Future policy benefits comprised 31% of the Company’s total liabilities at December 31, 2010. 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.
Deferred acquisition costs comprised 8% of the Company’s total assets at December 31, 2010. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to expense in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any previous calendar year.
Cash and investments comprised 77% of the Company’s total assets at December 31, 2010. Substantially all of the Company’s investments are in bonds and common and preferred stocks, the values of 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 fixed maturity securities that do not have publicly quoted values, but had an estimated fair value as determined by management of $1.9 million at December 31, 2010. 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, the Company evaluates such investment for an other than temporary impairment. The evaluation for an other than temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. Potential risks and uncertainties include, among other things, changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. In evaluating a potential impairment, the Company considers, among other factors, management’s intent and ability to hold these securities until price recovery, the nature of the investment and the prospects for the issuer and its industry, the status of an issuer’s continued satisfaction of the obligations in accordance with the contractual terms of the investment, and management’s expectation as to the issuer’s ability and intent to continue to do so, as well as ratings actions that may affect the issuer’s credit status. If an other than 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.
On a consolidated basis, the Company had net income of $2.5 million, or $0.09 per diluted share, in 2010, compared to a net loss of $1.2 million, or $0.08 per diluted share, in 2009. The net loss in 2009 was primarily attributable to a $2.0 million increase in the Company’s deferred tax asset valuation allowance. The 2009 change in the deferred tax asset valuation allowance was due to reassessment of the realization of certain capital loss carryforward benefits. In 2010, income before income taxes was $2.9 million compared to $1.4 million in 2009. The increase in income before income taxes during 2010 was primarily due to a higher level of realized investment gains. The Company’s underwriting results also improved moderately in 2010; however offsetting the increase in income before income taxes was a decrease in investment income due to declining yields from invested assets. During 2010, a large number of securities held by the Company were called by the issuers, the proceeds from which the Company was not able to reinvest at equivalent rates.
Total expenses were $106.3 million in 2010 as compared to $101.4 million in 2009. Insurance benefits and losses incurred and commissions and underwriting expenses as a percentage of premiums were 97.3% and 97.5% in 2010 and 2009, respectively. The slight decrease in the ratio was primarily due to the increase in premium revenue in the Company’s life and health operation partially offset by higher loss ratios in the property and casualty operations.
The Company’s property and casualty operations are comprised of American Southern and the Company’s life and health operation consists of Bankers Fidelity.
Gross written premiums at American Southern increased $4.4 million, or 11.4%, during 2010 as compared to 2009. The increase in gross written premiums was primarily attributable to an increase in commercial automobile business marketed through a newly appointed general agent. Partially offsetting the increase in gross written premiums was the continued decline in the general liability line of business resulting from continued weakness in the construction industry as well as decreases in business writings from certain targeted agencies due to the strengthening of the company’s underwriting guidelines.
Net earned premiums increased $0.6 million, or 1.9%, during 2010 as compared to 2009. The overall increase in net earned premiums during 2010 was primarily due to the increase in commercial automobile business. The decline in the general liability and surety earned premiums resulted from continued weakness in the construction industry. Premiums are earned ratably over their respective policy terms, and therefore premiums earned in the current year are related to policies written during both the current and immediate prior year. In 2010, American Southern’s five principal states in terms of premium revenue were Alabama, Florida, Georgia, Ohio, and Texas and accounted for approximately 62% of total earned premiums for 2010.
Contingent commissions, if contractually applicable, are ultimately payable to agents based on the underlying profitability of a particular insurance contract or a group of insurance contracts, and are periodically evaluated and accrued as earned. Approximately 80% of American Southern’s business provides for contractual commission arrangements which compensate the company’s agents in relation to the loss ratios of the business they write. By structuring its business in this manner, American Southern provides its agents with an economic incentive to place profitable business with American Southern. In periods when loss reserves reflect favorable development from prior years’ reserves, there is generally a highly correlated increase in commission expense also related to the prior year business. Accordingly, favorable loss development from prior years, while anticipated to continue in future periods, is not an indicator of significant additional profitability in the current year.
