The Company leases buildings that are used in the normal course of business which includes offices and facilities in Georgia, Mississippi, Tennessee and Virginia. These facilities are used by executive, claims and marketing personnel and are components of the insurance and noninsurance segments. Locations utilized by the Company’s independent exclusive and independent agents are normally leased by those agents as lessees.
Any statement contained in this report which is not a historical fact, or which might otherwise be considered an opinion or projection concerning the Company or its business, whether expressed or implied, is meant as and should be considered a forward-looking statement as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks, including but not necessarily limited to changes in market conditions, natural disasters and other catastrophic events, increased competition, changes in availability and cost of reinsurance, changes in governmental regulations, technological changes, political and legal contingencies and general economic conditions, as well as other risks and uncertainties more completely described in the Company’s filings with the Securities and Exchange Commission, including this report on Form 10-K. If any of these assumptions or opinions proves incorrect, any forward-looking statements made on the basis of such assumptions or opinions may also prove materially incorrect in one or more respects and may cause actual future results to differ materially from those contemplated, projected, estimated or budgeted in such forward-looking statements.
Alfa Corporation is affiliated with Alfa Mutual Insurance Company, Alfa Mutual Fire Insurance Company, and Alfa Mutual General Insurance Company (collectively, the Mutual Group). The Mutual Group owns 55.0% of Alfa Corporation’s common stock, their largest single investment. Alfa Specialty Insurance Corporation (Specialty) is a wholly-owned subsidiary of Alfa Mutual Insurance Company (Mutual). Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group and Specialty comprise the Alfa Group (Alfa). Prior to January 1, 2007, Virginia Mutual Insurance Company (Virginia Mutual) ceded 80% of its direct business to Alfa Mutual Fire Insurance Company (Fire) under a Strategic Affiliation Agreement signed in August 2001.
Effective January 1, 2007, the Company completed the previously approved plan of conversion and acquisition of Virginia Mutual. Under the plan, Virginia Mutual converted from a mutual company to a stock company and simultaneously was recapitalized as Alfa Alliance Insurance Corporation (Alliance), a wholly-owned subsidiary of the Company. In addition, the Pooling Agreement was amended to include Alliance as a participant in the pool and the quota share agreement between Fire and Virginia Mutual was terminated with applicable references removed from the Pooling Agreement.
The Company’s revenue consists mainly of premiums earned, policy charges, net investment income and fee income. Benefit and settlement expenses consist primarily of claims paid and claims in process and pending and include an estimate of amounts incurred but not yet reported along with loss adjustment expenses. Other operating expenses consist primarily of compensation expenses, and other overhead business expenses, net of deferred policy acquisition costs.
Property casualty insurance operations accounted for 82.1% of revenues and 91.6% of net income in 2007. Life insurance operations generated 17.6% of revenues and 24.2% of net income during the same period. Noninsurance operations, combined with corporate expenses for 2007, generated 0.3% of revenues and resulted in a net loss of $14.7 million, or 15.8%, of net income.
On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and
Management has discussed the Company’s critical accounting policies and estimates, together with any changes therein, with the Audit Committee of the Company’s Board of Directors. The Company’s Audit Committee has also reviewed the disclosures contained herein.
In accordance with the provisions of SFAS No. 60 and the AICPA Audit and Accounting Guide, credit insurance reserves are held as unearned premium reserves calculated using the “rule of 78” method. Reserves for supplementary contracts with life contingencies are determined using the 1971 Individual Annuity Mortality Table and interest rates that vary depending on date of issue. Likewise, reserves for accidental death benefits are determined predominantly by using the 1959 Accidental Death Benefit Mortality Table and an interest rate of 3%. Reserves for disability benefits, both active and disabled lives, are calculated primarily from the 1952 Disability Study and a rate of 2.5%. A small portion of the Company’s disabled life reserves are calculated based on the 1970 Intercompany Group Disability Study and a rate of 3%.
Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in stockholders’ equity as a component of accumulated other comprehensive income and, accordingly, have no effect on net income. Fair values for fixed maturities, equity securities and short-term bonds are based on quoted market prices, except for $35.0 million of the structured notes portfolio on which a market quote is not readily available. These structured notes represent 2.7% of fixed maturities available for sale. Those fair values are based on pricing models, and are discussed further in the section titled Investments. The cost of investment securities sold is determined by using the first-in, first-out methodology. In some instances, the Company may use the specific identification method. The Company monitors its investment
Policy acquisition costs, such as commissions, premium taxes and certain other underwriting and marketing expenses that vary with and are directly related to the production of business have been deferred.
Life Insurance Products: Traditional life insurance acquisition costs are being amortized over the premium payment period of the related policies using assumptions consistent with those used in computing policy benefit reserves. Acquisition costs for universal life type policies are being amortized over a thirty-year period in relation to the present value of estimated gross profits that are determined based upon surrender charges and investment, mortality and expense margins. Investment income is considered, if necessary, in the determination of the recoverability of deferred policy acquisition costs. If an internal replacement change is considered to be significant and integrated, the unamortized balance of deferred policy acquisition costs related to the original contract is extinguished and charged to income. The policy acquisition costs associated with the replacement policy are deferred and amortized to income.
Property Casualty Products: Acquisition costs for property casualty insurance are amortized over the period in which the related premiums are earned. If an internal replacement change is considered to be significant and integrated, the unamortized balance of deferred policy acquisition costs related to the original contract is extinguished and charged to income. The policy acquisition costs associated with the replacement policy are deferred and amortized to income. Future changes in estimates, such as the relative time certain employees spend in initial policy bookings, may require adjustment to the amounts deferred. Changes in underwriting and policy issuance processes may also give rise to changes in these deferred costs.
The Company is subject to lawsuits in the normal course of business related to its insurance and noninsurance products. At the time a lawsuit becomes known, management evaluates the merits of the case and determines the need for establishing estimated reserves for potential settlements or judgments as well as reserves for potential costs of defending the Company against the allegations of the complaint. These reserves may be adjusted as the case develops. Periodically, and at least quarterly, management assesses all pending cases as a basis for evaluating reserve levels. At that point, any necessary adjustments are made to applicable reserves as determined by management and are included in current operating results. Reserves may be adjusted based upon outside counsels’ advice regarding the law and facts of the case, any revisions in the law applicable to the case, the results of depositions and/or other forms of discovery, general developments as the case progresses such as a favorable or an adverse trial court ruling, whether a verdict is rendered for or against the Company, whether management believes an appeal will be successful, or other factors that may affect the anticipated outcome of the case. Management believes adequate reserves have been established in known cases. However, due to the uncertainty of future events, there can be no assurance that actual outcomes will not differ from the assessments made by management.
The following table sets forth consolidated summarized income statement information for the years ended December 31, 2007, 2006 and 2005:
Consolidated results of operations have been impacted by the following events in 2006 and 2007:
Effective January 1, 2006, a new life policy administration system was implemented with three new product offerings:
During the second quarter of 2006, management discovered fraudulent activity occurring within Financial. The misconduct was determined to be limited to the acts of a single person. As a result, the Company provided for a net charge of $3.5 million on a pretax basis and $2.3 million on an after tax basis or a $0.03 impact on diluted earnings per share. Subsequent recoveries of $815 thousand, on a pretax basis, were received during the first quarter of 2007.
On January 1, 2007, the Company completed the plan of conversion and acquisition of Virginia Mutual. Under the plan, Virginia Mutual converted from a mutual company to a stock company and simultaneously was recapitalized as Alliance, a wholly-owned subsidiary of the Company.
During the third quarter of 2007, the Company recorded a loss through its investment in MidCountry Financial Corporation (MidCountry) resulting from the fraudulent misappropriation of principal payments by one of MidCountry’s third-party loan servicers. In addition, the Company was negatively impacted by increased loan loss reserves and charge-offs related to a portfolio of residential construction loans at MidCountry during the third and fourth quarters of 2007.
