We derive our revenue from premiums earned, service fee income, net investment income and net realized gains and losses from investments. Our primary expense items are loss and loss adjustment expenses, underwriting, acquisition and insurance expenses, and interest expense.
Direct premiums written include all premiums charged for policies we issue during a fiscal period. Assumed premiums are premiums that we receive from an authorized state mandated pool. Gross premiums written is the sum of direct and assumed premiums written. Net premiums written represent gross premiums written less premiums ceded or paid to reinsurers (ceded premiums written).
Net premiums earned is the earned portion of our net premiums written. Premiums are earned over the terms of the related policies in proportion to the risks underwritten. Our policies typically have terms of 12 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. At the end of each accounting period, the portion of the premiums that are not yet earned is included in unearned premiums and is realized as revenue in the subsequent periods over the remaining term of the policies.
for the policies written by the Eagle Entities prior to the Acquisition. We expect income from these contracts to continue to decrease substantially over the next several years as transactions related to the Eagle Entities diminish. The next largest claims administration services customer represented approximately 20.5%, 17.9%, and 10.1% of claims service income for the years ended December 31, 2009, 2008 and 2007, respectively.
Included in other expense is interest expense we incur on $12.0 million in surplus notes that our insurance subsidiary issued in May 2004. The interest expense is paid quarterly in arrears. The interest expense for each interest payment period is based on the three-month LIBOR two London banking days prior to the interest payment period plus 400 basis points. The interest rates for the years ended December 31, 2009 and 2008 ranged from 4.26% to 6.15% and 6.15% to 9.03%, respectively.
Gross Premiums Written. Gross premiums written consists of direct premiums written and premiums assumed from the NCCI residual markets. The number of customers we service, in-force payrolls and in-force premiums represent some of the factors we consider when analyzing gross premiums written.
Gross premiums written totaled $290.0 million in 2009 compared to $270.3 million in 2008, representing an increase of $19.7 million, or 7.3%. Much of the increase in gross premiums written resulted from premium growth primarily related to new business growth in our “program” book of business. Program business, which includes alternative markets and small maritime programs, increased $32.2 million in 2009 compared to 2008. The increase in program business was offset by a $10.0 million decrease in our “core” product lines, which includes energy, maritime and construction business. The decrease was primarily driven by our construction business as a result of the continuing impact of the current economic downturn. Excluding work we perform as the servicing carrier for the Washington USL&H Assigned Risk Plan and excluding business assumed from the NCCI residual market pool, the total number of customers we serviced increased from more than 1,120 at December 31, 2008 to approximately 1,530 at December 31, 2009. Approximately 14.1% of the 410 customer increase related to our core book of business and 85.9% of the increase related to our program business. By design, our program business will have a larger number of customers with a smaller average premium size than our core book of business. Total in-force payrolls, one of the factors used to determine premium charges, increased 12.5% from $6.4 billion at December 31, 2008 to $7.2 billion at year-end 2009. California continues to be our largest market, accounting for approximately $132.5 million, or 43.1% of our in-force premiums at December 31, 2009. This represents an increase of $22.0 million, or 19.9%, from approximately $110.5 million, or 39.6%, of in-force premiums in California at December 31, 2008.
