Physical Properties of the Company and Its Subsidiaries. The principal executive offices are owned by Mutual and are located at 2108 East South Boulevard, Montgomery, Alabama, in a 342 thousand square foot primary facility and a 134 thousand square foot business processing center. The executive offices are a component of all segments.
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 54.8% of Alfa Corporation’s common stock, their largest single investment. Alfa Specialty Insurance Corporation is a wholly-owned subsidiary of Alfa Mutual Insurance Company (Mutual). The Company, together with the Mutual Group, comprise the Alfa Group (Alfa). Prior to January 1, 2007, Alfa Virginia Mutual Insurance Company (Virginia Mutual) ceded 80% of its direct business to Alfa Mutual Fire Insurance Company (Fire) under an affiliate agreement signed in August 2001. On January 1, 2007, Virginia Mutual demutualized and Alfa Alliance Insurance Corporation (Alliance), a new subsidiary of the Company, was formed. For more information on Alliance, refer to Note 2 - Pooling Agreement, Note 21 - Plan of Conversion of Virginia Mutual Insurance Company and Note 22 - Subsequent Events in the Notes to Consolidated Financial Statements.
In evaluating the performance of the Company’s segments, management believes operating income serves as a meaningful tool for assessing the profitability of the Company’s ongoing operations. Operating income, a non-GAAP financial measure, is defined by the Company as net income excluding net realized investment gains and losses, net of applicable taxes. Realized investment gains and losses are somewhat controllable by the Company through the timing of decisions to sell securities. Therefore, realized investment gains and losses are not indicative of future operating performance.
The Company’s internal actuarial staff conducts annual reviews of projected loss development information by line of business to assist management in making estimates of reserves for ultimate losses and loss adjustment expenses payable. Several factors are considered in estimating ultimate liabilities including consistency in relative case reserve adequacy, consistency in claims settlement practices, recent legal developments, historical data, actuarial projections, accounting projections, exposure growth, current business conditions, catastrophe developments, and late reported claims. In addition, reasonableness is established in the context of claim severity, loss ratio and trend factors, all of which are implicit in the liability estimates. On an interim basis, the Company’s internal actuarial staff reviews the direct emergence for each line of business compared to the expected emergence implied by the most recent annual review. If the emergence is not within acceptable bounds, the opinion on reserve adequacy is revised and reserve amounts are adjusted. Otherwise, IBNR reserves are adjusted as changes in exposure indicate that additional reserves are needed until the next annual review is completed. The following methodologies are used to develop a range of probable outcomes for estimated loss and loss adjustment expense reserves during the annual review, with the Catastrophes methods used during both annual and interim reviews:
Index to Financial Statements The annual actuarial reviews are presented to management with a point estimate established within the range of probable outcomes for evaluating the adequacy of reserves and determination of the appropriate reserve value to be included in the financial statements. Management establishes reserves slightly above mid-point to include an estimated provision for uncertainty and to minimize the necessity for changing historical estimates. Although management uses many internal and external resources, as well as multiple established methodologies to calculate reserves, there is no method for determining the exact ultimate liability.
are consistently applied and fairly stated in accordance with sound actuarial principles;
make a good and sufficient provision for all unmatured obligations of the Company guaranteed under the terms of its contracts;
are computed on the basis of assumptions consistent with those used in computing the corresponding items of the preceding year end; and
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.
Property Casualty Products: Acquisition costs for property casualty insurance are amortized over the period in which the related premiums are earned. 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.
As a result of the investigation, the results of operations for 2006 include a write off of loans totaling $5.5 million in Financial’s loan portfolio offset by insurance recoveries of $2.0 million. This net write off had an impact, after taxes, on net income of $2.3 million or $0.03 per diluted share for 2006. It was determined that the fraudulent transactions were limited to the acts of a single agent. Of the $6.2 million loan portfolio originated by this agent, it was determined that $5.5 million was fraudulently originated. The Company is pursuing additional recoveries through civil actions as of December 31, 2006. Amounts and timing of such recoveries will be contingent upon those actions.
On January 3, 2005, the Company completed the purchase of Vision, a managing general agency that writes nonstandard automobile insurance policies in nine states, and provides all underwriting, claims, actuarial and financial services on behalf of its contracted carriers, which includes AVIC.
On December 31, 2005, the Company completed the sale of a substantial portion of its commercial lease portfolio and other assets, net of related liabilities, to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry Financial Corporation (MidCountry). No gain or loss was recognized and no amounts of revenue and pretax profit or loss have been reported in discontinued operations due to the Company’s significant continuing involvement through its equity-method investment in MidCountry.
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 has 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.
Total premiums and policy charges increased $54.0 million, or 8.5%, in 2006 and $76.3 million, or 13.7%, in 2005.
Life Insurance: Life insurance premiums and policy charges increased $6.2 million, or 8.1%, in 2006 and $5.4 million, or 7.6%, in 2005.
Index to Financial Statements Policies inforce grew for all lines in 2006. The slight increase in traditional life was the result of increases in new product offerings offset by a decline in the direct mail product. Inforce annualized premium growth was 5.2%, with the largest increase in traditional life at 12.9%.
Other income increased $5.5 million, or 24.2% in 2006 and $14.7 million, or 181.3%, in 2005 due to increases in fee income from AVIC and commission income from Vision offset by intercompany eliminations.