Property casualty insurance earned and written premiums for 2007 increased $21.7 million, or 3.6%, and $3.6 million, or 0.6%, respectively. In 2006, earned and written premiums increased $47.8 million, or 8.6%, and $33.6 million, or 5.7%, respectively. The following table shows the Company’s growth in earned and written premiums for 2007 and 2006:
2007 Earned and Written Premium Growth: In the table above, premiums generated by Alliance, a new subsidiary of the Company, impact the relative growth rates of both earned and written premiums in personal and commercial lines. Declines in the reinsurance assumed earned and written premiums are primarily due to the termination of the Virginia Mutual quota share agreement.
Reinsurance ceded earned premiums increased 55.4%, or $1.7 million, due to increases in the Company’s catastrophe reinsurance premiums. Reinsurance assumed earned premiums increased 9.0%, or $2.0 million, due to a $2.6 million increase in the assumed premiums from the state of Texas through AVIC offset by a $556 thousand decrease in the assumed reinsurance premiums from Virginia Mutual’s quota share reinsurance treaty. The 26.9% decrease in reinsurance assumed written premiums is related to Virginia Mutual being added to the pool in 2005 offset by increases in assumed written premiums in Texas.
Pooling Agreement: The property casualty subsidiaries of the Company are participants in the Pooling Agreement with the Mutual Group including Specialty. Under the Pooling Agreement, the Company’s property
2007 Policies Inforce Growth and Inforce Annualized Premiums Growth: Policies inforce grew for all lines in 2007. The 4.3% increase in traditional life was the result of increases in the new level term product and in the direct mail product. Inforce annualized premium growth was 3.6%, with the largest increase in traditional life at 11.0%, or $5.2 million. Inforce annualized premium growth for annuities increased 54.6%, or $769 thousand, with an inforce growth of 40.4%. Policies inforce growth for the COLI plan was 66.2% in 2007. This increase represents additional coverage for the same group of employees due to the Pension Protection Act of 2006. Paid annualized premiums decreased 13.0% as the demographics of the group covered changed.
Operating income for the property casualty subsidiaries increased $341 thousand, or 0.4%, in 2007 and $4.8 million, or 6.0%, in 2006. In 2007, earned premiums increased 3.6%, or $21.7 million, with a 2.5%, or $1.8 million, increase derived from the nonstandard automobile market, which includes AVIC and Specialty, a 21.0%, or $4.4 million, increase from Alliance and the remainder of $15.5 million from the Alabama, Georgia and Mississippi preferred and standard markets. In 2006, earned premiums increased 8.6%, or $47.8 million, with a 95.9%, or $34.5 million, increase derived from the nonstandard automobile market and a 2.8%, or $13.9 million, increase derived from the Alabama, Georgia and Mississippi preferred and standard markets. These increases were offset by a decrease of 2.6%, or $556 thousand, in earned premiums derived from Virginia Mutual.
Property casualty losses and related expenses increased 4.3%, or $16.3 million, in 2007 due to a 0.4% increase in the loss ratio offset by a slight 0.1% decrease in the loss adjustment expense (LAE) ratio. In 2006, property casualty losses and related expenses increased 6.1%, or $21.8 million. The loss ratio decreased 2.1% and the LAE ratio increased 0.7%. Operating expenses also increased 4.5%, or $7.6 million, and 18.3%, or $26.0 million, in 2007 and 2006, respectively. The property casualty subsidiaries’ return on average equity for the trailing twelve-month period ended December 31, 2007 was 16.4% compared to 17.2% for 2006. Return on average equity, a non-GAAP financial measure, is defined as net income divided by the simple average of beginning and ending stockholder’s equity.
Life insurance operating income decreased $584 thousand, or 2.4%, in 2007 as a result of increases in life benefits, amortization of deferred acquisition costs and other operating expenses offset by a 6.7% increase in revenue and a decrease in the mortality ratio. The mortality ratio was 88% of expected for 2007 compared to 104% of expected for 2006. Mortality, a non-GAAP financial measure, represents the ratio of actual to expected death claims. Therefore, the Company experienced more favorable financial results when compared to 2006 due to the lower mortality ratio. The 6.7% revenue increase consisted of premiums and policy charge growth of 7.5% and net investment income growth of 5.5%. Amortization of deferred acquisition costs increased $2.3 million, or 19.5%, during 2007 when compared to 2006. The increase is primarily due to the effect of adopting SOP 05-1 on January 1, 2007, with the majority of the impact associated with a return of premium product conversion program
In 2006, Life insurance operating income increased $2.2 million, or 10.1%, as a result of premiums and policy charges growth of 8.1% and net investment income growth of 10.9% offset by an increase in the mortality ratio to 104% of expected for 2006 compared to 96% of expected for 2005. Therefore, for 2006, the Company experienced less favorable financial results when compared to the same period in 2005 due to the higher mortality ratio.
Noninsurance operating income decreased $1.7 million to an operating loss of $1.3 million for 2007 compared to an operating profit of $328 thousand for 2006. Agency operations decreased operating income by $1.2 million due to declines in production at Vision; loan operations, including MidCountry, decreased operating income by $2.3 million due to equity-method investment losses; commercial leasing operations increased operating income by $786 thousand; and ABC increased operating income by $974 thousand.
Corporate expenses increased $7.5 million in 2007 and decreased $1.2 million in 2006. Current year results were impacted by increases in borrowing costs and accounting fees as well as increases in legal and other expenses related to the privatization of the Company (refer to Note 21 - Privatization of the Company in the Notes to Consolidated Financial Statements). Prior year results were impacted by a change in the Company’s tax allocation agreement offset by increased costs on the Company’s short-term borrowings and increases in legal and accounting fees.
The following table sets forth summarized financial information for the Company’s property casualty insurance subsidiaries, AIC, AGI, AVIC and Alliance, for the years ended December 31, 2007, 2006 and 2005:
AIC and AGI contributed $14.8 million of earned premiums growth in 2007. The growth from AIC and AGI is related to increases in personal lines. During 2007, AIC’s and AGI’s earned premiums for homeowner and manufactured home increased $10.0 million, or 6.3%, automobile increased $2.9 million, or 0.9%, and farmowner increased $1.2 million, or 4.3%. In addition, there were increases in other personal lines of $421 thousand and a slight increase in commercial lines of $51 thousand with an increase in ceded catastrophe premiums and working cover premiums of $347 thousand. In addition, reinsurance assumed premiums increased $360 thousand.
For 2007, the expense ratio was impacted 3.2% by AVIC’s expense structure and 1.5% by Alliance, 0.3% by SFAS No. 123(R) and 0.6% due to technology costs. For 2006, the expense ratio was impacted 3.4% by AVIC, 1.2% by Virginia Mutual, 0.3% with the adoption of SFAS No. 123(R) and 0.7% due to technology costs.
The overall higher expense structures of AVIC and Alliance, the impact of SFAS No. 123(R), technology costs and an increased overall loss ratio produced an underwriting margin of 8.6% in 2007, compared with an underwriting margin of 9.2% in 2006. Underwriting margin, a non-GAAP financial measure, represents the percentage of each premium dollar earned which remains after losses, loss adjustment expenses and other operating expenses.
Property casualty insurance earned premiums increased $47.8 million, or 8.6%, during 2006 with AVIC contributing $31.5 million and AIC and AGI contributing $16.9 million of the increase. Virginia Mutual earned premiums decreased slightly to $20.8 million for 2006 compared to $21.4 million for 2005.
AVIC impacted the LAE ratio by 1.0% in 2006 compared to 0.4% in 2005. Technology costs have impacted the LAE ratio by 0.1% in 2006.
Life’s premiums and policy charges increased $6.2 million, or 7.5%, in 2007 compared to $6.2 million, or 8.1%, in 2006.
Life insurance policy charges increased $1.3 million, or 3.6%, in 2007 and $1.3 million, or 3.7%, in 2006 primarily due to an increase in universal life policy charges resulting from increases in fund balances that the charges are assessed against along with a slight increase of 0.3% in the number of universal life policies inforce. In addition, interest sensitive policy charges increased with a 1.3% increase in the number of interest sensitive life policies inforce.
