American Southern leases space for its office in a building located in Atlanta, Georgia. The lease term expires January 31, 2010. Under the terms of the lease, American Southern occupies approximately 17,014 square feet.
Self Insurance Administrators, Inc. (“SIA”), a non-insurance subsidiary of the Company, leases space for its office in a building located in Duluth, Georgia. The lease term expires March 31, 2008. Under the terms of the lease, SIA occupies 2,266 square feet.
Represents a cumulative effect of change in accounting principle with respect to the adoption of Statement of Financial Accounting Standards No. 142 regarding goodwill. See Note 1 of Notes to Consolidated Financial Statements.
The following is management’s discussion and analysis of the financial condition and results of operations of Atlantic American Corporation (“Atlantic American” or the “Parent”) and its subsidiaries (collectively, the “Company”) for each of the three years in the period ended December 31, 2005. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein.
Atlantic American is an insurance holding company whose operations are conducted through a group of regional insurance companies: American Southern Insurance Company and American Safety Insurance Company (together known as “American Southern”); Association Casualty Insurance Company and Association Risk Management General Agency, Inc. (together known as “Association Casualty”); Georgia Casualty & Surety Company (“Georgia Casualty”); and Bankers Fidelity Life Insurance Company (“Bankers Fidelity”). Each operating company is managed separately based upon the geographic location or the type of products offered; although management is conforming information systems, policies and procedures, products, marketing and other functions between Association Casualty and Georgia Casualty to create a southern “regional” property and casualty operation and increase efficiencies.
The accounting and reporting policies of Atlantic American and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and, in management’s belief, conform to general practices within the insurance industry. The following is an explanation of the Company’s accounting policies and the resultant estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual results could differ from management’s initial estimates. Atlantic American does not expect that changes in the estimates determined using these policies will have a material effect on the Company’s financial condition or liquidity, although changes could have a material effect on its consolidated results of operations.
Deferred acquisition costs comprised 6% of the Company’s total assets at December 31, 2005. Deferred acquisition costs are commissions, premium taxes, and other costs that vary with and are primarily related to the acquisition of new and renewal business and are generally deferred and amortized. The deferred amounts are recorded as an asset on the balance sheet and amortized to income in a systematic manner. Traditional life insurance and long-duration health insurance deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing the related liability for policy benefit reserves. The deferred acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance). Assessments of recoverability for property and casualty and short-duration health insurance are extremely sensitive to the estimates of a subsequent year’s projected losses related to the unearned premiums. Projected loss estimates for a current block of business for which unearned premiums remain to be earned may vary significantly from the indicated losses incurred in any given previous calendar year.
Receivables are amounts due from reinsurers, insureds and agents and comprised 21% of the Company’s total assets at December 31, 2005. Insured and agent balances are evaluated periodically for collectibility. Annually, the Company performs an analysis of the credit worthiness of the Company’s reinsurers using various data sources. Failure of reinsurers to meet their obligations due to insolvencies or disputes could result in uncollectible amounts and losses to the Company. Allowances for uncollectible amounts are established, as and when a loss has been determined probable, against the related receivable. Losses are recognized when determined on a specific account basis and a general provision for loss is made based on the Company’s historical experience.
Cash and investments comprised 69% of the Company’s total assets at December 31, 2005. Substantially all investments are in bonds and common and preferred stocks, which are subject to significant market fluctuations. The Company carries all investments as available for sale and accordingly at their estimated fair values. The Company owns certain non-redeemable preferred stocks that do not have quoted values and are carried at estimated fair values as determined by management. Such values inherently have a greater degree of judgement and uncertainty and therefore ultimately greater price volitility. On occasion, the value of an investment may decline to a value below its amortized purchase price and remain at such value for an extended period of time. When an investment’s indicated fair value has declined below its cost basis for a period of time, primarily due to changes in credit risk, the Company evaluates such investment for other than a temporary impairment. If other than a temporary impairment is deemed to exist, then the Company will write down the amortized cost basis of the investment to its estimated fair value. While such write down does not impact the reported value of the investment in the Company’s balance sheet, it is reflected as a realized investment loss in the Company’s consolidated statements of operations.
