(3) The sum of net losses, loss adjustment expenses and policy acquisition and other underwriting expenses divided by net premiums earned. A combined ratio of less than 100% means a company is making an underwriting profit.
(4) The ratio of net premiums written divided by ending statutory surplus.
The paid loss development method is mechanically identical to the incurred loss development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections. The validity of the results from using this development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in a company’s mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimates. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques.
Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss adjustment expenses will likely differ from the amount recorded at December 31, 2010.
The following table shows the breakdown of our gross loss reserves between reported losses and IBNR losses by segment (in thousands):
The following table shows the activity in the loss and LAE reserve balances of the Company for the years ended December 31, 2010, 2009 and 2008, prepared in accordance with accounting principles generally accepted in the United States of America.
The following table shows the development of our reserves for unpaid losses and LAE on a GAAP basis for each of the years ended December 31, from 2000 to 2010. The line in the table titled “Net liability for loss and LAE,” shows the initial reserves at the balance sheet date, including losses and LAE incurred but not reported. The portion of the table titled “Cumulative net paid as of,” shows the cumulative amounts subsequently paid as of successive years with respect to the reserve shown at the top of the table. The portion of the table titled “Re-estimated net liability as of:” shows the re-estimated amount of the previously reported liability for loss and LAE based on experience as of the end of each succeeding year. The estimates of liability for loss and LAE change as more information becomes available about the frequency and severity of claims for individual years. A redundancy (or deficiency) exists when the re-estimated amount of liability at each December 31 is less (or greater) than the prior liability estimate. The “Net cumulative redundancy (deficiency)” depicted in the table, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years and does not present accident year loss development. The portion of the table titled “Gross liability end of year” shows the impact of reinsurance for the years shown, reconciling the net reserves in the upper portion of the table to gross reserves. In evaluating the re-estimated liability and cumulative redundancy (deficiency), it should be noted that each data point includes the effects of changes in amounts for prior periods. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
Investments. At December 31, 2010 and 2009, all of the Company’s investments are classified as available-for-sale and are those investments that would be available to be sold in response to the Company’s liquidity needs, changes in market interest rates and asset-liability management strategies, among others. Available-for-sale investments are recorded at fair value, with the corresponding unrealized appreciation or depreciation, net of deferred income taxes, reported as a component of accumulated other comprehensive income or loss until realized.
The Company reviews the status and market value changes of its investment portfolio on at least a quarterly basis during the year, and any provisions for other-than-temporary impairments in the portfolio’s value are evaluated and established at each quarterly balance sheet date. When a fixed maturity security has a decline in value, where fair value is below amortized cost, an OTTI write-down is triggered in circumstances where (1) the Company has the intent to sell the security, (2) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell the security or if it is more-likely-than-not the Company will be required to sell the security before recovery, an OTTI write-down is recognized as a realized loss in the statement of operations equal to the difference between the security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more-likely-than-not that the Company will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized as a realized loss in the statement of operations, and the amount related to all other factors, which is recognized in other comprehensive income.
ceded programs to minimize its exposure to significant losses from reinsurer insolvencies. When necessary the Company holds collateral in the form of letters of credit or trust accounts for amounts recoverable from reinsurers that are not considered authorized insurers by the State of Michigan Office of Financial and Insurance Regulation.
Underwriting Results. The following table shows the components of the Company’s underwriting gain or loss for the years ended December 31, 2010 and 2009.
While the market continued to remain soft in 2010, the Company was again able to outperform our peers in the ability to grow our business. We continued to solidify our relationships with our agents and were ranked as the third best carrier in the state to do business with by our agents. Our Fremont Insurance Pure Michigan association continues to pay significant dividends with brand awareness by Michigan consumers. Direct premiums written were up 12.7%, with new business up 17.2% and renewal business up 11.9%. Direct premiums written for personal auto ended up 20.6% with new business up 16.5% and renewal business up 21.4%. Results were driven by the ease of placing personal auto business with Fremont through our award winning, web-based rating platform-Fremont Complete, rate increases, account rounding of current Fremont homeowner business, and a continuation of a solid renewal retention ratio in the low 90s. Direct premiums written for our homeowners product, which is the other major product line in the personal segment, were up 7.9%. This was driven by new and renewal business which were up 11.2% and 7.4%, respectively. Overall, the personal segment’s direct premiums written were up 14.3%, with new business up 14.3% and renewals up 14.3%, as well. In-force policy count increased 7.7% for the personal segment.