Investment income decreased $1.0 million, or 8.9%, in 2010 as compared to 2009. The decrease in investment income during 2010 was primarily attributable to a decrease in yield on invested assets. The average yield on the Company’s invested assets decreased to 4.4% in 2010 from 4.8% in 2009. Further, during 2010, a large number of higher yielding securities held by the Company were redeemed by the issuers in accordance with the contractual terms thereof, the proceeds from which the Company was not able to reinvest at equivalent rates.
Cash flows at the Parent are derived from dividends, management fees, and tax sharing payments, as described below, 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. At December 31, 2010, the Parent had approximately $25.0 million of unrestricted cash and investments. The Company believes that traditional funding sources for the Parent, combined with current cash and investments, should provide sufficient liquidity for the Company and/or the Parent for the foreseeable future.
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, 2010, the Parent’s insurance subsidiaries had an aggregate statutory surplus of $70.6 million.
In addition to these internal funding sources, the Company maintains its revolving credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”), pursuant to which the Company is able to, subject to the terms and conditions thereof, borrow or reborrow up to $5.0 million. 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 2.00%. Interest on amounts outstanding is payable quarterly. 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 certain redemptions, as well as minimum risk-based capital levels. Upon the occurrence of an event of default, Wells Fargo may terminate the Credit Agreement and declare all amounts outstanding due and payable in full. During 2010, there was no balance outstanding under this Credit Agreement and the Company was in compliance with all terms of the Credit Agreement. The termination date of this Credit Agreement is June 30, 2011. The Company expects that it will seek to extend or renew the Credit Agreement on or prior to expiration, although no assurances can be provided that any extension or replacement would be available to the Company on acceptable terms, or at all.
During 2006, the Company entered into a zero cost interest rate collar with Wells Fargo to hedge future interest payments on a portion of the Junior Subordinated Debentures. The notional amount of the collar was $18.0 million with an effective date of March 6, 2006. The collar has a LIBOR floor rate of 4.77% and a LIBOR cap rate of 5.85% and adjusts quarterly on the 4th of each March, June, September and December through termination on March 4, 2013. The Company began making payments to Wells Fargo under the zero cost interest rate collar on June 4, 2008. As a result of interest rates remaining below the LIBOR floor rate of 4.77% through 2010, these payments to Wells Fargo under the zero cost interest rate collar continued throughout 2010. While the Company may be exposed to counterparty risk should Wells Fargo fail to perform, based on the current level of interest rates, and coupled with the current macroeconomic outlook, the Company believes that its current exposure to nonperformance risks is minimal.
At December 31, 2010, the Company had 70,000 shares of Series D Preferred Stock (“Series D Preferred Stock”) outstanding. All of the shares of Series D Preferred Stock are held by an affiliate of the Company’s Chairman Emeritus. The outstanding shares of Series D Preferred Stock have a stated value of $100 per share; accrue annual dividends at a rate of $7.25 per share (payable in cash or shares of the Company’s common stock at the option of the board of directors of the Company) and are cumulative. In certain circumstances, the shares of the Series D Preferred Stock may be convertible into an aggregate of approximately 1,754,000 shares of the Company’s common stock, subject to certain adjustments and provided that such adjustments do not result in the Company issuing more than approximately 2,703,000 shares of common stock without obtaining prior shareholder approval; and are redeemable solely at the Company’s option. The Series D Preferred Stock is not currently convertible. During 2010 and 2009, the Company paid $0.5 million in Series D Preferred Stock dividends. As of December 31, 2010, the Company had accrued, but unpaid dividends, on the Series D Preferred Stock of $22,556.
As a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we have elected to comply with certain scaled disclosure reporting obligations, and therefore do not have to provide the table of contractual obligations required by this Item.