The following is a summary of our top five markets based on direct premiums written:
On March 27, 2009, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 24.4% increase in advisory pure premium rates on new and renewal policies effective on or
after July 1, 2009. On April 23, 2009, the WCIRB amended its filing to reduce the proposed rate increase to 23.7%. A public hearing on the proposed rate increase was held on April 28, 2009. Following the hearing, the California Insurance Commissioner issued a press release in which he urged the WCIRB to withdraw the portion of its requested rate increase related to recent decisions by the Workers’ Compensation Appeals Board (estimated to be approximately 6%) until the judicial process related to these decisions has concluded. A second hearing on medical treatment costs was held on June 8, 2009. On July 8, 2009, the California Insurance Commissioner announced his rejection of any increase in advisory pure premium rates. Rating decisions made by the California Insurance Commissioner are advisory only and insurance companies may choose whether or not to adopt, approve or disapprove rates. After completing an internal study of our California loss costs, on June 23, 2009, we filed with the California Department of Insurance revised rates for new and renewal workers’ compensation insurance policies written in the state of California on or after August 1, 2009. The new rates reflected an average increase of 10.6% from prior rates and were in response to increased projected medical costs and recent decisions by the Workers’ Compensation Appeals Board. On July 7, 2009, the California Department of Insurance approved our filing for the rate increase. We are unable to predict the impact that the rate increase adopted by us in California might have on our future financial position and results of operations. If other insurers do not adopt similar rate increases, this rate increase may have a negative effect on our ability to compete in California. On August 18, 2009, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 22.8% increase in advisory pure premium rates on new and renewal policies effective on or after January 1, 2010. A public hearing on the proposed rate increase was held on October 6, 2009. On November 9, 2009, the California Insurance Commissioner announced his decision to approve no change in advisory pure premium rates.
Rate reductions have also been adopted in other states in which we operate. For example, in Alaska we adopted rate decreases of 10.3% and 7.6% effective January 1, 2010 and 2009, respectively. In Louisiana, we adopted commissioner-approved rate decreases of 17.4% and 8.6% effective May 1, 2009 and 2008, respectively. In Hawaii, we adopted rate decreases of 13.7% and 5.8% effective January 1, 2010 and February 1, 2009, respectively. In Texas, we adopted rate decreases of 10.0% and 7.7% effective May 1, 2009 and January 1, 2008, respectively. In Florida, we adopted rate decreases of 6.8% and 18.6% effective January 1, 2010 and 2009, respectively. We adopted a rate decrease of 0.1% effective January 1, 2010 and rate increases of 2.5% and 3.5% in Illinois effective April 1, 2009 and January 1, 2009, respectively. In Arizona we adopted a rate decrease of 5.1% effective January 1, 2010 and a rate increase of 7.9% effective October 1, 2008. In Washington USL&H, we adopted a rate increase of 21% effective December 1, 2009.
Net premiums earned are also affected by premiums ceded under reinsurance treaties. Ceded earned premiums in 2009 totaled $22.7 million compared to $14.5 million in 2008, representing an increase of $8.2 million, or 56.6%. An increase in ceded earned premiums is a decrease to our overall net premiums earned Effective January 2009, we ceded 100% of NCCI assumed business for policy year 2009, which totaled $3.6 million for the year ended December 31, 2009.
For accident year 2008, the ultimate loss estimates at December 31, 2009 were higher when compared to December 31, 2008 and resulted in a net increase of our loss reserves of $8.8 million. The increase was primarily due to an increase in ultimate loss estimates due to higher severity development in our indemnity
For accident years 2006 and prior, the ultimate loss estimates at December 31, 2009 were slightly higher when compared to December 31, 2008 and resulted in a net increase of our loss reserves of $0.6 million. This small movement resulted from the recognition of the results from the standard actuarial methodologies in our December 31, 2009 IBNR study. This adverse development was offset by favorable development of $2.4 million related to ULAE and $3.5 million related to loss based assessments and NCCI. Due to the longer tail nature of workers’ compensation, small movement in an accident year’s ultimate loss estimate can be reasonably expected.
There is uncertainty about whether recent lower paid loss trends, which result primarily from California legislative reforms enacted in 2003 and 2004, will be sustained, particularly in light of current efforts to change or repeal portions of the reforms. We will not know the full impact of these reforms with a high degree of confidence for several years. We have recently observed an increase in severity estimates for accident years 2007 and 2008 in California following several years of decreasing trends. We have established loss reserves at December 31, 2009 that are based upon our current best estimate of ultimate loss costs, taking into consideration the recent paid loss claim data, incurred loss trends and uncertainty regarding the permanence of recent legislative reforms. We continue to monitor the impact of reforms and potential challenges to reforms in our loss data. See the discussion under the headings “Loss Reserves” in Part I, Item 1 and “Critical Accounting Policies, Estimates and Judgments - Unpaid Loss and Loss Adjustment Expenses” in this Item 7 for a further discussion of our loss reserving process.
