Net premiums written is the sum of direct premiums written and assumed premiums written less ceded premiums written. Ceded premiums written is the portion of our direct and assumed premiums that we transfer to our reinsurers in accordance with the
Gross revenues is the sum of direct premiums written and assumed premiums written (which we refer to in this report as gross premiums written) plus other revenues including finance income, commission and service fee income, and net investment income (excluding net realized gains (losses) on securities). We consider gross revenues to be a non-GAAP financial measure and have provided, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Measurement of Results”, an explanation of why we believe gross revenues is a financial measure that is useful to management and investors and a reconciliation of gross revenues to total revenues, which is the most directly comparable GAAP financial measure included in our financial statements.
Adjusted to reflect a 12 for 1 stock split that became effective prior to the closing of our initial public offering in August 2003.
We seek to attract customers by developing strong brand name recognition in our markets through our low-cost television advertising campaigns that emphasize our low down payment, flexible payment plans, convenient neighborhood locations and customer service. Our neighborhood offices serve as a network for both product delivery and payment collection. All policy applications are completed in the neighborhood sales offices, and most of our customers revisit these offices at least monthly to make their periodic payments.
• investment income that we earn on the invested assets of our subsidiaries.
• insurance losses and loss adjustment expenses (which we sometimes refer to in this report as LAE) including estimates for losses incurred during the period and changes in estimates from prior periods related to direct and assumed non-standard personal automobile and term life insurance policies (which we refer to in this report as gross insurance losses and loss adjustment expenses), less the portion of those insurance losses and loss adjustment expenses that are ceded to other insurers (which we refer to in this report as ceded insurance losses and loss adjustment expenses) (we refer to the difference as net insurance losses and loss adjustment expenses); and
• A 32% increase in book value per share to $10.96;
• Completely recouped the purchase price of the Cash Register agency, which was acquired in November 2003, due to increases in ancillary revenues and reductions in the cost structure;
• Commenced operations of Direct Cash Advance, our payday consumer loan program; and
During 2005, we expect to continue many of the initiatives that we started in 2004 including our expansion into Texas, Missouri, and Virginia. In addition, we expect to see continued success with the roll out of our Direct Prepaid Visa® and Direct Cash Advance programs.
Growth. We expect our gross revenues could increase in excess of 10% during 2005, with much of the growth expected to occur during the second half of the year. We anticipate that the majority of this growth will be generated by our expansion states of Texas, Missouri and Virginia. In January 2005, we completed our acquisition of the 65 AMCO offices in Texas. We also acquired two other agency operations in Texas that had a combined total of 17 offices. We have also developed approximately 13 of our own sales offices in Texas and we expect to continue to develop additional offices in Texas throughout 2005. We currently have approximately 95 sales offices in Texas, and ultimately, we believe it is a state that could support as many as 130 to 140 offices.
Over the past several months, we have been developing our initial offices in Missouri and Virginia. As of March 1, 2005, we have 13 offices in Missouri and six offices in Virginia. We plan to develop additional sales offices in both states during 2005, and believe that we may have close to 30 Missouri offices and 15 Virginia offices by the end of the year. We are primarily selling annual policies in these states, which we finance. In addition, we are selling our term life and ancillary products. Our initial advertising has commenced and will continue to encompass new territories within these states as additional offices are opened.
We expect that growth in 2005 in most of our existing states will be in the low single digits, due largely to the current competitive environment, our decision to cease writing new business in Miami, and our expectation that there will be a minimal impact on premiums in 2005 from rate increases. We are not currently aware of any major programs that have implemented substantial rate decreases in any of our existing states, but we are continuing to see increased advertising from our competitors. Consistent with our ongoing review of rates by coverage and state, we plan to make minor adjustments to our rates in certain states during 2005 as we do periodically; however, we do not expect that the impact of these adjustments will be significant. In order to try to improve our new business growth in our existing states, we periodically make modifications to our premium finance payment plans in many of our existing states and we believe that these adjustments, coupled with our new advertising campaigns, will improve our new business growth in our existing states.