Life insurance operating income increased $2.2 million, or 10.1% in 2006 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. Mortality, a non-GAAP financial measure, represents the ratio of actual to expected death claims. Therefore, for 2006, the Company experienced less favorable financial results when compared to the same period in 2005 due to the higher mortality ratio. Life insurance operating income increased $3.0 million, or 15.8%, in 2005 as a result of a lower mortality ratio of 96% compared to 104% during 2004, premiums and policy charges growth of 7.6% and net investment income growth of 3.7% due to increased investments in fixed maturities at a slightly lower yield. Due to the lower mortality ratio in 2005, the Company experienced more favorable financial results when compared to 2004.
Noninsurance operating income increased $366 thousand to an operating profit of $328 thousand for 2006. Agency operations increased operating income by $2.8 million due to increases in Vision’s operations, loan operations decreased operating income by $2.8 million due to increases in loan losses, commercial leasing operations increased operating income by $263 thousand and ABC increased operating income by $91 thousand. In 2005, noninsurance operating income decreased $2.2 million to an operating loss of $38 thousand. This decline was attributable to ABC’s recognition of a deferred tax asset and subsequent charge to earnings for the change in the deferred tax asset arising from the formation of the entity in 1999.
Realized investment gains, net of tax, declined $1.7 million, or 43.8% for 2006 as a result of increased losses on tax credit partnerships. On a pretax basis, writedowns increased from $2.1 million in 2005 to $2.9 million in 2006.
Corporate expenses decreased by $1.2 million in 2006 and increased $2.1 million in 2005. Current 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. Prior year results were impacted by increased costs on the Company’s short-term borrowings.
The following table sets forth summarized financial information for the Company’s property casualty insurance subsidiaries, AIC, AGI and AVIC, for the years ended December 31, 2006, 2005 and 2004:
AVIC, which writes nonstandard automobile business in nine states, was added as a participant to the pool.
During the fourth quarter of 2005, a new property casualty policy administration system was implemented for the automobile line of business.
Property casualty insurance 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 premium decreased slightly to $20.8 million for 2006 compared to $21.4 million for 2005.
AIC and AGI contributed $16.9 million of earned premium growth during 2006. The growth from AIC and AGI is related to increases in personal lines. During 2006, earned premium for homeowner and manufactured home increased $10.5 million, or 7.1%, automobile increased $5.5 million, or 1.8%, farmowner increased $1.6 million, or 6.1%. In addition, there was a slight increase in other lines offset by increases in ceded catastrophe premium and working cover premium of $1.6 million.
Index to Financial Statements 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.
The overall higher expense structures of AVIC and Virginia Mutual, along with the impact of SFAS No. 123(R) and technology costs offset by a decline of 2.1% in the overall loss ratio produced an underwriting margin of 9.2% in 2006, compared with 10.0% in 2005. 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.
Realized investment losses, net of tax, increased $3.2 million during 2006 as a result of lower net gains on equity securities offset by higher gains on fixed maturities and increased losses on tax credit partnerships. On a pretax basis, writedowns increased from $311 thousand in 2005 to $796 thousand in 2006.
Net income increased 2.0% for 2006, compared to 22.5% in 2005, with AVIC and Virginia Mutual contributing $2.0 million in 2006. Return on equity was 17.2% for 2006 compared to 18.6% in 2005.
At December 31, 2006, the Company’s property casualty subsidiaries’ Adjusted Capital calculated in accordance with National Association of Insurance Commissioners (NAIC) Risk-Based Capital (RBC) guidelines was $450.7 million compared to the Authorized Control Level (Required) RBC of $35.7 million. These statutory measures serve as a benchmark for the regulation of an organization’s solvency by state insurance regulators.
The overall higher expense structures of AVIC and Virginia Mutual, along with the impact of technology costs has produced a slightly lower underwriting margin of 10.0% in 2005, compared with 10.3% in 2004.
At December 31, 2005, the Company’s property casualty subsidiaries’ Adjusted Capital calculated in accordance with National Association of Insurance Commissioners (NAIC) Risk-Based Capital (RBC) guidelines was $407.5 million compared to the Authorized Control Level (Required) RBC of $30.3 million. These statutory measures serve as a benchmark for the regulation of an organization’s solvency by state insurance regulators.
The following table sets forth summarized financial information for the Company’s life insurance subsidiary, Life, for the years ended December 31, 2006, 2005 and 2004:
Index to Financial Statements 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.
Life insurance policy charges increased $1.3 million during 2006 primarily due to increased fund balances on which policy charges are assessed. In addition, a slight increase of 0.3% in the number of universal life policies inforce contributed to the increase.
On a statutory accounting basis, issued annualized new business premium increased by 29.0% to $17.8 million with a total volume of $3.4 billion of insurance being issued in 2006. The new product offerings for 2006 contributed as follows: return of premium level term - 6,329 policies issued, $4.6 million of issued annualized new business premium and volume of $1.1 billion of insurance issued; annuities - 57 policies issued and $1.4 million of issued annualized new business premium.
Invested assets increased 6.8% since December 31, 2005, while net investment income increased 10.9%. Interest income on fixed maturities increased 9.8% during 2006. Realized investment gains, net of tax, increased $1.5 million, or 40%, for 2006 as a result of increased gains on equity securities and fixed maturities. On a pretax basis, writedowns increased from $1.7 million in 2005 to $2.1 million in 2006.
