With our Merger with ProCentury, we assumed the lease of their corporate headquarters, an approximately 44,000 square foot office building located in Westerville, Ohio. The lease agreement for this building has an initial term of ten years, which expires in 2013.
Both the GAAP loss and loss adjustment expense ratio and the GAAP expense ratio are calculated based upon unconsolidated insurance company operations. The following table sets forth the intercompany fees, which are eliminated upon consolidation.
On July 31, 2008, our merger with ProCentury Corporation (“ProCentury”) was completed (“Merger”). Under the terms of the merger agreement, ProCentury shareholders were entitled to receive, for each ProCentury common share, either $20.00 in cash or Meadowbrook common stock based on a 2.5000 exchange ratio, subject to adjustment as described within the merger agreement. In accordance with the merger agreement, the stock price used in determining the final cash and share consideration portion of the purchase price was based on the volume-weighted average sales price of a share of Meadowbrook common stock for the 30-day trading period ending on the sixth trading day before the completion of the Merger, or $5.7326. Based upon the final proration, the total purchase price was $227.2 million, of which $99.1 million consisted of cash, $122.7 million in newly issued common stock, and approximately $5.4 million in transaction related costs. The total number of common shares issued for purposes of the stock portion of the purchase price was 21.1 million shares.
In July 2007, we completed an offering of 6,437,500 additional shares of newly issued common stock at $9.65 per share. The gross proceeds of the offering were $62.1 million. The net proceeds were $58.6 million. The net proceeds from the offering are being utilized to support organic growth within our underwriting operations, to fund select acquisitions and other general corporate purposes. Upon receipt of the net proceeds, we also reduced our outstanding line of credit balance from $22.0 million to zero.
Our specialty insurance operations segment, which includes insurance company specialty programs and fee-for-service specialty or managed programs, focuses on specialty or niche insurance business. Our specialty insurance operations provide services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention, and reinsurance placement, along with various types of property and casualty insurance coverage, including workers’ compensation, commercial multiple peril, general liability, commercial auto liability, excess and surplus lines, environmental, garage keepers, surety, legal, professional liability, errors and omissions, inland marine, and other lines of business, where we see a market need and a profit potential. Insurance coverage is provided primarily to associations or similar groups of members and to specified classes of business of our agents. We recognize revenue related to the services and coverages the specialty insurance operations provides within seven categories: net earned premiums, management fees, claims fees, loss control fees, reinsurance placement, investment income, and net realized gains (losses).
In recent years, we have derived our revenue from the following sources (in thousands):
We establish a liability for losses and LAE, which represents case based estimates of reported unpaid losses and LAE and actuarial estimates of incurred but not reported losses (“IBNR”) and LAE. Such liabilities, by necessity, are based upon estimates and, while we believe the amount of our reserves is adequate, the ultimate liability may be greater or less than the estimate. As of December 31, 2008 and 2007, we have accrued $885.7 million and $540.0 million of gross loss and LAE reserves, respectively.
The following table sets forth our gross and net reserves for losses and LAE based upon an underlying source of data, at December 31, 2008 (in thousands):
Residual markets represent mandatory pooled workers’ compensation business allocated to individual insurance company writers based on the insurer’s market share in a given state.
The following table sets forth our net case and IBNR reserves for losses and LAE by line of business at December 31, 2008 (in thousands):
In developing claim and claim adjustment expense reserve estimates, we perform a complete and detailed reserve analyses each quarter. To perform this analysis, the data is organized at a “reserve category” level. A reserve category can be a line of business such as commercial automobile liability, or it may be a particular geographical area within a line of business such as Nevada workers’ compensation. The reserves within a reserve category level are characterized as either short tail or long tail. About 95% of our reserves can be characterized as coming from long tail lines of business. For long tail business, several years may lapse between the time the business is written and the time when all claims are settled. Our long-tail exposures include workers’ compensation, commercial automobile liability, general liability, professional liability, products liability, excess, and umbrella. Short-tail exposures include property, commercial automobile physical damage, a portion of ocean marine, and inland marine. The analyses generally review losses both gross and net of reinsurance.
