Infinity’s insurance subsidiaries lease approximately 715,000 square feet of office and warehouse space in numerous cities throughout the United States. Most of these leases expire within five years. The most significant leased office spaces are located in Birmingham, Alabama (Infinity’s principal office); suburban Atlanta, Georgia; Irving, Texas; Windsor, Connecticut; and Los Angeles, California.
At December 31, 2002, AFG transferred the NSA Group to Infinity. Financial information for periods prior to the date of transfer represents the combined information of the NSA Group. Infinity also acquired the Assumed Agency Business from GAI through a reinsurance transaction effective January 1, 2003. The historical financial information shown below as of and for the years ended December 31, 2001 and December 31, 2002 was derived from audited financial statements. The Infinity financial data as of and for the twelve-month periods ended December 31, 2005, 2004 and 2003 include the results of the Assumed Agency Business. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related notes.
(a) The decline in earned premiums in 2002 is due primarily to a reinsurance agreement pursuant to which Infinity ceded 90% of the automobile physical damage business written. The increase in earned premium in years 2004 and 2005 is a result of the discontinuation of that reinsurance agreement as more fully discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Infinity continued to improve upon its successes in prior years by posting a 10.3% increase in net earnings in 2005 over 2004. Net earnings and diluted earnings per share for 2005 were $106.3 million and $5.09, respectively, compared to $96.4 million and $4.62 in 2004. Book value per share increased 14.1% from $26.60 to $30.34, primarily from the contribution of earnings in excess of shareholder dividends. The return on equity of 18.1% in 2005 exceeded Infinity’s long-term target of 12%.
A 10.2% increase in earned premiums and $22.3 million of realized gains resulted in a 10.7% increase in revenues in 2005. Earned premiums increased due substantially to significant written premium growth during the first half of 2005. Realized gains in 2005 include $20.3 million of taxable gains from securities sold to utilize a portion of available tax loss carryforwards.
Overall, market conditions continued to be very competitive in 2005 as many companies sought to generate premium growth through aggressive agent incentives, increased commission arrangements and increased advertising rather than significant rate reductions. While claims frequency on a national basis has declined since the prior year, Infinity has seen, in select states, early indications that claims frequency is again beginning to increase. Infinity will continue to assess its competitive position, rate adequacy and growth opportunities on a state-by-state basis while striving to maintain a desirable combination of profitability and growth. Infinity believes it is well positioned to do so given the opportunities to capitalize on its expertise in marketing to the Hispanic segment of the population, expand into additional markets such as Colorado and Nevada and capture a meaningful share of the uninsured driver population in California and Texas as those states more aggressively enforce their mandatory insurance laws for all drivers.
(See also Note 1 of the Consolidated Financial Statements, “Reporting and Accounting Policies”)
Insurance reserves, or unpaid losses and LAE, are management’s best estimate of (i) the ultimate amounts that will be paid for all claims that have been reported up to the date of the current accounting period but that have not yet been paid, (ii) an estimate of claims that have occurred but have not yet been reported to the Company (“incurred but not reported” or “IBNR”), and (iii) the claim settlement expenses.
data and analytical reserve development techniques, including projections of ultimate paid losses, to determine the ultimate amounts of reserves. The list of “key underlying assumptions” provided above are examples of major factors taken into account in developing these estimates.
During each quarterly review by the internal actuarial staff, using the additional information obtained with the passage of time, factor selections are updated, which in turn adjust the ultimate loss estimates and held IBNR reserves for the subset of the business and accident period affected by such updates. The actuarial staff also performs various tests to estimate ultimate average severity and frequency of claims. Severity represents the average cost per claim and frequency represents the number of claims per policy. As an overall review, the staff then evaluates for reasonableness loss and LAE ratios by accident year by state and by coverage.
The Company’s management believes that the historical magnitude of adjustments to ultimate losses on an accident year basis are indicative of the sensitivity of currently held loss reserves to changes in underlying assumptions. Over the past four accident years, the years for which data was readily available, the combined effects of adjustments to the initial estimate for average ultimate claims frequency and severity have ranged from (4.6)% to 4.3% (averaging (0.2)%).
The following table presents the development of loss reserves for the Assumed Agency Business through December 31, 2002. Development for 2003 for the Assumed Agency Business is included in the Infinity table above. Under the reinsurance agreement entered into with GAI, Infinity’s insurance subsidiaries assumed the net reserves from GAI. Accordingly, gross reserves and net reserves are the same.
During calendar year 2005, Infinity experienced $32.8 million of favorable reserve development, primarily from continued favorable development in the California business.
During calendar year 2004, Infinity experienced $14.5 million of favorable reserve development, primarily from continued favorable development in accident year 2003 on claim frequency on the California book of business, offset partially by continued unfavorable development in accident years 2000-2002 primarily from LAE on the declining New York book of business.