$2.2 million and $0.4 million in 2004 and 2003, respectively. Also contributing to the reduced net income in 2005 were several significant losses which resulted from an increase in both the frequency and severity of claims in the property and casualty operations, as described below. In addition, during 2005, net income increased by a $0.1 million deferred income tax benefit, compared to a similar $1.3 million and $1.5 million deferred income tax benefit in 2004 and 2003, respectively, all of which were related to adjustments to the Company’s income tax valuation allowance. The adjustments to the valuation allowance were the result of the annual reassessment of the realization of net operating loss carryforwards. Further, during 2005, the Company was directly impacted by four hurricanes, Dennis, Katrina, Rita and Wilma, all of which resulted in net hurricane related expenses of $2.3 million in the property and casualty operations, compared to $3.8 million in net hurricane related expenses incurred during 2004. The decrease in net income during 2004 from 2003 was primarily due to the hurricane related expenses of $3.8 million in the property and casualty operations as well as a $3.1 million reinsurance premium accrual related to the settlement of an arbitration proceeding between Georgia Casualty and a former reinsurance provider. The Company’s 2004 financial results were directly impacted by insured losses caused by four hurricanes, Charlie, Frances, Ivan, and Jeanne, all of which inflicted substantial damage, primarily in Florida. Also, during 2004, the Company recognized no tax benefit related to prior years’ alternative minimum tax payments; however, in 2003, the Company recognized a tax benefit of approximately $1.0 million related to such amounts.
Gross written premiums at American Southern increased $1.8 million, or 3.0%, during 2005 as compared to 2004. The increase in premiums was primarily attributable to increased business writings in the surety line of business. American Southern’s surety bond program, which began to increase production levels in the second half of 2004, generated $10.1 million in gross written premiums during 2005 compared to $6.3 million in 2004, a $3.8 million increase. Partially offsetting this increase was the loss of several
large commercial automobile liability accounts and the withdrawal from the dwelling property business, all of which had contributed approximately $2.9 million in written premiums during 2004.
Gross written premiums at American Southern increased $15.9 million, or 35.8%, during 2004 as compared to 2003. The increase in premiums was primarily attributable to new business opportunities in 2004 subsequent to the loss of American Southern’s largest account upon its contractual termination on April 30, 2003. This contract had previously represented annualized premiums of $14.3 million, or approximately 10% of annualized premium revenue for Atlantic American. In addition, American Southern generated new business and premium growth through new agency appointments and established agents.
The combined ratio for American Southern decreased to 93.6% in 2005 from a combined ratio of 94.2% in 2004. The loss ratio decreased to 48.2% in 2005 from 51.6% in 2004. The increased focus on new business writings in the general liability and surety lines of business resulted in a decrease in the 2005 loss ratio due to favorable loss experience in those lines of business. Also, during 2004, American Southern incurred, and its loss ratio was impacted by, $1.0 million in hurricane related expenses, which did not reoccur in 2005. The expense ratio for 2005 increased to 45.4% from 42.6% in 2004. The increase in the
the quota share reinsurance agreement with Georgia Casualty effective August 31, 2005. Further, effective September 1, 2005, Association Casualty no longer ceded any portion of its business to Georgia Casualty, which is expected to offset the decrease in premiums that resulted from the terminated quota share reinsurance agreement discussed previously. In addition, Association Casualty continues to experience an increased level of price competition in the Texas marketplace resulting in a decline in Texas direct written premiums. Direct written premium in other southeastern states has, to date, offset declines in Texas direct written premiums.
Ceded premiums at Association Casualty increased $0.1 million, or 2.6%, during 2004 as compared to 2003. Excluding assumed written premiums of $5.9 million and $3.6 million in 2004 and 2003, respectively, that were not subject to reinsurance, premiums ceded as a percentage of direct written premiums increased to 21.1% in 2004 from 19.7% in 2003 primarily due to changes in the mix of business and an average increase in overall rates.