The mortality ratio decreased to 88% of expected in 2007 from 104% of expected in 2006. Benefit and claims expense increased 7.0%, or $5.5 million, as a result of reserve increases and benefits interest expense. Operating expenses increased $4.7 million in 2007 with SFAS No. 123(R) expense decreasing $31 thousand to $235 thousand in 2007, legal and consulting expenses increasing $2.9 million due to net legal reserve reductions of $2.2 million in 2006 and increases in expenses related to the new policy administration system of $48 thousand. Also affecting 2007 was a net impairment charge of $691 thousand for an abandonment of software being developed for Life’s new policy administration system.
Amortization of deferred policy acquisition costs increased $2.3 million, or 19.5%, in 2007 compared to 2006 as a result of growth in deferred costs related to consistent new business production increases in prior periods and the current period effects of the return of premium conversion program after the adoption of SOP 05-1 as previously discussed in the Overview section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Life’s operating income, net of tax, decreased 2.4%, or $584 thousand, and net income decreased 22.8%, or $6.7 million, in 2007. The decrease in net income results primarily from the decrease in net realized investment gains of $6.1 million. Net income increased 14.6%, or $3.7 million, in 2006, resulting from increases in operating income and net realized investment gains, net of tax, of 10.1% and 40.0%, respectively.
Life’s premiums and policy charges increased $6.2 million, or 8.1%, for 2006, compared to an increase of $5.4 million, or 7.6%, in 2005.
Life insurance premiums increased $4.9 million, or 11.9%, in 2006 compared to $4.0 million, or 10.8%, in 2005. This growth is attributable to increases in term life insurance premiums of $4.7 million for 2006. In addition, term life policies inforce on a year to date basis have increased 7.8%. During January 2006, Life began offering a return of premium level term life product which contributed $3.1 million of the $4.9 million increase in life insurance premiums for 2006.
The mortality ratio increased to 104% of expected in 2006 from 96% of expected in 2005. The result was an increase of $5.3 million in benefits and claims expense for 2006. Operating expenses have increased $158 thousand for 2006 with SFAS No. 123(R) adding $266 thousand and the new policy administration system adding $2.4 million offset by decreases in legal costs of $2.5 million primarily due to net legal reserve reductions of $2.2 million. Amortization of deferred policy acquisition costs have increased in 2006 as a result of growth in deferred costs related to consistent new business production increases in prior periods.
At December 31, 2006, the life subsidiary’s Adjusted Capital calculation in accordance with NAIC RBC guidelines was $215.3 million compared to the Authorized Control Level (Required) RBC amount of $12.9 million.
Agency operations for the year produced a decrease in net income of $1.1 million with all of the decrease attributable to a decline in production at Vision. In 2007, Vision generated net income of $1.5 million compared to net income of $2.7 million in 2006. AAM and AAG contributed $99 thousand and $72 thousand in operating income in 2007 and 2006, respectively.
Financial’s equity in net earnings (after internal capital charge) of MidCountry decreased $8.7 million during 2007. The decrease is primarily a result of increases in loan loss reserves and charge-offs related to a portfolio of residential construction loans purchased from a third party and MidCountry’s share of a fraud loss resulting from the failure of a third party servicer to remit loan payments and payoffs from loans they were servicing. Amounts and timing of potential fraud recoveries, if any, by MidCountry cannot be estimated at this time. The carrying value increased 39.1% with an additional investment of $26.6 million during May 2007 for Financial to maintain its approximate original ownership in the entity.
Commercial lease operations in Financial produced a net loss of $1.1 million in 2007 compared to a net loss in 2006 of $1.9 million. Net losses are a result of servicing fee expenses, legal expenses and interest costs.
ABC had operating income of $133 thousand in 2007 compared to an operating loss of $840 thousand for 2006. The increase of $973 thousand is a result of decreased interest expense.
ABC had an operating loss of $840 thousand in 2006 compared to an operating loss of $931 thousand in 2005. The operating loss in 2006 is a result of increased benefit expenses offset by an increase in net investment income.
Corporate expenses, including the impact of eliminations, increased $7.5 million during 2007 due primarily to increases in borrowing costs and accounting fees as well as increases in legal and other expenses related to the privatization of the Company (refer to Note 21 - Privatization of the Company in the Notes to Consolidated Financial Statements). The Company’s borrowing costs increased $600 thousand in 2007 due to fluctuations in interest rates and the outstanding debt balance throughout the year. The weighted average interest rate at December 31, 2007 was 5.07% with corporate debt decreasing from $97.0 million at December 31, 2006 to $94.9 million at December 31, 2007. Included in the operating results for this segment is $85 thousand of SFAS No. 123(R) expense for 2007 compared to $94 thousand in 2006.
The Company has historically produced positive cash flow from operations which has resulted in increasing amounts of funds available for investment and, consequently, higher investment income. Investment income is also affected by investment yields. Information about cash flows, total invested assets, including investments in affiliates, and yields are presented below for the years ended December 31, 2007, 2006 and 2005:
The overall investment yield rate, calculated using amortized cost, declined during 2007 to 5.4%. The Company had net realized investment losses, before income taxes, of $1.1 million in 2007 compared to net realized investment gains of $3.4 million during the same period in 2006. These losses are primarily from writedowns of fixed maturities and equity securities and realized losses on tax credit partnerships offset by gains on sales of equity securities.
As discussed in Note 14 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation effective January 1, 2006. As discussed in Note 1 and Note 6 to the consolidated financial statements, the Company changed the manner in which it accounts for deferred acquisition costs associated with modifications or exchanges of insurance contracts effective January 1, 2007.
We have audited the accompanying consolidated statement of income, stockholders’ equity and comprehensive income (loss), and cash flows of Alfa Corporation and subsidiaries (the Company) for the year ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
Statutory Practices: Generally accepted accounting principles differ in certain respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed. Such practices differ from state-to-state, may differ from company-to-company within a state and may change in the future. Currently, the Company’s statutory net income and surplus is the same under NAIC accounting practices and the State of Alabama for Alfa Life Insurance Corporation, Alfa Insurance Corporation, Alfa General Insurance Corporation and Alfa Vision Insurance Corporation and the Commonwealth of Virginia for Alfa Alliance Insurance Corporation.
Specialty, which writes nonstandard auto business in Alabama, Georgia, Mississippi and Virginia. The Company’s pooled business is concentrated geographically in Alabama, Georgia and Mississippi with $543 million of premiums and policy charges, or 76%, generated during 2007 from policies written in Alabama. Accordingly, unusually severe storms or other disasters in this state might have a more significant effect on the Company than on a more geographically diversified insurance company and could have an adverse impact on the Company’s financial condition and operating results. Increasing public interest in the availability and affordability of insurance has prompted legislative, regulatory and judicial activity in several states. This includes efforts to contain insurance prices, restrict underwriting practices and risk classifications, mandate rate reductions and refunds, eliminate or reduce exemptions from antitrust laws and generally expand regulation. Because of Alabama’s low automobile rates as compared to rates in most other states, the Company does not expect the type of punitive legislation and initiatives found in some states to be a factor in its primary market in the immediate future.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates and assumptions are particularly important in determining reserves for future policyholder benefits, reserves for losses and loss adjustment expenses payable, evaluation of other-than-temporary impairments on investments, capitalization and amortization of deferred policy acquisition costs and reserves relating to litigation. Actual results could differ from those estimates.
Universal Life Products: Universal life type products include universal life insurance, other interest-sensitive life insurance policies and annuity products. Universal life revenues, which are considered operating cash flows, consist of policy charges for the cost of insurance, policy administration and surrender charges that have been assessed against policy account balances during the period. The timing of revenue recognition is determined by the nature of the charge. Cost of insurance and policy administrative charges are assessed on a monthly basis and recognized as revenue when remittances are processed. Percent of premium charges are assessed at the time of payment by the policyholder and recognized as revenue when processed. Surrender charges are recognized as revenue upon surrender of a contract by the policyholder in accordance with contractual terms. Benefit reserves for universal life represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include interest credited to policy account balances on a monthly basis and death claims reported in the period in excess of related policy account balances.