Farm direct premiums written were up 3.8% driven by renewals which were up 6.4%. New business was down 18.8% but this was due to a large farm account written last year as new business which was then renewed
in 2010. Direct premium written for the marine business was down 1.4%. New and renewal premiums were down 0.7% and 1.9%, respectively, as competition coupled with the challenging economy facing Michigan made it difficult to grow this segment in 2010. In-force count for farm and marine were flat.
The increase in net premiums written is due to the overall increase in direct premiums written of $8,462,000 offset by an increase of $2,000,000 in ceded premiums written under the Company’s reinsurance agreements.
The increase in net premiums earned is due to the overall increase in direct premiums earned of $7,052,000 offset by an increase of $1,527,000 in ceded premiums earned under the Company’s reinsurance agreements.
The farm segment’s loss and LAE ratio increased to 64.8% in 2010 from 50.5% in 2009 as a result of weather related losses sustained in 2010 as compared to 2009. The same storms which occurred in April and October 2010 that affected the personal segment also affected our farm segment. The marine segment’s loss and LAE ratio increased to 62.6% in 2010 from 59.3% in 2009 due to increased loss severity in 2010 as compared to 2009.
Portfolio duration declined slightly to 4.64 in 2010, down from 4.79 at the end of 2009, and below the 4.98 duration of the Barclays Aggregate Index. The tax-exempt municipal allocation dropped from 38% to 29%; the corporate, Treasury, and mortgage-backed allocations increased modestly. These changes increased the portfolio liquidity and reduced exposure to state and local governments, which continues to face budget pressures and negative sentiment.
The increase in income from the equity portfolio is due to higher dividend income as a result of the Company increasing its holdings of dividend paying common stocks. During the second quarter 2009, the Company began adding to its equity portfolio via purchases of common stocks and mutual funds.
Other Income, Net. Other income, net which includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income items increased 4.1% to $670,000 in 2010 compared to $644,000 in 2009. The increase was driven by premium volume growth in 2010.
Federal Income Tax. During the years ended December 31, 2010 and 2009, the Company recorded income tax expense of approximately $965,000 and $1,818,000, respectively. The decrease is due to a decline in pre-tax income in 2010 compared to 2009. The effective tax rate for 2010 was 28.3% compared to 30.0% in 2009. The effective tax rate differs from the statutory federal tax rate of 34% due primarily to nontaxable investment income.
Farm direct premiums written were up 7.7% driven by new business which was up 43.1% and renewals which were up 2.5%. The new business increase was impacted by a larger farm written during the first quarter of
2009. Direct premium written for the marine segment was basically flat (up 0.2%). Renewal premiums were up 4.8%, with new business premium down 21.7%. The flat marine volume is due to a competitive market place coupled with the Michigan economy. The farm in-force count was up slightly, at 0.7% and marine was down 0.7%.
In 2009, the commercial segment’s loss ratio increased to 56.8%. The loss ratio in 2009 was negatively affected by increased losses in commercial multi-peril, increased reinsurance costs resulting in lower net premiums earned for the commercial segment and increased incurred losses in the workers compensation line. These factors were partially offset by redundant loss development in all commercial product lines except for workers compensation. The increase in commercial multi-peril losses was driven by an increase in fire related losses in 2009.
The farm segment’s loss and LAE ratio dropped 3.8 percentage points as a result of lower weather related losses and a drop in claim frequency in 2009 as compared to 2008. The marine segment’s loss and LAE ratio increased 0.4 percentage points due to increased loss severity in 2009 as compared to 2008 offset by redundant development on prior accident year losses.
Investment Income. The Company’s net investment income excluding realized gains and losses, average invested assets including cash and cash equivalents and the rate of return for the years ended December 31 are as follows:
Other Income, Net. Other income, net which includes premium installment charges, fees for non-sufficient fund checks, late payment fees and other miscellaneous income and expense items increased 4.7% to $644,000 in 2009 compared to $615,000 in 2008. The increase was driven by premium volume growth in 2009.
Federal Income Tax. During the year ended December 31, 2009 and 2008 the Company recorded income tax expense of approximately $1,818,000 and $1,577,000 respectively. The increase is due to growth in pre-tax income in 2009 compared to 2008. The effective tax rate for 2009 was 30.0 % compared to 29.5% for 2008.