We have audited the accompanying consolidated balance sheets of Atlantic American Corporation and subsidiaries (the “Company”) as of December 31, 2010 and 2009 and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. In connection with our audits of the financial statements, we have also audited schedules II, III, IV and VI. These consolidated financial statements 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.
At December 31, 2010, the Parent owned three insurance subsidiaries, Bankers Fidelity Life Insurance Company (“Bankers Fidelity”), American Southern Insurance Company and its wholly-owned subsidiary, American Safety Insurance Company (together known as “American Southern”), in addition to two non-insurance subsidiaries, Self-Insurance Administrators, Inc. and xCalibre Risk Services, Inc.
The Company’s investments in both fixed maturity securities, which include bonds and redeemable preferred stocks, and equity securities, which include common and non-redeemable preferred stocks, are classified as “available-for-sale” and, accordingly, are carried at fair value with the after-tax difference from amortized cost, as adjusted if applicable, reflected in shareholders’ equity as a component of accumulated other comprehensive income or loss. The fair values for fixed maturity and equity securities are largely determined by either independent methods prescribed by the National Association of Insurance Commissioners (“NAIC”), which do not differ materially from publicly quoted market prices, when available, or independent broker quotations. The Company owns certain fixed maturity securities that do not have publicly quoted market values, but had an estimated fair value as determined by management of $1,943 at December 31, 2010. Such values inherently involve a greater degree of judgment and uncertainty and therefore ultimately greater price volatility. Policy and student loans, and real estate are carried at historical cost. Other invested assets are comprised of investments in limited partnerships, limited liability companies, and real estate joint ventures, and are accounted for using the equity method. If the value of a common stock, preferred stock, other invested asset, or publicly traded bond declines below its cost or amortized cost, if applicable, and the decline is considered to be other than temporary, a realized loss is recorded to reduce the carrying value of the investment to its estimated fair value, which becomes the new cost basis. The evaluation for an other than temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. Potential risks and uncertainties include, among other things, changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. In evaluating a potential impairment, the Company considers, among other factors, management’s intent and ability to hold these securities until price recovery, the nature of the investment and the prospects for the issuer and its industry, the issuer’s continued satisfaction of the investment obligations in accordance with their contractual terms, and management’s expectation that they will continue to do so, as well as rating actions that affect the issuer’s credit status. Premiums and discounts related to investments are amortized or accreted over the life of the related investment as an adjustment to yield using the effective interest method. Dividends and interest income are recognized when earned or declared. The cost of securities sold is based on specific identification. Unrealized gains (losses) in the value of invested assets are accounted for as a direct increase (decrease) in accumulated other comprehensive income in shareholders' equity, net of deferred tax and, accordingly, have no effect on net income.
In June 2009, the FASB issued amendments to Accounting Standards Codification (“ASC”) 810-10 (“ASC 810-10”), which amend the consolidation guidance applicable to variable interest entities (“VIEs”). Pursuant to these amendments, an entity would consolidate a VIE, as the primary beneficiary, when the entity has both of the following: (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE is required. The amendments to ASC 810-10 eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE. The amendments to ASC 810-10 are effective for fiscal years and interim periods beginning after November 15, 2009. The Company adopted the amendments to ASC 810-10 on January 1, 2010. Adoption of the amendments to ASC 810-10 did not have a material impact on the Company’s financial condition or results of operations.
The following tables set forth the carrying value, gross unrealized gains, gross unrealized losses and amortized cost of the Company’s investments, aggregated by type and industry, as of December 31, 2010 and December 31, 2009.
1) Media includes related party investments in Gray Television, Inc. with an amortized cost basis of $3,198 and which had an aggregate carrying value of $885 and $718 at December 31, 2010 and 2009, respectively. See Note 13.
The following is a summary of investment impairments the Company recorded due to other than temporary declines in values for the years ended December 31, 2010 and 2009.
The evaluation for an other than temporary impairment is a quantitative and qualitative process, which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. Potential risks and uncertainties include, among other things, changes in general economic conditions, an issuer’s financial condition or near term recovery prospects and the effects of changes in interest rates. In evaluating a potential impairment, the Company considers, among other factors, management’s intent and ability to hold these securities until price recovery, the nature of the investment and the prospects for the issuer and its industry, the status of an issuer’s continued satisfaction of the investment obligations in accordance with their contractual terms, and management’s expectation as to the issuer’s ability and intent to continue to do so, as well as ratings actions that may affect the issuer’s credit status.
As of December 31, 2010, securities in an unrealized loss position primarily included certain of the Company’s investments in fixed maturity securities and common and non-redeemable preferred stocks within the financial services and media sectors, and municipal bonds. Investments in the media sector include related party investments in Gray Television, Inc., which had unrealized losses of $2,313 as of December 31, 2010. The Company does not intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position. Based upon the Company’s expected continuation of receipt of contractually required principal and interest payments and its intent and ability to retain the securities until price recovery, the Company has deemed these securities to be temporarily impaired as of December 31, 2010.
The following and Note 15 describe the fair value hierarchy and provide information as to the extent to which the Company uses fair value to measure financial instruments and information about the inputs used to value those financial instruments. The fair value hierarchy prioritizes the inputs in the valuation techniques used to measure fair value into three broad levels.
Observable inputs that reflect quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date.
The Company’s Level 3 fixed maturity securities consist solely of issuances of pooled debt obligations of multiple, smaller financial services companies. They are not actively traded and valuation techniques used to measure fair value are based on future estimated cash flows discounted at a reasonably estimated rate of interest. Other qualitative and quantitative information received from the original underwriter of the pooled offering is also considered, as applicable.
Loss and claim reserves represent estimates of projected ultimate losses and are based upon: (a) management's estimate of ultimate liability and claims adjusters' evaluations for unpaid claims reported prior to the close of the accounting period, (b) estimates of incurred but not reported (“IBNR”) 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.
Prior years’ development was primarily the result of better than expected development on prior years IBNR reserves for certain lines of business primarily within American Southern.
In accordance with general practice in the insurance industry, portions of the life, property and casualty insurance written by the Company are reinsured; however, the Company remains liable with respect to reinsurance ceded should any reinsurer be unable or unwilling to meet its obligations. Approximately 99% of the Company’s reinsurance receivables were due from two reinsurers as of December 31, 2010. Reinsurance receivables of $9,512 were due from Swiss Reinsurance Corporation, rated “A+” by Standard & Poor’s and “A” (Excellent) by A.M. Best and $4,600 were due from General Reinsurance Corporation, rated “AA+” by Standard & Poor’s and “A++” (Superior) by A.M. Best. Allowances for uncollectible amounts are established against reinsurance receivables, if appropriate.
Deferred tax liabilities and assets at December 31, 2010 and 2009 were comprised of the following:
At December 31, 2010, the Company had regular federal net operating loss carryforwards (“NOLs”) of approximately $6,335 expiring generally between 2010 and 2029. Approximately $1,307 of the NOLs were estimated to have expired in 2010. Accordingly, as of December 31, 2010, a valuation allowance of $457 was established to reduce this deferred tax benefit to zero. Currently, the Company believes that the remaining deferred income tax benefits relating to the NOLs will be realized. However, realization of the NOLs will be assessed periodically based on the Company’s current and anticipated results of operations, and amounts could increase or decrease in the near term if estimates of future taxable income change.
As of December 31, 2010 and 2009, a valuation allowance of $6,558 and $6,650, respectively, was established against deferred income tax benefits relating primarily to capital loss carryforwards that may not be realized. The Company does not currently anticipate having sufficient future capital gains to offset certain of these capital losses during the applicable carryforward period. However, the Company continues to periodically assess the potential realization of these and all other deferred tax benefits. During 2010, the Company’s valuation allowance decreased by $92. The decrease was primarily due to the utilization of certain capital loss carryforward benefits that had been previously reduced to zero through an existing valuation allowance reserve. Partially offsetting this decrease in the valuation allowance was an increase resulting from the expired NOLs discussed previously.