Index to Financial Statements Invested assets increased 7.2%, with an increase of amortized value in fixed income securities of 12.5%, while net investment income increased 3.7%, with income from fixed maturities up $1.1 million, reflecting a slightly lower yield. Writedowns accounted for $1.1 million of the reduction in realized investment gains, net of tax.
Results of operations for this segment have been impacted by the following events in 2005 and 2006:
Noninsurance operating income increased $366 thousand to an operating profit of $328 thousand in 2006 compared to an operating loss of $38 thousand for 2005. Net income for 2006 was $277 thousand compared to a net loss of $64 thousand in 2005. Included in operating expenses for this segment is $142 thousand of SFAS No. 123(R) expense for 2006.
Agency operations for the year produced a net loss of $14 thousand. During 2005, AAM and AAG produced $72 thousand in operating income. Vision generated an operating loss of $86 thousand due to infrastructure costs and lower than anticipated premium volume attributable to delays in licensing.
Loan operations in Financial continue to grow with a 12.3% increase in the loan portfolio, an increase in the loan portfolio yield to 7.41% from 6.89%, and an average delinquency ratio of only 1.44%. Interest rate increases during the year reduced margins slightly. Equity in net earnings (after internal capital charge) of MidCountry increased 113.7% for the year while the carrying value increased 3.6%. These components of Financial produced net income of $3.1 million for the year.
Corporate expenses, including the impact of eliminations, decreased $1.2 million in 2006 due primarily to a change in the Company’s tax allocation agreement offset by increases in accounting fees, legal fees and borrowing costs. Unfavorable increases in short-term interest rates and an increase in the commercial paper borrowings attributable to corporate functions led the Company’s interest expense to rise by $1.8 million from levels experienced in 2005. The weighted average rate increased one hundred basis points from 4.3% at December 31, 2005 to 5.3% at December 31, 2006 with corporate debt increasing from $77.6 million at the end of 2005 to $97.0 million on December 31, 2006. Included in the operating results for this segment is $94 thousand of SFAS No. 123(R) expense for 2006.
Corporate expenses, including the impact of eliminations, increased $2.0 million in 2005 due primarily to an increase in borrowing costs. Unfavorable increases in short-term interest rates and an increase in the commercial paper borrowings attributable to corporate functions and the purchase of Vision led the Company’s interest expense to rise by $1.9 million from levels experienced in 2004. The weighted average rate increased from 2.3% to 4.3% with corporate debt increasing from $58.1 million at the end of 2004 to $77.6 million on December 31, 2005.
The majority of the Company’s investment portfolio consists of fixed maturities that are diverse as to both industry and geographic concentration. In 2006, the overall mix of investments shifted due to additional investments in short-term investments and partnerships yielding tax credits.
To the Board of Directors and Stockholders of the Alfa Corporation:
We have completed an integrated audit of the Alfa Corporation’s 2006 consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audit, are presented below.
company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments (consisting primarily of normal recurring accruals) necessary to present fairly its financial position, results of operations and cash flows. The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (GAAP).
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 is the same and the surplus is not significantly different under the State of Alabama and NAIC accounting practices.
During 2003, one of Financial’s investments, MidCountry Financial Corporation (MidCountry), pursued the opportunity to purchase Bayside Financial Corp. In order for this purchase to take place, approval had to be secured from the Office of Thrift Supervision. Consequently, due to ownership levels, this transaction qualified Financial and the Company as unitary thrift holding companies. As a condition of approval, the Company agreed to sell its residential and commercial construction subsidiary, Alfa Builders, Inc. (Builders) and its real estate sales subsidiary Alfa Realty, Inc. (Realty) to Southern Boulevard Corporation (Southern), a wholly-owned subsidiary of Alfa Mutual Insurance Company (Mutual) for their independently-determined fair values of $5.5 million and $2.6 million, respectively. Southern subsequently became Alfa Properties, Inc. (Alfa Properties) during the first quarter of 2004. No gain or loss was recorded on these transactions. The financial statements and notes to the financial statements contained within this report include the results of these subsidiaries for the first two months of 2004.
Alfa Corporation is affiliated with Mutual, Alfa Mutual Fire Insurance Company (Fire) and Alfa Mutual General Insurance Company (collectively, the Mutual Group). The Mutual Group owns 54.8% of Alfa Corporation’s common stock, their largest single investment. Alfa Specialty Insurance Corporation (Specialty) is a wholly-owned subsidiary of Mutual. Alfa Corporation and its subsidiaries (the Company) together with the Mutual Group comprise the Alfa Group (Alfa). Prior to January 1, 2007, Virginia Mutual Insurance Company (Virginia Mutual) ceded 80% of its direct business to Fire under a Strategic Affiliation Agreement signed in August 2001. On January 1, 2007, Virginia Mutual demutualized and Alfa Alliance Insurance Corporation (Alliance), a new subsidiary of the Company, was formed. Refer to Note 21 - Plan of Conversion of Virginia Mutual Insurance Company for further details.
Index to Financial Statements Property Casualty Products: Premiums written are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Premiums reported are net of ceded premiums. The liability for estimated unpaid property casualty losses and loss adjustment expenses is based upon an evaluation of reported losses and on estimates of incurred but not reported losses. Adjustments to the liability based upon subsequent developments are included in current operations.
The Company recognizes expense for its share-based compensation based on the fair value of the awards that are granted. The fair value of stock options is estimated at the date of grant using the Black-Scholes-Merton option valuation model. Option valuation methods require the input of assumptions, including the expected stock price volatility, expected option term, risk-free interest rate and expected dividend yield.
Index to Financial Statements Collateral Loans and Commercial Leases: Collateral loans and lease financings, included in other long-term investments, are reported in the balance sheet at outstanding principal balance adjusted for charge-offs and the allowance for losses in accordance with Statement of Position (SOP) 01-6, Accounting by Certain Entities That Lend to or Finance the Activities of Others. The allowance for losses on collateral loans and commercial leases represents the Company’s best estimate of probable losses inherent in the portfolios based on relevant observable data that include, but are not limited to, historical experience, collateral type, account balance and delinquency. Credit losses are deducted from the allowance and charged off in the period in which the loans or leases are deemed uncollectible. Recoveries previously charged off are recorded when received. The Company considers an account to be delinquent if it is thirty or more days late in its scheduled payments. If the account is over 90 days late, the Company considers repossession of the collateral. If collateral is repossessed, the loan or lease is written down against the allowance for losses and the asset is transferred to other assets and carried at the lower of cost or estimated fair value less the cost to dispose. Loans are placed on a nonaccrual status when a bankruptcy is reported or the collateralized assets are repossessed. The Company uses the effective interest method to recognize income on loans and leases. Deferred fees are amortized over the term of the commercial lease.
Other Long-term Investments: Partnerships, joint ventures and unconsolidated investee companies accounted for using the equity method are a component of other long-term investments and other long-term investments in affiliates. Investments in partnerships, joint ventures and unconsolidated investee companies are stated at the underlying audited equity value based on accounting principles generally accepted in the United States of America. Investments are reviewed annually for impairments and adjusted accordingly. It is the Company’s policy to review investments for applicability of Financial Accounting Standards Board Interpretation (FIN) 46(R), Consolidation of Variable Interest Entities. At December 31, 2006, the Company determined that no investment required consolidation based on FIN 46(R) criteria.
Cash consists of demand deposits at banks. Fair value equals the carrying value of such assets.
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. Unrealized holding gains are recorded as an adjustment to deferred policy acquisition costs under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, when amortization expense is determined under the gross profits method described in SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.
A premium deficiency reserve is recognized by recording an additional liability for the deficiency, with a corresponding charge to operations when anticipated losses, loss adjustment expenses, commissions and other acquisition costs, and maintenance costs exceed the recorded unearned premium reserve, and any future installment premiums on existing policies. The Company had no liability related to premium deficiency reserves at December 31, 2006 or 2005. The Company utilizes anticipated investment income as a factor in the premium deficiency calculation.
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.
Included in other assets, furniture, equipment, capital leases, software and leasehold improvements are stated at cost less accumulated depreciation or amortization. Depreciation is computed principally using the straight-line method over the estimated useful lives of the related assets. Software amortization for significant business software projects is computed using the 200% double declining basis (half year convention) over five years. Costs to develop internal use software in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, is capitalized and depreciated on a straight-line basis over the estimated useful life of the software, not to exceed five years. Leasehold improvements are amortized on a straight-line basis over the lesser of the lease terms or the estimated useful lives of the improvements, not to exceed seven years. Accumulated depreciation and amortization at December 31, 2006 and 2005 was $7.1 million and $3.8 million, respectively. Depreciation and amortization expense for 2006, 2005 and 2004 was $3.4 million, $1.6 million and $1.0 million, respectively.
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, and SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. 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.
Changes in fair value of the interest rate swap designated as a hedging instrument of the variability of cash flows associated with floating-rate, long-term debt obligation are reported in accumulated other comprehensive income, net of taxes. The Company accounts for the hedging instrument using the short-cut method and has not reclassified any of the gains or losses to interest expense in the subsequent periods. The fair value of the interest rate swap contract decreased by $180 thousand in 2006 prior to tax expense of $63 thousand.
The Company is subject to lawsuits in the normal course of business related to its insurance and noninsurance products. In accordance with SFAS No. 5, Accounting for Contingencies, management evaluates the merits of each 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 at the time a lawsuit becomes known. 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.
Certain amounts in prior periods have been reclassified to conform to the presentation adopted in the current fiscal year. Such reclassifications had no impact on previously reported net income or stockholders’ equity.
Effective October 1, 1996, Fire withdrew from participation in the Pooling Agreement.
Effective January 1, 2001, Fire and Specialty became participants in the Pooling Agreement.
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 receives from Virginia Mutual to the pool.
Effective January 1, 2007, the Pooling Agreement was amended to include Alliance, a subsidiary of the Company, as a participant in the pool. In addition, the quota share agreement between Fire and Virginia Mutual was terminated and applicable references were removed from the Pooling Agreement.
Index to Financial Statements The Mutual Group, Virginia Mutual, AIC and AGI 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. Effective January 1, 2007, Alliance is a direct writer of the same lines previously written by Virginia Mutual.
Approximately 68.1%, 75.6% and 80.5% of the Company’s property casualty premium income and 59.9%, 66.5% and 70.3% of its total premium income were derived from the Company’s participation in the Pooling Agreement in 2006, 2005 and 2004, respectively.
A committee consisting of two members of the Boards of Directors of the Mutual Group, two members of the Board of Directors of Specialty, two members of the Board of Directors of the Company and Jerry A. Newby, as chairman of each such Board, has been established to review and approve any changes in the Pooling Agreement. The committee is responsible for matters involving actual or potential conflicts of interest between the Company, Specialty and the Mutual Group and for attempting to ensure that, in operation, the Pooling Agreement is equitable to all parties. Conflicts in geographic markets are currently minimal because the Mutual Group writes property casualty insurance only in Alabama and at present all of such insurance written by the Company is
Mutual owns 42.6%, Fire owns 11.4% and Alfa Mutual General Insurance Company (General) owns 0.8% of the Company’s common stock. The Board of Directors of the Company consists of eleven members, six of whom serve as Directors of Mutual, Fire and General and two of whom at December 31, 2006 were executive officers of the Company. One of the Company’s directors and most of the Company’s executive officers, including the Company’s President, also hold the same positions with Mutual, Fire, General and Specialty. The Company paid stockholder dividends to the Mutual Group totaling $19.0 million in 2006, $17.2 million in 2005 and $15.1 million in 2004.
The Company’s property casualty subsidiaries have agreed to guarantee payment on debt owed by three real estate partnerships affiliated with Fire. These guarantees expire between 2007 and 2035 and, in the unlikely circumstance of a guarantee call, could negatively impact the Company by up to $1.6 million (refer to Note 11 - Commitments and Contingencies).
Index to Financial Statements 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, 2006 or 2005. No interest was earned by Financial related to this line of credit in 2006, 2005 or 2004.
In 1999, Realty 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, 2006 or 2005. No interest was earned by Financial related to this line of credit in 2006, 2005 or 2004.
Also, during 1999, 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 $3.0 million and $4.0 million at December 31, 2006 and 2005, respectively. Interest earned by Financial in 2006, 2005 and 2004 was $223 thousand, $161 thousand and $45 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 2006 and 2005.
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 $175 thousand and $184 thousand under these leases in 2006 and 2005, respectively.
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 one security valued at a cost of $3.0 million.
Applicable deferred income taxes on net unrealized gains for equity securities aggregated $3.6 million at both December 31, 2006 and 2005, respectively.
The amortized cost and estimated fair value of investments in fixed maturity securities are as follows:
Applicable deferred income taxes on net unrealized gains for fixed maturities available for sale aggregated $3.7 million and $8.7 million at December 31, 2006 and 2005, respectively.
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, 2006:
The Company did not consider any decline in value to be an other than temporary impairment at December 31, 2006.
Proceeds from sales of equity securities were $170.6 million in 2006, $137.3 million in 2005 and $167.3 million in 2004. Gross gains of $16.3 million in 2006, $14.5 million in 2005 and $20.5 million in 2004 and gross losses of $5.1 million in 2006, $2.8 million in 2005 and $3.1 million in 2004 were realized on those sales. The Company also recorded a loss of $2.9 million in 2006 and $1.0 million in 2005 for equity securities whose valuation was deemed to be an other than temporary decline. The Company recorded no such writedowns during 2004.
The Company’s collateral loan portfolio totaled $128.7 million and $124.7 million at December 31, 2006 and 2005, 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 $4.0 million, $422 thousand and $432 thousand in 2006, 2005 and 2004, respectively. At December 31, 2006 and 2005, respectively, the Company maintained an allowance for losses of $1.6 million and $1.4 million. The Company has estimated the fair value of the collateral loan portfolio to be $136.7 million and $130.3 million at December 31, 2006 and 2005, respectively. The estimated fair value was determined by discounting the estimated future cash flows from the loan portfolio at 6.17% for 2006 and 5.89% for 2005, the current interest rates offered for similar loans, and after allowing for estimated loan losses. The Company had impaired loans of $949 thousand and $634 thousand subject to individual valuation at December 31, 2006 and 2005, respectively. Loans in nonaccrual status at December 31, 2006 and 2005 were $421 thousand and $441 thousand respectively. Repossessed assets, net of allowance for losses on disposal, included in other assets were $51 thousand and $76 thousand at December 31, 2006 and 2005, respectively.
Commercial Leases: The Company’s commercial lease portfolio totaled $1.7 million and $2.5 million at December 31, 2006 and 2005, respectively. The majority of the commercial lease portfolio was sold in the fourth quarter of 2005 to OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry. During 2006, 2005 and 2004, the Company charged off leases totaling $328 thousand, $1.4 million and $8.3 million, respectively. At December 31, 2006, the Company had an allowance for losses of $1.2 million on the lease portfolio. At December 31, 2005, the allowance for losses on the lease portfolio was $8.1 million. The Company has estimated the fair value of the commercial lease portfolio to be $1.7 million and $2.5 million at December 31, 2006 and 2005, respectively. The estimated fair value of the lease portfolio at December 31, 2006 and 2005 approximates carrying value after allowing for estimated lease losses. Assets leased to affiliated companies are expected to be held until the lease terminates and, therefore, fair value is assumed to equal net cost. The Company had impaired leases and repossessed assets, net of allowances for
Ownership in partnership interests range from less than 1% to 62.5%. The Company’s investment in MidCountry is also 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 $115 thousand before tax expense of $40 thousand since the investment was made in 2002. The table below summarizes the company’s primary long-term investment interests at December 31, 2006 and related operating results for 2006.
The Company had net investment income from partnerships and other equity method investments of $4.2 million in 2006, $7.9 million in 2005 and $4.1 million in 2004. At December 31, 2006 and 2005, partnerships yielding tax credits from investments in low-income housing of $64.2 million and $43.0 million are included in the Company’s other long-term investments. The Company realized losses from its investments in low-income housing partnerships of $7.4 million in 2006, $4.1 million in 2005 and $10.9 million in 2004. In addition, the Company’s investment in MidCountry was $57.2 million and $53.3 million at December 31, 2006 and 2005, respectively. Net investment income from MidCountry was $1.4 million, $1.2 million and $540 thousand, respectively in 2006, 2005 and 2004.
Other Investments: Included in the Company’s other long-term investments is its leased asset portfolio (refer to Note 15 - Leases) and 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 $2.6 million and $2.9 million at December 31, 2006 and 2005, 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. Also included within other long-term investments in affiliates is a note receivable from OFC Servicing Corporation, a wholly-owned subsidiary of MidCountry, for $33.0 million and $55.5 million at December 31, 2006 and 2005, respectively, resulting from the sale of OFC Capital. The leased asset portfolio and the note receivable are carried at the net book value.
SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosures of fair value information of financial instruments. Information about specific valuation techniques and related fair value detail is provided in Note 1 - Summary of Significant Accounting Policies, Note 4 - Investments and Note 10 - Debt. The cost and estimated fair value of financial instruments as of December 31 are as follows:
Includes elimination of intercompany profits within the corporate and elimination segment.
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, 2006 and 2005.
A reconciliation of the tax provision at the U.S. Federal statutory rate to income tax expense is as follows:
In the fourth quarter of 2006, the Company entered into a settlement agreement with the Internal Revenue Service relating to the examination of tax returns for the years 1999 through 2001. As a result of these tax years being closed, the Company released $3.3 million previously held as a reserve for uncertain tax positions.
At December 31, 2006 and 2005, the Company had an income tax receivable of $1.3 million and an income tax payable of $1.1 million, respectively.
The Company had $206.9 million in commercial paper outstanding at a weighted average rate of 5.30% at December 31, 2006. Rates ranged from 5.28% to 5.35% with maturities from January 8, 2007 to January 31, 2007. At December 31, 2005, the Company had $213.8 million in commercial paper outstanding at a weighted average rate of 4.30%. Rates ranged from 4.24% to 4.33% with maturities from January 9, 2006 to January 23, 2006. The Company intends to continue to use the commercial paper program to fund its short-term needs. However, backup lines of credit are in place up to $300 million to cover up to $230 million in commercial paper and the $70 million variable-rate demand note described below. Commitment fees related to the backup lines were $257 thousand in 2006 and $304 thousand in 2005. The backup lines agreements contain usual and customary covenants requiring the Company to meet certain operating levels. Included in the financial covenants are requirements that the Company maintain minimum levels of stockholders’ equity and perform at a level that produces acceptable ratios of earnings before income taxes to interest expense and indebtedness to capitalization. The Company has maintained full compliance with all such covenants. The Company has A-1+ and P-1 commercial paper ratings from Standard & Poor’s and Moody’s Investors Service, respectively. The commercial paper is guaranteed by two affiliates, Mutual and Fire. Due to the short-term nature of the Company’s commercial paper borrowings, the fair value approximates the carrying value.
In addition, the Company had $27.5 million and $20.9 million in short-term debt outstanding to affiliates at December 31, 2006 and 2005, respectively, with interest payable monthly at rates established using the existing commercial paper rate and renewable for multiples of 30-day periods at the commercial paper rate then applicable. Due to the short-term nature of the Company’s outstanding debt to affiliates, the fair value approximates the carrying value.
Certain legal proceedings are in process at December 31, 2006. Costs for these and similar legal proceedings, including accruals for outstanding cases, totaled $219 thousand in 2006, $2.2 million in 2005, and $2.2 million in 2004. These proceedings involve alleged breaches of contract, torts, including bad faith and fraud claims, and miscellaneous other causes of action. These lawsuits involve claims for unspecified amounts of compensatory damages, mental anguish damages, and punitive damages.
Management believes adequate accruals have been established in these known cases. However, it should be noted that in Mississippi and Alabama, where the Company has substantial business, the likelihood of a judgment in any given suit, including a large mental anguish and/or punitive damage award by a jury, bearing little or no relation to actual damages, continues to exist, creating the potential for unpredictable material adverse financial results.
Guarantees: The Company’s property casualty subsidiaries entered into an agreement with Fire in 2000 with respect to a loan guarantee on Fire’s part, on behalf of EastChase Land Company, LLC to Whitney Bank. Fire’s guarantee amount to Whitney Bank is $1 million. In the unlikely event of a guarantee call, the Company’s property casualty subsidiaries would be liable to reimburse Fire a maximum of $200 thousand. Similarly, in 2003, the Company’s property casualty subsidiaries entered into a second agreement with Fire which agreed to guarantee, on behalf of Alfa Ventures II, LLC, the lesser of $25 million or 50% of the total obligations of The Shoppes at EastChase, LLC and EastChase Plaza, LLC with Columbus Bank & Trust Company (CB&T). This second guarantee is known as the “bucket” guarantee, and supercedes all previous CB&T guarantees for each of these EastChase entities. In the unlikely event of a guarantee call, the Company’s property casualty subsidiaries would be liable to reimburse Fire a maximum of $1.4 million.
