Association Casualty leases space for its office in a building located in Austin, Texas. The lease term expires April 30, 2011. Under the terms of the lease, Association Casualty occupies 15,777 square feet.
The following is management’s discussion and analysis of the financial condition and results of operations of Atlantic American Corporation (“Atlantic American” or the “Parent”) and its subsidiaries (collectively, the “Company”) for each of the three years in the period ended December 31, 2006. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein.
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and, in management’s belief, conform to general practices within the insurance industry. The following is an explanation of the Company’s accounting policies and the resultant estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ from management’s initial estimates determined using these policies. Atlantic American does not expect that changes in the estimates determined using these policies will have a material effect on the Company’s financial condition or liquidity, although changes could have a material effect on its consolidated results of operations.
Future policy benefits comprised 14% of the Company’s total liabilities at December 31, 2006. These liabilities relate primarily to life insurance products and are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. If actual results differ from the initial assumptions, the amount of the Company’s recorded liability could require adjustment.
Cash and investments comprised 71% of the Company’s total assets at December 31, 2006. Substantially all investments are in bonds and common and preferred stocks, which are subject to significant market fluctuations. The Company carries all investments as available for sale and, accordingly, at their estimated fair values. The Company owns certain non-redeemable preferred stocks that do not have quoted values and are carried at estimated fair values as determined by management. Such values inherently involve a greater degree of judgment and uncertainty and therefore ultimately greater price volatility. On occasion, the value of an investment may decline to a value below its amortized purchase price and remain at such value for an extended period of time. When an investment’s indicated fair value has declined below its cost basis for a period of time, primarily due to changes in credit risk, the Company evaluates such investment for other than a temporary impairment. If other than a temporary impairment is deemed to exist, then the Company will write down the amortized cost basis of the investment to its estimated fair value. While such write down does not impact the reported value of the investment in the Company’s balance sheet, it is reflected as a realized investment loss in the Company’s consolidated statements of operations.
Deferred income taxes comprised approximately 1% of the Company’s total assets at December 31, 2006. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for tax purposes. These deferred income taxes are measured by applying currently enacted tax laws and rates. Valuation allowances are recognized to reduce the deferred tax assets to the amount that is more likely than not to be realized. In assessing the likelihood of realization, management considers estimates of future taxable income and tax planning strategies.
On a consolidated basis, the Company had net income of $8.9 million, or $0.33 per diluted share, in 2006, compared to a net loss of $3.2 million, or $0.21 per diluted share, in 2005. The net loss for 2005 was primarily the result of a non-cash charge of $10.7 million ($7.0 million after taxes) to reflect the write down in the value of General Motors Corporation (“GM”), General Motors Acceptance Corporation (“GMAC”), and Ford Motor Credit Company (“Ford”) fixed maturity investments owned by the Company due to an other than temporary impairment. Net income was $5.0 million, or $0.18 per diluted share, in 2004. Total revenue for 2006 decreased $5.6 million, or 3.0%, to $179.5 million from $185.1 million in 2005. Premium revenue for 2006 decreased $23.9 million, or 13.5%, from 2005. The decrease in premiums was primarily attributable to increased pricing competition on most property and casualty lines, the non-renewal of targeted classes of property business as well as the reassessment of coastal property exposures in the Company’s property and casualty operations, the latter two of which began in late 2005. The Company’s life and health operations have also experienced a premium decline resulting from lower new sales activity and an increased level of product competition, specifically in the Medicare supplement market. Total revenue for 2005 decreased $5.0 million, or 2.6%, to $185.1 million from $190.1 million in 2004. Excluding the impairment charge discussed previously, total revenue in 2005 increased $5.7 million, or 3.0%, over 2004. The increase was primarily due to increased volume in the general liability and surety lines of business at American Southern as well as increased volume written in 2004 at Georgia Casualty, the majority of which was earned in 2005. Premium revenue for 2005 increased $6.7 million, or 3.9%, over 2004. Insurance premiums are earned ratably
Gross written premiums at American Southern increased $1.8 million, or 3.0%, during 2005 as compared to 2004. The increase in premiums was primarily attributable to increased business writings in the surety line of business. American Southern’s surety bond program, which began to increase production levels in the second half of 2004, generated $10.1 million in gross written premiums during 2005 compared to $6.3 million in 2004, a $3.8 million increase. Partially offsetting this increase was the loss of several large commercial automobile liability accounts and the withdrawal from the low-value dwelling property business, all of which had contributed approximately $2.9 million in written premiums during 2004.
The combined ratio for American Southern decreased to 93.6% in 2005 from a combined ratio of 94.2% in 2004. The loss ratio decreased to 48.2% in 2005 from 51.6% in 2004. The increased focus on new business writings in the general liability and surety lines of business resulted in a decrease in the 2005 loss ratio due to favorable loss experience in those lines of business. Also, during 2004, American Southern incurred, and its loss ratio was impacted by, $1.0 million in hurricane related expenses, which did not recur in 2005. The expense ratio for 2005 increased to 45.4% from 42.6% in 2004. The increase in the expense ratio for 2005 was primarily due to American Southern’s business structure, which compensates agents in relation to the profitability of business they write. In addition, in 2005 American Southern experienced an increase in acquisition costs associated with new programs and accounts underwritten. As a percentage of gross written premiums, net fixed commissions increased to 16.5% in 2005 from 16.3% in 2004. Total commissions (fixed plus variable) increased to 27.6% in 2005 from 26.3% in 2004.
Gross written premiums at Association Casualty increased $9.6 million, or 37.1%, during 2006 as compared to 2005. The increase in gross written premiums was primarily due to the additional premiums retained as a result of the mutual agreement not to enforce a separate reinsurance agreement between Association Casualty and Georgia Casualty. During 2005, Association Casualty had ceded $16.2 million in direct written premiums to Georgia Casualty under this agreement. Effective September 1, 2005, Association Casualty, ceased ceding any portion of its business to Georgia Casualty.
Net earned premiums increased $1.9 million, or 9.2%, during 2006 as compared to 2005. The increase in net earned premiums was primarily due to a higher level of premium volume written and retained during 2006 and 2005, the majority of which is reflected as earned in 2006. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2006 are related to premiums written during both 2005 and 2006.
The combined ratio for Association Casualty decreased to 96.0% in 2006 from 101.5% in 2005. The loss ratio decreased to 43.8% in 2006 from 59.2% in 2005. The decrease in the loss ratio was due to several factors. During 2005, Association Casualty incurred losses and loss adjustment expenses of $0.7 million in connection with the quota share reinsurance agreement with Georgia Casualty. This quota share reinsurance agreement was terminated in 2005 and, accordingly, no such losses were incurred in 2006. Also during 2005, Association Casualty’s loss ratio was negatively impacted by an increasing number of construction defect claims on liability policies, which did not recur in 2006. In addition, Association Casualty experienced favorable loss development during 2006, which also contributed to the decrease in the loss ratio. The expense ratio increased to 52.2% in 2006 from 42.3% in 2005. The increase in the expense ratio was primarily due to an increased share of allocated underwriting expenses that were directly related to the additional retained business that had previously been ceded to Georgia Casualty.
Written premiums of $0.7 million in 2005 and $5.9 million in 2004 ceded to Association Casualty under a quota share reinsurance agreement and eliminated in consolidation. This agreement was terminated effective August 31, 2005.
Net earned premiums decreased $18.1 million, or 46.0%, during 2006 as compared to 2005 primarily as a result of the initiatives discussed previously in combination with the significant price competition on significantly all of Georgia Casualty’s products.
Net earned premiums increased $4.6 million, or 13.3%, during 2005 as compared to 2004 primarily due to the non-recurrence of the $3.1 million arbitration award accrued as ceded premium in 2004. Also contributing to the increase was a higher level of premium volume written during 2004 which was reflected as earned in 2005. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2005 were related to premiums written during both 2004 and 2005.
The combined ratio for Georgia Casualty decreased to 123.9% in 2005 from 128.4% in 2004. The loss ratio decreased to 81.6% in 2005 from 82.7% in 2004. The decrease in the loss ratio was primarily due to a decrease in hurricane related losses. During 2005, Georgia Casualty incurred $1.0 million in net hurricane
Investment income of $18.3 million increased $1.6 million, or 9.8%, during 2006 as compared to 2005 and increased $0.8 million, or 5.2%, during 2005 as compared to 2004. The increase in investment income during 2006 and 2005 was primarily due to a higher level of average invested assets as well as a higher average yield on these investments.
While the impairments did not impact the carrying value of the investments, they resulted in realized losses of $10.8 million in 2005 and $0.5 million in 2004. The impairment losses for 2005 were due primarily to the write down of the value of GM, GMAC, and Ford fixed maturity investments, all of which resulted in a charge of $10.7 million. Management continually evaluates the Company’s investment portfolio and, as needed, makes adjustments for impairments and/or will divest investments. (See Note 2 of Notes to Consolidated Financial Statements.)
The primary cash needs of the Company are for the payment of claims and operating expenses, maintaining adequate statutory capital and surplus levels, and meeting debt service requirements. Current and expected patterns of claim frequency and severity may change from period to period but generally are expected to continue within historical ranges. The Company’s primary sources of cash are written premiums, investment income and the sale and maturity of invested assets. The Company believes that, within each subsidiary, total invested assets will be sufficient to satisfy all policy liabilities and that cash inflows from investment earnings, future premium receipts and reinsurance collections will be adequate to fund the payment of claims and expenses as needed. Cash flows at the Parent are derived from dividends, management fees, and tax sharing payments from the subsidiaries. The cash needs of the Parent are for the payment of operating expenses, the acquisition of capital assets and debt service requirements.
Dividend payments to the Parent by its insurance subsidiaries are subject to annual limitations and are restricted to the greater of 10% of statutory surplus or statutory earnings before recognizing realized investment gains of the individual insurance subsidiaries. At December 31, 2006, the Parent’s insurance subsidiaries had statutory surplus of $114.4 million.
The Parent provides certain administrative, purchasing and other services to each of its subsidiaries. The amounts charged to and paid by the subsidiaries were $14.8 million, $9.8 million, and $9.0 million in 2006, 2005, and 2004, respectively. In addition, the Parent has a formal tax-sharing agreement with each of its insurance subsidiaries. A net total of $2.1 million, $3.1 million and $4.5 million was paid to the Parent under
At December 31, 2006, the Company’s $54.0 million of borrowings consisted of $12.8 million of bank debt with Wachovia and an aggregate of $41.2 million of outstanding junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”). On December 22, 2006, the Company entered into a credit agreement (the “Credit Agreement”) with Wachovia providing for a reducing revolving credit facility pursuant to which the Company may, subject to the terms and conditions thereof, initially borrow or reborrow up to $15.0 million (the “Commitment Amount”). The Commitment Amount is incrementally reduced every six months beginning on July 1, 2007. Borrowings under the Credit Agreement were used to repay amounts outstanding under the Company’s prior term loans with Wachovia, which were terminated upon the closing of the Credit Agreement, and are to be used for general corporate purposes. The interest rate on amounts outstanding under the Credit Agreement is, at the option of the Company, equivalent to either (a) the base rate (which equals the higher of the Prime Rate or 0.5% above the Federal Funds Rate, each as defined) or (b) the LIBOR determined on an interest period of 1-month, 2-months, 3-months or 6-months, plus an Applicable Margin (as defined), and was 7.37% at December 31, 2006. The Applicable Margin varies based upon the Company’s leverage ratio (funded debt to total capitalization, each as defined) and ranges from 1.75% to 2.50%. Interest on amounts outstanding is payable quarterly. If not sooner repaid in full, the Credit Agreement requires the Company to repay $0.5 million in principal on each of June 30 and December 31, 2007 and 2008, $1.0 million and $1.5 million in principal on June 30 and December 31, 2009, respectively, with one final payment of $10.5 million in principal at maturity on June 30, 2010. The Credit Agreement requires the Company to comply with certain covenants, including, among others, ratios that relate funded debt to both total capitalization and earnings before interest, taxes, depreciation and amortization, as well as the maintenance of minimum levels of tangible net worth. The Company must also comply with limitations on capital expenditures, certain payments, additional debt obligations, equity repurchases and redemptions, as well as minimum risk-based capital levels. Upon the occurrence of an event of default, Wachovia may terminate the Credit Agreement and declare all amounts outstanding under the Credit Agreement due and payable in full.
The Company believes that the cash flows it receives from its subsidiaries and, if needed, additional borrowings from banks and affiliates of the Company will enable the Company to meet its liquidity requirements for the foreseeable future. Management is not aware of any current recommendations by regulatory authorities which, if implemented, would have a material adverse effect on the Company’s liquidity, capital resources or operations.
In July 2006, the FASB issued Financial Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken, or expected to be taken, in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with early adoption permitted. Adoption of this Interpretation is not expected to have a material impact on the Company’s financial position or results of operations.
Represents balances due for goods and/or services which have been contractually committed as of December 31, 2006. To the extent contracts provide for early termination with notice but without penalty, only the amounts contractually due during the notice period have been included.
Losses and claims include case reserves for reported claims and reserves for claims incurred but not reported (“IBNR”). While payments due on claim reserves are considered contractual obligations because they relate to insurance policies issued by the Company, the ultimate amount to be paid to settle both case reserves and IBNR reserves is an estimate, subject to significant uncertainty. The actual amount to be paid
Consolidated Statements of Operations for each of the three years in the period ended December 31, 2006
We have audited the accompanying consolidated balance sheets of Atlantic American Corporation and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. We have also audited schedules II, III, IV and VI as of and for each of the three years in the period ended December 31, 2006. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.
Cash and cash equivalents consist of cash on hand and investments in short-term, highly liquid securities which have original maturities of three months or less from date of purchase.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS No. 87, 88, 106, and 132(R).” SFAS No. 158 requires the full recognition of the overfunded or underfunded status of a defined benefit pension plan as an asset or liability along with a corresponding after-tax adjustment to accumulated other comprehensive income (loss) included in shareholders’ equity. Under previous accounting standards, information about the then-current funded status of such plan was reported in the notes to the financial statements. The recognition and the disclosure requirements of SFAS No. 158 are effective for fiscal years ending after December 15, 2006. Adoption of this statement did not have a material impact on the Company’s financial position or results of operations.
In July 2006, the FASB issued Financial Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken, or expected to be taken, in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with early adoption permitted. Adoption of this Interpretation is not expected to have a material impact on the Company’s financial position or results of operations.
disclosures previously permitted under SFAS No. 123 are no longer an alternative to financial statement recognition. The transition method included a prospective or retrospective adoption option. The Company adopted SFAS No. 123R during the first quarter of 2006 using the prospective method. Adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.
Securities with unrealized losses at December 31, 2006 and 2005 were as follows:
During the years ended December 31, 2006, 2005, and 2004, the Company recorded impairments related to the following investments.
because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s investments in fixed maturity securities of General Motors and General Motors Acceptance Corporation exceeded 10% of shareholders’ equity at December 31, 2006. The carrying value of these fixed maturity investments at December 31, 2006 was $17,305 with an adjusted cost basis of $13,705.
Loss and claim reserves represent estimates of projected ultimate losses and are based upon: (a) management’s estimate of ultimate liability and claim adjusters’ evaluations for unpaid claims reported prior to the close of the accounting period, (b) estimates of incurred but not reported claims based on past experience, and (c) estimates of loss adjustment expenses. The estimated liability is periodically reviewed by management and updated with changes to the estimated liability recorded in the statement of operations in the year in which such changes are known.
A reconciliation of the differences between income taxes computed at the federal statutory income tax rate and the income tax expense (benefit) was as follows:
At December 31, 2006, the Company had regular federal net operating loss carryforwards of approximately $11,889 expiring generally between 2007 and 2025. As of December 31, 2006 and 2005, a valuation allowance of $361 and $930, respectively, was established against deferred income tax benefits relating primarily to net operating loss carryforwards that may not be realized. In 2006 and 2005, the decrease of $569 and $125, respectively, in the valuation allowance was the result of a reassessment of the realization of certain net operating loss carryforwards. In 2004, the decrease of $1,291 in the valuation allowance was due
The financial structure of each of Atlantic American Statutory Trust I and II, as of December 31, 2006 and 2005, was as follows:
The Company’s rental expense, including common area charges, for operating leases was $1,798, $1,936, and $1,920 in 2006, 2005, and 2004, respectively. The Company’s future minimum lease obligations under non-cancelable operating leases are as follows:
A summary of the status of the Company’s stock options at December 31, 2006, 2005 and 2004, is as follows:
Data on options outstanding and exercisable at December 31, 2006 is as follows:
The accumulated benefit obligation for all defined benefit plans at December 31, 2006 and 2005 was $5,046 and $4,578, respectively.
The qualified defined benefit plan assets were invested in the AIM Basic Balanced Fund (the “Fund”), the prospectus for which indicates an average annual return of approximately 7% since its inception; accordingly, a 7.00% rate of return was used to calculate the periodic benefit cost for 2006. The Fund normally invests at least 65% of its assets in equity securities and at least 30% of its assets in fixed income securities that are investment grade at the time of purchase. The remaining assets of the Fund are allocated to other investments at the Fund manager’s discretion, based upon current business, economic and market conditions.
The Company’s investment strategy with respect to pension assets is to invest the assets in accordance with ERISA and fiduciary standards. The long-term primary investment objectives are to: 1) provide for a reasonable amount of long-term growth of capital, without undue exposure to risk, and protect the assets from erosion of purchasing power, and 2) provide investment results that meet or exceed the actuarially assumed long-term rate of return. The Fund does not include any equity securities of the Company in its portfolio at any time.
Under the insurance code of the state of jurisdiction under which each insurance subsidiary operates, dividend payments to the Parent by its insurance subsidiaries are subject to certain limitations without the prior approval of the applicable state’s Insurance Commissioner. The Parent received dividends of $9,226, $13,242 and $5,803 in 2006, 2005, and 2004, respectively, from its subsidiaries. In 2007, dividend payments by insurance subsidiaries in excess of $15,277 would require prior approval.
off, the Company received one share of Triple Crown common stock for every ten shares of Gray common stock and for every ten shares of Gray Class A common stock owned. In connection with the Bull Run acquisition, the Company received 0.0289 shares of Triple Crown common stock for each share of Bull Run common stock owned by it and Triple Crown Series A preferred stock in exchange for the shares of Bull Run Series D preferred stock. The exchange of Bull Run Series D preferred stock for Triple Crown Series A preferred stock resulted in a realized loss of $591. At December 31, 2006, the Company owned 54,732 shares of Triple Crown common stock, 388,060 shares of Gray Class A common stock and 106,000 shares of Gray common stock. At December 31, 2005, the Company owned 54,734 shares of Triple Crown common stock, 388,060 shares of Gray Class A common stock and 106,000 shares of Gray common stock. At December 31, 2006, the Company owned 175 shares of Gray Series C preferred stock and 2,360 shares of Triple Crown Series A preferred stock. At December 31, 2005, the Company owned 350 shares of Gray Series C preferred stock and 2,360 shares of Triple Crown Series A preferred stock. On September 28, 2006, the Company sold 175 shares of its investment in Gray Series C preferred stock to Gray at a price of $10,000 per share, and the transaction was settled on September 29, 2006. There was no gain or loss on the transaction. The aggregate carrying value of these investments in Triple Crown and Gray at December 31, 2006 was $2,086 and $5,701, respectively. The aggregate carrying value of these investments in Triple Crown and Gray at December 31, 2005 was $2,139 and $8,021, respectively.
In 1998, Georgia Casualty began directing certain workers’ compensation premiums to Delta Fire & Casualty Insurance Company (“Delta”) and fully reinsured such amounts. Delta is controlled by the Company’s Chairman. Premiums assumed and commissions paid were $171 and $23 in 2006, respectively, $532 and $80 in 2005, respectively, and $1,710 and $143 in 2004, respectively.
The Parent’s primary insurance subsidiaries operate with relative autonomy and each company is evaluated based on its individual performance. American Southern, Association Casualty, and Georgia Casualty operate in the Property and Casualty insurance market, while Bankers Fidelity operates in the Life and Health insurance market. All segments derive revenue from the collection of premiums, as well as from investment income. Substantially all revenue other than that in the corporate and other segment is from external sources.
The fair value estimates as of December 31, 2006 and 2005 were based on pertinent information available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, current estimates of fair value may differ significantly from amounts that might ultimately be realized.
Fixed Maturities, Common and Non-Redeemable Preferred Stocks and Publicly Traded Other Invested Assets
The fair value of investments in certain limited partnerships which are included in other invested assets on the consolidated balance sheet, were determined by officers of those limited partnerships.
The following table sets forth a summary of the quarterly unaudited results of operations for the two years in the period ended December 31, 2006: