Calculated by dividing amortization of deferred policy acquisition costs and net underwriting and administrative expenses (attributable to insurance operations) by net premiums earned.
has been adjusted, as of January 1, 2005, to reflect the adoption of Staff Accounting Bulletin (SAB) No. 108, Quantifying Financial Statement Misstatements.
Earnings per share reflect only net income for the period we were a publicly-traded company in 2009: October 17, 2009 through December 31, 2009. Net income during this period was $929.
Net book value per share is calculated by dividing total shareholders’ equity by the shares outstanding at the end of the period. Prior to October 16, 2009 there were no shares outstanding for Penn Millers Holding Corporation.
Factors that could affect our actual results include, among others, the fact that our loss reserves are based on estimates and may be inadequate to cover our actual losses; the uncertain effects of emerging claim and coverage issues on our business, including the effects of climate change; the geographic concentration of our business; an inability to obtain or collect on our reinsurance protection; a downgrade in the A.M. Best rating of our insurance subsidiaries; the impact of extensive regulation of the insurance industry and legislative and regulatory changes; a failure to realize our investment objectives; the effects of intense competition; the loss of one or more principal employees; the inability to acquire additional capital on favorable terms; a failure of independent insurance brokers to adequately market our products; and the effects of acts of terrorism or war.
We evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to reviewing our financial performance based on results determined in accordance with generally accepted accounting principles in the United States (GAAP), we utilize certain non-GAAP financial measures that we believe are valuable in managing our business and for comparison to our peers. These non-GAAP measures are underwriting income, combined ratios and written premiums. In addition, where we feel it enhances the presentation to the reader, we may present certain GAAP financial measures in a manner to reflect the impact of certain unusual or non-recurring situations. For the presentation of the years ended December 31, 2009 and 2008, we have presented certain summary results and ratios in such a manner to show the impact of our accounting for our aggregate stop loss reinsurance contract. For more information about our stop loss contract, see Item 1 - “Business - Reinsurance.”
Successful initial public offering in October 2009 raised $45,172 of capital
On April 22, 2009 Penn Millers Mutual adopted a plan of conversion to convert Penn Millers Mutual from the mutual to the stock form of organization, which was approved by our policyholders on October 15, 2009. Our public stock offering closed on October 16, 2009 and we issued 5,444,022 shares of Penn Millers Holding Corporation common stock at an initial price of $10.00 per share.
For the year ended December 31, 2009, we saw a year of lower catastrophic losses compared to 2008.
The net positive results on our investments for 2009 compared to 2008, contributed to our $9,946 increase in net income.
For both our agribusiness and commercial business segments, we continue to emphasize that we will not compromise profitability for top line growth.
Our focus on underwriting discipline and rate adequacy in the midst of this soft market has resulted in our premium revenue growth being relatively modest and somewhat volatile.
We believe our plans for the expansion of our PennEdge product, our strategic alliances and our plan to grow our producer network will position us to take advantage of profitable growth opportunities in the future.
Premiums earned are the earned portion of our net premiums written. Gross premiums written include all premiums recorded by an insurance company during a specified policy period. Insurance premiums on property and casualty insurance contracts are recognized in proportion to the underlying risk insured and are earned ratably over the duration of the policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. Our policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2009, one-half of the premiums would be earned in 2009 and the other half would be earned in 2010.
We invest our surplus and the funds supporting our insurance liabilities (including unearned premiums and unpaid losses and loss adjustment expenses) in cash, cash equivalents, equities and fixed maturity securities. Investment income includes interest and dividends earned on invested assets. Net realized gains and losses on invested assets are reported separately from net investment income. We recognize realized gains when invested assets are sold for an amount greater than their cost or amortized cost (in the case of fixed maturity securities) and recognize realized losses when investment securities are written down as a result of a credit-related other than temporary impairment or sold for an amount less than their cost or amortized cost, as applicable. Our portfolio of fixed maturity securities is managed by an independent investment manager who has discretion to buy and sell securities in accordance with the investment policy approved by our board of directors. However, by agreement, our investment manager cannot sell any security without our consent if such sale would result in a net realized loss.
We measure growth by monitoring changes in gross premiums written and net premiums written. We measure underwriting profitability by examining losses and loss adjustment expenses, underwriting expenses and combined ratios. We also measure profitability by examining underwriting income (loss) and net income (loss).
We use net income (loss) to measure our profit and return on average equity to measure our effectiveness in utilizing equity to generate net income. In determining return on average equity for a given year, net income (loss) is divided by the average of the beginning and ending equity for that year. For the year ended December 31, 2009, return on average equity has been weighted to account for the days in 2009 we were a public company.
When a claim is reported to us, our claims personnel establish a case reserve for the estimated amount of the ultimate payment. The amount of the loss reserve for the reported claim is based primarily upon a claim-by-claim evaluation of coverage, liability, injury severity or scope of property damage, and any other information considered pertinent to estimating the exposure presented by the claim. Each claim is settled individually based upon its merits, and some claims may take years to settle, especially if legal action is involved. Case reserves are reviewed on a regular basis and are updated as new data becomes available.
In addition to case reserves, we maintain estimates of reserves for losses and loss adjustment expenses incurred but not reported. Some claims may not be reported for many years. As a result, the liability for unpaid losses and loss adjustment reserves includes significant estimates for IBNR.
We accrue liabilities for unpaid losses and loss adjustment expenses based upon estimates of the ultimate amount payable. Our estimates of ultimate losses and loss adjustment expenses by line of business use the following actuarial methodologies:
2, 3, 4, and 5-Year Averages (straight averages and loss-weighted averages);
Incurred Loss Development Method - The Incurred Loss Development Method utilizes historical incurred loss (the sum of cumulative historical loss payments plus outstanding case reserves) patterns to estimate future losses. This method is often preferred over the paid method as it includes the additional information provided by the aggregation of individual case reserves. The resulting LDFs tend to be lower and more stable than those of the paid development method. However, the incurred development method may be affected by changes in case reserving practices and any unusually large individual claims. As with the Paid Loss Development Method, the actuary produces and reviews several indications of ultimate loss using this method based on various LDF selections.
We estimate IBNR reserves by first deriving an actuarially based estimate of the ultimate cost of total losses and loss adjustment expenses incurred by line of business as of the financial statement date. We then reduce the estimated ultimate losses and loss adjustment expenses by losses and loss adjustment expense payments and case reserves carried as of the financial statement date. The actuarially determined estimate is based upon indications from one of the above actuarial methodologies or uses a weighted average of these results. The specific method used to estimate the ultimate losses for individual lines of business, or individual accident years within a line of business, will vary depending on the judgment of the actuary as to what is the most appropriate method for a line of business’ unique characteristics. Finally, we consider other factors that impact reserves that are not fully incorporated in the actuarially based estimate, such as changes in the external business environment and changes in internal company processes and strategy.
Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability for losses and loss adjustment expenses may be higher or lower than the related loss reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially higher or lower in amount than current loss reserves. We reflect adjustments to loss reserves in the results of operations in the period the estimates are changed.
Trends in social and economic factors that may affect our loss experience, such as the impact of economic conditions on the speed in which injured workers return to their jobs;
The relatively small base of claims we have increases the risk that a few claims experiencing adverse development could significantly impact our loss reserve levels; and
The impact of changes in our net retention (i.e., changes in reinsurance) over the past few years on the potential magnitude of reserve development.
The following factors could impact the frequency and severity of claims, and therefore, the ultimate amount of losses and LAE paid:
Recent Variabilities of the Liability for Unpaid Losses and LAE, Net of Reinsurance Recoverables
If the losses and LAE reserves were recorded at the high end of the actuarially-determined range, the losses and LAE reserves would increase by $2,732. This increase in reserves would have the effect of decreasing net income and equity as of December 31, 2009 by $1,803. If the losses and LAE reserves were recorded at the low end of the actuarially-determined range, the losses and LAE reserves at December 31, 2009 would be reduced by $10,200, with corresponding increases in net income and equity of $6,732.
At December 31, 2009, our workers’ compensation line of business had recorded reserves, net of reinsurance, of $20,937, or 23.7% of our total net reserves. This reserve is $525, or 2.6%, above the actuarially selected estimate. In addition to the uncertainties associated with the actuarial assumptions and methodologies described above, the workers’ compensation line of business can be impacted by a variety of issues such as unexpected changes in medical cost inflation, medical treatment options and duration, changes in overall economic conditions, and company specific initiatives. Initiatives to limit the long term costs of workers’ compensation claims costs, such as return to work programs, can be adversely impacted by poor economic conditions when there are fewer jobs available for injured workers.
At December 31, 2009, our fire and allied lines of business had recorded reserves, net of reinsurance, of $4,790, which represented 5.4% of our total net reserves. These lines of business comprise a substantial amount of the property exposures that we insure. Our allied lines of business covers losses primarily from wind, hail, and snow. No adjustment has been made to the actuarially selected estimate for this line. Favorable or unfavorable development can occur on specific claims based on changes in the cost of building materials, refinement of damage assessments, and resolution of coverage issues; and as opportunities for salvage and subrogation are investigated.
At December 31, 2009 and December 31, 2008, we had gross unrealized losses on fixed maturity securities of $561 and $2,871, respectively. We have evaluated each security and taken into account the severity and duration of any declines in fair value, the current rating on the bond and the outlook for the issuer according to independent analysts. We believe that the foregoing declines in fair value in our existing portfolio are most likely attributable to the current market conditions and we will recover the entire amortized cost basis. Our fixed maturity investments are classified as available for sale because we will, from time to time, make sales of securities that are not impaired, consistent with our investment goals and policies. Our fixed maturity portfolio is managed by an independent investment manager who has discretion to buy and sell securities; however by agreement, the investment manager cannot sell any security without our consent if such sale will result in a net realized loss.
We monitor our investment portfolio and review securities that have experienced a decline in fair value below cost to evaluate whether the decline is other-than-temporary. When assessing whether the amortized cost basis of a fixed maturity security will be recovered, we compare the present value of the cash flows likely to be collected, based on an evaluation of all available information relevant to the collectability of the security, to the amortized cost basis of the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as the “credit loss.” If we determine that we intend to sell the securities that have experienced a decline in fair value below cost, or that it is more likely than not that we will be required to sell the securities prior to recovering their amortized cost basis less any current-period credit losses, the full amount of the other-than-temporary impairment will be recognized in earnings. If we conclude based on our analysis that there is a credit loss, and we determine that we do not intend to sell, and it is not more likely than not that we will be required to sell the securities, the amount of the credit loss will be recorded in earnings, and the remaining portion of the other-than-temporary impairment loss will be recognized in other comprehensive income (loss), net of tax.
In 2009, we determined that one security in our portfolio had sustained a loss from which it was unlikely to recover. In July 2009 we sold our entire holdings in this security, which resulted in a pre-tax other-than-temporary impairment in 2009 of approximately $197. For the year ended December 31, 2008, we recorded pre-tax charges to income of $2,922 for securities that we determined were other-than-temporarily impaired. Our net realized investment losses of $702 in 2007 included pre-tax impairment charges of $620 recognized as a result of other-than-temporary declines in fair values. Adverse investment market conditions, or poor operating results of underlying investments, could result in impairment charges in the future.
We use quoted values and other data provided by a nationally recognized independent pricing service in our process for determining fair values of our investments. Its evaluations represent an exit price and a good faith opinion as to what a buyer in the marketplace would pay for a security in a current sale. This pricing service provides us with one quote per instrument. For fixed maturity securities that have quoted prices in active markets, market quotations are provided. For fixed maturity securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of observable inputs including relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. The observable market inputs that our independent pricing service utilizes may include (listed in order of priority for use) benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, and other reference data on markets, industry, and the economy. Additionally, the independent pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. We evaluate the recoverability of deferred tax assets by taking into account the future taxable income of the legal entity that generated the deferred tax asset. Any changes in estimated future taxable income may require us to change our estimated valuation reserve against our deferred tax assets.
As of December 31, 2009, 2008 and 2007, we had no material unrecognized tax benefits or accrued interest and penalties. Federal tax years 2006 through 2009 were open for examination as of December 31, 2009.
The expected long-term rate of return on plan assets is applied in the determination of periodic pension benefit cost as a reduction in the computation of the expense. In developing the expected long-term rate of return assumption, we considered published surveys of expected market returns, actual returns of various major indices, and our own historical investment returns. If any of these variables materially change in the future, our assumption is reasonably likely to change. The expected long-term rate of return on plan assets is based on an asset allocation assumption of 60% in equity securities and 40% in long duration fixed maturity securities. We review our asset allocation at least annually and make changes when considered appropriate. In 2009, we did not change our expected long-term rate of return from the 7.5% used in 2008. Our pension plan assets are valued at actual fair value as of the measurement date.