During calendar year 2003, $11.7 million of adverse loss and LAE reserve development occurred primarily due to business from New York, partially offset by other reserve releases.
The National Association of Insurance Commissioners’ (“NAIC”) model law for risk-based capital (“RBC”) provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At December 31, 2005, the capital ratios of all Infinity insurance subsidiaries exceeded the RBC requirements.
At December 31, 2005 Infinity had $200 million principal of senior notes due 2014, bearing a fixed 5.5% interest rate (the “Senior Notes”) outstanding. Interest payments on the Senior Notes of $5.5 million are due each February and August through maturity in February 2014. (Refer to Note 3 of the Consolidated Financial Statements for more information on the Senior Notes).
Funds to meet these expenses come primarily from dividends from the insurance subsidiaries, as well as cash and investments held at the holding company. In 2005, Infinity’s insurance subsidiaries paid Infinity $62.5 million in ordinary dividends. In 2006, Infinity’s insurance subsidiaries may pay to Infinity up to $160.4 million in ordinary dividends without prior regulatory approval. As of December 31, 2005, Infinity had $135 million of cash and investments.
Infinity’s $20 million credit facility expired on August 31, 2005 and was replaced with a $50 million three-year revolving credit facility that includes requirements to meet certain financial and other covenants. Infinity is currently in compliance with all covenants under the agreement. Under this agreement, there were no borrowings outstanding at December 31, 2005.
Infinity’s insurance subsidiaries generate liquidity to satisfy their obligations, primarily by collecting and investing premiums in advance of paying claims. Infinity’s insurance subsidiaries had positive cash flow from operations of approximately $56.2 million in 2005, $61.0 million in 2004, and $67.2 million in 2003. In addition, to satisfy their obligations, Infinity’s insurance subsidiaries generate cash from maturing securities from their combined $1.2 billion fixed maturity portfolio. Management believes that cash and investment balances, which are supported by cash flows generated from operations and maturing investments, are adequate to meet the future liquidity needs for Infinity and its insurance subsidiaries.
(a) The payout pattern for reserves for losses and LAE is based upon historical payment patterns and do not represent actual contractual obligations. The timing and amounts ultimately paid can and will vary from these estimates, as discussed in the Critical Accounting Policies section.
future. Nevertheless, Infinity did not experience a significant decline in its principal payments during 2005. Principal payments, including prepayments, on MBS were approximately $39 million and $34 million for the twelve months ended December 31, 2005 and December 31, 2004, respectively. As of December 31, 2005, approximately 96% of Infinity’s MBS are rated “AAA” by a nationally recognized rating agency. Additionally, all but one MBS, amounting to $1.1 million of the $309 million MBS portfolio, are investment grade according to the NAIC rating guidelines.
The average duration of Infinity’s fixed maturity portfolio was 3.6 years at December 31, 2005.
The following table provides information about Infinity’s fixed maturity investments at December 31, 2005, which are sensitive to interest rate risk. The table shows expected principal cash flows by expected maturity date for each of the five subsequent years and collectively for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. MBS and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
Gross written premiums for the year ended December 31, 2005, grew 5.2% compared to 2004. Infinity achieved gross premium growth of 13.0% during the first six months of the year largely as a result of business from newly appointed agents and brokers, from success in the continued roll-out of its three-tiered product offering in its Focus States (see Business - Distribution and Marketing) as well as additional marketing efforts. Gross premiums declined 2.9% during the second half of the year as several competitors decreased rates with Infinity taking selective rate increases to improve profitability in several states. During 2005, Infinity implemented 57 rate revisions in various states with an overall rate impact of a modest 2.2% increase. For the same reasons discussed above, Infinity’s policies-in-force grew 3.8% compared to December 31, 2004.
Gross written premiums in Infinity’s commercial vehicle business continued to grow in 2005. Premium and policies-in-force growth of 6.8% and 7.4%, respectively, was primarily driven by increases in California, Florida and Texas.
Classic Collector business and other personal lines premiums grew 12.5% in 2005. Classic Collector premiums and policies-in-force grew 5.1% and 0.2%, respectively, during 2005 primarily from growth in California, Florida and Pennsylvania. The remaining growth in gross written premiums is attributable to a change in the reinsurance agreement on the homeowners business. Beginning in 2005, GAI eliminated its reinsurance program and cedes 100% of the homeowners business to Infinity. However, Infinity’s net retention of 10% has not changed as the company put in place its own reinsurance agreement.
Premiums ceded under reinsurance coverages fell during the year as a result of the elimination of the physical damage quota share agreement at December 31, 2004 (See Note 10 of the Consolidated Financial Statements).
