(9) Includes our Series C and Series D convertible preferred stock, each of which is mandatorily redeemable upon the occurrence of certain events that are deemed to be outside our control. In November 2006, 250,000 shares of Series C preferred stock were converted into shares of common stock by the holders in connection with a secondary public offering of common stock. For years prior to 2005, also includes our Series A preferred stock, which was mandatorily redeemable upon the occurrence of certain events that were deemed to be outside our control. In connection with the initial public offering of our common stock in November 2005, all outstanding shares of our Series A preferred stock were redeemed and exchanged for shares of our common stock.
(10) In 1997, we entered into a recapitalization transaction that resulted in a $164.2 million charge to retained earnings.
AMERISAFE is a holding company that markets and underwrites workers’ compensation insurance through its insurance subsidiaries. Workers’ compensation insurance covers statutorily prescribed benefits that employers are obligated to provide to their employees who are injured in the course and scope of their employment. Our business strategy is focused on providing this coverage to small to mid-sized employers engaged in hazardous industries, principally construction, trucking, agriculture and logging. Employers engaged in hazardous industries pay substantially higher than average rates for workers’ compensation insurance compared to employers in other industries, as measured per payroll dollar. The higher premium rates are due to the nature of the work performed and the inherent workplace danger of our target employers. Hazardous industry employers also tend to have less frequent but more severe claims as compared to employers in other industries due to the nature of their businesses. We provide proactive safety reviews of employers’ workplaces. These safety reviews are a vital component of our underwriting process and also promote safer workplaces. We utilize intensive claims management practices that we believe permit us to reduce the overall cost of our claims. In addition, our audit services ensure that our policyholders pay the appropriate premiums required under the terms of their policies and enable us to monitor payroll patterns that cause underwriting, safety or fraud concerns. We believe that the higher premiums typically paid by our policyholders, together with our disciplined underwriting and safety, claims and audit services, provide us with the opportunity to earn attractive returns for our shareholders.
One of the key financial measures that we use to evaluate our operating performance is return on average equity. We calculate return on average equity by dividing annual net income by the average of annual shareholders’ equity plus redeemable preferred stock. Our return on average equity was 17.1% in 2008, 24.1% in 2007 and 22.6% in 2006. Our overall financial objective is to produce a return on equity of at least 15% over the long-term while maintaining optimal operating leverage in our insurance subsidiaries that is commensurate with our A. M. Best rating.
The use of reinsurance is an important component of our business strategy. We purchase reinsurance to protect us from the impact of large losses. Our reinsurance program for 2009 includes 16 reinsurers that provide
coverage to us in excess of a certain specified loss amount, or retention level. Our 2009 reinsurance program provides us with reinsurance coverage for each loss occurrence up to $50.0 million, subject to applicable deductibles, retentions and aggregate limits. However, for any loss occurrence involving only one claimant, our reinsurance coverage is limited to $10.0 million for any single claimant, subject to applicable deductibles, retentions and aggregate limits. Our 2009 program calls for us to retain the first $1.0 million of each loss. For losses between $1.0 million and $5.0 million, we are subject to an annual aggregate deductible of $20.0 million before our reinsurers are obligated to reimburse us. The aggregate limit for all claims for losses between $1.0 million and $5.0 million has two parts, as fully described in “Business-Reinsurance” in Item 1 of this report. For losses between $5.0 million and $10.0 million, the three year aggregate limit is $20.0 million. As losses are incurred and recorded, we record amounts recoverable from reinsurers for the portion of the losses ceded to our reinsurers.
Our focus on providing workers’ compensation insurance to employers engaged in hazardous industries results in our receiving relatively fewer but more severe claims than many other workers’ compensation insurance companies. Severe claims, which we define as claims having an estimated ultimate cost of more than $500,000, usually have a material effect on each accident year’s loss reserves (and our reported results of operations) as a result of both the number of severe claims reported in any year and the timing of claims in the year. As a result of our focus on higher severity, lower frequency business, our reserve for loss and loss adjustment expenses may have greater volatility than other workers’ compensation insurance companies.