Provisions in the three lower layer treaties (covering losses from $1.0 million to $10.0 million) in our 2006-2007 reinsurance program allow us the ability, at our sole discretion, to commute the contracts within 24 months of expiration in return for a contingent profit commission calculated in accordance with terms specified in the contracts. In accordance with these provisions, we commuted the $5.0 million excess $5.0 million layer of this treaty in 2009 in return for a contingent profit commission of approximately $0.7 million. The two lower layers (from $1.0 million to $5.0 Million) were not commuted. As of December 31, 2009, there were no ceded losses associated with the $5.0 million excess $5.0 million layer and it is not expected that developed losses that would otherwise be covered by reinsurance will exceed the contingent profit commission. The contingent profit commission was recorded as a reduction of loss and loss adjustment expenses.
Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled $73.0 million in 2009 compared to $71.2 million in 2008, representing an increase of $1.8 million, or 2.6%. Our net underwriting expense ratio, which is calculated by dividing underwriting, acquisition and insurance expenses less other service income by premiums earned, was 29.8% in 2009 compared to 28.5% in 2008. The increase in the expense ratio was driven primarily by increased staffing costs and other premium production related
expenses as we invest in the geographic expansion and development of our business, higher broker commissions, Florida policyholder dividend expense, and lower-than-expected earned premiums when compared to the increase in gross premiums written, primarily as a result of the impact of the continuing economic recession on covered payrolls, and adjustments related to retrospectively rated policies.
Other Expenses. Other expenses totaled $14.1 million in 2009, an increase of $2.9 million, or 26.3%, from $11.2 million in 2008. Other expenses result primarily from the operations of PointSure (including BWNV), which continued to experience direct costs associated with the expansion of insurance products they offer, and THM. PointSure and THM each accounted for roughly half of the $2.9 million increase in other expenses.
Income Tax Expense. The effective tax rate for the year ended December 31, 2009 was 18.4% compared to 30.5% for the same period in 2008. The effective tax rate for 2009 was lower than the statutory tax rate of 35.0% primarily as a result of tax exempt interest income, which accounted for approximately 20.8 percentage points of the reduction from the statutory rate. This decrease was partially offset by approximately $0.7 million, or 4.2 percentage points, due to state income taxes and other expenses. The effective rate for December 31, 2008 was lower than the statutory rate of 35.0% primarily as a result of tax exempt interest income, which accounted for approximately 7.5 points of the reduction from the statutory rate. This decrease in the statutory rate was partially offset by approximately $1.0 million, or 2.3 points, due to a valuation allowance established against our deferred tax assets as of December 31, 2008.
Net Income. Net income totaled $13.5 million in 2009 compared to $29.3 million in 2008, representing a decrease of $15.8 million, or 53.8%. The 2009 decrease in net income resulted primarily from a reduction in earned premiums, primarily resulting from the effects of the current economic downturn, and increases in loss and loss adjustment expense, underwriting, acquisition, and insurance expenses, and other expenses, offset by $13.4 million of OTTI losses in 2008.
December 31, 2008 and non-California in-force payrolls increased 21.4% over the same period. The following is a summary of our top five markets based on direct premiums written in 2008:
In addition to the significant rate reductions in California over the last five years, rate reductions have also been adopted in other states in which we operate. For example, in Alaska we adopted rate decreases of 4.8% and 10.9% effective January 1, 2009 and 2008, respectively. Effective July 1, 2007, we adopted the Louisiana Insurance Commissioner’s recommendation of a 15.8% reduction in Louisiana, which was 2.0% more than the 13.8% decrease recommended by the NCCI. On March 7, 2008, we adopted a further 8.6% rate reduction approved by the Louisiana Insurance Commissioner for new and renewal workers’ compensation insurance policies written in Louisiana on or after May 1, 2008. In Florida, we adopted rated decreases of 18.6% and 18.4% effective January 1, 2009 and 2008, respectively. We have also adopted rate increases of 3.5% and 4.0% in Illinois effective January 1, 2009 and 2008, respectively.
Net Investment Income. Net investment income was $22.6 million in 2008 compared to $20.3 million in 2007, representing an increase of $2.3 million, or 11.3%. Average invested assets increased $67.1 million, or 14.4%, from $467.5 million in 2007 to $534.6 million in 2008. This increase in our investment portfolio is due primarily to cash flow from operations of $66.9 million for the year ended December 31, 2008, which was invested primarily in fixed income securities. Net investment income as a percentage of average invested assets decreased slightly to 4.2% in 2008 from 4.3% in 2007 due to the effects of the global financial crisis discussed previously.
Other Income. Other income totaled $8.7 million for the twelve months ended December 31, 2008 compared to $4.4 million for the same period in 2007, representing an increase of $4.3 million, or 97.7%. The increase in other income relates primarily to the acquisition of THM and BWNV, which contributed approximately $3.8 million in other income for the year ended December 31, 2008. Additionally, PointSure has, as a result of the expansion of its portfolio of insurance products, been able to increase the amount of income from external sources.
Loss and Loss Adjustment Expenses. Loss and loss adjustment expenses totaled $141.9 million in 2008 compared to $128.2 million in 2007, representing an increase of $13.7 million, or 10.7%. The higher loss and loss adjustment expenses in 2008 were attributable to the increase in premiums earned for the period as well as lower favorable development of $8.0 million in 2008 compared to 2007. These increases were off set by a $2.3 million commutation gain associated with the 2005-2006 reinsurance treaty year and a $0.9 million decrease in assumed NCCI losses. The total reserve reduction of approximately $19.7 million of previously recorded direct net loss reserves in 2008, compared to approximately $27.7 million in 2007, reflects an overall
The positive development for accident years 2005 and prior is largely attributed to accident year 2005. For accident year 2005, the actual paid and incurred loss severity developed better than expected based on the underlying development patterns, resulting in decreases in the estimated ultimate losses for indemnity and medical. The ALAE for accident year 2005 developed slightly worse than expected, resulting in an increase in the estimated ultimate ALAE. There was limited movement in the estimated ultimate losses for accident years 2004 and 2003. As discussed under the heading “Critical Accounting Policies, Estimates and Judgments - Unpaid Loss and Loss Adjustment Expenses - Impact of Changes in Key Assumptions on Reserve Volatility” in Part II, Item 7 of this annual report, our loss reserve estimates rely heavily on historical reserving and loss payment patterns referred to as loss development. To the extent that the actual paid and incurred losses vary from the historical loss development patterns underlying the ultimate loss estimates, we will experience changes in reserves, either upward or downward, in future periods. The loss reserve estimates for prior years are changed when the available information indicates a reasonable likelihood that the ultimate losses will vary from the prior estimates.
There is uncertainty about whether recent lower paid loss trends, which result primarily from California legislative reforms enacted in 2003 and 2004, will be sustained, particularly in light of current efforts to change or repeal portions of the reforms. We will not know the full impact of these reforms with a high degree of confidence for several years. We had established loss reserves at December 31, 2008 that were based upon our current best estimate of ultimate loss costs, taking into consideration the recent lower paid loss claim data, incurred loss trends and uncertainty regarding the permanence of recent legislative reforms. See the discussion under the headings “Loss Reserves” in Part I, Item 1 and “Critical Accounting Policies, Estimates and Judgments - Unpaid Loss and Loss Adjustment Expenses” in this Item 7 for a further discussion of our loss reserving process.
Provisions of the three lower layer treaties (covering losses from $0.5 million to $10.0 million) in our 2005-2006 reinsurance program give SeaBright the right, at its sole discretion, to commute the contracts within 24 months of expiration in return for a contingent profit commission calculated in accordance with terms specified in the contracts. In accordance with these provisions, we commuted these treaties in 2008 in return for a contingent profit commission of approximately $2.3 million. The amount related to each treaty was as follows: $596,000 for the $500,000 excess $500,000 layer; $989,000 for the $4.0 million excess $1.0 million layer; and $666,000 for the $5.0 million excess $5.0 million layer. The contingent profit commission was recorded as a reduction of loss and loss adjustment expenses. There are currently no ceded losses associated with these layers and it is not expected that developed losses that would otherwise have been covered by reinsurance will exceed the contingent profit commission.
Underwriting, Acquisition and Insurance Expenses. Underwriting expenses totaled $71.2 million in 2008 compared to $58.9 million in 2007, representing an increase of $12.3 million, or 20.9%. Our net underwriting expense ratio was 28.5% in 2008 compared to 25.8% in 2007. The increase in the expense ratio was driven primarily by $6.7 million in increased staffing costs and other premium production related expenses as we invest in the geographic expansion and development of our business. Increases of approximately $1.2 million in commission costs, driven in part by the increase in earned premium, and $2.2 million in equity compensation costs related to stock options and restricted stock also contributed to the increase in our underwriting expenses.
Net Income. Net income totaled $29.3 million in 2008 compared to $39.9 million in 2007, representing a decrease of $10.6 million, or 26.6%. The 2008 decrease in net income resulted primarily from the increase in premiums earned and investment income for the period, offset by related increases in loss and loss adjustment expenses, underwriting acquisition and insurance expenses, net realized losses (including OTTI charges) and net other income/other expense.
At December 31, 2009, of our investment portfolio consisted of investment-grade fixed income securities with fair values subject to fluctuations in interest rates, as well as other factors such as credit. In July 2009, our investment policy was revised to allow for investment in domestic and international equities up to 6% and 1.5%, respectively, of our statutory consolidated capital and surplus. All of the securities in our investment portfolio are accounted for as “available for sale” securities. While we have structured our investment portfolio to provide an appropriate matching of maturities with anticipated claim payments, if we decide or are required in the future to sell securities in a rising interest rate environment, we would expect to incur losses from such sales.
We had no direct sub-prime mortgage exposure in our investment portfolio as of December 31, 2009 and $5.4 million of indirect exposure to sub-prime mortgages. As of December 31, 2009, our portfolio included $212.3 million of insured municipal bonds and $132.3 million of uninsured municipal bonds.
The following table provides a breakdown of ratings on the bonds in our municipal portfolio as of December 31, 2009:
Our ability to adequately provide funds to pay claims comes from our disciplined underwriting and pricing standards and the purchase of reinsurance to protect us against severe claims and catastrophic events. Effective October 1, 2008 and as renewed on October 1, 2009, our reinsurance program provides us with reinsurance protection for each loss occurrence in excess of $0.75 million, up to $85.0 million, subject to various deductibles and exclusions. Our reinsurance program that was effective October 1, 2007 to October 1, 2008, provides us with reinsurance protection for each loss occurrence in excess of $1.0 million, up to $75.0 million, subject to various deductibles and exclusions. See the discussion under the heading “Reinsurance” in Part I, Item 1 of this annual report. Given industry and predecessor trends, we believe we are sufficiently capitalized to cover our retained losses.
Our insurance subsidiary is required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The NAIC has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2009, the statutory surplus of our insurance subsidiary was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action.
SeaBright is a holding company with minimal unconsolidated revenue and expenses. As SeaBright pays dividends and has other capital needs in the future, we anticipate that it will be necessary for our insurance subsidiary to pay dividends to SeaBright. The payment of such dividends will be regulated as previously described.
We used net cash of $77.8 million for investing activities in 2009 compared to $65.6 million in 2008 and $95.1 million in 2007. The increase in 2009 from 2008 was driven by higher net investment purchase activity (purchases, net of sales and maturities) partially offset by a reduction in purchases of property and equipment. The reduction in 2008 from 2007 was primarily attributable to a reduction in funds generated by operations and made available for investing.
Net cash provided by (used in) financing activities totaled $(0.4) million in 2009, an increase of $1.6 million from $1.2 million in 2008, which increased $0.8 million from $0.4 million in 2007.
The following table identifies our contractual obligations by payment due period as of December 31, 2009:
The loss and loss adjustment expense payments due by period in the table above are based upon the loss and loss adjustment expense estimates as of December 31, 2009 and actuarial estimates of expected payout patterns and are not contractual liabilities as to time certain. Our contractual liability is to provide benefits under the policies we write. As a result, our calculation of loss and loss adjustment expense payments due by period is subject to the same uncertainties associated with determining the level of unpaid loss and loss adjustment expenses generally and to the additional uncertainties arising from the difficulty of predicting when claims (including claims that have not yet been reported to us) will be paid. For a discussion of our unpaid loss and loss adjustment expense process, see the heading “Loss Reserves” in Part I, Item 1 of this annual report and “Critical Accounting Policies, Estimates and Judgments - Unpaid Loss and Loss Adjustment Expenses” in Part II, Item 7 of this annual report. Actual payments of loss and loss adjustment expenses by period will vary, perhaps materially, from the above table to the extent that current estimates of loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result of variations between expected and actual payout patterns. See the discussion under the heading “Risks Related to our Business - Our loss reserves are based on estimates and may be inadequate to cover our actual losses” in Part I, Item 1A of this annual report for a discussion of the uncertainties associated with estimating unpaid loss and loss adjustment expenses.
Unpaid loss and loss adjustment expense represents our estimate of the expected cost of the ultimate settlement and administration of losses, based on known facts and circumstances. Our policy is to record the liability for unpaid claims and claim adjustment expense equal to the point estimate we determine. Included in unpaid loss and loss adjustment expense are amounts for case-based reserves, including estimates of future developments on those claims, and claims incurred but not yet reported to us, second injury fund expenses, and allocated and unallocated claim adjustment expenses. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may differ, perhaps materially, from the original estimate. These estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s operating results.
Following is a summary of the gross loss and loss adjustment expense reserves by line of business as of December 31, 2009 and 2008. The workers’ compensation line of business comprises over 98% of our total loss reserves as of both dates.
We have been growing consistently since we began operations and have entered into several new states that are not included in our predecessor’s historical data.
AB 749 significantly increased most classes of workers’ compensation indemnity benefits over a four-year period beginning in 2003.
In February of 2009 the California Workers’ Compensation Appeals Board ( the “Appeals Board”) rendered an en banc decision on a series of cases, commonly referred to as Almarez, Guzman and Ogilvie, that could have a material impact on the value of permanent disability awards. The en banc decision led to considerable comment and debate in the Workers’ Compensation community. Given this, the Appeals Board subsequently granted a petition for reconsideration on the subject cases, allowing interested parties until May 1, 2009 to provide input via an amicus curiae brief. In September of 2009, the Appeals Board reaffirmed most aspects of its prior work, with some clarifications to its February decisions. While its decision is considered final, several aspects are likely to still be determined by case law and through appeal. However, it could take two to three years before review by higher courts is complete.
We review the following significant components of loss reserves on a quarterly basis:
Our analysis is done separately for the indemnity, medical and DCC components of the total loss reserves within each accident year. In addition, the analysis is completed separately for the following five categories: State Act, California (California); State Act, Alaska and Hawaii (Alaska&Hawaii); State Act, Illinois (Illinois); State Act, all other states (All Other); and USL&H claims. The business is divided into these three categories for the determination of ultimate losses due to differences in the laws that cover each of these categories.
Our business is also affected by federal laws including the USL&H Act, which is administered by the Department of Labor, and the Merchant Marine Act of 1920, or Jones Act. The USL&H Act contains various provisions affecting our business, including the nature of the liability of employers of longshoremen, the rate of compensation to an injured longshoreman, the selection of physicians, compensation for disability and death and the filing of claims. We refer to the business covered under the USL&H Act and the Jones Act as USL&H.
Because there are different laws and benefit levels that affect the State Act versus USL&H business, there is a strong likelihood that these categories will exhibit different loss development characteristics which will influence the ultimate loss calculations. Separating the data into the State Act and USL&H categories allows us to use actuarial methods that contemplate these differences.