Assumptions. Statements made in this section, including those concerning our anticipated growth in gross revenues and our estimated loss and expense ratios are forward-looking statements. Some important factors that must occur in order for us to achieve these results include:
• favorable trends in inflation and other matters that could affect operating expenses;
• our ability to effectively compete against other insurance companies and independent agencies selling similar products in our markets;
• the absence of our losses and loss adjustment expenses exceeding our reserves which would require us to increase our reserves which would lower our earnings.
Gross Revenues (a non-GAAP financial measure). Gross revenues is the sum of gross premiums written plus ancillary income (finance income and commission and service fee income) and net investment income (excluding net realized gains (losses) on securities). We use gross revenues as the primary measure of the underlying growth of our revenue streams from period to period. Gross revenues are reconciled to total revenues in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations”.
Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. For statutory accounting purposes, operating expenses of an insurance company exclude investment expenses, and are reduced by other income. There is no such industry definition for determining an expense ratio for GAAP purposes. As a result, we apply the statutory definition
to calculate our expense ratio on a GAAP basis. We reduce our operating expenses by ancillary income (excluding net investment income and realized gains (losses) on securities) to calculate our net operating expenses. Due to our historically high levels of reinsurance, we calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in evaluating our financial results that are net of ceded reinsurance, as reflected in our consolidated financial statements, we believe that the gross expense ratio better reflects the operational efficiency of the underlying business and is a better measure of future trends.
The following table presents our gross premiums written in our major markets and provides a summary of gross, ceded and net premiums written and earned for the periods indicated.
During 2004, we continued our expansion into Texas, where we are assuming non-standard personal automobile insurance policies underwritten by a Texas county mutual insurer. The business we assumed in Texas, which was comprised entirely of monthly policies, increased to $29.6 million in 2004, an increase of 89.7% over 2003. This growth was primarily related to increases in the number of policies produced in Texas. In anticipation of our acquisition of the 65 sales offices owned by the AMCO agency at the end of 2004, we commenced our initial advertising campaign co-branding the Direct and AMCO names. However, the impact of this television advertising was not as effective as anticipated, which we believe was due to a weaker than expected AMCO brand that had not been supported by yellow page advertising, an essential component of our overall marketing strategy in Texas. Our yellow page advertising is being included in most major markets in the new 2005 versions of their publications.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Gross premiums written increased $100.0 million or 29.8% to $435.2 million in 2003 from $335.2 million in 2002. The majority of our growth occurred in our largest state, Florida, which represented 51.4% of our business and accounted for $49.2 million of the increase. Approximately 80% of the growth in Florida was attributable to an increase in average policies inforce, including an increase in the number of renewal policies, with the remaining 20% coming from an increase in the average premiums per policy. In January 2003, we began our expansion into the state of Texas and are assuming non-standard personal automobile insurance policies underwritten by a Texas county mutual insurer. We assumed $15.6 million of gross premiums written in Texas during 2003. The majority of the increases in gross premiums written in our other states were due primarily to increased market penetration. Gross premiums earned, a function of gross premiums written over the current and prior periods, increased to $394.9 million in 2003 from $284.3 million in 2002.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net premiums written increased 63.0% to $295.1 million in 2003 from $181.0 million in 2002. The ratio of net premiums written to gross premiums written increased to 67.8% in 2003 from 54.0% in 2002 as the increased capitalization of our insurance subsidiaries enabled us to reduce our ceding percentage and retain more business. Net premiums earned, a function of net premiums written over the current and prior periods, amounted to $228.5 million and equaled 77.4% of net premiums written. This percentage is lower than the relationship of gross premiums earned to gross premiums written of 90.7% since the majority of the increase in business retained did not occur until the third and fourth quarters of 2003.
