains, for the twelve-month period ending December 31 of the preceding year, in each case determined in accordance with statutory accounting practices. Dividends or distributions falling below this threshold are considered ordinary shareholder dividends. Ordinary shareholder dividends declared by our Michigan insurer must be reported to the Michigan insurance regulator at least ten days before they are paid, but these dividends are not subject to prior approval. Michigan’s insurance law would allow North Pointe Insurance to pay up to $5.0 million in ordinary dividends in 2007. Nonetheless, the Michigan insurance regulator retains the right to deny any dividend, extraordinary or otherwise. Accordingly, we typically obtain prior approval on all dividend distributions from North Pointe Insurance.
Dividends or distributions falling below these thresholds are not subject to prior approval by the Florida insurance regulator. Florida’s insurance law would allow for North Pointe Casualty and Home Pointe to pay any dividends of $946,00 and $687,000, respectively without prior regulatory approval in 2007.
Senior Credit Facility. On June 30, 2006, we entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”) with Comerica Bank, as agent (“Comerica”), JP Morgan Chase Bank, and Fifth Third Bank, which replaced a previous Amended Credit Agreement between the parties dated January 26, 2004, the term of which was set to expire on July 1, 2006. The Credit Agreement provides for a revolving credit line in the aggregate amount of $25.0 million. At December 31, 2006, there was no outstanding balance on the line.
the ratio of gross premiums written to statutory surplus will not exceed more than 10.0 to 1.0 in the case of North Pointe Casualty Insurance Company and Home Pointe Insurance Company and 3.0 to 1.0 in the case of North Pointe Insurance Company.
The Credit Agreement contains negative covenants restricting our ability to, among other things, enter into a merger or consolidation, sell, lease or otherwise dispose of our assets, acquire the stock or assets of another entity or declare or pay any dividends, guaranty the obligations of a third party, incur indebtedness, and make certain investments. As of December 31, 2006, we were in compliance with all of our covenants.
In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, to permit all entities to choose to elect, at specified election dates, to measure eligible financial instruments at fair value. An entity would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize upfront costs and fees related to those items in earnings as incurred and not deferred. SFAS No. 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. An entity is prohibited from retrospectively applying SFAS No. 159, unless it chooses early adoption. SFAS No. 159 also applies to eligible items existing at November 15, 2007 (or early adoption date). We are currently in the process of evaluating the impact of SFAS No. 159.
In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 157, Fair Value Measurements, which redefines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. SFAS No. 157 applies where other accounting pronouncements require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The effects of adoption will be determined by the types of instruments carried at fair value in the Company’s financial statements at the time of adoption as well as the method utilized to determine their fair values prior to the adoption. Based on our current use of fair value measurements, SFAS No. 157 is not expected to have a material effect on the results of operations or financial position of the Company.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 is intended to eliminate the potential for the build up of improper amounts on the balance sheet due to the limitations of certain methods of materiality assessment utilized in current practice. SAB 108 establishes a single quantification framework wherein the significance measurement is based on
the effects of the misstatements on each of the financial statements as well as the related financial statement disclosures. Our adoption of SAB 108 in 2006 did not have any effect on our results of operations or financial position.
The Consolidated Financial Statements of North Pointe Holdings Corporation and the Report of Independent Registered Public Accounting Firm thereon are filed pursuant to this Item 8 and are included in this report at Item 15.
Our results of operations may vary significantly from quarter to quarter depending on a number of factors, including seasonal variations in claims related to seasonal weather patterns, and market and economic conditions.