For example, for the five year period ended December 31, 2008, we had recorded 137 severe claims, or an average of 27 severe claims per year for accident years 2004 through 2008. The number of severe claims reported in any one year in this five-year period ranged from a low of 18 in 2008 to a high of 31 in 2006 and 2007. The average severity of these claims ranged from $842,000 in 2006 to $1.4 million in 2005. On average, over the five-year period, these severe claims by themselves accounted for 10.1 percentage points of our overall loss and defense and cost containment (“DCC”) ratio.
A key assumption used by management in establishing loss reserves is that average per claim case incurred loss and loss adjustment expenses will increase year over year. We believe this increase primarily reflects
Substantial judgment is required to determine the relevance of our historical experience and industry information under current facts and circumstances. The interpretation of this historical and industry data can be impacted by external forces, principally frequency and severity of unreported claims, length of time to achieve ultimate settlement of claims, inflation in medical costs and wages, insurance policy coverage interpretations, jury determinations and legislative changes. Accordingly, our reserves may prove to be inadequate to cover our actual losses. If we change our estimates, these changes would be reflected in our results of operations during the period in which they are made, with increases in our reserves resulting in decreases in our earnings.
In 2008, we decreased our estimates for prior year loss reserves by $20.4 million, which increased net income by $13.3 million. In 2007, we decreased our estimates for prior year loss reserves by $9.5 million, which increased net income by $6.2 million. In 2006, we decreased our estimates for prior year loss reserves by $2.2 million, which increased net income by $1.4 million.
periods over the remaining term of the policy. Our insurance policies typically have a term of one year. Thus, for a one-year policy written on July 1, 2008 for an employer with constant payroll during the term of the policy, we would earn half of the premiums in 2008 and the other half in 2009. On a monthly basis, we also recognize net premiums earned from mandatory pooling arrangements.
Prior to 2006, we periodically reviewed EBUB premium trends, however, the variability in those trends caused us to conclude that EBUB premium could not be reasonably estimated. As a result, we recorded EBUB premium as gross written premium and earned premium in the period that the premium audit was completed. In 2006, we recorded an estimate for EBUB premium of $5.3 million, or 1.6% of gross premiums written in 2006. At December 31, 2007, our estimate for EBUB premium was $9.0 million, a change of $3.7 million or 1.1% of gross premiums written in 2007. At December 31, 2008, our estimate for EBUB premium was $10.2 million, a change of $1.2 million or 0.4% of gross premiums written in 2008. On a quarterly basis, we review our estimate of EBUB premiums and record an adjustment to premium, related losses and expenses.
an aggregate basis that have been incurred but not reported, or IBNR. Our IBNR reserves are also intended to provide for aggregate changes in case incurred amounts as well as the unpaid cost of recently reported claims which an initial case reserves have not been established. The third component of our reserves for loss and loss adjustment expenses is our AO reserve. Our AO reserve is established for those future claims administration costs that cannot be allocated directly to individual claims. The final component of our reserves for loss and loss adjustment expenses is the reserve for mandatory pooling arrangements.
In establishing our reserves, we review the results of analyses using actuarial methods that utilize historical loss data from our more than 23 years of underwriting workers’ compensation insurance. The actuarial analysis of our historical data provides the factors we use in estimating our loss reserves. These factors are primarily measures over time of the number of claims paid and reported, average paid and incurred claim amounts, claim closure rates and claim payment patterns. In evaluating the results of our analyses, management also uses substantial judgment in considering other factors that are not considered in these actuarial analyses, including changes in business mix, claims management, regulatory issues, medical trends, employment and wage patterns, insurance policy coverage interpretations, judicial determinations and other subjective factors. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may vary significantly from our original estimates.