Pension expense for 2009 would have increased approximately $24 if our expected return on plan assets were one half of one percent lower. The benefit obligation at December 31, 2009 would have increased by approximately $499 if our assumed discount rate were one half of one percent lower. We believe that a one half of one percent change in the discount rate and/or the return on plan assets has a reasonable likelihood of occurrence. However, actual results could differ significantly from this estimate.
Further information on our pension and other employee benefit obligations is included in Note 10 of the notes to our consolidated financial statements under Part II Item 8 - “Financial Statements and Supplementary Data.”
Our premium growth and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is more significant than during a hard market cycle and makes it difficult to attract and retain properly priced agribusiness and commercial business. The insurance industry is currently experiencing a soft market cycle. Therefore, insurers may be unable to increase premiums and increase profit margins. A hard market typically has a positive effect on premium growth.
The major components of operating revenues and net income (loss) are as follows:
Net premiums earned decreased $3,379, or 4.3% in 2009 compared to 2008 primarily due to:
According to our stop loss contract with our reinsurers, if losses are ceded additional ceded premiums are accrued at 20% of the ceded losses. In 2008, an unusually high level of property losses, both catastrophe and non-catastrophe related, resulted in losses and additional reinsurance premiums being ceded to the reinsurers under the stop loss contract. As a result of the loss recoverable under the stop loss contract, we recorded $3,322 of ceded premium under the stop loss for 2008.
Increases in ceded premiums written of $1,625 on our underlying reinsurance program are due to decreased retentions and increased rates in 2009. Excess of loss ceded premiums written and earned in our agribusiness segment increased $1,774 in 2009 compared to 2008.
In 2009, we lowered our participation rate on our per-risk reinsurance treaty:
Losses between $1,000 million and $5,000 are retained at 0% in 2009 versus our 25% retention rate in 2008.
Net investment income increased from $5,335 in 2008 to $5,648 in 2009. The increase in the period is primarily attributable to higher balances of available for sale securities arising from operating cash flows and the proceeds of our public offering, which were partially offset by the impact of declining interest rates and lower dividend income in 2009.
Our net realized investment losses of $702 in 2007 included pre-tax impairment charges of $620 recognized as a result of other-than-temporary declines in fair values.
As discussed above, we evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to using GAAP based performance measurements, we also utilize certain non-GAAP financial measures that we believe are valuable in managing our business and for comparison to our peers. These non-GAAP measures are underwriting (loss) income, combined ratios, written premiums and discussion of our results that exclude the impact of our aggregate stop loss contract.
This lower level of claim activity included a decline in catastrophe losses of $2,903 in 2009 compared to 2008.
Favorable loss development in the fire and allied (approximately $1,659) resulting from favorable settlements on prior years’ claims.
Increases in other non-catastrophe property losses and increased automobile and liability losses; and
Favorable development in our workers’ compensation line of $1,652 due to the general observation of declines in claims severity on prior accident years; and
In 2009, the combination of higher reinsurance costs (and therefore lower earned premium) and an overall decline in direct earned premium from our reduction of unprofitable business in our commercial business segment has caused this underwriting expense ratio to increase, with partially offsetting lower loss and LAE ratios.
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs, was $25,382 for the year ended 2009 and $26,562 for the year ended 2008.
Amortization of deferred policy acquisition costs decreased $1,698 for 2009 as compared to 2008, as a result of the previously described decrease in earned premiums.
Underwriting and administrative expenses increased $518 primarily from increased compliance costs in preparing to become a public company and increased employee incentive costs based on company results.
Interest expense was $22 for the year ended 2009, as compared to $184 for the year ended 2008. The decrease of $162 for the period is primarily due to the 2009 reversal of interest expense on our aggregate stop loss reinsurance contract. For additional information concerning the stop loss reinsurance contract, see Item 1 - “Business - Reinsurance.”
Other expense is comprised primarily of estimated reserves and specific write-offs of uncollectible premiums.
Other expense increased $181 in 2008 as compared to 2007, primarily due to increased write-offs and aging of receivables.
Realized losses of $5,819 recognized in 2008, resulting from an other-than-temporary impairment charge of $2,922 on our equity portfolio and losses on sales of equity investments of $2,827;
Lower losses and LAE in 2009 from a significantly lower level of large losses, particularly relating to property losses. In addition to reduced severity, we observed some moderate declines in new claim frequency in 2009. There was a decline in catastrophe losses in 2009 compared to 2008.
For the year ended December 31, 2008 we had a pre-tax loss from continuing operations of $5,837 compared to pre-tax income of $1,845 in 2007. This decrease was largely attributable to the increase in catastrophe and non-catastrophe weather-related losses in 2008 and realized losses from other-than-temporary impairments and the sales of equity securities in 2008.
For the year ended 2009, the income tax benefit for continuing operations was $346, or an effective rate of (11.3)%. The 2009 provision for income taxes includes a reversal of our deferred tax valuation reserve of $1,026 from 2008, as we have determined that it is more likely than not that we will be able to realize the full benefit of our deferred tax assets related to our capital losses.
For the year ended 2008, the income tax benefit for continuing operations was $1,378 of income tax benefit, or an effective rate of 23.6%, compared to $396 of income tax expense, or an effective rate of 21.5% for the year ended 2007. The 2008 provision for income taxes included expense associated with a valuation reserve of $1,026 attributable to our capital losses for which it was considered at that time to be more likely than not that we would not realize a tax benefit.
Net (loss) income from discontinued operations includes the results related to our agency operations at Eastern Insurance Group and our technology consulting firm, Penn Software. The sale of the net assets of Penn Software was completed in July 2008, and the sale of the net assets of Eastern Insurance Group was completed in February 2009.
For the year ended 2009, the net loss from discontinued operations of $840 includes a provision for income taxes of $879, the majority of which represents state and federal income tax expense from the sale of the net assets of Eastern Insurance Group whose book basis exceeded their tax basis.
For the year ended 2007, the net loss from discontinued operations of $363 included an after-tax charge of $438 for executive severance related to the agency operations, and an after-tax goodwill impairment of $106 for Penn Software.
The favorable items listed above were offset by lower earned premium in 2009 of $3,379.