The Company’s method of accounting for income taxes is the liability method in accordance with Statement of Financial Accounting Standard (SFAS) No. 109, Accounting for Income Taxes. Under the liability method, deferred tax assets and liabilities are adjusted to reflect changes in statutory tax rates resulting in income adjustments in the period such changes are enacted. Deferred income taxes are recognized for temporary differences between the financial reporting basis and income tax basis of assets and liabilities, based on enacted tax laws and statutory tax rates applicable to the periods in which the temporary difference is expected to reverse. The Company files a consolidated tax return. The method of allocation between subsidiaries is subject to a written agreement, approved by the Board of Directors. The tax liability of the Company is allocated to each subsidiary on the basis of the percentage of total tax of the subsidiary, if computed on a separate return, compared to the total amount of taxes computed for the Company.
On January 1, 2007, the Company adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues.
At the date of adoption, the Company had an unrecognized tax benefit of $2.8 million. No adjustments were made to retained earnings at the date of adoption.
The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. Tax years 2004 through 2006 are still subject to examination by the Internal Revenue Service. There are no federal income tax examinations currently in process. Tax years 2004 through 2006 are still subject to examination by the various state jurisdictions.
The Company does not anticipate any significant changes to its total unrecognized tax benefits within the next 12 months.
Inc., respectively, or are rated by the NAIC Securities Valuation Office as Class 1. These funds are diversified money market funds investing in Tier 1 commercial paper and bank obligations, U.S. Treasury, U.S. government obligations, certificates of deposits and repurchase agreements. Bonds consist of notes and treasury bills. These securities are carried at fair value with the unrealized gains or losses reflected in accumulated other comprehensive income within stockholders’ equity, net of taxes. Amortization of discount is calculated using the scientific interest method and is recorded as an adjustment to investment income. Certificates of deposit are carried at cost which approximates fair value.
At December 31, 2007, Vision had a carrier contract requiring them to fund a collateral trust based on a percentage of written premiums. The primary purpose was to provide collateral for the payment of all obligations and performance of all duties set forth in the contract. The amount in the trust is reviewed on an annual basis and adjusted accordingly. The amount of cash restricted at December 31, 2007 and 2006 was $1.0 million and $982 thousand, respectively.
Accounts receivable are primarily comprised of premium installment plan receivables from policyholders, insurance policy-related receivables and amounts due from brokers for security trades not yet settled. The allowance for doubtful accounts at December 31, 2007 and 2006 was $561 thousand and $1.5 million, respectively.
Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts, are reviewed by the Company to determine whether changes made are considered to be significant and integrated. If changes are significant and integrated, the unamortized balance of deferred policy acquisition costs related to the original contract is extinguished and charged to income. Acquisition costs associated with the replacement policy are deferred and amortized to income. At the date of adoption of SOP 05-1, no adjustments were made to retained earnings in the property casualty segment.
Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The Company performs an annual review in the fourth quarter of each year, or more frequently if indicators of potential impairment exist, to determine if the carrying value of the recorded goodwill is impaired. If the fair value of the subsidiary were less than its carrying value at the valuation date, an impairment loss would be recorded to the extent that the implied value of the goodwill is less than the recorded amount of goodwill. Fair value is estimated based on various valuation metrics.
Intangible assets include agent relationships, information technology and restrictive covenants, and are amortized on a straight-line basis over periods ranging from 5 to 20 years. The Company evaluates the remaining useful life of the intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. If the estimate of the remaining useful life is changed, the remaining carrying amount of the intangible asset would be amortized prospectively over the revised remaining useful life.
The Company accounts for derivative instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - An Amendment of FASB Statement No. 133, SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, and SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133 and 140. The statements require that the Company recognize all derivatives as either assets or liabilities in the consolidated balance sheet at fair value. Changes in the fair value of derivatives are recorded currently in earnings unless special hedge accounting criteria are met. For derivatives designated as fair value hedges, the changes in the fair value of both the derivative instrument and the hedged item are recorded in earnings. For derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivative are reported in other comprehensive income. Any ineffective portions of hedges would be recognized in earnings.
Cash Flow Hedges: The Company uses variable-rate debt to partially fund its consumer loan and commercial lease portfolios. In particular, it issued variable-rate long-term debt and commercial paper. These debt obligations exposed the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases.
If the Company determined that the swap ceased to be a highly effective hedge, was sold, or was terminated, hedge accounting would be discontinued prospectively. The change in fair value of the hedged item attributable to hedged risk, as reported in accumulated other comprehensive income, would be amortized to interest expense over the remaining life of the hedged item.
Other Derivative Instruments: Covered call options are contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to purchase a financial instrument at a specified price within a specified period of time. The Company writes (sells) call options on certain common stocks it already owns to enhance returns to the extent of the premium received. The premium received for a written call option is recorded in other liabilities until the option is exercised, expires, or is otherwise terminated. On disposition, gains (losses) are recognized immediately, with gains (losses) on exercise combined with gains (losses) on the covering asset. The liability is marked to market at each statement date with the changes in the market value of the open options recognized as realized gains (losses) and recorded in the statement of income. The Company had $3 thousand and $132 thousand in options outstanding at December 31, 2007 and 2006, respectively.
Components of Net Periodic Benefit Cost: Total net periodic benefit cost for the year ended December 31, 2007 for pension benefits was $129 thousand which includes the interest cost component of $374 thousand offset by expected return of plan asset component of $271 thousand and amortization of losses of $26 thousand. Total net periodic benefit cost for the year ended December 31, 2007 for other postretirement benefits was $107 thousand, which is the interest cost component.
In 2007, no additional contributions were made to the pension plan. As of December 31, 2007, the liabilities for pension and postretirement benefits were $1.3 million and $1.8 million, respectively. Both liabilities are included in other liabilities on the consolidated balance sheets. Accumulated other comprehensive income, as of December 31, 2007, includes a pension liability adjustment of $703 thousand, net of applicable taxes of $379 thousand.
Effective January 1, 2005, the Pooling Agreement was amended and restated, commuting certain pools from August 1, 1987 through December 31, 2001. In addition, AVIC was added as a participant in the Pooling Agreement and Fire began retroceding the quota share business it received from Virginia Mutual to the pool.
The Mutual Group, AIC, AGI and Alliance write preferred risk automobile and homeowner insurance, manufactured home insurance, fire and allied lines, standard risk automobile and homeowner insurance and a limited amount of commercial insurance, including auto, church and businessowner insurance. Mutual is also a direct writer of farmowner insurance. Specialty and AVIC are direct writers of nonstandard risk automobile insurance. Prior to January 1, 2007, Virginia Mutual was a direct writer of the same lines currently written by Alliance.
As a result of the Pooling Agreement, the Company had receivables of $1.2 million and $2.4 million from the Mutual Group at December 31, 2007 and 2006, respectively, for transactions originating in December and settled the following month.
On October 1, 1996, the Pooling Agreement was amended in conjunction with the restructuring of the Alfa Insurance Group’s catastrophe protection program. Effective November 1, 1996, the allocation of catastrophe costs among the members of the pool was changed to better reflect the economics of catastrophe finance. The amendment limited the Company’s participation in any single catastrophic event or series of disasters to its pool share (65%) of a lower catastrophe pool limit unless the loss exceeded an upper catastrophe pool limit. In cases where the upper catastrophe limit is exceeded on a 100% basis, the Company’s share in the excess loss would be based upon its amount of surplus relative to other members of the group. Lower and upper catastrophe pool limits are adjusted periodically due to increases in insured property risks. The limits and participation levels since inception of the program are summarized below:
The Boards of Directors of the Mutual Group and of the Company’s property casualty insurance subsidiaries have established the pool participation percentages and must approve any changes in such participation. The Pooling Agreement, and any amendments thereto, require the regulatory approval of the Alabama Department of Insurance. In addition, the Virginia State Corporation Commission, Bureau of Insurance requires prior approval of any changes in the Pooling Agreement, so long as Alliance is a party to the Pooling Agreement.
The Mutual Group and the Company’s insurance subsidiaries are considered an insurance company holding system with Mutual being the controlling party under the Alabama Insurance Holding Company Systems Regulatory Act and their activities and transactions are subject to reporting, examination and regulation thereunder. The Company’s insurance subsidiary, Alfa Alliance Insurance Corporation, is a Virginia domiciled property casualty company, and as such, is subject to regulatory oversight and examination by the Virginia State Corporation Commission, Bureau of Insurance.