Selection of the paid loss pattern requires analysis of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves.
Claims for short-tail lines of business settle more quickly than long-tail lines of business, and in general, loss development factors for short-tail lines are smaller than long-tail lines. For long-tail lines, we tend to rely on initial expected loss methods throughout the current accident year then move to development factor based methods for older accident years. Development methods on short-tail lines are generally reliable in the third and fourth quarter of the initial accident year and recorded loss ratios reflect a blend of the development and forecast methods. Short-tail lines represent 5% of our total reserves at December 31, 2008.
Construction Defect Method. The provision for IBNR loss and ALAE for construction defect claims is analyzed by projecting the number of IBNR claim counts and applying a selected severity (i.e., a frequency severity type approach). The provision for development on reported claims is projected using a methodology similar to the incurred loss development approach described above. However, the claims are organized in a report year rather than accident year format. The advantage of this is that it substantially reduces the length or “tail” of the development.
Each of the methods listed above requires the selection and application of parameters and assumptions. For all but the initial expected loss method, the key assumptions are the patterns with which our aggregate claims data will be paid or will emerge over time (“development patterns”). These patterns incorporate inherent assumptions of claims cost inflation rates and trends in the frequency of claims, both overall and by severity of claim. These are affected by underlying loss trends, rate changes, benefit changes, reinsurance
structure and cost changes and other pertinent adjustments which are explicit key assumptions underlying the initial expected loss method. Each of these key assumptions is discussed in the following paragraphs.
By its nature, the estimate of ultimate losses and LAE is subject to variability due to differences between our assumptions and actual events in the future. Although many factors influence the actual cost of claims and our corresponding reserve estimates, we do not measure and estimate values for all of these variables individually. This is due to the fact that many of the factors known to impact the cost of claims cannot be measured directly, such as the impact on claim costs due to economic inflation, coverage interpretations and jury determinations. In most instances, we rely on our historical experience or industry information to estimate the values for the variables that are explicitly used in our reserve analyses. We assume that the historical effect of these unmeasured factors, which is embedded in our experience or industry experience, is representative of the future effects of these factors. Where we have reason to expect a change in the effect of one of these factors, we perform analyses to perform the necessary adjustments.
One implicit assumption underlying development patterns is that the claims inflation trends will continue into the future similar to their past patterns. To estimate the sensitivity of the estimated ultimate loss and settlement expense payments to an unexpected change in inflationary trends, our actuarial department derives expected payment patterns separately for each major line of business. These patterns were applied to the December 31, 2008 loss and settlement expense reserves to generate estimated annual incremental loss and
Historic development as shown within the “Analysis of Loss and Loss Adjustment Expense Development” table has been five percent or less in the last four years but was ten to twenty-eight percent in the years prior to the underwriting and reserving shift in 2002. At that time, we concentrated our efforts on eliminating underwriting relationships where we had substantial liabilities above an aggregate exposure retained by risk sharing associations and captives. For a large share of our business, we also accelerated the pace at which we brought the claim administration to our employees and away from outside third party administrators. This change enabled us to more rapidly recognize trends and underlying loss patterns, and establish more accurate reserves in a timely manner.
Our range of loss and LAE reserves table shows that presently we estimate them as going from favorable development of 8.9% to unfavorable of 6.1%. The range was evaluated based on the ultimate loss estimates from the actuarial methods described above.
The sensitivity around our commercial multiple peril/general liability reserves primarily reflects the longer duration of reserves relating to our liability excess program, which started in 2003, and construction defect exposure, which together represent approximately 19% of the $317.2 million reserves in this line of business as of December 31, 2008. These lines of business are subject to greater uncertainty than the remainder of our book of business. With the ProCentury merger, our liability reserves represent slightly over 50% of our total reserves as of December 31, 2008.
The sensitivity around the other lines of business primarily reflects the size of the underlying book of business. Our other reserves represent 7% of total reserves at December 31, 2008. A large portion of these reserves represent professional liability programs which tend to be claims-made and reinsured at lower limits, therefore reducing the volatility that is inherent in a smaller book of business. Another large portion represents property claims, which have a shorter reporting and payout pattern than liability and workers’ compensation claims.
Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), FASB Emerging Issues Task Force (EITF) 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” requires us to periodically update our best estimate of cash flows over the life of the security. If management determines that the fair value of a securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other than temporary impairment is recognized.
After review of our investment portfolio in relation to our policy, we recorded a pre-tax realized loss of $11.7 million, for the year ended December 31, 2008, related to certain preferred stock investments, including Fannie Mae, Freddie Mac, and Lehman Brothers investments, as well as several corporate bonds and asset-backed and mortgage-backed securities. There were no impaired investments written down in 2007 or 2006.
At December 31, 2008 and 2007, we had 365 and 160 securities that were in an unrealized loss position, respectively. Of the securities held at December 31, 2008, twenty-three had an aggregate $24.5 million and $3.7 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months. At December 31, 2007, 128 had an aggregate $122.2 million and $1.3 million fair value and unrealized loss, respectively, and have been in an unrealized loss position for more than twelve months. As of December 31, 2008 and 2007, gross unrealized losses on available for sale securities were $22.1 million and $1.9 million, respectively.
Premiums written, which include direct, assumed, and ceded premiums are recognized as earned on a pro rata basis over the life of the policy term. Unearned premiums represent the portion of premiums written that are applicable to the unexpired terms of an in force policy. Provisions for unearned premiums on reinsurance assumed from others are made on the basis of ceding reports when received and actuarial estimates.
For the year ended December 31, 2008, total assumed written premiums were $8.1 million, of which $1.0 million relates to assumed business we manage directly. The remaining $7.1 million of assumed written premiums relates to residual markets, mandatory assumed pool business, and other unaffiliated entities.
We review, on an ongoing basis, the collectibility of our receivables and establish an allowance for estimated uncollectible accounts. As of December 31, 2008 and 2007, the allowance for uncollectibles on receivables was $2.9 million and $2.7 million, respectively.
Goodwill represents the excess of the cost over the fair value of net assets of subsidiaries acquired and was $119.0 million, or 6.6% of total assets, as of December 31, 2008. As required by SFAS No. 142 “Goodwill and Other Intangible Assets,” we no longer amortize goodwill and, at least annually, we test all existing goodwill for impairment using a fair value approach, on a reporting unit basis. Our annual assessment date for goodwill impairment testing is October 1st. We test for impairment more frequently if events or changes in circumstances indicate that there may be an impairment to goodwill. Based on our most recent evaluation of goodwill impairment, we determined that no impairment of goodwill exists. Refer to Note 16 - Goodwill and Other Intangible Assets for further discussion relating to our reporting units.
Over the last half of the year, there have been many well-documented events that have occurred in the global economy and financial markets, some of which adversely impacted our results. Among those events was the impact on our investment portfolio primarily because of impairments we recorded related to certain
preferred stock investments, which primarily consisted of Fannie Mae, Freddie Mac, and Lehman Brothers investments. In addition, ProCentury’s results since the consummation of the Merger included property losses from Hurricanes Gustav and Ike. Despite these unusual factors, our core operating results continue to be favorable. Our results include the positive impact from continued selective growth, coupled with adherence to strict corporate underwriting guidelines, expense savings from the elimination of the fronting fees paid prior to achievement of our A.M. Best upgrade to “A−” (Excellent), as well as a focus on current accident year price adequacy. In addition, we continue to experience a favorable impact due to the further leveraging of our fixed costs, which has helped reduce our expense ratio. Our generally accepted accounting principles (“GAAP”) combined ratio improved 2.1 percentage points to 93.3% in 2008 from 95.4% in 2007. Net operating income, excluding amortization, increased $15.3 million, or 51.3%, to $45.1 million, compared to $29.8 million in 2007.
We believe that overall, the specialty insurance market will continue to be competitive in 2009, but less than last year. We continue to follow pricing guidelines mandated by our corporate underwriting guidelines. Throughout 2008 we experienced declining rates, and on average, Meadowbrook’s rates were down about 4%, while ProCentury’s were down by about 6%. We remain selective on new program implementation by focusing only on those programs that meet our underwriting guidelines and have a proven history of profitability.