An increase in our losses and loss adjustment expenses of $7,607;
The amounts listed above were partially offset by increased earned premium in 2008 compared to 2007 of $7,767.
Our operations are organized into three business segments: agribusiness, commercial business, and our other segment. These segments reflect the manner in which we are currently managed based on type of customer, how the business is marketed, and the manner in which risks are underwritten. Within each segment we underwrite and market our insurance products through packaged offerings of coverages sold to generally consistent types of customers.
The components of premiums written and earned, for the years ended December 31, 2009, 2008 and 2007 of our agribusiness segment are as follows:
Effective January 1, 2009, we modified our excess of loss reinsurance program and retained less of our losses as compared to 2008, which resulted in an increase in ceded premiums written and earned of $1,774 for 2009, as compared to 2008. The reversal of the stop loss had the effect of reducing ceded premiums for 2009 as compared to 2008. For the year ended 2009, our agribusiness segment benefitted from a net reversal of stop loss ceded premiums of $615, while the segment recognized ceded premiums of $1,548 in 2008. For additional information concerning the stop loss reinsurance contract, see Item 1 - “Business - Reinsurance.” The total net decrease in ceded premiums written for 2009 of $283, when added to the $1,394 increase in direct premiums written for the same period, resulted in growth of net premiums written of $1,677 for 2009 as compared to 2008. Net premiums earned were $45,289 and $45,298 for the years ended 2009 and 2008, respectively.
Direct premiums written increased 2.4% for the year ended December 31, 2008 compared to 2007. Effective January 1, 2008, we modified our reinsurance program by retaining more of our losses above $500, which resulted in a decrease in ceded premiums written. The 2.4% increase in gross premiums written for 2008, combined with the reduction in ceded premiums, resulted in net premiums written increasing by 9.0% for the year ended December 31, 2008 compared to 2007. As a result, growth in net premiums written in 2007 and 2008 continued to drive the growth in net premiums earned in 2008, in which net premiums earned increased by 12.6% compared to 2007.
prior year development excludes the impact of the stop loss reversal.
$2,727 of lower incurred catastrophe losses in 2009, which were partially offset by a lower level of favorable prior year development in 2009 as compared to 2008 of $2,856 (excluding the impact of the stop loss reversal on ceded losses).
The reversal of the stop loss in the third quarter of 2009 resulted in $568 of ceded incurred losses being reversed for the agribusiness segment, compared to ceded losses incurred of $568 that were recognized in 2008. For additional information concerning the stop loss reinsurance contract, see Item 1 - “Business - Reinsurance.”
Losses and LAE increased $3,824 for the year ended December 31, 2008, 14.0% higher than in 2007. The increase in losses and loss adjustment expenses was primarily driven by growth in insured exposures, non-catastrophe weather related losses, increased automobile and liability losses, and the increase in the reinsurance retention for 2008. Catastrophe losses were $4,485 in 2008, compared to $1,609 in 2007. The increase in losses and LAE was partially offset by favorable prior year losses and LAE development of approximately $4,803 in 2008, compared to $4,264 in 2007.
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs were $13,650 for the year ended 2009 as compared to $13,848 for the same period in 2008, a decrease of $198. This decrease in underwriting expenses was due to lower amortization of deferred policy acquisition cost as a result of the relatively flat growth in premiums earned in 2009. This decrease relative to the smaller decrease in net premiums earned resulted in the underwriting expense ratio decreasing slightly from 30.6% for 2008 to 30.1% for 2009.
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs, increased by $1,357 in 2008, a 10.9% increase from 2007. The increase is due to increased amortization of deferred policy acquisition costs associated with the growth in premiums earned in 2008. This increase in underwriting expenses relative to the larger increase in net premiums earned resulted in the underwriting expense ratio declining from 31.0% for 2007 to 30.6% for 2008. This decline in the underwriting expense ratio was insufficient to offset the increase in losses and loss adjustment expense during 2008 primarily caused by the $2,876 increase in catastrophe losses. As a result, our combined ratio rose from 98.9% for 2007 to 99.3% for the same period in 2008.
Liability insurance includes commercial general liability, products liability, and professional liability covering our agribusiness insureds’ operations. As of December 31, 2009, our agribusiness segment had approximately 1,200 general liability insurance policies in force. Our liability loss ratio declined in 2009 as we observed a lower level of severity on newer claims and we experienced favorable development on the settlement of prior accident year claims.
The components of premiums written and earned, for the years ended December 31, 2009, 2008 and 2007 of our commercial business segment are as follows:
Our direct premiums written in our commercial business segment were $29,449 for the year ended 2009 and $37,458 for the year ended 2008. This decline of $8,009 is primarily attributable to:
We have elected to withdraw from certain unprofitable classes of business and terminate relationships with several underperforming producers;
Net premiums earned were $28,961 and $31,805 for the years ended 2009 and 2008, respectively. This decrease in net premiums earned is due primarily to the decline in direct premiums written resulting from the runoff of unprofitable business and changes in our reinsurance program in 2009, the impacts of which were partly offset by the impact of the stop loss on ceded premiums of $2,876. For additional information concerning the stop loss reinsurance contract, see Item 1 - “Business - Reinsurance.” Direct premiums written decreased by $402 in the year ended 2008 compared to the same period in 2007.
The decrease in direct premiums written for 2008, combined with the described changes to ceded premiums, resulted in net premiums written decreasing by 2.0% in the year ended 2008 compared to the same period of 2007. The growth in net premiums written in 2007 continued to drive the growth in net premiums earned in 2008, which increased 8.7% to $31,805.
The discussion below provides more insight into the variances in the categories of losses and LAE and underwriting and administrative expense, which impact underwriting profitability:
This decrease is partly offset by a $440 increase in prior year development (excluding the impact of the stop loss reversal).We have experienced a modest level of unfavorable development of $323 in this segment in 2009 compared to favorable prior year development of $117 experienced in 2008.
The increase in losses and LAE is due to increases in non-catastrophe property losses, increased automobile and workers compensation losses;
Total underwriting and administrative expenses, including amortization of deferred policy acquisition costs in our commercial business segment were $10,775 and $11,371 for the years ended 2009 and 2008, respectively. This decrease of $596 is primarily due to the reduction in our net premiums earned in 2009. The 5.2% lower underwriting expenses, combined with an 8.9% decline in net premiums earned, resulted in the underwriting expense ratio increasing from 35.8% in 2008 to 37.2% in 2009.