Infinity’s personal auto writings in its Top Five Focus States for the year ended December 31, 2004 grew 3.1% compared to 2003. Policies-in-force for these states grew 1.8% compared to 2003. Premium growth accelerated during the year, primarily from substantial growth in Florida as a result of the introduction of Infinity’s Low-Cost and Value-Added products. Premium growth and policies-in-force in California were relatively flat at 0.3% and 0.5%, respectively, compared to 2003. Although Georgia and Pennsylvania posted declines in premiums for the year, both states posted positive growth during the second half of 2004 as a result of new program introductions.
Premiums ceded under reinsurance coverages fell during the year as a result of the reduction in the percentage of premiums ceded under the physical damage quota share agreement. 10% of auto physical damage premiums were ceded during 2004 compared to 90% during the first six months of 2003 and 20% during the last six months of 2003 (See Note 10 of the Consolidated Financial Statements).
Overall, the statutory combined ratio for the year ended December 31, 2005, increased 0.1 points compared to 2004. In 2005, on a statutory basis, Infinity had $17.0 million of favorable development, including $15.8 million of unfavorable development on extra-contractual liabilities arising from bad faith claims, on a prior accident period loss and LAE reserves. In 2004, on a statutory basis, Infinity had $14.5 million of favorable reserve development, excluding $9.3 million of unfavorable development on extra-contractual liabilities arising from bad faith claims, on prior accident period loss and LAE reserves. The favorable development in both years is primarily attributable to California business for 2004 and 2003 as the Company experienced continued improvement in claims frequency trends. Catastrophe related losses were $2.3 million in 2005 compared to $1.6 million in 2004.
An increase in the loss and LAE ratio, offset by a decrease in the underwriting ratio, resulted in a modest 2.0 point increase in the combined ratio for the Top Five Focus States compared to that in 2004. The 3.0 point increase in the loss and LAE ratio was primarily attributable to an increase in the loss and LAE ratios in Florida. The book in Florida has grown substantially as a result of new business writings, which typically have higher loss and LAE ratios than renewal business. In light of the increase in the loss and LAE ratio in Florida, Infinity took several rate adjustments in this state with an overall effect of a 15.0% increase. The underwriting expense ratio fell 1.0 point compared to 2004 as a result of the benefit of increased premium volume over which to spread fixed expenses.
The statutory combined ratio in the twelve Remaining Focus States decreased 0.9 points overall in 2005 with a decrease in underwriting ratio of 1.6 points offset by an increase in the loss and LAE ratio of 0.7 points. Infinity took rate actions throughout 2005 to improve the profitability in these states with an overall annual rate increase of 7.0% with double digit increases in some states. In spite of Infinity’s increased marketing costs as new products were introduced, the underwriting expense ratios fell 1.6 points as fixed expenses were spread over a larger premium base.
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Net investment income decreased $0.2 million for the twelve-month period ended December 31, 2005 from 2004. This slight decrease was due to lower interest expense on the physical damage quota share agreement as a result of the elimination in 2005 of that facility, offset by lower gross investment income despite a 3.9% increase in average invested assets. Infinity’s weighted-average gross investment yield decreased from 5.1% to 4.8% for the twelve-month periods ended December 31, 2004 and 2005, respectively.
Other income for the twelve-month period ended December 31, 2005 decreased $2.9 million from 2004, primarily due to reduced finance charge income and due to nonrecurring 2004 gains of $2.2 million for the sale of property and management fee income. Management anticipates a continued decline in future years’ finance charge income due to an expected continued decrease in the Assumed Agency Business. Other income decreased $5.3 million for the twelve-month period ended December 31, 2004 from 2003, primarily due to a nonrecurring gain of $6.7 million on the commutation of service and indemnity agreements with AFG in 2003.
The Senior Notes carry a coupon rate of 5.50%, effective yield of 5.55%, require no amortization payment and mature in February 2014. The term loan accrued interest at a variable rate, which averaged 3.7% from July 16, 2003, the date of issue through February 18, 2004, at which time it was refinanced with the Senior Notes. The risk of variability in future interest expense was partially hedged by the interest rate swap. Interest expense was accrued at a fixed rate of 8.5% on the $55 million note due to AFG until its repayment in mid-July 2003 using a portion of the proceeds of the $200 million term loan. (Refer to Note 3 of the Consolidated Financial Statements for additional information on the Senior Notes.)
Other expenses increased $10.8 million for the twelve-month period ended December 31, 2005 as compared to 2004. The increase relates primarily to the increased write-offs of uncollectible premium balances and higher corporate litigation expenses. The increase in premiums receivable charged off is a result of more liberal credit terms in certain states and a result of increased charge-offs in Florida, where the Department of Insurance prohibited canceling coverage for non-payment after hurricanes occurred in the second half of 2005. The increase in corporate litigation expenses was a result of the disposition of several claims-related lawsuits that sought damages beyond policy limits. In addition, the loss recorded on sub-leased space during 2005 contributed to the increase in other expenses. This loss was generated as vacant space following the consolidation of certain redundant administrative functions was sublet.