Amounts Recoverable from Reinsurers. Amounts recoverable from reinsurers represents the portion of our paid and unpaid loss and loss adjustment expenses that are assumed by reinsurers. These amounts are separately reported on our balance sheet as assets and do not reduce our reserves for loss and loss adjustment expenses because reinsurance does not relieve us of liability to our policyholders. We are required to pay claims even if a reinsurer fails to pay us under the terms of a reinsurance contract. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, as well as the terms and conditions of our reinsurance contracts, which could be subject to interpretation. In addition, we bear credit risk with respect to our reinsurers, which can be significant because some of the unpaid loss and loss adjustment expenses for which we have reinsurance coverage remain outstanding for extended periods of time.
expect to incur as the premiums are earned, less related net investment income. Judgments as to the ultimate recoverability of these deferred policy acquisition costs are highly dependent upon estimated future profitability of unearned premiums. If the unearned premiums were less than our expected claims and expenses after considering investment income, we would reduce the deferred costs.
Net Premiums Earned. Net premiums earned for 2008 were $289.5 million, compared to $306.9 million for 2007, a decrease of 5.7%. The decrease was attributable to a decline in net premiums written offset by earnings from premiums written in the previous four quarters.
Net Realized Gains (Losses) on Investments. Net realized losses on investments for 2008 totaled $18.9 million, compared to gains of $147,000 for 2007. Net realized losses in 2008 were attributable to $1.6 million in realized losses, primarily on the sale of equity securities, and $17.3 million in other-than-temporary impairments of certain equities and asset-backed securities. Other-than-temporary impairments are discussed below in “Investment Portfolio.” Net realized gains in 2007 were the result of sales of equity securities and calls on fixed maturity securities.
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits for 2008 were $55.9 million, compared to $65.5 million for 2007, a decrease of 14.6%. This decrease was primarily due to $9.5 million of experience-rated commissions from our 2008 reinsurance agreement, covering the $4 million excess of $1 million reinsured layer. This $9.5 million is recorded as an offset to expenses. Additionally, we realized a $4.4 million decrease in insurance-related assessments. Offsetting these expense decreases, accounts receivable write-offs increased $2.2 million, salary and benefits increased $1.5 million and commissions increased $240,000. Our underwriting expense ratio declined from 21.3% in 2007 to 19.3% in 2008.
Income Tax Expense. Income tax expense for 2008 was $20.2 million, compared to $20.9 million for 2007. The decrease was primarily attributable to a $7.0 million decrease in our pre-tax income, from $71.1 million for 2007 to $64.1 million for 2008. Our effective tax rate for 2008 was 31.6%, compared to 29.4% for 2007. The increase in the effective tax rate from 2007 to 2008 was attributable to the recording of a $3.0 million valuation allowance for deferred tax assets related to unrealized losses on our investment portfolio. We recognized $18.6 million of realized losses in 2008, for which a deferred tax asset was recorded.
Gross Premiums Written. Gross premiums written in 2007 were $327.8 million, compared to $332.5 million in 2006, a decrease of 1.4%. The decrease was attributable to a $14.3 million decrease in premiums resulting from payroll audits and related premium adjustments, a $1.7 million decrease in direct assigned risk premiums, and a $316,000 decrease in assumed premiums from mandatory pooling arrangements. The decrease in payroll audits and related premium adjustments was the result of a slowing economy and lower loss costs. These decreases were offset by an $11.6 million increase in annual premiums on voluntary policies written during the period.
Net Premiums Written. Net premiums written in 2007 were $307.5 million, compared to $312.5 million in 2006, a decrease of 1.6%. The decrease was attributable to the decrease in gross premiums written and a $265,000 increase in premiums ceded to reinsurers in 2007. As a percentage of gross premiums written, ceded premiums were 6.2% in 2007, compared to 6.0% in 2006.
Index to Financial Statements Net Realized Gains on Investments. Net realized gains on investments in 2007 totaled $147,000, compared to $7.4 million in 2006. Net realized gains in 2007 are primarily from called fixed maturity securities. The net realized gains in 2006 were attributable to actions resulting from a strategic assessment of our investment guidelines as discussed below under “-Investment Portfolio.”
Underwriting and Certain Other Operating Costs, Commissions and Salaries and Benefits. Underwriting and certain other operating costs, commissions and salaries and benefits in 2007 were $65.5 million, compared to $71.3 million in 2006, a decrease of 8.1%. This decrease was due in part to $3.7 million from the commutation of several reinsurance agreements, as discussed below in “Liquidity and Capital Resources.” In addition, insurance-related assessments decreased $1.5 million, professional fees decreased $1.1 million and premium taxes decreased $820,000. Ceding commissions from reinsurers increased $593,000, which acts to reduce underwriting expenses. Offsetting these decreases, salary and benefits increased $1.7 million and commissions increased $1.3 million, due to the increase in gross premiums earned. Our underwriting expense ratio declined from 23.8% in 2006 to 21.3% in 2007.
Interest Expense. Interest expense was $3.5 million in 2007 and 2006. Our weighted average interest rate increased from 9.1% per annum in 2006 to 9.4% per annum 2007. Our weighted average borrowings for both years were $36.1 million.
Income Tax Expense. Income tax expense in 2007 was $20.9 million, compared to $15.1 million in 2006. The increase was primarily attributable to an $18.6 million increase in our pre-tax income, from $52.4 million in 2006 to $71.1 million in 2007. Our effective tax rate in 2007 was 29.4%, compared to 28.8% in 2006.
Index to Financial Statements As discussed above under “-Overview,” we purchase reinsurance to protect us against severe claims and catastrophic events. Based on our estimates of future claims, we believe we are sufficiently capitalized to satisfy the deductibles and retentions in our 2009 reinsurance program. We reevaluate our reinsurance program at least annually, taking into consideration a number of factors, including cost of reinsurance, our liquidity requirements, operating leverage and coverage terms.
Net cash provided by operating activities was $64.9 million in 2008, as compared to $100.4 million in 2007 and $81.8 million in 2006. Major components of cash provided by operating activities in 2008 were net premiums collected of $282.3 million, investment income collected of $33.7 million and amounts recovered from reinsurers of $20.4 million, offset by claim payments of $183.4 million, $58.6 million of operating expenditures, federal taxes paid of $25.0 million, and dividends to policyholders paid of $4.5 million. Major components of cash provided by operating activities in 2007 were net premiums collected of $299.1 million, investment income collected of $31.9 million and amounts recovered from reinsurers of $33.7 million, offset by claim payments of $181.8 million, operating expenditures of $63.6 million and federal taxes paid of $19.6 million. Major components of cash provided by operating activities in 2006 were net premiums collected of $292.5 million, investment income collected of $26.3 million and amounts recovered from reinsurers of $7.9 million, offset by claim payments of $160.2 million, federal taxes paid of $15.2 million and operating expenditures of $66.3 million. Included in these operating expenditures were pre-tax expenses of $1.1 million related to a public offering of common stock by certain of our shareholders. We were obligated to pay these expenses under the terms of a registration rights agreement.
In October 2008, we commuted certain reinsurance agreements with Liberty Syndicate Management Limited (“Liberty Re”) covering portions of the 2005 and 2006 accident years. As a result of this commutation, we recorded pre-tax income of approximately $319,000 in the fourth quarter of 2008. Liberty Re remains obligated to the Company’s insurance subsidiaries under other reinsurance agreements.
In June 2007, we commuted our First Casualty Excess of Loss Reinsurance Contract with Hannover and Lloyd’s Underwriters and Companies (“Lloyd’s”) covering excess of loss layers for the 2006 accident year. As a result of this commutation, we recorded pre-tax income of $1.0 million in the second quarter of 2007. Hannover and Lloyd’s remain obligated to the Company’s insurance subsidiaries under other reinsurance agreements.
In total, we received $26.5 million in cash from commutations in 2007. The majority of that cash was invested in fixed maturity securities.
In October 2007, we entered into an agreement providing for a line of credit in the maximum amount of $20.0 million. The agreement expires in October 2010. Under the agreement, advances may be made either in the form of loans or letters of credit. Borrowings under the agreement accrue interest at rates based either on the prime rate or LIBOR. Letters of credit issued under the arrangement accrue fees on undrawn amounts as long as the letters are outstanding. We do not pay a facility fee on amounts available under the line of credit unless they are advanced and outstanding. The facility is unsecured. No borrowings and loans were outstanding under the line of credit at December 31, 2008.