The combined ratio for Association Casualty decreased to 101.5% in 2005 from 102.2% in 2004. The loss ratio decreased to 59.2% in 2005 from 60.8% in 2004. The decrease in the loss ratio was primarily due to a decline in the overall number of claims reported in 2005 and the severity of those claims as compared to 2004. However, Association Casualty’s loss ratio during 2005 was impacted by an increasing number of construction defect claims on liability policies, which increased loss adjustment expenses and produced a higher than targeted loss ratio. The expense ratio increased to 42.3% in 2005 from 41.4% in 2004 primarily due to an increase in premium tax rates. Effective September 1, 2005, Association Casualty no longer ceded any portion of its business to Georgia Casualty. This business, now being retained by Association Casualty, has premium tax rates that approximate up to 4% compared to its previous average rate of 2.8%.
Also contributing to the increase in the expense ratio was the decrease in net earned premiums coupled with a consistent level of fixed expenses.
The combined ratio for Association Casualty decreased to 102.2% in 2004 from 114.9% in 2003. The loss ratio decreased to 60.8% in 2004 from 74.9% in 2003. The decrease in the loss ratio was primarily attributable to an extensive re-underwriting of the workers’ compensation book of business that began in 2002. Association Casualty benefited from these initiatives and has continued to diversify its book of business and improve underwriting criteria. The expense ratio increased to 41.4% in 2004 from 40.0% in 2003 primarily due to increased data processing and conversion costs associated with the conversion of Association Casualty’s underlying information systems to mirror those of Georgia Casualty.
Additionally, in 2005, Georgia Casualty accrued hurricane related expenses of $0.9 million in catastrophic reinsurance reinstatement premiums, compared to $1.4 million in the same periods of 2004, which consisted of $0.5 million in catastrophic reinsurance reinstatement premiums and $0.9 million for the reinsurance provisional rate adjustment. Offsetting the decrease in ceded premiums were increased rates from new reinsurance treaty agreements that became effective on January 1, 2005. Ceded premiums increased by approximately $3.2 million due to 2005 rate increases. Prior to 2005, Georgia Casualty’s primary working layer reinsurance contract provided for variable pricing based upon the company’s actual loss experience; beginning in 2005 all of the company’s reinsurance contracts provide for fixed rate pricing. Georgia Casualty has accrued additional reinsurance charges in 2005 related to prior years’ reinsurance contracts with experience rated variable pricing based on current year development of prior accident year claims.
The combined ratio for Georgia Casualty decreased to 123.9% in 2005 from 128.4% in 2004. The loss ratio decreased to 81.6% in 2005 from 82.7% in 2004. The decrease in the loss ratio was primarily due to a decrease in hurricane related losses. During 2005, Georgia Casualty incurred $1.0 million in net hurricane related losses compared to $1.4 million in 2004. However, Georgia Casualty’s loss ratio during 2005 was impacted by a significant increase in both the frequency and severity of claims particularly in the first quarter of 2005. In 2005, Georgia Casualty incurred numerous large claims related to losses for fires, fatalities, and tornados. The magnitude and frequency of these claims had a significant impact on the 2005 loss ratio. Management has undertaken a comprehensive review of the existing book of business and, based on recent experience, has non-renewed several significant pieces of business, revised underwriting guidelines, and, in one instance, cancelled a significant insured in mid-term in accordance with the terms of the policy. While the impact of such actions is not immediately apparent, management expects improved results on a longer term basis. The expense ratio decreased to 42.3% in 2005 from 45.7% in 2004. The decrease in the expense ratio was primarily due to a consistent level of fixed expenses coupled with an increase in net earned premiums.