Cash used in investing activities was $6,203,000 and $6,002,000 during the years ended December 31, 2010 and 2009, respectively, an increase of $201,000. During 2010, net cash invested into the Company’s investment portfolio was $4,484,000 compared to $4,763,000 in 2009, a decrease of $279,000. The decrease is a result of lower cash generated from operations in 2010.
During 2009, capital expenditures increased $114,000 to $1,263,000. The majority of the Company’s capital expenditures were related to Fremont Complete, the Company’s web based rating platform. The focus has been to add the commercial package product line to the platform. Cash used in financing activities during 2009 amounted to $157,000 and consisted of shares repurchases of $274,000 and dividends to stockholders of $228,000 offset by proceeds from the issuance of stock of $345,000
During 2010, the Company paid a quarterly cash dividend. The Company paid a quarterly dividend of $.04 per share in each quarter of 2010. Total dividends paid were approximately $283,000. The Company cannot assure our stockholders that dividends will continue to be paid in the future. The Board’s current intention is to evaluate each quarter whether a cash dividend will be declared. The payment of future dividends will depend upon the availability of cash resources at the Company, the financial condition and results of operations of the Company and such other factors as are deemed relevant by the Board of Directors. The Company’s principal source of cash available for payment of dividends is dividends from the Insurance Company. The annual future cash requirements of the Company are not foreseen to be significant. They include dividends paid to shareholders and other administrative expenses related to annual filings such as income tax returns and other compliance type filings. During 2010, the Board of Directors of the Insurance Company declared and paid ordinary dividends totaling $1,000,000 to the Company, its sole shareholder. As of December 31, 2010, the Company had a cash balance of approximately $473,000.
company continue to be safe, reliable and entitled to public confidence. Also, in the absence of approval of the Insurance Commissioner, dividends may only be paid from statutory earned surplus. Also, dividends may not exceed the amount of the Insurance Company’s statutory capital stock account in any one-year unless it meets certain other requirements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fremont Michigan Insuracorp, Inc. at December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
When an equity security has a decline in value, where fair value is below cost, that is deemed to be other than temporary, the Company reduces the book value of such security to its current fair value, recognizing the
Cash and cash equivalents include cash on hand and highly liquid short-term investments. The Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents.
Insurance premium revenue is recognized on a pro rata basis over the respective terms of the policies in-force and unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of the policies in-force. Generally, premiums are collected in advance of providing risk coverage, minimizing the Company’s exposure to credit risk. Premiums due from policyholders are net of an allowance for doubtful accounts of $85,637 and $43,034 at December 31, 2010 and 2009, respectively.
The Company presents other comprehensive income or loss as a component of stockholders’ equity on the consolidated statements of stockholders’ equity and comprehensive income. For the years ended December 31, 2010, 2009, and 2008 the components of other comprehensive income consisted of the following:
The components of and changes to accumulated other comprehensive income (loss) as of and for the years ended December 31, 2010, 2009, and 2008 were as follows:
Policy acquisition costs, which consist of commissions net of ceding commissions and premium taxes, that vary with and are primarily related to the production of new and renewal business are deferred, subject to ultimate recoverability from future income, including investment income, and amortized to expense over the period in which the related premiums are earned.
Current accounting guidance requires companies to recognize the funded status of defined benefit postretirement plans on the balance sheet and recognize changes in the funded status of the plan in the year in which the changes occur. See Note 9-Employee Benefit Plans for additional information.
The Company accounts for stock-based compensation using the fair value based method. The Company values stock options issued based upon an option-pricing model and recognizes the fair value as an expense over the period in which the options vest.
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. If no accrual is made for a loss contingency, disclosure of the contingency is made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred.
transparency and comparability of fair value information in financial reporting. Specifically, the new guidance requires separate disclosure of the amounts of significant transfers in and out of Levels 1 and 2, as well as the reasons for the transfers, and separate disclosure for the purchases, sales, issuances and settlement activity in Level 3. In addition, this ASC update requires fair value measurement disclosure for each class of assets and liabilities, and disclosures about the input and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements in Levels 2 and 3. The new disclosures and clarifications of existing disclosures were adopted on January 1, 2010, except for the requirement to provide Level 3 activity detail which will become effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Early adoption is permitted. These amendments do not require disclosures for earlier periods presented for comparative purposes at initial adoption. The updated disclosures are included in note 3 to the consolidated financial statements.