The Company maintains a variety of funding agreements in the form of lines of credit with affiliated entities. The chart below depicts, at December 31, 2006, the cash outlay by the Company representing the potential amounts the Company would have to supply to other affiliated entities if they made full use of their existing lines of credit during 2006 with the Company’s finance subsidiary. Other commercial commitments of the Company shown below include partnership commitments, potential performance payouts related to Vision, funding of a policy administration system project of the life subsidiary and recourse on commercial leases sold.
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, the failure of the policy administration system being developed for use by the life insurance operations to perform properly and achievement of specific metrics by Vision are examples of situations that would impact the financial position and results of the Company.
Guaranty Fund and Other Insurance-related Assessments: In all states, insurers licensed to transact certain lines of insurance are required to become members of a guaranty fund. In most states, in the event of the 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 no assessments in 2006, 2005 or 2004.
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 (refer to Note 9 - Income Taxes).
Dividends: Alfa Corporation paid $34.6 million in dividends to stockholders in 2006. ABC paid dividends of $54 thousand in 2006 on preferred stock. Their minority interest of $600 thousand is classified as other liabilities in the consolidated balance sheet.
Dividend Restrictions: Alfa Corporation is a holding company with no operations and, accordingly, any cash available for dividends or other distributions must be obtained by it from borrowings or in the form of distributions from its operating subsidiaries. Distributions to the Company from its insurance subsidiaries are subject to regulatory restrictions. Under applicable regulatory requirements, the Company’s insurance subsidiaries can distribute to the Company an aggregate of $95.8 million without prior regulatory approval.
At December 31, 2006, 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 3,111,139 shares at a cost of $17.0 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, 2006.
Index to Financial Statements These transactions increased the total number of shares outstanding to 80,459,113 shares.
The following table summarizes the effects of reinsurance on premiums and losses for the years ended December 31, 2006, 2005 and 2004:
The Company’s life insurance subsidiary reinsures portions of its risks with other insurers under yearly renewable term agreements and coinsurance agreements. Generally, Life will not retain more than $500 thousand of individual life insurance on a single risk with the exception of COLI and group policies where the retention is limited to $100 thousand per individual. The amount retained on an individual life will vary depending upon age and mortality prospects of the risk. At December 31, 2006, Life had total insurance inforce of $22.6 billion of which $2.4 billion was ceded to other insurers. In addition, reserve credits of $9.1 million have been taken as a result of the ceding of these inforce amounts to other insurers.
Index to Financial Statements 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.
The Company’s subsidiaries participate in a catastrophe protection program through the Pooling Agreement. Under this program, the Company participates in only its pooled share of a lower catastrophe pool limit unless the losses exceed an upper catastrophe pool limit. In cases where the upper catastrophe limit is exceeded on a 100% basis, the Company’s share in the loss would be based upon its amount of statutory surplus relative to other members of the group as of the most recently filed annual statement. Lower and upper catastrophe pool limits are adjusted periodically due to increases in insured property risks. Refer to Note 2 - Pooling Agreement, Catastrophe Protection Program section for further details.
On October 25, 1993, the Company established a Stock Incentive Plan (the 1993 Plan). The 1993 Plan was subsequently amended on April 26, 2001. On April 28, 2005, the Company’s stockholders approved the 2005 Amended and Restated Stock Incentive Plan (the 2005 Plan). This Plan amends and restates the 1993 Plan. The 2005 Plan permits the grant of a variety of equity-based incentives based upon the Company’s common stock. These include stock options, which may be either “incentive stock options” as that term is defined in Section 422 of the Internal Revenue Code of 1986, as amended or “nonqualified options”. The 2005 Plan also permits awards of Stock Appreciation Rights, Restricted Shares, Restricted Share Units and Performance Shares. A maximum of 3,800,000 shares of stock may be issued under the 2005 Plan. At December 31, 2006, 3,193,098 shares were available for grant.
It is the Company’s policy to issue treasury shares upon exercise of options or release of awards. The Company currently has a stock repurchase program to repurchase its outstanding common stock in the open market or in negotiated transactions in such quantities and at such times and prices as management may decide. At December 31, 2006, 3,307,911 treasury shares were available for issuance.
As a result of adopting SFAS No. 123(R), the Company’s share of compensation expense during 2006 related to stock options was $2.2 million, restricted share awards was $599 thousand with tax benefits of $974 thousand. Compensation cost for share-based payment arrangements reduced the Company’s net earnings by $1.8 million and diluted earnings per share by $0.02 for 2006. 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 $559 thousand for 2006. 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.
Amounts disclosed in this section represent gross amounts under the 2005 Plan.
The total intrinsic value of options exercised during 2006, 2005 and 2004, was $1.7 million, $2.5 million and $3.7 million, respectively. Intrinsic value is measured using the fair market value at the date of exercise (for shares exercised) or at December 31, 2006 (for outstanding options), less the applicable exercise price.
Cash received from option exercises totaled $2.8 million, $3.0 million and $3.3 million during 2006, 2005 and 2004, respectively. The tax benefit realized from stock options exercised during the same periods was $533 thousand, $795 thousand and $1.3 million, respectively, based on deductions from earnings of $1.5 million, $2.3 million and $3.6 million, respectively.
Risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury note yield rate in effect on the date of the grant with a maturity approximating the expected term.
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 are awards of restricted stock to certain officers based on specified target levels of ownership of Company common stock by those officers. These shares vest on the third anniversary after the date of grant, but are not negotiable by the recipients until the recipients terminate employment with the Company. The Company will vote these shares until they are issued to the recipients and dividends paid will be credited as additional shares of restricted stock and held by the Company until such shares are issued.
At December 31, 2006, there was $693 thousand of unrecognized compensation expense related to restricted share awards that are expected to be charged to expense over a weighted-average period of 1.51 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, 2006, 2005 and 2004 was $4.5 million, $3.9 million and $4.1 million, respectively. No contingent rentals have been included in income. Similarly, the Company recorded depreciation expense on leased assets within the Noninsurance segment of $3.4 million, $2.9 million and $2.9 million in 2006, 2005 and 2004, respectively. The cost, accumulated depreciation and net book value of major classes of leased property at December 31, 2006 were:
At December 31, 2006, the aggregate minimum rental payments to be received under leases having initial or remaining lease terms in excess of one year are $3.8 million in 2007, $1.7 million in 2008, $907 thousand in 2009, $261 thousand in 2010 and $66 thousand thereafter.
Future minimum lease payments to be received on capital leases including interest at December 31, 2006 are $1.6 million in 2007, $469 thousand in 2008, $118 thousand in 2009 and $25 thousand in 2010. Future minimum lease receivables do not include contingent rentals.
All investing activities are allocated to the segments based on the actual assets, investments, and cash flows of each segment.
Summarized revenue data for each of the Company’s business segments are as follows:
The following computations set forth the calculation of basic and diluted net income per common share and common shares equivalents for the years ended December 31, 2006, 2005, and 2004:
In November 2005, the FASB issued FASB Staff Position (FSP) Nos. FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in the FSP amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. It also nullifies certain requirements of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments and supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. The Company adopted FSP Nos. FAS 115-1 and 124-1 on January 1, 2006 and it did not have a significant impact on the Company’s financial position or results of operations.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement for APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. This statement changes the requirements for the accounting for and reporting of a change in accounting principle. It applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary changes in accounting principles be recognized retrospectively to financial statements for prior periods, rather than recognition in the net income of the current period. Retrospective application requires restatements of prior period financial statements as if that accounting principle had always been used. This statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. The Company adopted this statement on January 1, 2006. It has not had a significant impact on the Company’s financial position or results of operations.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an Amendment of FASB Statements No. 133 and 140, which eliminates the exception from applying SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to interests on securitized financial assets so similar instruments are accounted for consistently regardless of the form. This Statement also 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 derivative would otherwise have to bifurcate. SFAS No. 155 is effective for all financial instruments acquired or issued in an entity’s first fiscal year beginning after September 15, 2006. The Company has reviewed the guidance of SFAS No. 155 and believes that the adoption of this statement on January 1, 2007 will not have a significant 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. The statement is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact this statement may have on its financial position or results of operations at the time it is adopted.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement provides reporting entities an option to report selected financial assets, including investment securities designated as available for sale, and liabilities, including most insurance contracts, at fair value. SFAS No. 159 establishes presentation and disclosure requirements designed to facilitate comparisons between companies choosing different measurement attributes for similar
The FASB ratified the consensus on EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation), in June 2006. This consensus requires disclosure of the accounting policy employed by the Company for any tax assessed by a governmental authority that is directly related to a revenue-producing transaction between a seller and a customer. EITF 06-3 requires that taxes be presented in the income statement either on a gross basis (included in revenues and costs) or a net basis (excluded from revenues), and that this accounting policy decision be disclosed. EITF 06-3 is effective for financial reports for interim and annual reporting periods beginning after December 15, 2006. The Company will disclose its related accounting policy as required by EITF 06-3 in its first quarter Form 10-Q with the adoption of this pronouncement having no significant impact on the Company’s financial position or results of operations.
In July 2006, the FASB released FASB 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 a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007 and does not believe it will have a significant impact on its financial position or results of operations.
* The sum of the quarters may not equal annual amounts due to the rounding effects on a quarterly basis.
During the third quarter of 2006, the Company executed a Plan of Conversion of Virginia Mutual Insurance Company. Under the agreement, Virginia Mutual Insurance Company plans to convert from a mutual company to a stock company and simultaneously
merge with a wholly-owned subsidiary of the Company. As a result of this mutual conversion, Virginia Mutual’s excess surplus will be distributed to eligible policyholders and the Company will recapitalize the business in a new subsidiary, Alfa Alliance Insurance Corporation, herein referred to as the “Restructuring”. Virginia Mutual and the Alfa companies have participated in a Strategic Affiliation Agreement since 2001. The Virginia State Corporation Commission (the “Commission), which includes the Bureau of Insurance (the primary regulator of Virginia Mutual under applicable Virginia law), conducted a public hearing on the Restructuring on October 3, 2006. The Commission subsequently issued an Order dated October 4, 2006, approving the Plan and finding that the terms of the Restructuring are fair and equitable to the Virginia Mutual policyholders. Virginia law requires that the Restructuring cannot be completed without the affirmative vote of the Virginia Mutual policyholders. On November 29, 2006, a special meeting of the Virginia Mutual policyholders was held for the purpose of permitting such vote. Following policyholder approval, the Restructuring became effective January 1, 2007. Consequently, Virginia Mutual recapitalized as Alliance, a wholly-owned subsidiary of the Company.
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 has been recapitalized as Alfa Alliance Insurance Corporation (Alliance), a wholly-owned subsidiary of the Company (refer to Note 21 - Plan of Conversion of Virginia Mutual Insurance 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.