The combined ratio for Georgia Casualty increased to 128.4% in 2004 from 106.1% in 2003. The loss ratio increased to 82.7% in 2004 from 64.9% in 2003. The increase in the loss ratio was primarily attributable to hurricane related losses in the state of Florida that increased net losses by $1.4 million during 2004. Such losses did not occur in 2003. Also in 2004, Georgia Casualty incurred several additional large losses other than the hurricane related losses discussed previously. The expense ratio increased to 45.7% in 2004 from 41.2% in 2003. The increase in the expense ratio was due to several factors. First, during 2004, Georgia Casualty had a reduction in reinsurance profit sharing commissions of $0.4 million, which had been recognized in prior years, due to deteriorating loss experience from a number of similar claims specifically related to one accident year. Also, during 2003 there was a reversal of Georgia Casualty’s accrued 2002 policyholder dividend. The $0.4 million policyholder dividend liability was reversed due to substandard results from the workers’ compensation business in the states of Florida and Georgia, which decreased expenses in 2003 and resulted in a comparative increase to expenses in 2004. In addition, the PMA Re arbitration award of $3.1 million and the hurricane related reinsurance expense accruals of $1.4 million that occurred in 2004 decreased net earned premiums and, as a result, increased both the loss ratio and the expense ratio for 2004.
Premium revenue at Bankers Fidelity increased $2.8 million, or 4.4%, during 2004 as compared to 2003. The Medicare supplement line of business increased $3.4 million, or 7.3%, in 2004 over 2003 and accounted for 76% of total 2004 earned premiums. In 2004, the company’s key states in terms of premium revenue were Georgia, Pennsylvania, Ohio, Utah and West Virginia, which collectively accounted for approximately 58% of total earned premium for 2004. The Medicare supplement line of business in these states increased approximately $3.1 million as compared to 2003. Significant rate increases on existing Medicare supplement business that were implemented in varying amounts by state and plan in 2003 resulted in increased revenues in 2004. Premiums from the life insurance line of business decreased $0.6 million, or 4.5%, during 2004 due to a decline in sales related activities.
The increase in both “benefits and losses” and “underwriting expenses” during 2005 and 2004 was primarily attributable to the increase in premiums for those periods. As a percentage of premiums, benefits and losses were approximately 70.0% for all years presented. Rate increases implemented by Bankers Fidelity during both 2005 and 2004 on the Medicare supplement line of business have helped to mitigate the impact of higher medical costs.
Investment income of $16.7 million increased $0.8 million, or 5.2%, during 2005 as compared to 2004. The increase in investment income during 2005 was primarily due to a higher level of average invested assets in addition to a higher average yield on investments. Investment income of $15.9 million increased slightly by $0.2 million, or 1.5%, during 2004 over 2003.
While the impairments did not impact the carrying value of the investments, they resulted in realized losses of $10.8 million in 2005, $0.5 million in 2004, and $1.2 million in 2003. The impairment losses for 2005 were due primarily to the write down of the value of GM, GMAC, and Ford fixed maturity
The major cash needs of the Company are for the payment of claims and operating expenses, maintaining adequate statutory capital and surplus levels, and meeting debt service requirements. Current and expected patterns of claim frequency and severity may change from period to period but generally are expected to continue within historical ranges. The Company’s primary sources of cash are written premiums, investment income and the sale and maturity of invested assets. The Company believes that, within each subsidiary, total invested assets will be sufficient to satisfy all policy liabilities and that cash inflows from investment earnings, future premium receipts and reinsurance collections will be adequate to fund the payment of claims and expenses as needed. Cash flows at the Parent are derived from dividends, management fees, and tax sharing payments from the subsidiaries. The cash needs of the Parent are for the payment of operating expenses, the acquisition of capital assets and debt service requirements.