The financial structure of each of Atlantic American Statutory Trust I and II, as of December 31, 2010 and 2009, was as follows:
In accordance with the Company’s 1992 Incentive Plan, the Board of Directors was authorized to grant up to 1,800,000 stock options or share awards. The Board of Directors may grant: (a) incentive stock options within the meaning of Section 422 of the Internal Revenue Code; (b) non-qualified stock options; (c) performance units; (d) awards of restricted shares of the Company’s common stock and other stock unit awards; (e) deferred shares of common stock; or (f) all or any combination of the foregoing to officers and key employees. Stock options granted under this plan expire five or ten years from the date of grant, as specified in an award agreement. Vesting occurs at 50% upon issuance of an option, and the remaining portion vests in 25% increments in each of the following two years. In accordance with the Company’s 1996 Director Stock Option Plan, a maximum of 200,000 stock options were authorized to be granted, which fully vest six months after the grant date. In accordance with the Company’s 2002 Incentive Plan (the “2002 Plan”), the Board of Directors was authorized to grant up to 2,000,000 stock options or share awards. Subject to adjustment as provided in the 2002 Plan, the Board of Directors is authorized to grant: (a) incentive stock options; (b) non-qualified stock options; (c) stock appreciation rights; (d) restricted shares; (e) deferred shares; and (f) performance shares and/or performance units. Further, the Board may authorize the granting to non-employee directors of stock options and/or restricted shares. No restricted shares were issued in either 2010 or 2009. As of December 31, 2010, an aggregate of twenty employees, officers and directors held options under the three plans.
Prior to May 2010, the Company had a qualified funded noncontributory defined benefit pension plan covering the employees of American Southern and, prior to May 2009, had an unfunded noncontributory defined benefit pension plan (“SERP”). The plans provided defined benefits based on years of service and average salary. Effective May 31, 2008, the Company froze all benefits related to its qualified pension plan, as well as its SERP. In May 2009, the Company terminated the SERP and distributed the accumulated benefits to those participating employees. On March 11, 2010, the Company received a determination letter from the Internal Revenue Service approving the termination of the Company’s qualified pension plan. In May 2010, the Company distributed the accumulated benefits, as directed, to participating employees, and terminated the qualified pension plan. In connection with the May 2010 termination and settlement of the qualified pension plan, the Company incurred a 2010 charge of $319. The measurement date for these plans was December 31 of each year.
The assumed conversion of the Company’s Series D Preferred Stock was excluded from the earnings (loss) per common share calculation for all periods presented since its impact would have been antidilutive. All outstanding stock options were excluded from the earnings (loss) per common share calculation for 2009 since their impact also would have been antidilutive.
The Company leases approximately 49,586 square feet of office and covered garage space from an entity which is an affiliate of the Company and its Chairman Emeritus. During the years ended December 31, 2010 and 2009, the Company paid $849 and $827, respectively, under this lease.
The fair value estimates as of December 31, 2010 and 2009 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.
The Company’s fixed maturity securities valued using Level 3 inputs consist solely of issuances of pooled debt obligations of multiple, smaller financial services companies. They are not actively traded and valuation techniques used to measure fair value are based on future estimated cash flows discounted at a reasonably estimated rate of interest. Other qualitative and quantitative information received from the original underwriter of the pooled offerings is also considered, as applicable. As the derivative is an interest rate collar, changes in valuation are more closely correlated with changes in interest rates and, accordingly, values are estimated using projected cash flows at current interest rates discounted at a reasonably estimated rate of interest. Fair value quotations are also obtained and considered, as applicable, from the counterparty to the transaction.
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 Company's comprehensive income (loss) consists of net income (loss), unrealized gains and losses on securities available for sale, fair value adjustments from the ownership of a derivative financial instrument and for 2009, minimum additional pension liability, all net of applicable income taxes. Other than net income (loss), the other components of comprehensive income (loss) for the years ended December 31, 2010 and 2009 were as follows: