AssuranceAmerica Corporation leases office space for its corporate headquarters located at RiverEdge One, Suite 600, 5500 Interstate North Parkway, Atlanta, Georgia 30328. Effective October 1, 2009 the Company signed an amendment to extend its lease until 2019 under more favorable lease terms. AssuranceAmerica Managing General Agency, LLC., leases a claims office in the state of Florida. The TrustWay retail operations leases retail office space at various locations in Georgia, Florida and Alabama under short to medium term commercial leases. The above mentioned segments lease office equipment for use in its various locations. The Company believes that its existing facilities in the various states are adequate for the Company’s current requirements and operations. Rent expense for long-term leases with predetermined minimum rental escalations is recognized on a straight-line basis, and the difference between the recognized rental expense and amounts payable under the leases, or deferred rent, is included in other liabilities.
The Company reported net income of $0.9 million for the year ended December 31, 2010 compared to $0.4 million for the year ended December 31, 2009. The Company reported basic and fully diluted earnings per common share of $0.014 for the year ended December 31, 2010 compared to $0.007 for the year ended December 31, 2009. The pre-tax income was $1.9 million for the period ended December 31, 2010 and $0.9 million compared to the same period last year.
The higher pre-tax earnings in 2010 as compared to 2009 primarily relates to a $3.5 million gain on the extinguishment of debt and a slight improvement in the TrustWay Retail operations of $0.3 million resulting from cost reductions in selling and advertising costs, offset by lower earnings within the wholesale operation (AAIC and MGA) of $1.3 million mainly driven by lower premium volume. The earnings were further impacted by a $1.5 million goodwill impairment related to the Company’s retail operations.
Gross premiums written for the year ended December 31, 2010 were $100.9 million compared to $107.2 million in gross premiums written in 2009. The reduction in gross premiums reflects actions taken by the Company to improve profitability in underperforming market segments. In Florida, gross premiums written declined by $8.7 million, the result of rate increases, implementation of tighter underwriting guidelines and agency actions. In the states of Georgia and Louisiana, rate increases coupled with soft market conditions reduced premium volume by $4.7 million and $2.3 million, respectively. Partially offsetting these reductions was $6.4 million of gross premiums written from the state of Virginia, which the Company entered in early 2010. The Company also increased its market penetration in the states of Texas and Alabama, generating growth of $1.9 million and $1.4 million, respectively. The Company ceded approximately 70% or $67.8 million of its direct premiums written to its reinsurers during 2010.
Commission income for the year ended December 31, 2010, was $20.9 million compared to $21.6 million for the same period ended December 31, 2009. The $0.7 million decrease in commissions is primarily related to lower premium volume generated by the MGA, which impacted commission income by $1.3 million, offset by an increase in the TrustWay retail agency commission of $0.6 million as certain program revenue is fully recognized when contracts are sold instead of over the contract period. Also AAIC pays MGA commission on approximately 30% of premium, which AAIC retains and this amount is subsequently eliminated upon consolidation.
On December 30, 2010, AAIC issued a dividend in-kind to its parent Company of all the 5,000 of the Trust’s floating rate capital securities, with a liquidation amount of $1,000 per capital security (the “Capital Securities”) in the amount of $1,001,089 and the Company extinguished the floating rate junior subordinated debentures of the Company (the “Debentures”) of $4,988,513, which resulted in a gain of $3,509,845 after considering the unamortized issuance cost.
After making deductions for the effect of reinsurance, losses and loss adjustment expenses were $25.0 million for the period ended December 31, 2010, compared to $25.2 million for the same period in 2009. As a percentage of earned premiums, this amount increased for the period ended December 31, 2010, from 73.3% to 75.0%, when compared with the same period in 2009. The amount represents actual payments made and changes in estimated future payments to be made to or on behalf of AAIC’s policyholders, including the expenses associated with settling claims. The year-over-year increase in the loss and loss adjustment expense ratio of 1.7 points is due to prior year loss development. The unfavorable development in the 2010 calendar year results is heavily weighted to claims from accident year 2009. This adverse development is partially offset by improvement in the 2010 accident year results, both in incurred severity (average cost per claim) and incurred frequency. The improvement in severity was primarily in the property coverages and the improvement in frequency is predominantly in bodily injury and PIP coverages.
The selling, general and administrative expenses increased $0.6 million for the year ended December 31, 2010 when compared to the same period of 2009. The year over year increase as a percentage of revenue, excluding the gain on extinguishment of debt, is 1.5 points. The increase in expenses associated, in part, with additional investment of $1.0 million in our Information Technology, Product and Sales. Additionally, TWAY retail agency commission expense increased $0.4 million related to the increase in program revenue. These increases were partially offset by $0.5 million of management incentive expenses incurred in 2009 but not in 2010, as well as $0.3 million reduction in MGA selling expenses resulting from lower premium volume. Depreciation and amortization expense remained flat year over year. Interest expense was lower in 2010 as compared to 2009 resulting from the reduction in notes payable. Stock option expense increased $0.1 million as a result of new stock issues in 2010.
The Company recognized a $1.5 million goodwill impairment loss after conducting a review of the carrying value of goodwill and other intangible assets and concluded that the fair value of its retail operations was less than the carrying amount.
As of December 31, 2010, the Company had investments and cash of $21.9 million, compared to $18.9 million as of December 31, 2009. The Company’s investment strategy is to be invested in highly liquid short-term investments and equity securities as well as investing in bonds with short durations in order to meet its insurance obligations. For the year ended December 31, 2010, the Company had $10.3 million in cash and short-term investments, which included $1.8 million of cash restricted to provide security for certain reinsurance reserve obligations. The equity security portfolio amounted to $2.2 million and is diversified amongst various industries. The Company’s long term investments of $8.6 million are spread among direct obligations of the U.S. Treasury and those securities unconditionally guaranteed as to the payment of principal and interest by the United States government or any agency thereof and in corporate bonds. The other long term investments of $0.7 million represents low income housing credits, which will be used to offset the Company’s tax liability.
The Company’s investment activities are made in accordance with the Company’s investment policy. The objectives of the investment policy are to obtain favorable after-tax returns on investments through a diversified portfolio of fixed income and equity. The Company’s investment criteria and practices reflect the short-term duration of its contractual obligations with policyholders and regulators. Tax considerations include federal and state income tax as well as premium tax abatement and credit opportunities offered to insurance companies in the states where AAIC writes policies.
Prepaid expenses as of December 31, 2010, increased $0.2 million to $0.7 as of December 31, 2010, compared to $0.5 million as of December 31, 2009. The increase in prepaid was mainly due to $0.1 million of prefunding of operational expenses and $0.1 million related to prepaid advertising costs.
Index to Financial Statements Intangible assets as of December 31, 2010, decreased $1.5 million to $6.0 million from the balance of $7.5 million as of December 31, 2009. This decrease is mainly related to the goodwill impairment of $1.5 million mentioned previously. Further, the Company had acquisitions during the year of $0.4 million, which was offset by $0.4 million of amortization.
Prepaid income taxes decreased by $0.2 as of December 31, 2010 to $0.1 million from $0.3 million as of December 31, 2009. The tax benefit mainly resulted from a lower utilization of net operating loss carry-forwards as compared to the prior year.
Deferred tax assets decreased $1.1 million to $1.8 million as of December 31, 2010, compared to the balance of $2.9 million as of December 31, 2009. This decrease primarily related to the tax deferment of the gain on the extinguishment of debt during 2010.
Unearned premium as of December 31, 2010 decreased $1.7 million to $34.2 million as of December 31, 2010 from $35.9 million as of December 31, 2009, and represents premiums written but not earned. This is directly attributable to the decrease in AAIC’s premium writings during 2010.
Unpaid losses and loss adjustment expenses decreased $8.7 million to $33.3 million as of December 31, 2010 from $42.0 million at December 31, 2009. This amount represents management’s estimates of future amounts needed to pay claims and related expenses. The decrease is primarily driven by the Company’s strategy to settle claims quicker, thereby reducing future loss exposure.
Provisional commission reserves represent the difference between our minimum ceding commission and the provisional amount paid by the reinsurers. These balances as of December 31, 2010 decreased $0.3 million to $3.3 million, compared to the balance at December 31, 2009 of $3.6 million. The decrease is related to a decline in AAIC premium writings.
Net cash provided by operating activities for the year ended December 31, 2010, was $5.1 million compared to net cash used by operating activities of $0.8 million for the same period of 2009. The increase is driven primarily by $3.0 million reimbursement received from reinsurers and $2.9 million increase in premiums collected, partly offset by higher claims paid.
Investing activities used for the year ended December 31, 2010 amounted to $2.5 million as compared to $1.8 million used as of December 31, 2009. The increase in the amount used was mainly attributable to higher
Financing activities for the year ended December 31, 2010 included debt repayments in the amount of $0.6.