The Mutual Group is a partner in a real estate partnership, which in 2000 established a revolving line of credit with Financial of $4.0 million at a rate of interest equal to the prime lending rate less 1.0%. During 2002, this line of credit was increased to $5.0 million. At December 31, 2007 and 2006, the amount loaned to the partnership under the line of credit was $4.0 million and $3.6 million, respectively. Interest earned by Financial from the partnership was $271 thousand, $271 thousand and $235 thousand in 2007, 2006 and 2005, respectively.
In 1997, Mutual established a revolving line of credit with Financial of $20 million at a rate of interest equal to the one-month London Interbank Offered Rate (LIBOR) plus .75%. No balance was outstanding at either December 31, 2007 or 2006. No interest was earned by Financial related to this line of credit in 2007, 2006 or 2005. The line of credit expired December 31, 2007 and was not renewed.
In 1999, Alfa Realty, Inc. secured a line of credit with Financial of $250 thousand with interest payable monthly at the Company’s commercial paper rate then applicable plus .35%. No balance was outstanding at either December 31, 2007 or 2006. No interest was earned by Financial related to this line of credit in 2007, 2006 or 2005.
Also, during 1999, Alfa Builders, Inc. (Builders) established a line of credit with Financial of $5 million with interest payable monthly at the Company’s commercial paper rate then applicable plus 1.00%. The unpaid balance on this line of credit was $1.8 million and $3.0 million at December 31, 2007 and 2006, respectively. Interest earned by Financial in 2007, 2006 and 2005 was $155 thousand, $223 thousand and $161 thousand, respectively.
The Company’s commercial paper is guaranteed by Mutual and Fire. The Company paid fees of $50 thousand and $25 thousand to Mutual and Fire, respectively, for their guarantees in 2007, 2006 and 2005.
On February 1, 1997, Mutual began covering its employees with a Corporate Owned Life Insurance (COLI) plan utilizing Life’s universal life product. Premiums paid to Life totaled $16.9 million in 2007, $18.5 million in 2006 and $17.9 million in 2005. Policy charges recorded from such premiums totaled $4.2 million in 2007, $4.0 million in 2006 and $3.8 million in 2005. Policy reserves and insurance in force on the COLI plan at December 31, 2007 were $190.0 million and $792.4 million, respectively. Certain of Mutual’s employees and those of the Mutual Group’s sponsoring organization, the Alabama Farmers Federation (Federation), not covered by the COLI plan are covered by group life insurance provided by Life. During 2002, certain retired employees of Virginia Mutual also began being covered by group life insurance provided by Life. Contingency reserves held for this group at both December 31, 2007 and 2006 were $142 thousand. Group life insurance premiums paid to Life totaled $529 thousand in 2007, $493 thousand in 2006 and $517 thousand in 2005. Insurance inforce under this plan at December 31, 2007 was $48.4 million. Reserves for group life insurance represent the excess present value of future guaranteed benefits over future premiums plus any unearned premium. Since this one-year term contract renews on January 1 of each year at the discretion of each party, there is no future excess present value of future guaranteed benefits over future premiums at December 31. Since all of the certificates have a renewal date of January 1, the premium for each certificate is fully earned on the following December 31 and no unearned premium liability is present. This reserving method has been used since the Company’s inception.
Alfa Properties has a partnership interest in Marshall Creek, Ltd., a real estate development. Financial established capital leases with this entity during 2002 and received payments of $99 thousand and $175 thousand under these leases in 2007 and 2006, respectively.
The Company periodically has investment transactions with the Mutual Group. In 2007, the Company purchased four securities at fair value of $8.3 million. In 2006, the Company sold one security at fair value for a loss of $601 thousand and purchased two securities at fair value of $4.9 million. Investment transactions between the Company and the Mutual Group were insignificant in 2005. The Company is also a partner in Alfa Investors Partnership with the Mutual Group. The amount contributed to the partnership was $42.1 million and $39.0 million at December 31, 2007 and 2006, respectively. The Company had committed to fund up to $5.9 million additional investment in the partnership at December 31, 2007. The Company received distributions from the partnership of $2.8 million and $3.2 million in 2007 and 2006, respectively. In 2000, the Company became a member in Alfa Ventures II, LLC with the Mutual Group. The amount contributed to the limited liability company was $1.9 million at both December 31, 2007 and 2006, respectively. The Company received distributions from this partnership of $345 thousand in 2007 and $203 thousand in 2006.
The Company’s life subsidiary is a general partner in two investment partnerships with a trust created by Mutual and Fire. The carrying value of the partnerships was $1.1 million at both December 31, 2007 and 2006, respectively.
During the third quarter of 2002, the Company’s finance subsidiary invested $13.5 million in MidCountry Financial Corporation (MidCountry), a financial services holding company. Two of the Company’s executive officers are board members of MidCountry with one executive officer serving as Chairman of the Board. At December 31, 2007 and 2006, Financial’s ownership was 41% and 42%, respectively. Due to ownership levels, Financial and the Company qualify as unitary thrift holding companies.
Financial made additional investments of $36.1 million during the fourth quarter of 2004 and $26.6 million during the second quarter of 2007 to maintain its approximate original ownership in the entity. Financial accounts for earnings from MidCountry using the equity method of accounting. Pretax operating loss, net of the cost of capital, was $7.3 million in 2007. Conversely, the Company recognized pretax operating income, net of the cost of capital, of $1.4 million in 2006 and $1.2 million in 2005.
During the third quarter of 2007, Financial invested $3.0 million in MidCountry preferred stock. In 2007, Financial recognized $63 thousand in pretax earnings on this preferred stock.
Changes in net unrealized investment gains and losses on fixed maturities and equity securities are as follows:
Unrealized investment gains and losses are based on fair values that were determined using nationally recognized pricing services, broker/dealers securities firms and market makers with the exception of six structured notes valued at $35.0 million, which were based on internal pricing models, and one security valued at a cost of $3.0 million.
The cost and estimated fair value of investments in equity securities are as follows:
Management analyzes net unrealized losses on investments for impairment. The following table shows the Company’s net unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007:
subprime mortgage-related risk in fixed income securities is limited to investments in collateralized debt obligations (CDOs) with underlying subprime mortgage exposure. Careful consideration is given in determining the Company’s exposure to subprime mortgage-related risk through analysis of the quality of collateral, rating downgrades, deterioration or loss of credit support, time period in which there has been a decline in value, changes in cash flow, and the Company’s ability and intent to hold the security until full value is recovered. Unrealized losses due to asset valuation changes at December 31, 2007 and 2006 were due to changes in interest rates and not credit quality. Realized losses were taken on those securities in which the Company had determined a decline in credit value of the underlying support had occurred. Other information used in the assessment for impairment includes industry analyst reports and the volatility of the security’s market price.
There were 39 equity positions with unrealized losses at December 31, 2007. One position comprised 18.2% of the total gross unrealized losses. No other single holding in an unrealized loss position comprised over 15% of the total gross unrealized losses. The Company has investments in four publicly traded equity securities of financial institutions that have been adversely affected by the subprime credit market. These equity securities were written down to their respective fair values at December 31, 2007.
The Company did not consider any security with an unrealized loss at December 31, 2007 to be other than temporarily impaired.
The amortized cost and estimated fair value of fixed maturities available for sale at December 31, 2007 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s fixed maturity portfolio is predominantly comprised of investment grade securities. At December 31, 2007, $10.7 million in fixed maturities (0.8% of the total fixed maturity portfolio) are considered below investment grade. The Company considers bonds with a quality rating of BB+ and below, based on Standard & Poor’s rating scale, to be below investment grade. A single investment of $3.0 million was not rated at December 31, 2007.
Proceeds from sales of equity securities were $200.0 million in 2007, $170.6 million in 2006 and $137.3 million in 2005. Gross gains of $30.1 million in 2007, $16.3 million in 2006 and $14.5 million in 2005 and gross losses of $5.4 million in 2007, $5.1 million in 2006 and $2.8 million in 2005 were realized on those sales. The Company also recorded a loss of $15.0 million in 2007, $2.9 million in 2006 and $1.0 million in 2005 for equity securities whose decline in fair value was deemed to be other than temporary. In 2007, $3.4 million of the total writedowns were related to publicly traded positions in financial institutions which had been adversely affected by the subprime credit market.
The Company’s collateral loan portfolio totaled $121.5 million and $128.7 million at December 31, 2007 and 2006, respectively. These portfolios consisted of mortgage and consumer loans in the Company’s primary market area of Alabama, Georgia and Mississippi. Management evaluates the creditworthiness of customers on a case-by-case basis and obtains collateral as deemed necessary based on this evaluation. The Company had charged off loans totaling $570 thousand, $4.0 million and $496 thousand in 2007, 2006 and 2005, respectively. At both December 31, 2007 and 2006, respectively, the Company maintained an allowance for losses of $1.6 million. The Company has estimated the fair value of the collateral loan portfolio to be $140.3 million and $136.7 million at December 31, 2007 and 2006, respectively. The estimated fair value was determined by discounting the estimated future cash flows from the loan portfolio at rates between 4.92% and 5.61% for 2007 and at a rate of 6.17% for 2006, the current interest rates offered for similar loans, and after allowing for estimated loan losses. The Company had impaired loans of $2.3 million and $949 thousand subject to individual valuation at December 31, 2007 and 2006, respectively. Loans in nonaccrual status at December 31, 2007 and 2006 were $910 thousand and $421 thousand respectively. Repossessed assets, net of allowance for losses on disposal, included in other assets were $146 thousand and $51 thousand at December 31, 2007 and 2006, respectively.
The Company holds a position in Waveland NCP Alabama Ventures, LLC, a certified capital company that is an investment premium tax credit program sanctioned by the State of Alabama. This investment is carried at its unpaid principal balance of $2.3 million and $2.6 million at December 31, 2007 and 2006, respectively. Principal and interest are received in accordance with a contractual agreement and repayment of principal is protected by strict guidelines imposed by the governing agency. The Company has two partnerships with ownership percentages of less than 1% accounted for using the cost method. These positions total $2.1 million and $2.0 million at December 31, 2007 and 2006, respectively. These investments are stated at cost. For cost method partnerships, income is recognized based on distributed earnings received from the investee.
The Company’s investment in MidCountry is accounted for using the equity method. In addition to earnings reflected within the statements of income, this investment has generated gross accumulated other comprehensive income of $471 thousand before tax expense of $165 thousand since the investment was made in 2002. The table below summarizes the company’s primary long-term investment interests at December 31, 2007 and related operating results for 2007.
Short-term investments are reflected at fair value and include money market funds and certificates of deposit, not discounted due to their liquidity and short-term nature. Therefore, the Company considers the fair value of these short-term investments to be equal to cost. Also included are short-term investments in bonds with maturity dates ranging from January 16, 2008 to March 13, 2008. These investments are carried at fair value.
The Company evaluated its final allocation of purchase price and adjusted its goodwill carrying value by $4.3 million as of December 31, 2006.
The Company’s goodwill impairment test performed in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, resulted in no writedowns for the years ended December 31, 2007, 2006 and 2005.
“Restrictive Covenants” intangible asset is a covenant not to compete for one Vision executive.
The following table shows other intangible assets that continue to be subject to amortization and aggregate amortization expense as of December 31, 2007:
Changes in other intangible assets by asset class for 2007 and 2006 are as follows:
The cost of other intangible assets is being amortized over a range of 5 to 20 years, with a weighted average original life of 17.5 years. Amortization expenses for 2007, 2006 and 2005 were $683 thousand in each year. Amortization expense for intangible assets is estimated to be $683 thousand in 2008, $683 thousand in 2009 and $379 thousand in 2010 and thereafter.
Activity in the liability for unpaid losses is summarized as follows:
The estimated cost of loss and loss adjustment expenses attributable to insured events of prior years decreased by $4.7 million during 2007 as a result of re-estimation of unpaid losses and loss adjustment expenses. Increases or decreases of this nature occur as the result of claim settlements during the current year, and as additional information is received regarding individual claims, causing changes from the original estimates of the cost of these claims. The table below summarizes the 2007 changes in estimated loss reserves by component and period in thousands of dollars.
The Company is primarily an insurer of private passenger motor vehicles and of single-family homes and has limited exposure for difficult-to-estimate claims such as environmental, product and general liability claims. The Company does not believe that any such claims will have a material impact on the Company’s liquidity, results of operations, cash flows or financial condition. Deducted from the liability for estimated unpaid losses and loss adjustment expenses are the Company’s estimates of salvage and subrogation recoverable of $12.7 million and $11.6 million at December 31, 2007 and 2006, respectively.
At December 31, 2007 and 2006, the Company had an income tax payable of $3.5 million and an income tax receivable of $1.3 million, respectively.
On January 1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues.
At the date of adoption, the Company had an unrecognized tax benefit (UTB) of $2.8 million and interest and penalties of $285 thousand. No adjustments were made to retained earnings at the date of adoption.
One purported class action lawsuit is pending against both Builders and Fire. Additionally, two purported class action lawsuits are pending against the property casualty companies involving a number of issues and allegations which could affect the Company. No class has been certified in any of these three purported class action cases. In the event a class is certified in any of these purported class actions, reserves may need to be adjusted.
On November 7, 2007, the counsel to the parties in the above referenced Alabama consolidated action entered into a Memorandum of Understanding to settle such action, subject to approval of the court. Under the terms of the Memorandum of Understanding (Alabama MOU), Mutual and Fire agreed to pay $22.00 per share to acquire the outstanding shares of common stock of the Company that are not currently owned by them. As further consideration, lead counsel to the Alabama consolidated action was provided an opportunity to review and comment on the preliminary proxy statement. The Alabama MOU also provided for confirmatory discovery, which has been completed.
On November 9, 2007, a policyholder of Mutual filed a purported class action and derivative action against Mutual in the Circuit Court of Macon County, Alabama, Preston M. Wright v. Alfa Mutual Insurance Co., No. CV-07-900070. The policyholder contended that Mutual’s and Fire’s acquisition of the outstanding stock of the Company was not in the best interest of the policyholders of Mutual and Fire. Plaintiffs asserted purported claims for the alleged impairment of Mutual’s assets. The plaintiffs sought to enjoin the proposed acquisition, other injunctive relief, and unspecified damages, costs and attorneys’ fees. The Company believed that this action was without merit.
On November 21, 2007, certain policyholders of the Mutual Group filed a purported class action and derivative action against the Company, the Mutual Group and certain of their officers and directors in the Circuit Court of Walker County, Alabama, Mr. and Mrs. Prince Hagler et. al. v. Alfa Mutual Insurance Co., et. al., No. CV-07-408. In Hagler, the policyholders contended that the merger was not in the best interest of the policyholders of the Mutual Group and would unjustly enrich the defendants. Plaintiffs asserted purported claims for breach of fiduciary duty and unjust enrichment. The plaintiffs sought to enjoin the proposed acquisition, other injunctive relief, and unspecified damages, costs and attorneys’ fees. The Company believes that this action is without merit.
On or about December 19, 2007, the defendants in the above-described Macon County litigation filed a Motion to Sever and Transfer, requesting that the court sever the class action allegations related to the transaction from unrelated individual insurance fraud allegations contained in the Complaint. The motion requested that, once severed, the class action allegations be transferred to the Circuit Court of Montgomery County, Alabama.
On December 21, 2007, some of the defendants in the above-described Walker County litigation filed a motion to transfer said litigation to the Circuit Court of Montgomery County, Alabama.
On or about January 4, 2008, the plaintiffs in the above-described Walker County litigation served discovery requests on the defendants, seeking production of documents purportedly related to the transaction.
On or about February 12, 2008, the Notice of Pendency and Proposed Settlement of Class Action was mailed to members of the class.