This increase in the underwriting expense ratio when netted against the decrease in the loss and LAE ratio resulted in our combined ratio of our commercial business segment decreasing from 115.9% in 2008 to 115.6% in 2009. Excluding the effects of the stop loss on our earned premium and losses, the combined ratio in our commercial business declined from 120.9% in 2008 to 106.8% in 2009, which reflects the improvement in the underwriting results that we believe is primarily attributable to the actions taken to remove unprofitable producers and classes of business from our book of business and lower large loss severity in 2009.
Underwriting and administrative expenses, including amortization of deferred policy acquisition costs increased $768 in the year ended 2008, 7.2% higher than 2007 due primarily to an increase in acquisition expenses associated with the growth in premium revenues in 2008. This increase in underwriting expenses relative to the larger increase in net premiums earned resulted in the underwriting expense ratio declining from 36.2% for 2007 to 35.8% for 2008. This 40 basis point decrease in the underwriting expense ratio only partially offset the significant rise in our loss and loss adjustment expense ratio. As a result, our combined ratio increased from 106.5% for 2007 to 115.9% for 2008.
The following table sets forth the direct premiums written, net premiums earned, and calendar year net loss ratios of our commercial lines products for the periods indicated:
Both revenues and expenses in our other segment have experienced volatility over the last three years due to fluctuating rates of participation in our mandatory pools. This is reflected in net premiums earned of $1,108 in 2009, $1,634 in 2008 and $1,465 in 2007. Net premiums written were $520 lower in 2009 compared to 2008. The reduction is due to declines in premium assumed from the National Workers Compensation Reinsurance Pool. Our total claims and expenses were $933 in 2009, compared to $1,346 in 2008 and $2,463 in 2007.
On October 16, 2009, we completed an initial public offering of 5,444,022 shares of common stock at $10.00 per share. Consistent with our expectations, the gross proceeds of $54,440 were allocated through December 31, 2009 as follows: conversion and offering expenses and commissions of $3,867; the loan to our ESOP of $5,400; pay down of our line of credit of $1,800; and general corporate purposes of approximately $43,373. After using a portion of the proceeds to fund a loan to our ESOP and retire our line of credit, we contributed $25,000 of the remaining net proceeds from the offering to Penn Millers Insurance Company. These net proceeds will supply additional capital that Penn Millers Insurance Company needs to support future premium growth through the expansion of our producer networks and the marketing of our new PennEdge product. The net proceeds have been invested in securities consistent with our investment policy.
Cash flows from continuing operations for the years ended December 31, 2009, 2008, and 2007 were as follows:
Cash flows from operating activities decreased by $1,103 for the period ended December 31, 2009 compared to the period ended December 31, 2008. The change is primarily due to increased claims payments and lower premium volume in 2009 compared to 2008.
As of December 31, 2009, the amount available for payment of dividends from Penn Millers Insurance Company in 2010 without the prior approval of the Pennsylvania Insurance Department is $7,249 based upon the insurance company’s 2009 annual statement. Prior to its payment of any dividend, Penn Millers Insurance Company is required to provide notice of the dividend to the Pennsylvania Insurance Department. This notice must be provided to the Pennsylvania Insurance Department 30 days prior to the payment of an extraordinary dividend and 10 days prior to the payment of an ordinary dividend. The Pennsylvania Insurance Department has the power to limit or prohibit dividend payments if Penn Millers Insurance Company is in violation of any law or regulation. These restrictions or any subsequently imposed restrictions may affect our future liquidity.
It is anticipated that approximately 10% of the ESOP shares will be allocated annually to employee participants of the ESOP. An expense charge is booked ratably during each year for the shares committed to be allocated to participants that year, determined with reference to the fair market value of our stock at the time the commitment to allocate the shares is accrued and recognized. For 2009 we recognized compensation expense of $92 on 9,000 shares of our common stock that were committed to be released to participants’ accounts at December 31, 2009.
The following table summarizes, as of December 31, 2009, our future payments under contractual obligations and estimated claims and claims related payments:
Inflation increases consumers’ needs for property and casualty insurance coverage due to the increase in the value of the property covered and any potential liability exposure. Inflation also increases claims incurred by property and casualty insurers as property repairs, replacements and medical expenses increase. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We establish property and casualty insurance premiums levels before the amount of losses and loss expenses, or the extent to which inflation may impact these expenses, are known. Therefore, we attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, financial results have not been significantly affected by it.
On July 1, 2009, the Accounting Standards Codification (ASC) became the Financial Accounting Standards Board’s (FASB) officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities, superseding the then existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. The adoption of this guidance in the second quarter of 2009 changed our references to GAAP but did not impact our consolidated financial statements.
In December 2008, the FASB issued guidance on “Employer’s Disclosures about Postretirement Benefit Plan Assets.” New authoritative accounting guidance under FASB ASC 715, Compensation-Retirement Benefits provides guidance related to an employer’s disclosures about plan assets of defined benefit pension or other post-retirement benefit plans. Under ASC 715, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The new guidance was effective for fiscal years ending after December 15, 2009. The adoption of this guidance did not have an impact on our results of operations or financial condition.
In April 2009, the FASB issued guidance on “Recognition and Presentation of Other-Than-Temporary Impairments.” This update amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. For debt securities that have fair values less than their amortized cost, this guidance modifies the prior requirements that to avoid recognizing an other-than-temporary impairment, management must assert that it has both the intent and ability to hold a security for a period of time sufficient to allow for an anticipated recovery in its fair value to its amortized cost basis. Instead, an entity should assess whether the entity (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery. An entity must recognize an other-than-temporary impairment if either of these conditions is met. Also, if an entity does not expect to recover the entire amortized cost basis of a security, an other-than-temporary impairment shall be considered to have occurred. If the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the other-than-temporary impairment shall be separated into (a) the amount representing the credit loss, which is recognized in earnings, and (b) the amount related to all other factors, which is recognized in other comprehensive income. This guidance was effective for interim and annual reporting periods ending after June 15, 2009. Adoption of this guidance did not have a material impact on our results of operations or financial condition.
In May 2009, additional new authoritative accounting guidance (Accounting Standards Update No. 2009-5) under ASC 820 was issued. This update provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing principles of ASC 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The adoption of this guidance in the third quarter of 2009 did not have an impact on our results of operations or financial condition.