The First Amendment extends the maturity date for the facility to July 16, 2011. The proceeds of the facility may be used for funding certain permitted acquisitions, funding short-term loans to the Company’s wholly owned subsidiary, AAIC, or for working capital or general corporate needs in the ordinary course of business. When the facility matures, the Company will still be able to meet its obligations if the line of credit is not renewed. The credit facility is secured by a pledge of the Company’s ownership interests in two of the Company’s subsidiaries, TrustWay and MGA, and is guaranteed by the same entities. In addition, TrustWay pledged its ownership interest in TrustWay T.E.A.M., Inc., which is also a guarantor.
The Loan Agreement includes customary covenants, including financial covenants regarding minimum fixed charge coverage ratio and minimum net worth. As of December 31, 2010, management believes the Company was in compliance with all these covenants. The First Amendment provides that the facility shall be repaid in full and no loans under the facility may be outstanding for at least one period of 30 consecutive days during each 12-month period in which the Loan Agreement is in effect. In addition, the Company’s minimum fixed charge coverage ratio, which was 1.35 under the Loan Agreement, decreases to 1.10 for each of the fiscal quarters ended June 30, 2010, and September 30, 2010 and increases to 1.25 for each subsequent fiscal quarter. The interest rate is 3.00% plus 90-day LIBOR (3.3003% December 31, 2010) due and payable monthly. As of December 31, 2010, there is $1.5 million in borrowings outstanding under the credit agreement.
On December 30, 2010, AAIC issued a dividend in-kind to its parent Company of all the Capital Securities issued by the Trust in the amount of $1,001,089 and the Company extinguished the related Junior Subordinated Debentures of $4,988,513, which resulted in a gain of $3,509,845. On March 10, 2009, AAIC purchased all of the Capital Securities issued by the Trust at a discounted price of $1,000,000 from the non-affiliated holder of those securities. The discount was accreted to interest income over the remaining life of the Capital Securities using the interest method. The purchase resulted in an increase in our investment portfolio for redeemable preferred stock in the amount of $1,001,089.
Loss and LAE reserves are determined using actuarial and statistical procedures and represent undiscounted estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. When establishing loss and LAE reserves, the Company considers its historical loss experience and current trends or assumptions, particularly those relating to the following factors:
Legal and regulatory trends affecting claims settlements and average legal defense costs by state and other geographical regions as they relate to personal injury protection (PIP) and bodily injury.
The Company considers its historical loss experience and the factors set forth above at a state, product and line of business level to estimate its loss and LAE reserves. The Company reviews its loss and LAE reserves by line of business on a monthly basis as new information becomes known and it is able to observe actual loss development. Our statistical average reserves are reviewed, at a minimum, on a semiannual basis. If emerging issues relating to a product or state necessitate a change in our scheduled reviews of a particular coverage of the business, we would identify and measure variances and make adjustments if necessary. For example, we track medical and auto repair costs and may adjust statistical averages if trends were emerging.
Index to Financial Statements GROSS RESERVES BY LINE OF BUSINESS AS OF DECEMBER 31, 2010 AND 2009
The following table presents the gross reserves by line of business as of December 31, 2010 and 2009:
In analyzing the ultimate accident year loss experience, our staff reviews incurred and paid loss development patterns at a detailed, line of business level on a monthly basis and the actuaries review on a quarterly basis. Changes in patterns are taken into account when selecting loss development factors. These lines of business consist of minimal liability limits, and the loss development is usually short term because a large majority of the parties involved in an accident report their claims within a short time period after the occurrence.
Assumptions regarding needed reserve levels made by the actuaries take into consideration influences on available historical data that reduce the predictability of our projected future loss costs. Internal considerations that are process-related, which generally result from changes in our claims organization’s activities, include claim closure rates and the number of claims that are closed without payment. External items considered include the litigation atmosphere, state-by-state changes in medical costs, and the availability of services to resolve claims. These also are better understood at the state level than at a more generalized national level.
IBNR reserves are established on a quarterly basis and are based on a reserve analysis by the Company’s external actuarial firm. Various standard actuarial tests are applied to lines of business. Included in the analyses are the following:
For each line of business evaluated, each test generates a low, high and medium point estimate based on development factors applied to known paid and incurred losses. Selections of factors are based on historical loss development patterns with adjustments based on actuarial judgment where anticipated development patterns vary
from those seen historically. This estimation of IBNR requires selection of various factors. A single point estimate for the line of business being evaluated is then selected from the results of various tests, based on a combination of simple averages of the point estimates of the various tests and selections based on actuarial judgment.
During the fiscal year ended December 31, 2010, the Company used average paid losses to establish estimated case reserves. The Company believes that the average paid losses are more indicative of the reserve estimates than average case reserve estimates, which were used in the past. The average paid losses better reflect the aforementioned underlying factors used to estimate reserves, thereby improving the accuracy of the reserving.