Ancillary income includes finance income, commission and service fee income and other income. Finance income primarily consists of interest, acquisition and service fees, and delinquency fees on the premium finance agreements related to the insurance policies we finance. Our agency and administrative subsidiaries produce and service non-standard personal automobile insurance business for other insurers from which we assume a portion of this business, and in some cases the entire premium, through reinsurance treaties. We receive service fees for agency, underwriting, policy administration, and claims adjusting services performed on behalf of these unaffiliated insurers. We also receive commission and service fee income on other insurance products produced for unaffiliated insurance companies on which we do not bear underwriting risk, including travel protection, vehicle protection and hospital indemnity insurance policies. Our business model allows us to generate a significant amount of ancillary income, which we measure as a percentage of gross earned premiums and as a percentage of our operating expenses. Our goal is to generate ancillary income in amounts that will offset a majority of, or even exceed, our operating expenses. The following table summarizes the components of our ancillary income for the periods indicated.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003. Ancillary income increased 24.6% to $97.8 million in 2004 from $78.5 million in 2003. This increase was primarily due to increased sales of ancillary insurance products including approximately $5.3 million of increased business produced by the 42 Cash Register sales offices in Florida that we acquired in November 2003. Prior to our acquisition of these offices, the majority of the ancillary revenues were retained by owners of the
agency. During 2004, we also recognized approximately $3.4 million of increased service fee income related to the administration of our assumed business in Texas. In addition, premium finance income increased as a result of higher premium volumes. The increase in premium finance income is net of an increase in the provision for finance receivable losses to $7.3 million in 2004 from $7.0 million in 2003. The majority of the increase in premium finance income is attributable to the increase in average gross premium finance receivables outstanding during the year. The allowance for credit losses was 2.8% and 2.9% of gross finance receivables in 2004 and 2003, respectively. For the year ended December 31, 2004 and 2003, the ratio of ancillary income to gross premiums earned was 20.7% and 19.9%, respectively, and the ratio of ancillary income to operating expenses was 85.8% and 97.0%, respectively.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Net investment income increased to $6.7 million in 2003 from $5.3 million in 2002 as a result of an increase in average invested assets that was partially offset by a decrease in the average yield on investments. Average invested assets increased 55.8% to $180.9 million in 2003 from $116.1 million in 2002 primarily as a result of the proceeds from our initial public offering, the majority of which were invested in the fourth quarter of 2003. The average investment yield decreased to 3.7% in 2003 from 4.4% in 2002 since a large portion of our portfolio was invested during the lower interest rate environment prevailing in 2003.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002. Gross gains on debt securities for the year ended December 31, 2003 were $2.6 million, which were partially offset by gross losses of $0.6 million. Gross gains were primarily attributable to the sale of certain securities as we repositioned our bond portfolio based on our investment guidelines for changes in market conditions and other factors. Comparatively, in 2002, we realized gross gains on debt securities of $0.9 million that largely offset our gross losses of $1.0 million resulting from our investment in WorldCom, Inc. bonds. There was no impact on realized losses attributable to adjustments for other than temporary impairment of securities held in our portfolio as of the end of either period.
Insurance losses and loss adjustment expenses represent our largest expense item and include payments made to settle claims, estimates for future claim payments and changes in those estimates for current and prior periods, as well as loss adjustment expenses incurred in connection with settling claims. Insurance losses and loss adjustment expenses are influenced by many factors, such as claims frequency and severity trends, the impact of changes in estimates for prior accident years, and increases in the cost of medical treatment and automobile repairs among other factors. The anticipated impact of inflation is considered when we establish our premium rates and set loss reserves. We perform an actuarial analysis each quarter and establish or adjust (for prior accident quarters) reserves, based upon our estimate of the ultimate incurred losses and loss adjustment expenses to reflect loss development information and trends that have been updated for the most recent quarter’s activity. Each quarter our estimate of ultimate loss and loss adjustment expenses is evaluated by accident quarter, by state and by major coverage grouping (e.g., bodily injury, physical damage) and changes in estimates are reflected in the period the additional information becomes known.