Because our convertible preferred stock is mandatorily redeemable upon the occurrence of certain events that are deemed to be outside of our control, our preferred stock is presented on the balance sheet outside of shareholders’ equity. As a result of the conversion of 50% of shares of preferred stock into common stock in 2006, we increased shareholders’ equity by $25.0 million, which is the amount we received when the preferred shares were issued in 1998. Offsetting this increase were expenses of $1.1 million associated with the public offering.
Index to Financial Statements AMERISAFE is a holding company that transacts business through its operating subsidiaries, including American Interstate, Silver Oak Casualty and American Interstate of Texas. AMERISAFE’s primary assets are the capital stock of these insurance subsidiaries. The ability of AMERISAFE to fund its operations depends upon the surplus and earnings of its subsidiaries and their ability to pay dividends to AMERISAFE. Payment of dividends by our insurance subsidiaries is restricted by state insurance laws, including laws establishing minimum solvency and liquidity thresholds. See “Business-Regulation-Dividend Limitations” in Item 1of this report. Based on reported capital and surplus at December 31, 2008, American Interstate is permitted under Louisiana insurance law to pay dividends to AMERISAFE in 2009 in an amount up to $17.6 million without approval by the Louisiana Department of Insurance.
The principal priorities of our investment portfolio are to provide capital preservation and liquidity. The portfolio’s secondary priority is to provide maximized after-tax income. We presently expect to maintain sufficient liquidity from funds generated by operations to meet our anticipated insurance obligations and operating and capital expenditure needs. Excess funds from operations will be invested in accordance with our investment policy and statutory requirements. Because we have the positive intent and ability to hold our fixed maturity securities to maturity, we classify these securities as held-to-maturity.
We allocate our portfolio into three categories: cash and cash equivalents, fixed maturity securities and equity securities. Cash and cash equivalents include cash on deposit, pooled short-term money market funds and certificates of deposit. Our fixed maturity securities include obligations of the U.S. Treasury or U.S. agencies, obligations of states and their subdivisions, long-term certificates of deposit, U.S. Dollar-denominated obligations of the U.S. corporations, U.S. agency-based mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities. Our equity securities principally include four value-based exchange traded funds.
Under Louisiana and Texas law, as applicable, each of American Interstate, Silver Oak Casualty and American Interstate of Texas is required to invest only in securities that are either interest-bearing or eligible for dividends, and must limit its investment in the securities of any single issuer to five percent of the insurance company’s assets. As of December 31, 2008, we were in compliance with these requirements.
On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, which establishes a fair value hierarchy and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. As disclosed in Note 19 of the financial statements, our securities available-for-sale are classified using Level 1 inputs. We did not elect the fair value option prescribed under SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, for any financial assets or financial liabilities in 2008.
(1) Equity securities represented 8.8% of shareholders’ equity plus redeemable preferred stock as of December 31, 2008.
Index to Financial Statements The pre-tax investment yield on our investment portfolio was 4.0% per annum during the twelve months ended December 31, 2008, compared to 4.2% per annum during the same period in 2007.
In recent periods, we increased our efforts to close prior year claims in those circumstances where the claim could be settled for less than the corresponding case reserve amount (which amount represents estimated ultimate cost to settle the claim, undiscounted). As a result of these efforts, our claims closure rate accelerated in 2008, which in turn contributed to favorable prior accident year development recorded in 2008. While we intend to continue to seek to settle claims on a more accelerated basis, we do not presently anticipate that the claims closure rate will continue to increase as the number of existing, prior year open claims decreases, on a percentage basis, compared to the total number of open claims.
At December 31, 2008, our case incurred amounts for certain accident years, particularly 2006 and 2007, have not developed to the degree management previously expected. The assumptions we used in establishing our reserves for these accident years were based on our 23 years of historical claims data. However, as of December 31, 2008, actual results for these two accident years have been better than our assumptions would have predicted. We do not presently intend to modify our assumptions for establishing reserves in light of these recent results for the 2006 and 2007 accident years. However, if actual results for current and future accident years are consistent with, or better than, our results in these recent accident years, our historical claims data will reflect this change and, over time, will impact the reserves we establish for future claims.
We lease equipment and office space under noncancelable operating leases. Future minimum lease payments at December 31, 2008, were as follows:
Risks Related to Our Business-Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Item 1A of this report for a discussion of the uncertainties associated with estimating loss and loss adjustment expenses.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AMERISAFE, Inc. and Subsidiaries at December 31, 2008 and 2007 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The Company has the ability and positive intent to hold these investments until maturity. Therefore, investments in held-to-maturity fixed maturity securities are recorded at amortized cost. Available-for-sale fixed maturity securities and equity securities are recorded at fair value. Temporary changes in the fair value of the available-for-sale fixed maturity and equity securities are reported in shareholders’ equity as a component of other comprehensive income, net of deferred income taxes.
Cash equivalents include pooled short-term money market funds and certificates of deposit with an original maturity of three months or less.
Ceding commissions are earned from certain reinsurance companies and are intended to reimburse the Company for policy acquisition costs related to those premiums ceded to the reinsurers. Ceding commission income is recognized over the effective period of the related insurance policies in proportion to premium revenue earned and is reflected as a reduction in underwriting and other operating costs.
Experience-rated commissions are earned from certain reinsurance companies based on the financial results of the applicable risks ceded to the reinsurers. These commission revenues on reinsurance contracts are recognized during the related reinsurance treaty period and are based on the same assumptions used for recording loss and allocated loss adjustment expenses. These commissions are reflected as a reduction in underwriting and other operating costs and are adjusted as necessary as experience develops or new information becomes known. Any such adjustments are included in current operations. Experience-rated commissions reduced underwriting and other operating costs by $13.6 million in 2008, $3.8 million in 2007 and $66,000 in 2006.
shares in earnings as if all earnings for the period had been distributed. The amount of earnings allocated to common shares is divided by the weighted-average number of common shares outstanding for the period. Participating securities that are convertible into common stock are included in the computation of basic EPS if the effect is dilutive.
The Company recognizes the impact of its share-based compensation in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 123 (R) (revised 2004)-Share-Based Payment. All share-based grants are recognized as compensation expense over the vesting period.
In December 2007, the FASB issued FASB Statement No. 141(R), Business Combinations (“SFAS No. 141(R)”. SFAS No. 141(R) establishes principles and requirements for how an acquiring company recognizes and measures in its financial statements the identifiable assets and goodwill acquired, the liabilities assumed and any noncontrolling interest in the acquired company. It also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008. The impact of adopting SFAS No. 141(R) has not been determined since the Company has not had any business combinations.
In January 2009, the FASB issued FASB Staff Position No. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20 (“FSP EITF 99-20-1”). FSP EITF 99-20-1 amends the impairment guidance in EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets, to achieve more consistent determination of whether an other-than-temporary impairment has occurred. FSP EITF 99-20-1 also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and other related guidance. FSP EITF 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008, and is to be applied prospectively. Retrospective application to a prior interim or annual reporting period is not permitted. The Company does not anticipate that the adoption of EITF 99-20-1 will have a material effect on the Company’s financial position or results of operations.
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as held-to-maturity at December 31, 2007 are summarized as follows:
The gross unrealized gains and losses on, and the cost and fair value of, those investments classified as available-for-sale at December 31, 2007 are summarized as follows:
The following table summarizes the gross unrealized losses on securities that were at a loss for either less than twelve months or twelve months or longer:
In 2008, the Company recorded aggregate impairment charges of $17.3 million with respect to two asset-backed securities, two equity securities and four value-based exchange traded funds in its investment portfolio. Of the $17.3 million of impairment charges, $14.0 million related to four value-based exchange traded funds. The value of these securities fell throughout 2008 in line with other major indices during a volatile market cycle. As of December 31, 2008, the unrealized losses on these exchange-traded funds exceeded 35% of cost. While the Company believes some portion of the value will be regained as the economy recovers, such recoveries can not be determined to be in the near term. These securities were impaired using the market close price on the last day of the year.
In addition, an impairment of $3.1 million was recorded related to one asset-backed security. The Company determined to impair this security because, among other things, the credit rating of the security had been downgraded to below investment grade, and the fair value of the security had been less than 80% of its amortized cost for an extended period of time. The Company believes that the factors resulting in the impairment of this asset-backed security were generally specific to this security and do not impact its other investments. This security was impaired at fair value as of December 31, 2008.
In 2006, the Company recorded an estimate for EBUB premium of $5.3 million, or 1.6% of gross premiums written in 2006. At December 31, 2007, the Company’s revised estimate for EBUB premium was $9.0 million, a change of $3.7 million or 1.1% of gross premiums written in 2007. At December 31, 2008, the Company’s revised estimate for EBUB premium was $10.2 million, a change of $1.2 million or 0.4% of gross premiums written in 2008.
The Company cedes certain premiums and losses to various reinsurers under quota share and excess-of-loss treaties. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. Ceded reinsurance contracts do not relieve the Company from its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers on a continual basis. The effect of reinsurance on premiums written and earned in 2008, 2007 and 2006 was as follows:
At December 31, 2008, unsecured reinsurance recoverables from reinsurers that exceeded 1.5% of statutory surplus of the Company’s insurance subsidiary are shown below (in thousands). The A.M. Best Company rating for the reinsurer is shown parenthetically.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no such uncertain positions as of December 31, 2008 and 2007.
Tax years 2004 through 2008 are subject to examination by the federal and state taxing authorities. There are no income tax examinations currently in process.
On April 29, 2004, the Company entered into a second trust preferred securities transaction pursuant to which it issued $25,780,000 aggregate principal amount of subordinated debt securities due in 2034. To effect the transaction, the Company formed a Delaware statutory trust, Amerisafe Capital Trust II (“ACT II”). ACT II issued $25,000,000 of preferred securities to investors and $780,000 of common securities to the Company. ACT II used the proceeds from these issuances to purchase the subordinated debt securities. The Company pays interest on its ACT II subordinated debt securities quarterly at a rate equal to LIBOR plus 3.80% per annum (5.9% at December 31, 2008). ACT II pays interest on its preferred securities at the same rate. The Company subordinated debt securities and ACT II preferred securities are repayable on or after April 29, 2009. Payments of principal, interest and premium, if any, on the ACT II preferred securities are guaranteed by the Company.
The following table provides a reconciliation of the beginning and ending reserve balances, net of related amounts recoverable from reinsurers, for 2008, 2007 and 2006:
At December 31, 2008, 1,214,770 shares of common stock were issuable upon conversion of all outstanding shares of Series C and Series D convertible preferred stock, based on the conversion price on that date of $20.58.
The Company is authorized to issue 500,000 shares of convertible preferred stock, par value $0.01 per share, of which 300,000 shares are designated as Series C convertible deferred pay preferred stock and 200,000 shares are designated as Series D non-voting convertible deferred pay preferred stock (collectively, the “Convertible Preferred Stock”). The terms of the Series C and Series D convertible preferred stock are identical, except that holders of Series C convertible preferred stock are entitled to vote (on an as-converted to common stock basis) on all matters to be voted on by shareholders of the Company.
The Series C convertible preferred stock is convertible at the option of the holder into shares of common stock at a rate of $100 per share divided by the then-applicable conversion price. The Series D convertible preferred stock is convertible at the option of the holder into shares of non-voting common stock at a rate of $100 per share divided by the then-applicable conversion price. In turn, each share of non-voting common stock is convertible at the option of the holder into one share of common stock. As of December 31, 2008, the conversion price was $20.58 per share and the outstanding shares of Convertible Preferred Stock were convertible into 1,214,770 shares of common stock.
Subject to certain exceptions, the conversion price will be adjusted if the Company issues or sells shares of common stock or non-voting common stock (including options to acquire shares and securities convertible into or exchangeable for shares of common stock or non-voting common stock) without consideration or for a consideration per share less than the market price of the common stock or non-voting common stock in effect immediately prior to the issuance or sale. In that event, the conversion price will be reduced to a conversion price
The Convertible Preferred Stock is classified outside of permanent equity because the shares are mandatorily redeemable at $100 plus the cash value (calculated at the rate of $100 per share) of all accrued and unpaid dividends per share from the most recent quarterly dividend payment date to the redemption date.
No shares of Convertible Preferred Stock were issued during the three-year period ended December 31, 2008. On November 21, 2006, 250,000 shares of Series C convertible preferred stock were converted into 1,214,771 shares of common stock. The 250,000 shares of Series C preferred stock exchanged were canceled and retired and cannot be reissued.
In the event of any liquidation or dissolution of the Company, the holders of Convertible Preferred Stock will receive $100 for each outstanding share before any distributions are made to holders of any other then-outstanding series of preferred stock, junior preferred stock, common stock or non-voting common stock. Any remaining net assets will be distributed first to holders of common stock and non-voting common stock, subject to any other preferential amounts payable to holders of any then-outstanding series of preferred stock or junior preferred stock.
As of December 31, 2008, the Company had made awards of stock options under the 2005 Incentive Plan on September 1, 2006, September 25, 2006, March 2, 2007, January 24, 2008 and November 10, 2008. At December 31, 2008, 280,609 shares of common stock were available for future awards under the 2005 Incentive Plan.
The assumptions used in the Black-Scholes-Merton pricing model for options granted on the above option grant dates were as follows:
The following table summarizes information about the stock options outstanding under the 2005 Incentive Plan at December 31, 2006, 2007 and 2008:
In February 2008, the compensation committee of the Board approved incentive compensation awards to each of the Company’s executive officers for services rendered in 2007. The awards were composed of cash bonuses and grants of restricted common stock. The restricted stock awards were made pursuant to the Company’s 2005 Incentive Plan and vest on the first anniversary of the date of grant. The fair value of the restricted stock at the date of grant was $121,000.
The Company recognized compensation expense of $1,177,000, $973,000 and $850,000 in 2008, 2007 and 2006, respectively, related to the 2005 Incentive Plan.
of the Board to adjust this amount in the event of a merger, consolidation, reorganization, stock split, combination of shares, recapitalization or similar transaction affecting the common stock. At December 31, 2008, there were 29,227 shares of common stock available for future awards under the 2005 Restricted Stock Plan.
As of December 31, 2008, there were 6,468 shares of restricted stock outstanding under the 2005 Restricted Stock Plan, all of which will vest on the date of the annual meeting of shareholders in 2009.
The following table summarizes information about the restricted stock outstanding under the 2005 Restricted Stock Plan at December 31, 2008:
The Company recognized compensation expense of $108,000 in 2008, $70,000 in 2007 and $72,000 in 2006 related to the 2005 Restricted Stock Plan. Total tax expense realized for tax from vesting of restricted stock was $3,000 in 2008. In 2007 and 2006, total tax benefits realized for tax deductions from vesting of restricted stock was $9,000 and $4,000, respectively.
The Company leases equipment and office space under noncancelable operating leases. At December 31, 2008, future minimum lease payments are as follows (in thousands):
The Company determined the fair values of its financial instruments based on the fair value hierarchy established in SFAS No. 157, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard defines fair value, describes three levels of inputs that may be used to measure fair value, and expands disclosures about fair value measurements.
Fair value is defined in SFAS No. 157 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is the price to sell an asset or transfer a liability and, therefore, represents an exit price, not an entry price. Fair value is the exit price in the principal market (or, if lacking a principal market, the most advantageous market) in which the reporting entity would transact. Fair value is a market-based measurement, not an entity-specific measurement, and, as such, is determined based on the assumptions that market participants would use in pricing the asset or liability. The exit price objective of a fair value measurement applies regardless of the reporting entity’s intent and/or ability to sell the asset or transfer the liability at the measurement date.
Securities classified by the Company as available-for-sale investments were reported at fair value utilizing mostly Level 1 inputs. The fair value measurements consider quoted prices in active markets for identical assets. Level 2 inputs such as previous day and subsequent day trade prices were used if a trade for the security was not made on the date of measurement.
The following table represents unaudited quarterly financial data for the years ended December 31, 2008 and 2007.
Index to Financial Statements Schedule II. Condensed Financial Information of Registrant
Index to Financial Statements Schedule II. Condensed Financial Information of Registrant-(Continued)