The cost or amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value of investments at December 31, 2010 and 2009 are as follows:
During the year ended December 31, 2008, other-than-temporary impairment losses on available-for-sale fixed maturity investments amounted to $362,000 and are included in net realized investment gains (losses) on investments in the consolidated statement of operations. There were no other-than-temporary impairment losses in 2010 or 2009.
As of December 31, 2010, the investment portfolio included 64 fixed maturity securities and 32 equity securities in an unrealized loss position for less than 12 months and 9 equity securities in an unrealized loss position for more than 12 months. Of the fixed maturity securities, 11 were trading between 91% and 95% of cost and 53 were trading above 95% of amortized cost. All of the fixed maturity securities in an unrealized loss position and assigned a rating by a commercial credit rating agency are rated investment grade securities.
As of December 31, 2010, the investment portfolio included 41 equity securities in an unrealized loss position. Of these forty-one equity securities, 1 was trading under 75% of amortized cost, 3 were trading between
assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:
The following tables present our available-for-sale investments measured at fair value on a recurring basis as of December 31, classified by the valuation hierarchy (as discussed above):
The Company’s catastrophe treaty has three layers which in total provided up to $24,750,000 of coverage above a $1,250,000 retention in 2010, 2009 and 2008. The Company has an automatic reinstatement provision after the first loss for each layer to provide coverage in the event of subsequent catastrophes during the year. Coverage would have lapsed after the second event, in which case the Company would have evaluated the need for a new contract for the remainder of a particular year. During 2010, 2009 and 2008 the coverage could be reinstated for a fee of 100% of the original premium.
Although reinsurance agreements contractually obligate the Company’s reinsurers to reimburse the Company for their share of losses, they do not discharge the primary liability of the Company. The Company remains liable for the ceded amount of reserves for unpaid losses and loss adjustment expenses and ceded unearned premiums in the event the assuming insurance organizations are unable to meet their contractual obligations. As a result, the Company is subject to credit risk with respect to the obligations of its reinsurers.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. At December 31, 2010 and 2009, amounts recoverable from reinsurers consisted of the following:
Based upon management’s assessment of all available evidence, including the Company’s cumulative net income for recent fiscal years, estimates of current and future profitability and the overall prospects of our business, it has been determined that as of December 31, 2010 it is more likely than not that sufficient taxable income will exist in the periods of reversal in order to realize the recorded net deferred tax asset.
At December 31, 2010 and 2009, property and equipment consisted of the following:
At December 31, 2010, furniture, fixtures and equipment includes $39,220 of capitalized costs related to equipment that has not yet been placed in-service. The Company expects to begin using the equipment in 2011 at which time it will begin depreciating the asset.
In 2010, the Company experienced favorable development of $1,714,000 on loss and loss adjustment expense (LAE) reserves for prior accident years. In the personal segment, homeowners had redundant development of $917,000 while personal auto experienced adverse development of $486,000 and other personal segment products had redundant development of $62,000. The adverse development in personal auto was concentrated in accident years 2007, 2008 and 2009. In the commercial segment, commercial multi-peril had redundant development of $830,000 while workers compensation had redundant development of $281,000.
At December 31, 2010, 2009 and 2008 the funded status of $2,152,865, $1,819,308 and $1,738,697, respectively, is recognized in the accompanying balance sheet as accrued expenses and other liabilities.
For measurement purposes as of December 31, 2010, 2009 and 2008 the annual rate of increase in the per capita cost of covered health care benefits assumed for the subsequent year was 7.0%, 8.0% and 9.0%, respectively. The rate was assumed to decrease to an ultimate rate of 5.0% in 2013. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan. A one percentage-point change in assumed health care cost trend rates would have the following effects:
The Company has a defined contribution 401(k) plan covering substantially all employees meeting certain eligibility requirements. The 401(k) plan provides for matching contributions and /or profit sharing contributions as defined by the Board of Directors. Company contributions approximated $166,000 in 2010, $147,000 in 2009 and $150,000 in 2008.
preceding calendar year. Accordingly, FIC may pay dividends of approximately $3,219,000 in 2011 without prior approval. However, the OFIR has the authority to prohibit payment of any dividend.
Segment data for the years ended December 31 are as follows:
The Company has two stock-based compensation plans which are described below. The compensation cost for these plans that has been charged against income for the years ended December 31, 2010, 2009 and 2008 was $131,211, $122,057 and $103,228, respectively. The total income tax benefit recognized in the statement of operations for stock-based compensation was $44,612, $41,499 and $35,098, for the years ended December 31, 2010, 2009 and 2008, respectively.