Unfunded Commitments: The Company periodically invests in affordable housing tax credit partnerships. At December 31, 2007, the Company had legal and binding commitments to fund partnerships of this type in the amount of $34.3 million. These commitments are included in other liabilities in the consolidated balance sheet and are, therefore, excluded from the table below.
Certain commercial commitments in the table above include items that may, in the future, require recognition within the financial statements of the Company. Events leading to the call of a guarantee, achievement of specific metrics by Vision and the consummation of the privatization transaction are examples of situations that would impact the financial position and results of the Company.
insolvency of an insurer writing any such line of insurance in the state, members of the funds are assessed to pay certain claims of the insolvent insurer. A particular state’s fund assesses its members based on their respective written premiums in the state for the lines of insurance in which the insolvent insurer was engaged. The Company paid assessments totaling $2 thousand in 2007. The Company paid no assessments in 2006 or 2005.
The Company’s investment in affiliated equity-method investments have resulted in cumulative earnings of $7.3 million at December 31, 2007 that are included as a part of retained earnings that have not yet been distributed.
The Company increased capital in excess of par value by $4.8 million in 2005 for the establishment of future tax benefits in ABC resulting from the transfer of liabilities to ABC when it was formed in 1999.
Dividends: Alfa Corporation paid $37.3 million in dividends to stockholders in 2007. ABC paid dividends of $54 thousand in 2007 on preferred stock. Their minority interest of $600 thousand is classified as other liabilities in the consolidated balance sheet.
At December 31, 2007, the Company had repurchased a total of 8,364,123 shares at a cost of $66.9 million and due to the exercise of stock options had reissued 3,413,805 shares at a cost of $19.4 million under this program. The Company had also reissued 12,271 shares at a cost of $103 thousand due to the release of restricted stock awards. In addition, the Company began funding its dividend reinvestment plan through the sale of treasury stock during 2002 and, therefore, had reissued an additional 1,607,767 shares at a cost of $9.7 million at December 31, 2007.
Certain subsidiaries are party to working cover reinsurance treaties for property casualty lines. Under the property per risk excess of loss treaty, AIC, AGI and Alliance are responsible for the first $750 thousand of each covered loss, and the reinsurers are responsible for 100% of the excess over $750 thousand of covered loss with a maximum recovery of $1.75 million. Under a separate treaty, Alliance is responsible for the first $600 thousand of each covered liability loss, and the reinsurers are responsible for 100% of the excess over $600 thousand of covered liability loss with a maximum recovery of $1.4 million. The rates for these reinsurance treaties are negotiated annually. The subsidiaries also make use of facultative reinsurance for unique risk situations. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Amounts recoverable from reinsurers are estimated in a manner consistent with the claims liability associated with the reinsured policy.
The Company’s subsidiaries are participants in a Pooling Agreement with the Mutual Group and Specialty in which each participant cedes premiums, losses and underwriting expenses on all of their direct property casualty business to Mutual, and Mutual, in turn, retrocedes to each participant a specified portion of premiums, losses and underwriting expenses based on each participant’s pooling percentage. Refer to Note 2 - Pooling Agreement for further information.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 123 (revised 2004), Share-Based Payment, using the modified prospective transition method. Under this method, share-based compensation expense is recognized using the fair value based method for all awards granted on or after the date of adoption. Compensation expense for unvested stock options and awards that were outstanding on December 31, 2005 will be recognized over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under the pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. The Company determined the fair value of these awards using the Black-Scholes-Merton option pricing model. Under SFAS No. 123(R), an estimate is made for the number of awards that are expected to vest and this forfeiture rate is applied to determine the amount of compensation cost to be recognized. The forfeiture rate must be evaluated at each reporting period to determine if any changes should be made which could impact the amount of compensation cost that will be ultimately recognized. In addition, the non-substantive vesting period approach is used for attributing stock compensation to individual periods for awards to retirement eligible employees, which requires recognition of compensation expense immediately for such grants or over the period from the grant date to the date retirement eligibility is achieved. This change will not affect the overall amount of compensation expense to be recognized but will impact the timing of expense recognition. The effect on the amount of expense the Company recorded in 2006 was an increase of $950 thousand. In accordance with the modified prospective transition method, results for prior periods have not been restated.
Prior to adoption and consistent with the provisions of SFAS No. 123, the Company used the intrinsic value based method to account for stock options issued under the 1993 Plan and provided pro forma disclosures as if the fair value based method had been applied. The Company accounted for the 2005 Plan under SFAS No. 123 using the recognition and measurement principles of the fair value method.
The Company’s share of compensation expenses related to stock options was $2.1 million and $2.2 million, restricted share awards was $829 thousand and $599 thousand and with tax benefits of $1.0 million and $974 thousand for 2007 and 2006, respectively. Compensation cost for share-based payment arrangements reduced the Company’s net earnings in 2007 and 2006 by $1.9 million and $1.8 million and diluted earnings per share by $0.02 for both periods. For 2005, share-based compensation was $416 thousand, principally related to restricted awards and dividend equivalents on options granted in prior years with tax benefits of $145 thousand. These expenses are allocated to the Company based on the Management and Operating Agreement with Mutual (refer to Note 3 - Related-Party Transactions).
The tax benefits associated with tax deductions that exceed the amount of compensation expense recognized in the financial statements were $791 thousand and $559 thousand for 2007 and 2006, respectively. This reduced cash flows from operating activities and increased cash flows for financing activities compared to amounts that would have been reported if the standard had not been adopted.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model based on the following assumptions and range of assumptions:
Beginning in 2005, the Company awarded two types of service-based nonvested restricted shares to certain officers: restricted shares and career shares. Restricted shares vest and are issuable on the third anniversary after the date of grant. Prior to issuance, the Company will vote the shares and dividends paid will be credited as additional shares of restricted stock that vest along with the original grant. Career shares
Nonvested restricted shares are measured at fair value on the date of grant. Compensation cost for restricted share awards with cliff vesting is recognized using the straight-line method over the three-year vesting period for non-retirement eligible employees. Compensation cost for restricted share awards is recognized immediately for grants to retirement-eligible employees or over the period from the grant date to the date retirement eligibility is achieved.
At December 31, 2007, there was $624 thousand of unrecognized compensation expense related to restricted share awards that is expected to be charged to expense over a weighted average period of 0.89 years. This expense will be allocated according to Alfa’s Management and Operating Agreement.
Financial leases certain property and equipment to the Company’s subsidiaries, Mutual and its affiliates (refer to Note 3 - Related-Party Transactions) and to third parties under operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. Total rental income for the years ended December 31, 2007, 2006 and 2005 was $5.6 million, $4.5 million and $3.9 million, respectively. No contingent rentals have been included in income. Similarly, the Company recorded depreciation expense on leased assets within the Noninsurance segment of $3.6 million, $3.4 million and $2.9 million in 2007, 2006 and 2005, respectively. The cost, accumulated depreciation and net book value of major classes of leased property at December 31, 2007 were:
At December 31, 2007, the aggregate minimum rental payments to be received under leases having initial or remaining lease terms in excess of one year are $3.9 million in 2008, $1.8 million in 2009, $491 thousand in 2010, $66 thousand in 2011 and $0 thereafter.
The Company leases certain office facilities and equipment from Financial and third parties under various operating leases. Profits from related party leasing transactions are eliminated within the corporate segment. These leases expire at various dates through 2015. At December 31, 2007, the aggregate minimum rental payments to be made under leases having initial or remaining lease terms in excess of one year are $1.8 million in 2008, $1.4 million in 2009, $886 thousand in 2010, $504 thousand in 2011, $471 thousand in 2012 and $1.4 million thereafter. Certain leases are subject to allocation under a Management and Operating Agreement (refer to Note 3 - Related-Party Transactions) and the Pooling Agreement (refer to Note 2 - Pooling Agreement). Lease expense incurred for these leases, prior to allocation, was $1.4 million in 2007, $1.3 million in 2006 and $1.5 million in 2005.
At December 31, 2007 and 2006, future minimum lease payments to be received on leases are $648 thousand and $2.2 million, respectively; with separate deductions for allowance for uncollectible minimum lease payments receivable of $285 thousand and $1.2 million, respectively. Unguaranteed residual values accruing to the benefit of the lessor total $355 thousand and $743 thousand at December 31, 2007 and 2006, respectively. Initial direct costs and unearned income at December 31, 2007 were $0 and $33 thousand, respectively. Initial direct costs and unearned income at December 31, 2006 were $0 and $156 thousand, respectively.