The Parent provides certain administrative, purchasing and other services to each of its subsidiaries. The amounts charged to and paid by the subsidiaries was $9.8 million, $9.0 million, and $7.6 million in 2005, 2004, and 2003, respectively. In addition, the Parent has a formal tax-sharing agreement with each of its insurance subsidiaries. A net total of $3.1 million, $4.5 million and $0.9 million was paid to the Parent under the tax sharing agreements in 2005, 2004, and 2003, respectively. Dividends were paid to Atlantic American by its subsidiaries totaling $13.2 million in 2005, $5.8 million in 2004, and $5.7 million in 2003. As a result of the Parent’s tax loss carryforwards, which totaled approximately $14.3 million at December 31, 2005, it is anticipated that the tax sharing agreements will continue to provide the Parent with additional funds with which to meet its cash flow obligations.
At December 31, 2005, the Company’s $51.5 million of borrowings consisted of $10.3 million of bank debt (the “Term Loan”) with Wachovia and an aggregate of $41.2 million of outstanding junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”). The Term Loan requires the Company to pay $0.5 million in principal on June 30 and $1.3 million in principal on December 31 in each of 2006 and 2007, with one final payment of $6.8 million at maturity on June 30, 2008. The interest rate on the Term Loan is equivalent to three-month LIBOR plus an applicable margin, and was 6.53% at December 31, 2005. The margin varies based upon the Company’s leverage ratio (debt to total capitalization, each as defined) and ranges from 1.75% to 2.50%. The Term Loan requires the Company to comply with certain covenants including, among others, ratios that relate funded debt, as defined, to total capitalization and earnings before interest, taxes, depreciation, and amortization (“EBITDA”), as well as the maintenance of minimum levels of tangible net worth. The Company must also comply with limitations on capital expenditures, additional debt obligations, equity repurchases and redemptions, as well as minimum risk-based capital levels. During 2005, in accordance with the Term Loan, the Company repaid $1.8 million in principal, thereby reducing the outstanding principal amount of the Term Loan to $10.3 million at December 31, 2005. On February 28, 2006, the Company entered into a $3.0 million credit agreement with Wachovia. This new credit agreement (the “Second Term Loan”), the proceeds of which were used for general corporate purposes, matures on April 1, 2007, has the same interest rate, covenants and collateral as the Term Loan. Effective December 31, 2005, and February 28, 2006, the Term Loan and the Second Term Loan, respectively, were amended. The amendments were necessitated by the recorded impairment charge taken on the Company’s automotive sector fixed maturity investments previously discussed. Approximately $5.3 million of the total $10.7 million impairment charge was the result of an impairment in the value of the Company’s investment in General Motors bonds. The amendments to the Term Loan and Second Term Loan provide that the definition of consolidated net
income, as calculated for the fourth quarter of 2005, excludes the $5.3 million GM bond impairment. Further, the definition of consolidated tangible net worth was amended to exclude the after-tax impact of the same impairment. After giving effect to the amendment to the December 31, 2005 ratio of funded debt to EBITDA, both as defined, the Company was in compliance with the amended agreements. Various provisions contained in the amendments extend through 2006, and the Company believes it will be in compliance with all such provisions in future periods.
The Company has formed two statutory business trusts which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trusts and investing the gross proceeds of the trust preferred securities in Junior Subordinated Debentures. The outstanding $41.2 million of Junior Subordinated Debentures mature in 2032 and 2033, respectively, are callable, in whole or in part, only at the option of the Company five years after their respective dates of issue and quarterly thereafter, and have an interest rate of three-month LIBOR plus an applicable margin. The margin ranges from 4.00% to 4.10%. At December 31, 2005, the effective interest rate was 8.44%. The obligations of the Company with respect to the issuances of the trust preferred securities represent a full and unconditional guarantee by the Parent of each trust’s obligations with respect to the trust preferred securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer Junior Subordinated Debenture interest payments, which would result in a deferral of distribution payments on the related trust preferred securities.