On July 31, 2008, we completed our Merger with ProCentury. The total purchase price, as determined in accordance with GAAP, was $227.2 million, of which $99.1 million consisted of cash, $122.7 million in newly issued common stock, and approximately $5.4 million in transaction related costs. The total number of common shares issued for the stock portion of the purchase price was approximately 21.1 million shares. The purchase price was calculated based upon the volume-weighted average sales price of a share of our common stock for the 30-day trading period ending the sixth trading day prior to completing the Merger, or $5.7326. We financed the cash portion of the Merger consideration with a combination of an $18.8 million dividend from our insurance company subsidiary, Star Insurance Company, available cash of $12.6 million, and loan proceeds of approximately $67.8 million.
As of September 30, 2008, we recorded $48.8 million in goodwill from the ProCentury merger. In addition, we recorded an increase to other intangible assets of approximately $21.0 million and $5.0 million related to agent relationships and trade names, respectively.
As of December 31, 2008, we recorded an increase to goodwill of $10.7 million from the ProCentury merger. This increase was primarily related to a $9.1 million adjustment to record a deferred tax liability
related to the other intangible assets related to the agent relationships and the trade name. The remaining increase to goodwill was primarily related to adjustments recorded to reflect updated information on certain accruals and related expenses as more refined information became available during our fourth quarter review.
capitalizing on enhanced business development capabilities by having a more comprehensive risk management offering and shared marketing platform;
On June 4, 2008, we announced the affirmation of A.M. Best Company’s financial strength rating of “A−” (Excellent) for our Insurance Company Subsidiaries.
In addition, the revenues reflect a $10.2 million increase in investment income, which primarily reflects the increase in invested assets acquired in the ProCentury merger. The remaining increase in investment income was partially the result of overall positive cash flow and the net proceeds received from our equity offering in July 2007. Slightly offsetting the increases was the $11.4 million in realized losses, primarily related to the other than temporary impairments recorded in the last half of 2008, as previously indicated.
Revenues from specialty insurance operations increased $97.1 million, or 29.4%, to $427.0 million for the year ended December 31, 2008, from $329.9 million for the comparable period in 2007.
Management fees decreased $2.8 million, or 11.7%, to $21.2 million for the year ended December 31, 2008, from $24.0 in the comparable period in 2007. This decrease was primarily the result of a decrease in fees related to our New England-based programs, primarily caused by a decrease in premium volume due to reduced rates in the self-insured markets on which the fees are based, because of mandatory rate reductions and an increase in competition.
Management fees increased $5.3 million, or 28.0%, to $24.0 million, for the year ended December 31, 2007, from $18.7 million for the comparable period in 2006. This increase was related to fees received as a result of our acquisition of the USSU business. Total fees received in 2007 as a result of the USSU acquisition
Specialty insurance operations generated pre-tax income of $47.9 million for the year ended December 31, 2007, compared to pre-tax income of $38.3 million for the year ended December 31, 2006. This increase in pre-tax income primarily reflects expansion of cash margins on our fee revenue, an increase in net investment income, increased underwriting profits, favorable development in prior accident year reserves, and a slightly lower expense ratio. The GAAP combined ratio was 95.4% for the year ended December 31, 2007, compared to 96.8% for the comparable period in 2006.
Agency operations generated pre-tax income, after the allocation of corporate overhead, of $1.1 million for the year ended December 31, 2008, compared to $2.1 million for the comparable period in 2007. The decrease in the pre-tax income is primarily attributable to the decrease in agency commission revenue mentioned above.
the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple factors.
The key assumptions used in our selection of ultimate reserves included the underlying actuarial methodologies, a review of current pricing and underwriting initiatives, an evaluation of reinsurance costs and retention levels, and a detailed claims analysis with an emphasis on how aggressive claims handling may be impacting the paid and incurred loss data trends embedded in the traditional actuarial methods. With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the years ended December 31, 2008, 2007, and 2006.
Paid and incurred loss and LAE activity includes that related to ProCentury of $247.7 million of net loss and LAE reserves added at August 1, 2008. Therefore, incurred and paid loss and LAE activity on these reserves do not constitute a full calendar year.
The projected net ultimate loss estimate for the commercial automobile line of business decreased $5.2 million, or 6.0% of net commercial automobile reserves. This net overall decrease reflects decreases of $2.8 million, $2.5 million and $501,000 in accident years 2007, 2006, and 2004, respectively. These decreases primarily reflect better than expected case reserve development on two California-based programs. These decreases were offset by an increase in the net ultimate loss estimates of $853,000 for accident year 2005 due to greater than expected claim emergence in a California-based program and an excess liability program. The change in ultimate loss estimates for all other accident years was insignificant.
The workers’ compensation residual market line of business had a decrease in net ultimate loss estimate of $2.7 million, or 10.8% of net reserves. This decrease reflects reductions of $404,000, $916,000 and $1.1 million in accident years 2007, 2006 and 2005, respectively. We record loss reserves as reported by the National Council on Compensation Insurance (“NCCI”), plus a provision for the reserves incurred but not yet analyzed and reported to us due to a two quarter lag in reporting. These changes reflect a difference between our estimate of the lag incurred but not reported and the amounts reported by the NCCI in the year. The change in ultimate loss estimates for all other accident years was insignificant.
Other administrative expenses increased $2.7 million, or 8.4%, to $35.0 million, from $32.3 million in 2007. This increase was primarily the result of slight increases in various general operating expenses, primarily due to the Merger with ProCentury. Partially offsetting this increase was a reduction in the management fee previously associated with our acquisition of USSU. In January 2008, we exercised our option to purchase the remainder of the economics related to the acquisition of the USSU business, by terminating the Management Agreement with the former owners, thereby eliminating the management fee associated with the Management Agreement.
Interest expense for 2007 includes interest related to a temporary increase in our line of credit, which was associated with borrowings to fund the cash portion of the USSU business acquisition. Upon receipt of the net proceeds from our capital raise in July 2007, we reduced this outstanding balance to zero. The average interest rate for the year ended December 31, 2007 was 8.67%, compared to 8.48% in 2006.
influence the operations of the issuer such as changes in technology or discontinuance of a business segment; (3) prospects for the issuer’s industry segment; and (4) our intent and ability to retain the investment for a period of time sufficient to allow for anticipated recovery in fair value. We evaluate our investments in securities to determine other than temporary impairment, no less than quarterly. Investments that are deemed other than temporarily impaired are written down to their estimated net fair value and the related losses recognized in operations.
For additional information regarding our other than temporary impairments and their fair value and amount of unrealized losses segregated by the time period the investment has been in an unrealized loss position, please refer to Note 3 - Investments.
subsidiaries. Earnings before interest, taxes, depreciation, and amortization from non-regulated subsidiaries were approximately $14.0 million for the year ended December 31, 2008. These earnings were available for debt service.
We have a line of credit totaling $35.0 million, of which there was no outstanding balance at December 31, 2008. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to our Insurance Company Subsidiaries to support premium growth or strategic acquisitions.
Cash flow provided by operations was $100.9 million, $88.6 million, and $74.3 million in 2008, 2007, and 2006, respectively. The increase in cash from operations reflects growth in underwriting profits, the increase in duration of our reserves, and growth in net investment income.
The underlying three-month LIBOR rate varies as a result of the interest rate reset dates used in determining the three-month LIBOR rate, which varies for each long-term debt item each quarter.
We received a total of $53.3 million in net proceeds from the issuances of the above long-term debt, of which $26.2 million was contributed to the surplus of our Insurance Company Subsidiaries and the remaining balance was used for general corporate purposes. Associated with the issuance of the above long-term debt we incurred approximately $1.7 million in issuance costs for commissions paid to the placement agents in the transactions.
We have entered into interest rate swap transactions to mitigate our interest rate risk on our existing debt obligations. We accrue for these transactions in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” as subsequently amended. These interest rate swap transactions have been designated as cash flow hedges and are deemed highly effective hedges under SFAS No. 133. In accordance with SFAS No. 133, these interest rate swap transactions are recorded at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income. The interest differential to be paid or received is accrued and recognized as an adjustment to interest expense.
Relates to our term loan, which has an effective date of July 31, 2008 and an expiration date of July 31, 2013. We are required to make fixed rate interest payments on the current balance of the term loan, amortizing in accordance with the term loan amortization schedule. We fixed only the variable interest portion of the loan. The actual interest payments associated with the term loan also include an additional rate of 2.00% in accordance with the credit agreement, as of December 31, 2008.
On July 31, 2008, we executed $100 million in senior credit facilities (the “Credit Facilities”). The Credit Facilities included a $65.0 million term loan facility, which was fully funded upon the closing of our Merger with ProCentury and a $35.0 million revolving credit facility, which was partially funded upon closing of the Merger. As of December 31, 2008, the outstanding balance on our term loan facility was $60.25 million. We did not have an outstanding balance on our revolving credit facility as of December 31, 2008. The undrawn portion of the revolving credit facility is available to finance working capital and for general corporate purposes, including but not limited to, surplus contributions to our Insurance Company Subsidiaries to support premium growth or strategic acquisitions. These Credit Facilities replaced our prior revolving credit agreement, which was terminated upon the execution of the Credit Facilities. At December 31, 2007, we did not have an outstanding balance on our former revolving line of credit.
The principal amount outstanding under the Credit Facilities provides for interest at LIBOR, plus the applicable margin, or at our option, the base rate. The base rate is defined as the higher of the lending bank’s prime rate or the Federal Funds rate, plus 0.50%, plus the applicable margin. The applicable margin is determined by the consolidated indebtedness to consolidated total capital ratio. In addition, the Credit Facilities provide for an unused facility fee ranging between twenty basis points and forty basis points, based on our consolidated leverage ratio as defined by the Credit Facilities. At December 31, 2008, the interest rate on our term loan was 5.95%, which consisted of the fixed rate of 3.95%, plus an applicable margin of 2.00%.
At December 31, 2008, shareholders’ equity was $438.2 million, or a book value of $7.64 per common share, compared to $301.9 million, or a book value of $8.16 per common share, at December 31, 2007. In
conjunction with the share consideration portion of the purchase price, we issued 21.1 million shares, or $122.7 million of new equity.
Following the close of business on July 31, 2008, our Merger with ProCentury was completed. In accordance with the Merger Agreement, the stock price used in determining the final cash and share consideration portion of the purchase price was based on the volume-weighted average sales price of a share of Meadowbrook common stock for the 30-day trading period ending on the sixth trading day before the completion of the Merger, or $5.7326. Based upon the final proration, the total purchase price was $227.2 million, of which $99.1 million consisted of cash, $122.7 million in newly issued common stock, and approximately $5.4 million in transaction related costs. The total number of new common shares issued for purposes of the stock portion of the purchase price was 21.1 million shares.
The Merger was accounted for under the purchase method of accounting, which resulted in goodwill of $48.8 million equaling the excess of the purchase price over the fair value of identifiable assets. Goodwill is not amortized, but is subject to at least annual impairment testing. Identifiable intangibles of $21.0 million and $5.0 million were recorded related to agent relationships and trade names, respectively.
As of December 31, 2008, we recorded an increase to goodwill of $10.7 million. This increase was primarily related to a $9.1 million adjustment on the holding company to a deferred tax liability related to the other intangible assets related to the agent relationships and the trade name. The remaining increase to goodwill was primarily related to adjustments recorded to reflect updated information on certain accruals and related expenses as more refined information became available during the fourth quarter of 2008.
Effective January 31, 2008, we exercised our option to purchase the remainder of the economics related to the acquisition of the USSU business in April 2007, by terminating the Management Agreement for a payment of $20.9 million. As a result, we recorded an increase to other intangible assets of approximately $4.9 million and an increase to goodwill of approximately $16.0 million.
Adjustment to include pre-tax income from total fee-for-service income is calculated by dividing total fee-for-service income by net earned premiums.
Our Insurance Company Subsidiaries are required to maintain certain deposits with regulatory authorities, which totaled $100.9 million and $115.2 million at December 31, 2008 and 2007, respectively.
The following table is a summary of our contractual obligations and commitments as of December 31, 2008 (in thousands):
Five year call feature associated with debentures, estimated seven year repayment. For a description of our debentures and related interest rate terms, as well as actual rates in accordance with our interest rate swap transactions, refer to Note 8 - Debt and Note 9 - Derivative Instruments.
award. There were no accounting adjustments as a result of the amendment as there were no changes to the underlying plan, only an adjustment to the performance period.
Both the Bonus Plan and the LTIP are administered by the Compensation Committee and all awards are reviewed and approved by the Board of Directors at both inception and at distribution.
At December 31, 2008, each of our Insurance Company Subsidiaries was in excess of any minimum threshold at which corrective action would be required.
$6.3 million as a result of the intercompany pooling. Excluding the intercompany pooling, this ratio would have been within the usual range for 2008.
In regard to our excess-of-loss reinsurance, we manage our credit risk on reinsurance recoverables by reviewing the financial stability, A.M. Best rating, capitalization, and credit worthiness of prospective or existing reinsurers. We generally do not seek collateral where the reinsurer is rated “A−” or better by A. M. Best, has $500 million or more in surplus, and is admitted in the state of Michigan. The following table sets forth information relating to our five largest unaffiliated excess-of-loss reinsurers based upon ceded premium as of December 31, 2008:
In December 2005, we entered into a $6.0 million convertible note receivable with an unaffiliated insurance agency. The effective interest rate of the convertible note is equal to the three-month LIBOR, plus 5.2% and is due December 20, 2010. This agency has been a producer for us for over ten years. As security for the loan, the borrower granted us a security interest in its accounts, cash, general intangibles, and other intangible property. Also, the shareholder then pledged 100% of the common shares of three insurance agencies, the common shares owned by the shareholder in another agency, and has executed a personal guaranty. This note is convertible upon our option based upon a pre-determined formula. The conversion feature of this note is considered an embedded derivative pursuant to SFAS No. 133, and therefore is accounted for separately from the note. At December 31, 2008, the estimated fair value of the derivative is not material to the financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities the option to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis as of specified election dates. This election is irrevocable as to specific assets and liabilities. The objective of SFAS No. 159 is to improve financial reporting and reduce the volatility in reported earnings caused by measuring related assets and liabilities differently. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We did not elect the fair value option for existing eligible items under SFAS No. 159; therefore it did not impact our consolidated financial condition or results of operations.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” SFAS No. 141(R) provides revised guidance on how an acquirer recognizes and measures in its financial statements, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. In addition, it provides revised guidance on the recognition and measurement of goodwill acquired in the business combination. SFAS No. 141(R) 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 business combinations completed on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, or January 1, 2009. We do not expect the provisions of SFAS No. 141(R) to have a material impact on our consolidated financial condition or results of operations.
At December 31, 2008 and 2007, we held an $852,000 and $870,000 note receivable from one of our executive officers, including $191,000 and $209,000 of accrued interest, respectively. This note arose from a transaction in late 1998 in which we loaned the officer funds to exercise 64,718 common stock options to cover the exercise price and the taxes incurred as a result of the exercise. The note bears interest equal to the rate charged pursuant to our revolving credit agreement and is due on demand any time after January 1, 2002. As of December 31, 2008, the rate was 3.42%. The loan is partially collateralized by 64,718 shares of our common stock under a stock pledge agreement. For the years ended December 31, 2008 and 2007, $43,800 and $43,800, respectively, have been paid against the loan. As of December 31, 2008, the cumulative amount that has been paid against this loan was $206,600. Refer to Note 20 - Related Party Transaction for further information.
Refer to list of Financial Statement Schedules and Note 22 - Quarterly Financial Data (Unaudited) of the Notes to the Consolidated Financial Statements.