Future minimum lease payments to be received on capital leases including interest at December 31, 2007 are $518 thousand in 2008, $105 thousand in 2009, $25 thousand in 2010 and $0 thereafter. Future minimum lease receivables do not include contingent rentals.
The Company reports operating segments based on the Company’s legal entities, which are organized by line of business:
All investing activities are allocated to the segments based on the actual assets, investments and cash flows of each segment.
Life declared a dividend to the Company consisting of the 16 thousand shares of the Company’s common stock held by Life. The transaction was valued at $21.50 per share based on the current market price on November 27, 2007, the date of transfer. The $343 thousand gain recognized by Life from this transaction was eliminated during consolidation. These shares are held as treasury stock.
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of shares outstanding. Diluted EPS is computed similarly except that the shares outstanding are increased to give effect to all potentially dilutive shares that would have been outstanding if such shares had been issued. The Company’s dilutive shares are the result of stock options outstanding and nonvested restricted stock awards.
On January 1, 2007 the Company adopted SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133 and 140. This statement provides clarification and additional guidance regarding derivative accounting, as well as allows the election of fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement event, on an instrument-by-instrument basis, in cases in which a hybrid financial instrument that contains a derivative would otherwise require bifurcation in accordance with SFAS No. 133. The adoption of this statement did not have an impact on the Company’s financial position or results of operations at January 1, 2007, or for the year ended December 31, 2007.
On January 1, 2007, the Company adopted SFAS No. 156, Accounting for Servicing of Financial Assets, an Amendment of Statement No. 140. This statement requires entities to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations. It also requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value and allows a choice of either the amortization or fair value measurement method for subsequent measurement. The adoption of this statement did not have an impact on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement establishes a common definition for fair value to be applied to U.S. GAAP guidance requiring the use of fair value. It also outlines the framework for measuring fair value and expands disclosure about fair value measurements. In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, and FSP 157-2, Effective Date of FASB Statement No. 157. FSP 157-1 amends SFAS No. 157 to remove certain lease transactions from its scope. FSP 157-2 delays the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities, except for items recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of 2009 for the Company. The measurement and disclosure requirements related to financial assets and financial liabilities are effective for the Company beginning in the first quarter of 2008. The adoption of SFAS No. 157 for financial assets and financial liabilities is not expected to have a significant impact on the Company’s financial position or results of operations. However, the resulting fair values calculated under SFAS No. 157 after adoption may be different from the fair values calculated under previous guidance. The Company is currently evaluating the impact SFAS No. 157 will have on its financial position and results of operations when it is applied to non-financial assets and non-financial liabilities beginning in the first quarter of 2009.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115, which will become effective at the beginning of the fiscal year that begins after November 15, 2007. SFAS No. 159 permits entities to measure eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. The Company has elected not to measure eligible items at fair value upon initial adoption on January 1, 2008 and does not believe the adoption of this statement will have a significant impact on its financial position or results of operations.
In June 2007, the FASB ratified the Emerging Issues Task Force (EITF) consensus on EITF Issue No. 06-11, Accounting for Income Tax Benefits on Dividends on Share-Based Payment Awards. This EITF indicates that tax benefits of dividends on unvested restricted stock are to be recognized in equity as an increase in the pool of excess tax benefits. Should the related awards forfeit or no longer become expected to vest, the benefits are to be reclassified from equity to the income statement. The EITF is effective for fiscal years beginning after December 15, 2007. The Company adopted the EITF effective January 1, 2008 and does not currently believe this consensus will have a significant impact on its financial position or results of operations.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, and SFAS No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment
of ARB No. 51. These statements will significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141, Business Combinations, while providing additional definitions, such as the definition of the acquirer in a purchase and improvements in the application of how the acquisition method is applied. SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests, and classified as a component of equity. These statements will simultaneously become effective for the Company on January 1, 2009. The Company is currently evaluating the impact these statements may have on its financial position or results of operations upon adoption.
Pursuant to the Merger Agreement, each option to purchase shares of common stock granted under the Company’s stock incentive plan outstanding at the effective time of the merger (whether vested or unvested) will be cancelled, and each holder thereof will be entitled to receive, at or as soon as practicable after the effective time of the merger, an amount in cash equal to the product of the number of shares subject to such stock option, multiplied by the excess, if any, of the per-share merger consideration of $22.00 over the per-share exercise price of such stock option, less applicable taxes required to be withheld with respect to such payment. In addition, each outstanding share of common stock that is subject to a restricted share award that is outstanding immediately prior to the effective time of the merger and remains subject to vesting or other lapse restrictions pursuant to the Company’s stock incentive plan (including career shares and shares credited to restricted share awards as dividend equivalents) will vest, become free from any such restrictions as of the effective time of the merger, and at the effective time of the merger, the holder thereof will be entitled to receive $22.00 in cash for each such restricted share award, less applicable withholding taxes.
For additional information, refer to Note 22 - Subsequent Events and the Company’s Schedules 14A and 13E-3 filed with the Securities and Exchange Commission on January 11, 2008, Form 8-Ks filed with the Securities and Exchange Commission on July 18, 2007, November 5, 2007 and December 21, 2007, and the News Releases dated August 15, 2007 and November 5, 2007.
Collectively, the lawsuits as originally filed alleged generally that the original proposed offer price of $17.60 per share was below fair value, that the process was materially unfair and that defendants breached their fiduciary duties and/or aided and abetted breaches of fiduciary duties to the stockholders by negotiating a proposed transaction at $17.60 per share. The actions filed in Delaware further alleged that certain acts and omissions by defendants before the July 17, 2007 announcement were intended to, and had the effect of, depressing the market price of the Company. The actions sought an injunction against the proposed transaction, other injunctive relief and unspecified damages, costs and attorneys fees. The Company believes that each of the actions is without merit.
After participating in confirmatory discovery along with the parties to the Alabama consolidated action, on December 20, 2007, the counsel to the parties in the above referenced Delaware consolidated action also entered into a Memorandum of Understanding to settle that action, subject to approval of the court in Alabama. Under the terms of that Memorandum of Understanding, Mutual and Fire agreed to pay $22.00 per share to acquire the outstanding shares of the Company that it does not currently own, and counsel in the Delaware consolidated action were provided an opportunity to review and comment on the preliminary proxy statement.
above referenced action in Alabama that was brought on behalf of the Company’s public stockholders is currently pending. The Walker County court did not rule on the motion to transfer. Meanwhile, the plaintiffs filed an Amended Complaint on or about January 22, 2008 in which they added as defendants the directors who served on the special committees of the Company, Mutual and Fire. On February 23, 2008, counsel for the parties in the Walker County action entered into a Memorandum of Understanding to settle such action, subject to approval of the court. On March 4, 2008, the Walker County court conditionally approved the settlement and set a final approval hearing for May 28, 2008.
On February 12, 2008, the Company commenced mailing a Notice of Pendency and Proposed Settlement of Class Action to each member of the class in In Re Alfa Corporation Shareholder Litigation, in the Circuit Court of Montgomery County, Alabama, CV-07-900485. The class includes all persons who were record or beneficial owners of common stock of the Company since July 17, 2007. For additional information, refer to the Company’s Form 8-K filed with the Securities and Exchange Commission on February 13, 2008.
On February 13, 2008, the Company announced that it has scheduled a record date and special meeting date for its stockholders to consider and vote upon a proposal to approve the previously announced Agreement and Plan of Merger, dated as of November 4, 2007 (refer to Note 21 - Privatization of the Company for additional information). The Company’s stockholders of record at the close of business on March 3, 2008 will be entitled to notice of the special meeting and to vote on the proposal. The special meeting of the stockholders will be held on April 15, 2008 at the Company’s executive offices in Montgomery, Alabama. For additional information, refer to the Company’s Form 8-K filed with the Securities and Exchange Commission on February 13, 2008.