While the ultimate liability may be greater or lower than recorded loss reserves, the development period for personal auto coverage is shorter than that associated with many other property and casualty coverages and can therefore be established with more certainty than coverages developing over longer periods such as environmental coverage.
AssuranceAmerica estimates liabilities for the costs of losses and LAE for both reported and unreported IBNR claims based on the historical trends and assumptions set forth above. When possible, where deviations from historical trends in these key areas exist, quantitative and qualitative modifications to, or selections of, such factors are made to reflect such deviations. Management analyzes the adequacy of reserves using actuarial data and analytical reserve development techniques, including projections of ultimate paid losses, to determine the ultimate amount of reserves. The key assumptions and factors discussed under “Critical Accounting Policy Section” previously are taken into account in developing these estimates. AssuranceAmerica reviews loss reserve adequacy quarterly by accident year at a line of business level. Reserves are adjusted as additional information becomes known. Such adjustments are reflected in current year operations. Loss and LAE reserves are also certified to state regulators annually.
During each quarterly review by the external actuarial staff, factor selections are updated using the additional information obtained with the passage of time. The ultimate loss estimates and held IBNR reserves for the line of business and accident periods effected are adjusted through this updating process. Additionally, the external actuaries and internal staff evaluate the overall reasonableness of the loss and LAE ratios by accident year and by line of business.
Factors that can affect actual frequency include, among others, changes in weather, driving patterns or trends and class of driver. Estimates of average frequency can be affected by changes in claims settlement and
reserving practices. Loss severity can be affected by auto repair and medical cost inflation, jury awards and changes in policy limit profiles. Estimation of LAE reserves is subject to variation from factors such as the use of outside adjusters, frequency of lawsuits, claims staffing and experience levels. Key assumptions as of December 31, 2010 and 2009 were premised on historical loss reserve development patterns.
(1) The ratio was calculated by taking losses and LAE divided by the Net Premiums Earned.
Index to Financial Statements Reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company periodically reviews the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The Company has seven reinsurers, of which six are A- rated or better based on the most recent A.M. Best ratings available, while the seventh reinsurer does not have a rating but the contract is in run-off. Further, the reinsurers cover up to $2,000,000 in aggregate claims for extra contractual obligations each policy year.
During 2010 and 2009, the Company ceded approximately 70% of its premium and losses to the contracted reinsurers. Premium ceded under this reinsurance agreement for the twelve months ended December 31, 2010 and 2009 were $67.8 million and $72.0 million, respectively. The related ceding commission was approximately $15.4 million in 2010 and $16.7 million in 2009. The lower ceded premium is mainly due to a decrease in volume within the states of Florida, Georgia and Louisiana.
Index to Financial Statements AssuranceAmerica’s ceded unearned premium relates to policies in force and is earned ratably over the policy period. As of December 31, 2010 and 2009, the ceded unearned reserves amounted to $23.6 million and $25.1 million, respectively. Reinsurance payable of $29.4 million and $28.5 million as of December 31, 2010 and 2009 represents the amounts due to reinsurers for ceded premiums net of commissions. The Company pays its reinsurers on a collected premium basis, and no balances are in dispute through December 31, 2010.
AssuranceAmerica’s quota share reinsurance facility has a significant impact on its cash flows. Since the Company cedes approximately 70% of its premium and losses, the Company relies heavily on its reinsurers to settle outstanding reinsurance balances due for loss payments net of premiums collected. AssuranceAmerica paid ceded premiums net of commissions of $51.5 million and $53.2 million and received reinsurance recoverables on paid loss and loss adjustment expenses of $71.3 million and $58.1 million in 2010 and 2009, respectively.
The Company’s reinsurance strategies have not changed from previous years and the Company’s limited loss exposure is approximately 30%, which is based on the existing quota share agreement, whereby the Company cedes approximately 70% of its losses. While the Company monitors conditions within the reinsurance market, adverse conditions could have an impact on the Company’s ability to secure reinsurance capacity, thereby limiting its ability to cede future losses.
significant changes in the manner of our use of these assets or the strategy for our overall business; and
When we determine that the carrying amount of intangible assets or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure the impairment based on the pro forma sustainable earnings capacity and discounted cash flows. This review is based upon our historical earnings and underlying risk inherent in the agencies current business model and industry comparisons.
The TrustWay division recorded an impairment loss of $1.5 million in the fourth quarter of 2010 to reduce the carrying amount. The impairment loss is presented as impairment of goodwill in the consolidated income statement. We have performed our annual goodwill impairment testing during the fourth quarter of 2010.