At December 31, 2005, the Company had one series of preferred stock outstanding, substantially all of which was held by affiliates of the Company’s chairman and principal shareholders. The outstanding shares of Series B Preferred Stock (“Series B Preferred Stock”) have a stated value of $100 per share; accrue annual dividends at a rate of $9.00 per share and are cumulative; in certain circumstances may be convertible into an aggregate of approximately 3,358,000 shares of common stock; and are redeemable at the Company’s option. The Series B Preferred Stock is not currently convertible. At December 31, 2005, the Company had accrued, but unpaid, dividends on the Series B Preferred Stock totaling $12.1 million.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123R requires all companies to recognize compensation costs for share-based payments to employees based on the grant-date fair value of the award for financial statements. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. The transition methods include both prospective and retrospective adoption options. The Company will adopt SFAS No. 123R during the first quarter of 2006 using the prospective method, which requires that compensation expense be recorded for all unvested stock-based awards, including those granted prior to adoption of the fair value recognition provisions of SFAS No. 123, at the beginning of the first quarter of adoption of SFAS No. 123R. Currently, the Company does not expect the adoption of SFAS 123R to have a material impact on its financial condition or results of operations. The further effect of adoption of SFAS 123R on future operating results will depend on the levels of share-based payments granted in the future, the groups of employees to whom awards are granted, the terms of any future awards, as well as the final methods and assumptions used to determine the fair value of those share-base payments.
In the normal course of business, the Company has structured borrowings that, in accordance with U.S. GAAP, are recorded on the Company’s balance sheet at an amount that differs from the ultimate contractual obligation. See Note 6 of Notes to Consolidated Financial Statements.
Interest payable is based on interest rates as of December 31, 2005 and assumes that all debt remains outstanding until its stated contractual maturity. The interest rates on outstanding bank debt and trust preferred obligations are variable and are equal to three-month LIBOR plus an applicable predetermined margin.
Losses and claims include case reserves for reported claims and reserves for claims incurred but not reported (“IBNR”). While payments due on claim reserves are considered contractual obligations because they relate to insurance policies issued by the Company, the ultimate amount to be paid to settle both case reserves and IBNR reserves is an estimate, subject to significant uncertainty. The actual amount to be paid is not determined until the Company reaches a settlement with any applicable claimant. Final claim settlements may vary significantly from the present estimates, particularly since many claims will not be settled until well into the future. In estimating the timing of future payments by year, the Company has assumed that its historical payment patterns will continue. However, the actual timing of future payments will likely vary materially from these estimates due to, among other things, changes in claim reporting and payment patterns and large unanticipated settlements. Amounts reflected do not include reinsurance amounts which may also be recoverable based on the level of ultimate sustained loss.
Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2005
Life insurance premiums are recognized as revenues when due; accident and health premiums are recognized over the premium paying period and property and casualty insurance premiums are recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. Benefits and expenses are associated with premiums as they are earned so as to result in recognition of profits over the lives of the contracts. For traditional life insurance and long-duration health insurance, this association is accomplished by the provision of a future policy benefits reserve and the deferral and subsequent amortization of the costs of acquiring business, “deferred policy acquisition costs” (principally commissions, premium taxes, and other expenses of issuing policies). Deferred policy acquisition costs are amortized over the estimated premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. The Company provides for insurance benefits and losses on accident, health, and property-casualty claims based upon estimates of projected ultimate losses. The deferred policy acquisition costs for property and casualty insurance and short-duration health insurance are amortized over the effective period of the related insurance policies. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future premiums (for traditional life and long-duration health insurance) and from the related unearned premiums and investment income (for property and casualty and short-duration health insurance).
Goodwill represents the excess of cost over fair value of net assets acquired. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized. The Company periodically reviews its goodwill to determine if any adverse conditions exist that could indicate impairment. Conditions that could trigger impairment include, but are not limited to, a significant change in business climate that could affect the value of the related asset, an adverse action, or an assessment by a regulator. No impairment of the Company’s recorded goodwill was identified during any of the periods presented.