In May 2009, the FASB issued guidance on “Subsequent Events.” This guidance establishes general standards of accounting for, and requires disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This guidance was effective for interim or annual periods ending after June 15, 2009. This guidance was updated in February 2010 to remove the requirement for an SEC filer, as defined, to disclose the date through which subsequent events have been evaluated. Adoption of this guidance did not have an impact on our results of operations or financial condition.
All other standards and updates of those standards issued during the twelve months ended December 31, 2009 either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to us or (iv) are not expected to have a significant impact on our results of operations or financial condition.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Penn Millers Holding Corporation and subsidiary as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, 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 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in note 2 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (included in FASB ASC Topic 715, Compensation - Retirement Benefits), as of December 31, 2007.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including loss reserves, contingent assets and liabilities, tax valuation reserves, valuation of defined benefit pension obligations, valuation of investments, including other-than-temporary impairment of investments, the disclosure of contingent assets and liabilities, at the date of the consolidated financial statements, and the reported amounts of revenues and expenses, during the reporting period. Actual results could differ from these estimates.
Additionally, one producer, Arthur J. Gallagher Risk Management Services, which writes business for the Company through nine offices, accounted for 14% of the Company’s direct premium writings for 2009. Only one other producer accounted for more than 5% of the Company’s 2009 direct premium writings.
Realized gains and losses on sale of investments are recognized in net income on the specific identification basis as of the trade date. Realized losses also include losses for fair value declines that are considered to be other-than-temporary. Changes in unrealized gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income.
Policy acquisition costs, such as commissions, premium taxes, and certain other underwriting expenses that vary with, and are primarily related to, the production of new and renewal business, have been deferred and are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisitions costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, may require adjustments to deferred policy acquisition costs. If the estimation of net realizable value indicates that the deferred policy acquisition costs are not recoverable, they would be written off.
Deferred offering costs of $1,015 are reported separately on the consolidated balance sheet at December 31, 2008.
The Company had no goodwill on its consolidated balance sheets at December 31, 2009 and 2008 related to continuing operations.
Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. PSTS and EIG had goodwill, which was classified as assets held-for-sale. The Company performed the impairment tests as of December 31, 2008 and 2007 for PSTS and EIG. Goodwill of EIG was also tested as of September 30, 2008 after information obtained during the selling process and the further deterioration of economic conditions indicated that it was more likely than not that the fair value of the EIG reporting unit was below its carrying amount. Goodwill in PSTS was impaired by $160 as of December 31, 2007. PSTS was sold in July 2008, resulting in a pretax loss on sale of $117.
The Company completed step two of the goodwill impairment test in the fourth quarter 2008 and recorded an adjustment of $165 to the goodwill impairment write-down that was recorded at September 30, 2008. The fair value of the reporting unit was based on the actual selling price of EIG as executed on February 2, 2009. The adjusted carrying amount of goodwill of $2,147 is in assets held-for-sale at December 31, 2008.
The Company utilizes the corridor method of amortizing actuarial gains and losses. The amortization of experience gains and losses is recognized only to the extent that the cumulative unamortized net actuarial gain or loss exceeds 10% of the greater of the projected benefit obligation and the fair value of plan assets at the beginning of the year. When required, the excess of the cumulative gain or loss balance is amortized over the expected average remaining service life of the employees covered by the plan. On December 31, 2007, the Company adopted the provisions SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (included in FASB ASC Topic 715, Compensation - Retirement Benefits). This statement requires recognition of the deferred gains and losses on the balance sheet with a corresponding charge to accumulated other comprehensive income (loss).
Basic and diluted earnings per share (EPS) are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The denominator for basic EPS includes ESOP shares committed to be released. In calculating diluted EPS, the weighted average shares outstanding includes all potentially dilutive securities.
On July 1, 2009, the Accounting Standards Codification (ASC) became the FASB’s officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. The adoption of this guidance in the third quarter of 2009 did not have an impact on the Company’s results of operations or financial position.
In December 2008, the FASB issued guidance on “Employer’s Disclosures about Postretirement Benefit Plan Assets.” New authoritative accounting guidance under FASB ASC 715, Compensation-Retirement Benefits provides guidance related to an employer’s disclosures about plan assets of defined benefit pension or other post-retirement benefit plans. Under ASC 715 , disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The new guidance was effective for fiscal years ending after December 15, 2009. The adoption of this guidance did not have an impact on the Company’s results of operations or financial position.
In April 2009, the FASB issued guidance on “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” New authoritative accounting guidance under FASB ASC 820, Fair Value Measurements and Disclosures affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. This guidance was effective for interim and annual reporting periods ending after June 15, 2009, with prospective application. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.
Supplementary new authoritative accounting guidance (Accounting Standards Update No. 2010-06) under ASC 820 requires additional disclosures related to transfers between levels in the hierarchy of fair value measurement. The standard is effective for reporting periods beginning after December 15, 2009. The standard does not change how fair values are measured. Accordingly, the standard will not have an impact on the Company, other than possible additional disclosures.
The Company’s estimates of fair value for financial assets and financial liabilities are based on the framework established in the fair value accounting guidance, which is now a part of ASC 820.
The fair value of a financial asset or financial liability is the amount at which that asset or liability could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidated sale. In accordance with the guidance set forth by ASC 820, the Company’s financial assets and financial liabilities measured at fair value are categorized into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access. The Company classifies U.S. Treasury debt securities as Level 1.
The Company uses quoted values and other data provided by a nationally recognized independent pricing service in its process for determining fair values of its investments. The pricing service provides the Company one quote per instrument. For fixed maturity securities that have quoted prices in active markets, market quotations are provided. For fixed maturity securities that do not trade on a daily basis, the independent pricing service prepares estimates of fair value using a wide array of observable inputs including relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. The observable market inputs that the Company’s independent pricing service utilizes include (listed in order of priority for use) benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, and other reference data on markets, industry, and the economy. Additionally, the independent pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
The fair value estimates of the Company’s investments provided by the independent pricing service at December 31, 2009, were utilized, among other resources, in reaching a conclusion as to the fair value of investments. As of December 31, 2009, all of the Company’s fixed maturity investments were priced using this one primary service. Management reviews the reasonableness of the pricing provided by the independent pricing service by employing various analytical procedures. The Company reviews all securities to identify recent downgrades, significant changes in pricing, and pricing anomalies on individual securities relative to other similar securities. This will include looking for relative consistency across securities in various common blocks or sectors, durations, and credit ratings. This review will also include all fixed maturity securities rated lower than “A” by Moody’s or S&P. If, after this review, management does not believe the pricing for any security is a reasonable estimate of fair value, then it will seek to resolve the discrepancy through discussions with the pricing service or its asset manager. The classification within the fair value hierarchy as presented in ASC 820 is then confirmed based on the final conclusions from the pricing review. The Company did not have any such discrepancies at December 31, 2009.
The amortized cost and fair value of investments in fixed maturity securities, which are all available for sale, at December 31, 2009 and 2008 are as follows:
Income tax expense (benefit) on net realized investment gains (losses) was $61, $(1,965) and $(222) for the years ended December 31, 2009, 2008, and 2007, respectively. Deferred income tax expense applicable to net unrealized investment gains included in equity was $1,845 and $468 at December 31, 2009 and 2008, respectively.
The Company entered into an interest rate swap agreement in 2005 to manage interest rate risk associated with its variable rate debt. The fixed interest rate as a result of the agreement was 5.55% for the full five year term of the debt. The notional amount of the swap was $1,432 at December 31, 2008. Investment gain (losses) of $19, $(41) and $(49) were recorded within net realized investment gains (losses) on the consolidated statements of operations in 2009, 2008 and 2007, respectively. On August 3, 2009 the variable rate debt was paid off and the interest rate swap terminated.
The Company invests in high credit quality bonds. These fixed maturity investments are classified as available for sale because the Company will, from time to time, sell securities that are not impaired, consistent with its investment goals and policies. Fair values of interest rate sensitive instruments may be affected by increases and decreases in prevailing interest rates which generally translate, respectively, into decreases and increases in fair values of fixed maturity investments. The fair values of interest rate sensitive instruments also may be affected by the credit worthiness of the issuer, prepayment options, relative values of other investments, the liquidity of the instrument, and other general market conditions. There are $5,964 in fixed maturity securities, at fair value, that at December 31, 2009, had been below cost for over 12 months. The $138 of unrealized losses on such securities relates to securities, which carry an investment grade debt rating and have declined in fair value roughly in line with overall market conditions. The Company has evaluated each security and taken into account the severity and duration of the impairment, the current rating on the bond, and the outlook for the issuer according to independent analysts. The Company has found that the declines in fair value are most likely attributable to the current interest rate environment.
Per the Company’s current policy, a fixed maturity security is other-than-temporarily impaired if the present value of the cash flows expected to be collected is less than the amortized cost of the security or where the Company intends to sell or more likely than not will be required to sell the security before recovery of its value. The Company believes, based on its analysis, that these securities are not other-than-temporarily impaired. However, depending on developments involving both the issuers and overall economic conditions, these investments may be written down in the consolidated statements of income in the future.
As of December 31, 2009, the Company incurred impairment charges of $197 related to one fixed maturity security. The carrying value of the security was written down to fair value as of June 30, 2009 and the security was sold in July 2009. For December 31, 2008 and 2007, the Company recorded impairment charges of $2,922 and $620, respectively, on its investments.
The Company does not engage in subprime residential mortgage lending. The only securitized financial assets that the Company owns are residential and commercial mortgage-backed securities of high credit quality. The Company’s exposure to subprime lending is limited to investments in corporate bonds of banks, which may contain some subprime loans on their balance sheets. These bonds are reported at fair value. As of December 31, 2009, fixed maturity securities issued by banks accounted for 7.8% of the bond portfolio’s book value. None of the Company’s fixed maturity securities have defaulted or required an impairment charge due to the subprime credit crisis.
Changes in deferred policy acquisition costs for the years ended December 31, 2009, 2008, and 2007 are as follows:
Interest paid was $73, $90, and $108 as of December 31, 2009, 2008, and 2007, respectively.
The Company has a noncontributory defined benefit pension plan covering substantially all employees. Retirement benefits are a function of both the years of service and level of compensation. It is the Company’s policy to fund the plan in amounts not greater than the amount deductible for federal income tax purposes and not less than the minimum required contribution under the Pension Protection Act of 2006. The Company also sponsors a SERP. The SERP, which is unfunded, provides defined pension benefits outside of the qualified defined benefit pension plan to eligible executives based on average earnings, years of service, and age at retirement.
The accumulated benefit obligation for the qualified defined benefit pension plan was $7,380 and $6,894 at December 31, 2009 and 2008, respectively.
Pension plan assets are invested for the exclusive benefit of the plan participants and beneficiaries and are intended, over time, to satisfy the benefit obligations under the plan. The Company maintains an investment policy for the pension plan, which is reviewed at least annually by the finance committee. The overall investment strategy is to maintain appropriate liquidity to meet the cash requirements of the short-term plan obligations and to maximize the plan’s return while adhering to the policy’s objectives and risk guidelines, as well as the regulations set forth by various government entities. The policy sets forth asset allocation guidelines that emphasize U.S. investments with strong credit quality and restrict traditionally risky investments.
The current target allocations for plan assets are 60% for equity securities, 38% for fixed income securities, and 2% for cash. Equity securities include investments in domestic large and small cap index funds, as well as an international developed markets index fund. The target asset allocation within equities is 70% domestic large cap, 15% domestic small cap, and 15% international developed markets. Fixed income securities include an investment grade long term bond index fund. Investment asset allocation is measured and monitored on an ongoing basis.
The estimated fair value of the Company’s equity and debt mutual funds is disclosed in Level 1 as the estimates are based on unadjusted market prices.
This category seeks to track the performance of the MSCI® US Small Cap 1750 Index and it is a small-cap equity diversified across growth and value styles. It follows a passively managed, full replication approach.
This category seeks to track the performance of a benchmark index that measures the investment return of large-capitalization stocks. The fund employs a passive management investment approach designed to track the performance of the Standard & Poor's 500 index. It invests all, or substantially all, of assets in the stocks that make up the index, holding each stock in approximately the same proportion as its weighting in the index.
This category seeks to track the performance of the Barclays Capital U.S. Long Government/Credit Float Adjusted Bond Index with diversified exposure to the long-term, investment-grade U.S. bond market. It is passively managed using index sampling and provides high current income with high credit quality.
The expected contribution for the SERP plan will be a minimum of $47, representing the normal benefit payments to the lone participant in payment status. However, the board is considering terminating the plan and replacing it with restricted stock grants if shareholders approve the Company's stock based incentive plan. If that occurs, then the one participant in pay status would receive a payment for the present value of the accrued benefit, estimated to be $595. The present value of the accrued benefit for the remainder of the participants is expected to be settled in restricted stock.
For the year ended December 31, 2009, the Company made a cash contribution of $111 to the ESOP. The ESOP used these contributions to make the annual payment to the Company related to the outstanding balance of the loan. The transactions between the Company and the ESOP are eliminated for purposes of the consolidated statements of cash flows.
Deferred income taxes reflect the tax effect of temporary differences between the amounts of assets and liabilities for financial reporting and the amounts for income tax purposes. Components of the Company’s deferred tax assets and liabilities from continuing operations for the years ended December 31, 2009 and 2008 are as follows:
At December 31, 2009 and 2008, the Company had available $3,503 and $5,694, respectively, of federal capital loss carryforwards and $6,295 and $5,721, respectively, of state income tax net operating loss (NOL) carryforwards. The capital loss carryforwards have a five year carryforward and will expire in 2013.
A valuation reserve is required to be established for any portion of the deferred tax asset that management believes more likely than not will not be realized. As a result of declining interest rates and the improvement in the credit markets, the Company’s fixed maturity investments have appreciated in value by $4,049 for the period ended December 31, 2009. Due to this improvement and the resulting unrealized capital gains, the Company intends to accelerate the reversal of the deferred tax liability associated with these unrealized gains through the sale of said investments. Therefore, as of December 31, 2009, the Company reversed the valuation reserve of $1,026 that was recorded against the deferred tax asset associated with the capital loss carryforwards as of December 31, 2008.
The Company concluded it is not more likely than not that state taxable income will be generated in the future to utilize the state NOL carryforwards. At December 31, 2009 and 2008, a valuation reserve of $629 and $571, respectively, was recorded against the deferred tax asset associated with the state income tax NOL carryforwards. The state NOL carryforwards have a 20 year carryforward and will expire from 2019 through 2029.
Reinsurance is ceded by the Company on a pro rata and excess of loss basis, with the Company’s retention generally at $500 per occurrence in 2009, 2008, and 2007. The Company purchased catastrophe excess-of-loss reinsurance with a retention of $2,000 per event in 2009, 2008, and 2007.
The effect of reinsurance, with respect to premiums and losses, for the years ended December 31, 2009, 2008, and 2007 is as follows:
The Company recognized unfavorable development in the provision for insured events of prior years of $1,555 in 2009 and favorable development of $5,222, and $4,638 in 2008 and 2007, respectively. Increases or decreases of this nature occur as the result of claim settlements during the current year, and as additional information is received regarding individual claims, causing changes from the original estimates of the cost of these claims. Recent loss development trends are also taken into account in evaluating the overall adequacy of unpaid losses and loss adjustment expenses.
Overall the Company experienced prior year unfavorable development of $1,555 in 2009. The development in 2009 is primarily attributable to unfavorable development in the workers’ compensation line of business of $2,173 and the commercial auto liability line of business of $740, partially offset by favorable development in the fire and allied line of business of $636 and the liability line of business of $478. The workers’ compensation development was the result of a higher level of incurred loss emergence relative to expectations for the 2008 and 2007 accident years and the reduction of ceded losses under the aggregate stop loss contract. The commercial auto liability development was primarily the result of adverse case development on previously reported claims. The overall development of $1,555 related to all of these lines of business has been adversely impacted by the reversal of the accident year 2008 ceded losses under the aggregate stop loss contract in the amount of $4,292.
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse impact on the Company’s financial position or results of operations.
In 2008 and 2007, the Company incurred retirement and severance expense of $254 and $663, respectively, for terminated employees. Total retirement and severance expense of $363 and $831 was unpaid as of December 31, 2009 and 2008, respectively.
The Company’s operations are organized into three segments: agribusiness, commercial business, and other. These segments reflect the manner in which the Company currently manages the business based on type of customer, how the business is marketed, and the manner in which risks are underwritten. Within each segment, the Company underwrites and markets its insurance products through a packaged offering of coverages sold to generally consistent types of customers.
The other segment includes the runoff of discontinued lines of insurance business and the results of mandatory-assigned risk reinsurance programs that the Company must participate in as a cost of doing business in the states in which the Company operates. The discontinued lines of insurance business include personal lines, which the Company began exiting in 2001, and assumed reinsurance contracts for which the Company participated on a voluntary basis. Participation in these assumed reinsurance contracts ceased in the 1980s and early 1990s.
Segment information for the years ended December 31, 2009, 2008, and 2007 is as follows:
A reconciliation of the Company’s statutory net income (loss) and surplus to net income (loss) and equity, under GAAP, is as follows:
The Company’s insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis, are subject to risk-based capital requirements, and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. As of December 31, 2009, the Company’s insurance subsidiaries were in compliance with their risk-based capital requirements. Applying the current regulatory restrictions as of December 31, 2009, approximately $7,249 would be available for distribution to the Company during 2010 without prior approval.
The results of operations for PSTS were reported within discontinued operations in the accompanying consolidated statements of operations for all periods presented.
EIG’s operating results for the years ended December 31, 2009, 2008, and 2007 are as follows:
Assets and liabilities of EIG as of December 31, 2008, which is included in assets and liabilities held-for-sale on the consolidated balance sheet, comprise the following:
On October 16, 2009, Penn Millers Mutual completed its conversion to stock form. The Corporation sold a total of 5,444,022 shares in a subscription and community offering at $10.00 per share, through which the Corporation received proceeds of $45,172, net of conversion and offering costs of $3,867. On July 28, 2009, the board of directors approved the implementation of an ESOP. The ESOP acquired 539,999 shares at $10.00 per share.
In April 2009 the board of directors approved the authorization of 1,000,000 shares of no par preferred stock of the Corporation upon conversion. The authorized but unissued preferred shares may be issued in one or more series and the share of each series shall have such rights as fixed by the board of directors.
As of December 31, 2009, 54,440 shares remained under the share repurchase authorization that was approved by the board of directors in October 2009. The authorization has no expiration date.
Earnings per share data reflects only the net income for the period from October 17, 2009 through December 31, 2009, the period subsequent to the conversion and sale of stock. Net income during this period was $929.
Earnings per share for the periods prior to October 17, 2009 are not applicable.