The prior year development of $6.3 million resulted in a 1.7 point increase in our 2004 loss ratio. Our 2004 loss ratio would have been 74.0% excluding the impact of the adverse development relating to prior years. Approximately $4.5 million of this increase was attributable to higher than expected frequency and severity trends in the Florida personal injury protection (“PIP”) and property damage coverages that were offset by better than expected loss trends in bodily injury coverage. A significant component of the increase in PIP reserves was related to higher than expected reported frequency and closed with payment trends, which we believe was
During 2003 and 2004, we endeavored to improve our personal injury protection loss trends in the Miami market, principally by adjusting rates and enhancing our claims SIU presence in the Miami market. In addition, we expected that our Miami results would benefit from some of the fraud prevention initiatives that were a part of the Act. While these changes did, at times, appear to improve our trends, they were not sufficient to improve our loss ratio to our target. As a result, in October 2004, we decided to stop writing new business in the Miami market.
Based upon our analysis as of December 31, 2003, the frequency and severity trends in the majority of our coverages remained relatively flat on a country-wide basis. We did note an increase in claims frequency in the Florida personal injury protection coverage, which we believe is generally attributable to increased fraud activity in the Miami market. We increased rates for personal injury protection coverages in October 2003 and noted a substantial reduction in new business in this market in November and December. Our special investigations unit was actively challenging those claims believed to be fraudulent. Overall, the gross accident year loss ratio for the Florida automobile book of business increased 1.7 points during 2003. The increase in the Florida gross accident year loss ratio was offset by lower accident year loss ratios in the majority of the states in which we operate, including Texas where our loss experience was below our countrywide average. Accident year loss ratios, as compared to the loss ratios included in our financial statements, include the impact of losses occurring within the current accident year and exclude the current year impact of any increase or decrease in losses and loss adjustment expenses related to losses that occurred in prior years.
We file a consolidated federal income tax return that includes all of our subsidiaries other than our two life insurance subsidiaries, which file separate federal income tax returns. The statutory rate used in calculating our tax provision was 35% and our effective tax rates for the years ended December 31, 2004, 2003 and 2002 were 36.6%, 36.7%, and 33.3%, respectively.
Amounts outstanding under this facility were $135.2 million and $148.0 million as of December 31, 2004 and 2003, respectively. Interest on the facility is payable quarterly and all outstanding advances and accrued interest are due on or before June 30, 2007. The weighted average interest rate in effect was 3.4% in 2004 and 3.6% in 2003. The loan is principally secured by our finance receivables of our premium finance subsidiaries and is guaranteed by Direct General Corporation. See Note 6 to our audited consolidated financial statements included in this report for further discussion regarding our current outstanding debt.
For the year ended December 31, 2004, we received net proceeds from the issuance of common stock of $17.0 million, which included the $16.0 million from the secondary offering and $1.0 million from the exercise of employee stock options. During 2004, we made net payments under our premium finance revolving credit facility of $12.8 million and repaid $1.3 million of principal associated with other notes and capital lease obligations. Interest paid on outstanding indebtedness totaled $5.5 million and dividends paid on common stock were $3.5 million for the year.
As of December 31, 2004, the amount of unsecured reinsurance recoverables was $24.5 million or 10.0% of shareholders’ equity as compared to $32.7 million or 18.4% of shareholders’ equity at December 31, 2003. In addition, the largest unsecured recoverable from a single reinsurer was $8.2 million at December 31, 2004. This same amount was due from both National Union Fire Insurance Company of Pittsburgh, PA, a subsidiary of American International Group, Inc., and Swiss Re America, which are rated “A++ (Superior)” and “A+ (Superior)”, respectively, by A.M. Best.