Stock options are reported under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” instead of the fair value approach recommended in SFAS No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” Accordingly, no stock-based employee compensation cost attributable to stock options is reflected in net income, as all stock options granted have an exercise price equal to the market value of the underlying common stock on the date of grant. Pro forma net income (loss) and net income (loss) per common share were determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using an options pricing model, which requires the input of subjective assumptions, including the volatility of the stock price. If the
In May 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and SFAS No. 3”. SFAS 154 applies to all voluntary changes in accounting principles and changes the requirements of accounting for and reporting a change in accounting principle and is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless such application is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income, in the period of the change, the cumulative effect of change to the new accounting principle. The Company expects to adopt SFAS 154 on its effective date.
Bonds and short-term investments having an amortized cost of $17,861 and $17,194 were on deposit with insurance regulatory authorities at December 31, 2005 and 2004, respectively, in accordance with statutory requirements.
Securities with unrealized losses at December 31, 2005 and 2004 were as follows:
Excluding U.S. Treasury securities and obligations of U.S. Government agencies and authorities, the change in value of which is deemed solely related to interest rate movements; the Company held investments in less than 30 and 20 issuers which had unrealized investment losses at December 31, 2005 and 2004, respectively. At December 31, 2005, the Company had investments exceeding $1,000 in the redeemable preferred stocks of JP Morgan Chase and Viacom with temporary impairments not exceeding 7% of the carrying value. At December 31, 2004, the Company had one corporate security investment in Converium, a Swiss based independent international multi-line reinsurer, with a temporary impairment exceeding 10% of the carrying value. The Company continues to monitor these, and all other investments, but believes the impairment to be temporary.
During the years ended, December 31, 2005, 2004, and 2003, the Company recorded impairments related to the following investments.
The Company’s investment in the common stock of Wachovia Corporation exceeded 10% of shareholders’ equity at December 31, 2005. The carrying value of this investment at December 31, 2005 was $22,867 with a cost basis of $4,229.
The Company’s bond portfolio included 90% investment grade securities at December 31, 2005 as defined by the NAIC.
Liabilities for life insurance future policy benefits are based upon assumed future investment yields, mortality rates, and withdrawal rates after giving effect to possible risks of adverse deviation. The assumed mortality and withdrawal rates are based upon the Company’s experience. The interest rates assumed for life, accident and health are generally: (i) 2.5% to 5.5% for issues prior to 1977, (ii) 7% graded to 5.5% for 1977 through 1979 issues, (iii) 9% for 1980 through 1987 issues, and (iv) 5% to 7% for 1988 and later issues.
Prior years development, as reported in 2005, was primarily the result of better than expected development on prior years IBNR reserves for Medicare supplement and certain American Southern business.
Deferred tax liabilities and assets at December 31, 2005 and 2004 were comprised of the following:
rate of 5.85% on LIBOR and adjusts quarterly on the 4th of each March, June, September and December through termination on March 4, 2013.
The Company has both a funded and unfunded noncontributory defined benefit pension plan covering the employees of American Southern. The plans provide defined benefits based on years of service and average salary. The Company’s general funding policy is to contribute annually the maximum amount that can be deducted for income tax purposes. The measurement date for these plans was December 31, of each year.
Net periodic pension cost for the Company’s qualified and non-qualified defined benefit plans for the years ended December 31, 2005, 2004 and 2003 included the following components:
The Company expects to contribute $184 for all defined benefit plans in 2006.
Estimated future benefit payments as of December 31, 2005 were as follows:
The Company had 134,000 shares of Series B Preferred Stock (“Series B Preferred Stock”) outstanding at December 31, 2005 and 2004, having a stated value of $100 per share. Annual dividends on the Series B Preferred Stock are $9.00 per share and are cumulative. Dividends accrue whether or not declared by the Board of Directors. The Series B Preferred Stock is not currently convertible, but may become convertible into shares of the Company’s common stock under certain circumstances. In such event, the Series B Preferred Stock would be convertible into an aggregate of approximately 3,358,000 shares of the Company’s common stock at a conversion rate of $3.99 per share. The Series B Preferred Stock is redeemable at the option of the Company. As of December 31, 2005 and 2004, the Company had accrued but unpaid dividends on the Series B Preferred Stock of $12,060 and $10,854, respectively.
In 2005, all outstanding options were excluded from the earnings per share calculation since their impact was antidiluted. Average outstanding options of 59,000 and 335,000 were excluded from the earnings per common share calculation in 2004 and 2003, respectively, since their impact was antidilutive. The assumed conversion of the preferred stock was also excluded from the earnings per common share calculation, as applicable, for all years presented since its impact was antidilutive.
The assets, liabilities and results of operations have been reported on the basis of GAAP, which varies from statutory accounting practices (“SAP”) prescribed or permitted by insurance regulatory authorities. The principal differences between SAP and GAAP are that under SAP: (i) certain assets that are non-admitted assets are eliminated from the balance sheet; (ii) acquisition costs for policies are expensed as incurred, while they are deferred and amortized over the estimated life of the policies under GAAP;
(iii) the provision that is made for deferred income taxes is different than under GAAP; (iv) the timing of establishing certain reserves is different than under GAAP; and (v) valuation allowances are established against investments.
Does not include 2005 automotive sector impairments which will be recorded in the first quarter of 2006 for statutory purposes.
Under the insurance code of the state of jurisdiction under which each insurance subsidiary operates, dividend payments to the Parent by its insurance subsidiaries are subject to certain limitations without the prior approval of the applicable state’s Insurance Commissioner. The Parent received dividends of $13,242, $5,803 and $5,728 in 2005, 2004, and 2003, respectively, from its subsidiaries. In 2006, dividend payments by insurance subsidiaries in excess of $15,716 would require prior approval.
Financing for the Company has been provided through affiliates of the Company or its Chairman, in the form of the Series B Preferred Stock (See Note 10).
The Company has made mortgage loans to finance properties owned by Leath Furniture, LLC (“Leath”), which is owned by an affiliate of the Chairman. At December 31, 2005 and 2004, the balance of mortgage loans owed by Leath to the Company’s insurance subsidiary was $1,941 and $2,997, respectively. For 2005, 2004, and 2003, interest paid by Leath on the mortgage loans totaled $250, $285, and $299, respectively.
Certain members of management are shareholders and on the Board of Directors of Triple Crown Media, Inc (“Triple Crown”) and Gray Television, Inc. (“Gray”). On August 3, 2005, Gray announced a plan to spin-off its newspaper publishing and wireless businesses to its shareholders. The new company formed as a result of the spin-off, Triple Crown, then acquired Bull Run Corporation (“Bull Run”). In connection with the spin-off, the Company received one share of Triple Crown common stock for every ten shares of Gray common stock and for every ten shares of Gray Class A common stock owned. In connection with the Bull Run acquisition, the Company received 0.0289 shares of Triple Crown common stock for each share of Bull Run common stock owned by it and Triple Crown Series A preferred stock in exchange for the shares of Bull Run Series D preferred stock. The exchange of Bull Run Series D preferred stock for Triple Crown Series A preferred stock resulted in a realized loss of $591. At December 31, 2005, the Company owned 54,734 shares of Triple Crown common stock, 388,060 shares of Gray Class A common stock and 106,000 shares of Gray common stock. At December 31, 2004, the
Company owned 184,337 shares of Bull Run, 376,060 shares of Gray Class A common stock, and 106,000 shares of Gray common stock. At December 31, 2005, the Company owned 350 shares of Gray Series C preferred stock and 2,360 shares of Triple Crown Series A preferred stock. At December 31, 2004, the Company owned 350 shares of Gray Series C preferred stock and 2,000 shares of Bull Run Series D preferred stock. The aggregate carrying value of these investments in Triple Crown and Gray at December 31, 2005 was $2,139 and $8,021, respectively. The aggregate carrying value of these investments in Bull Run and Gray at December 31, 2004 was $2,083 and $10,464, respectively.
The fair value estimates as of December 31, 2005 and 2004 were based on pertinent information available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, current estimates of fair value may differ significantly from amounts that might ultimately be realized.