We had total cash, cash equivalents and invested assets of $407.5 million as of December 31, 2004. The following table summarizes our cash, cash equivalents and invested assets as of the dates indicated.
we reduce the risk of margin call by limiting our investment to 15% of the account balance. In addition, we closely monitor the performance of the account in an effort to reduce the risk of losses. During 2004, we realized gross gains of $2.4 million and gross losses of $2.2 million on closed contracts in our trading portfolio. Since the trading portfolio, which primarily consists of futures contracts, swaps, and other derivative instruments, represents a speculative investment and does not represent a hedge, all open contracts are marked to market with the change in market values included in “net realized gains (losses) on securities and other” in our consolidated statement of operations. The net unrealized loss on open contracts decreased from $0.4 million in 2003 to $0.1 million in 2004, which was comprised of gross unrealized gains of $0.1 million and gross unrealized losses of $0.2 million. For the year ended December 31, 2004, “net realized (losses) gains on securities and other” included a net gain of $0.3 million related to the increase in the market value of open contracts.
As of December 31, 2004, the impact of an immediate 100 basis point increase in market interest rates on our debt securities portfolio would have resulted in an estimated decrease in fair value of 4.2%, or approximately $14.2 million. As of the same date, the impact of an immediate 100 basis point decrease in market interest rates on our debt securities portfolio would have resulted in an estimated increase in fair value of 4.2%, or approximately $14.2 million.
As of December 31, 2004, cash and investments carried at fair value totaling approximately $12.1 million were on deposit with state insurance regulatory authorities. Additionally, investments carried at fair value totaling approximately $3.7 million had been pledged to an unaffiliated insurer to secure our assumed reinsurance obligations.
. statements and assumptions relating to future growth, earnings, earnings per share and other financial performance measures, as well as management’s short-term and long-term performance goals;
. statements relating to the anticipated effects on results of operations or financial condition from recent and expected developments or events;
. any other statements or assumptions that are not historical facts.
The Company’s management carried out an evaluation, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its internal control over financial reporting as of December 31, 2004. The framework on which such evaluation was based is contained in the report entitled “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”). Based upon the evaluation described above under the framework contained in the “COSO Report”, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2004.
We conducted our audits in accordance with the standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Direct General Corporation and Subsidiaries as of December 31, 2004 and 2003 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
The Company finances the majority of the insurance policies sold under a variety of payment plans. Finance income consists of interest, installment fees, acquisition and service fees, and delinquency fees. Finance income, other than delinquency fees, is recognized using the interest (actuarial) method or similar methods that produce a level yield. Delinquency fees are earned when billed. Acquisition fees, net of directly related lending costs, are deferred and amortized into finance income over the remaining lives of the related loans. Upon cancellation of the underlying insurance policies, any uncollected earned interest or fees are charged off. The Company’s allowance for finance receivable losses is comprised of a reserve for uncollected finance acquisition fees and a provision for the write-off of premium finance balances (primarily realized but uncollected interest and fees), which is calculated using the historical level of finance receivable losses as a percentage of outstanding balances under the premium finance agreements.
The Company’s insurance agencies receive commission income on the sale of ancillary insurance products offered by non-affiliated insurance companies. Commission is generally recognized into income when the ancillary insurance policies are issued, net of a provision for return commissions on anticipated cancellations. The commissions received are calculated as a straight percentage of premiums produced and are not contingent upon achieving volume, profitability or other financial goals.
Property and equipment is recorded at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, which are principally as follows: computer hardware and software (3-5 years), furniture and equipment (3-7 years), leasehold improvements (3-14 years based on the expected remaining life of the lease) and Company-owned buildings and related improvements (31.5 years). Property and equipment includes software developed and capitalized for internal use.
The Company uses a derivative financial instrument known as an interest rate collar primarily for the purpose of hedging exposures to the variability in future cash flows associated with fluctuating interest rates on its revolving credit agreement. At the inception of the derivative contract and at least quarterly thereafter, the Company formally documents and updates the risk management strategy, the underlying exposure of the hedge, and the effectiveness of the hedging transaction in offsetting changes in the fair value or cash flows of the exposure being hedged. This derivative is recorded at fair value on the balance sheet with the changes in fair value recognized in earnings or other comprehensive income. Gains or losses reported in other comprehensive income are reclassified into income in the period in which earnings are affected by the underlying hedged item. The ineffective portion of the hedge is recognized in earnings in the current period.
The majority of the Company’s net claim payments during 2004, 2003, and 2002 were related to accidents occurring in the current accident year. In 2002, the Company’s net claim payments made of $79,745,000 and the net claim payments made that related to prior years of $13,126,000, were both net of $10,463,000 of reinsurance payments received in conjunction with the commutation of a reinsurer’s obligation for unpaid losses and $7,357,000 of reinsurance payments received in conjunction with the commutation of the Company’s stop loss reinsurance agreement.
The Company has maintained a revolving credit facility with a consortium of banks to fund the working capital needs of the Company’s premium finance operations since 1994. Under the terms of the current facility, interest is payable quarterly at a rate elected by the Company of either the base commercial rate of First Tennessee Bank, N.A., as “Agent”, or at 1.5% to 2.0% above LIBOR. The LIBOR spread at the time of the election is determined based upon the Company’s “Average Funded Debt to EBITDA Ratio” as defined in the agreement. At December 31, 2004, the weighted average rate in effect was 4.41%. Under terms of the current facility, the Company may borrow up to $190,000,000. As of December 31, 2004, the unused amount was $54,800,000. The current facility matures on June 30, 2007. The loan is principally secured by finance receivables, as well as the stock of Direct Insurance Company.
The revolving credit facility contains covenants which, among other matters 1) limit the Company’s ability to incur or guarantee indebtedness, merge, consolidate and acquire or sell assets without bank approval; 2) require the Company to satisfy certain financial ratios, including those related to net worth, debt-to-equity, and profitability; and 3) restrict the payment of cash dividends on common stock. As of December 31, 2004, the Company was in compliance with all covenants related to the credit agreement.
The Company enters into various other credit agreements from time to time, primarily to finance the purchase of computer equipment and other assets. As of December 31, 2004, the Company has one such credit agreement bearing interest at 5.46%. Principal and interest are payable monthly, with principal totaling $426,000 due in 2005. The note is secured by computer equipment.
The Company assumed, under quota-share reinsurance agreements, a percentage of personal automobile insurance produced for other insurers (see Note 8). As of December 31, 2004, the Company provided an unsecured letter of credit in the amount of $4,000,000 and provided reinsurance security trust accounts totaling $11,073,000 for the benefit of certain unaffiliated insurers with respect to its obligations under the assumed reinsurance agreements.
The Company’s agency subsidiaries and administrative service subsidiaries produce and administer personal automobile insurance business for other insurers. The Company receives service fees for its underwriting, policyholder administration and claims processing services. Administrative service fees earned, net of the related fronting fees and premium taxes, were approximately $10,653,000, $7,574,000 and $7,018,000 in 2004, 2003 and 2002 respectively, and are included in the caption commissions and service fee income in the Statements of Operations.
From the proceeds of the offerings, Direct General Corporation used $63,400,000 of the proceeds, $51,900,000 in 2003 and $11,500,000 in 2004, to increase its investment in insurance subsidiaries and approximately $600,000 to increase the capitalization of its non-insurance subsidiaries. Additionally in 2003, the Company used $7,700,000 to repay outstanding term loans with First Tennessee Bank National Association and Hibernia National Bank. The Company intends to utilize the remaining proceeds to further increase the capital of its insurance subsidiaries and for general corporate purposes.
As of December 31, 2004, shares of common stock have been reserved for the following :
The monetary effect on statutory capital and surplus of the Company’s insurance subsidiaries of using accounting practices prescribed or permitted by the Department of Insurance in each state of domicile as of December 31 is as follows:
The Company’s insurance subsidiaries are restricted by state insurance laws as to the amounts they may pay as dividends without prior approval from their respective state insurance departments. For 2005, $10,067,000 in dividends is available to be paid to the Company from insurance subsidiaries without prior approval. Property and casualty insurance companies are subject to certain Risk-Based Capital (RBC) requirements as specified by the NAIC. Under those requirements, the amount of capital maintained by an insurance company is to be determined based on the various risk factors related to it. At December 31, 2004, each of the Company’s insurance subsidiaries exceeds the RBC requirements.
The Company maintains a $190,000,000 variable rate revolving credit agreement with a group of banks (Note 6), which subjects the Company to exposures from fluctuations in interest rates under the agreement. Effective November 1, 2001, the Company purchased an interest rate cap and sold an interest rate floor in a combined derivative instrument known as a zero-cost collar (derivative), which has been designated as a hedge of variable cash flows associated with interest rate increases above the 30-day LIBOR rate of 5.05% on a notional amount of $50,000,000 (cap) and interest rate decreases below the 30-day LIBOR rate of 5.05% on a notional amount of $25,000,000 (floor). This derivative instrument requires monthly settlements whereby the Company pays the difference between the current 30-day LIBOR rate and the floor of 5.05% on $25,000,000 and receives the excess of the 30-day LIBOR rate over the cap of 5.05% on $50,000,000. At December 31, 2004, the 30-day LIBOR rate in effect was 2.39%, which resulted in an increase to the monthly interest payments of approximately $65,000. The derivative expires on November 1, 2005.
The Company has designated this derivative instrument as a cash flow hedge in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” as subsequently amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of SFAS No. 133”. The credit risk associated with this contract is limited to the uncollected interest payments and the fair market value of the derivative
Baton Rouge Facility. The Company currently leases a facility in Baton Rouge, Louisiana for its administrative and customer service center. This lease is scheduled to mature in April 2008. The Company plans to expand its administrative and customer service operations to support its future growth and, in conjunction with these plans, the Louisiana Local Government Environmental and Community Development Authority (“Authority”) will construct a new facility (“Facility”) and the Company will, in turn, lease the Facility from the Authority. On October 29, 2004, the Company and certain of its subsidiaries invested $10,000,000 in Louisiana Taxable Lease Revenue Bonds (“Bonds”) in order to provide the Authority with funds to finance the acquisition of land and the construction of the Facility. Under the terms of the agreements, the ownership of the Facility will transfer to the company and the lease will expire upon the full repayment of all principal and interest related to the Bonds, which have a scheduled maturity of June 1, 2024. Construction of the Facility is expected to begin in the summer of 2005.
In a related transaction, the Louisiana Economic Development Corporation (“Corporation”) granted the Company an Economic Development Award in the amount of $1,837,000 to be used in the construction of a new facility in Baton Rouge. Under the Economic Development Award agreement, the Company must fulfill certain commitments for employees and payroll. In the event the Company does not meet these commitments, all or a portion of the award may be required to be returned to the Corporation.
Notes payable - The carrying values reported in the accompanying balance sheets for these financial instruments were estimated using projected cash flows, discounted at rates currently being offered for similar notes.
Effective November 1, 2003, the Company acquired from LR3 Enterprises, Inc., Maitland Underwriters, Inc., and each of the Cash Register Auto Insurance Agencies, Friendly Auto Insurance Agencies, and Insurance Options Agencies the assets of 42 offices used to conduct their automobile insurance agency business in the State of Florida. The purchase price was $13,792,000, which resulted in approximately $13,400,000 of goodwill.
On January 31, 2005, the Company announced that its Board of Directors approved the repurchase of up to $20,000,000 of its outstanding common stock.
Quarterly results of operations for 2004 and 2003 are summarized as follows:
Information is not meaningful since prior to August 11, 2003 the Company’s stock was not publicly traded.