Gross ultimate loss (indemnity, medical and ALAE separately) for each category is estimated using the following actuarial methods:
The most significant factor currently impacting our loss reserve estimates is the reliance on historical reserving patterns and loss payments from our predecessor and the industry, also referred to as loss development. This is due to our limited operating history as discussed above. The actuarial methods that we use depend at varying levels on loss development patterns based on past information. Development is defined as the difference, on successive valuation dates, between observed values of certain fundamental quantities that may be used in the loss reserve estimation process. For example, the data may be paid losses, case incurred losses and the change in case reserves or claim counts, including reported claims, closed claims or reopened
As discussed in the previous section, there are a number of variables that can impact, individually or in combination, the adequacy of our loss and loss adjustment expense liabilities. While the actuarial methods employed factor in amounts for these circumstances, the loss reserves may prove to be inadequate despite the actuarial methods used. Several examples are provided below to highlight the potential variability present in our loss reserves. Each of these examples represents scenarios that are reasonably likely to occur over time. For example, there may be a number of claims where the unpaid loss and loss adjustment expense associated with future medical treatment proves to be inadequate because the injured workers do not respond to medical treatment as expected by the claims examiner. If we assume this affects 10% of the open claims and, on average, the unpaid loss and loss adjustment expenses on these claims are 20% inadequate, this would result in our unpaid loss and loss adjustment expense liability being inadequate by approximately $7.0 million, or 2%, as of December 31, 2009. Another example is claim inflation. Claim inflation can result from medical cost inflation or wage inflation. As discussed above, the actuarial methods employed include an amount for claim inflation based on historical experience. We assume that the historical effect of this factor, which is embedded in our experience and industry experience, is representative of future effects for claim inflation. To the extent that the historical factors, and the actuarial methods utilized, are inadequate to recognize future inflationary trends, our unpaid loss and loss adjustment expense liabilities may be inadequate. If our estimate of future medical trend is two percentage points inadequate (e.g., if we estimate a 9% annual trend and the actual trend is 11%), our unpaid loss and loss adjustment expense liability could be inadequate. The amount of the inadequacy would depend on the mix of medical and indemnity payments and the length of time until the claims are paid. For example, if we assume that 50% of the unpaid loss and loss adjustment expense is associated with medical payments and an average payout period of 5 years, our unpaid loss and loss adjustment expense liabilities would be inadequate by approximately $17.6 million on a pre-tax basis, or 5%, as of December 31, 2009. Under these assumptions, the inadequacy of approximately $17.6 million represents approximately 4.9% of total stockholders’ equity at December 31, 2009. The impact of any reserve deficiencies, or redundancies, on our reported results and future earnings is discussed below.
Reinsurance recoverables on paid and unpaid losses represent the portion of the loss and loss adjustment expenses that is assumed by reinsurers. These recoverables are reported on our balance sheet separately as assets, as reinsurance does not relieve us of our legal liability to policyholders and ceding companies. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance
agreement. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts, which could be subject to interpretations that differ from ours based on judicial theories of liability. We calculate amounts recoverable from reinsurers based on our estimates of the underlying loss and loss adjustment expenses, which themselves are subject to significant judgments and uncertainties described above under the heading “Unpaid Loss and Loss Adjustment Expenses.” Changes in the estimates and assumptions underlying the calculation of our loss reserves may have an impact on the balance of our reinsurance recoverables. In general, one would expect an increase in our underlying loss reserves on claims subject to reinsurance to have an upward impact on our reinsurance recoverables. The amount of the impact on reinsurance recoverables would depend on a number of considerations including, but not limited to, the terms and attachment points of our reinsurance contracts and the incurred amount on various claims subject to reinsurance. We also bear credit risk with respect to our reinsurers, which can be significant considering that some claims may remain open for an extended period of time.
We periodically evaluate our reinsurance recoverables, including the financial ratings of our reinsurers, and revise our estimates of such amounts as conditions and circumstances change. Changes in reinsurance recoverables are recorded in the period in which the estimate is revised. We assessed the collectibility of our year-end receivables and believe that all amounts are collectible based on currently available information. Therefore, as of December 31, 2009 and 2008, we had no reserve for uncollectible reinsurance recoverables. As of December 31, 2009, the top ten companies from which we had reinsurance amounts recoverable had A.M. Best ratings of “A−” or higher.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. This analysis requires management to make various estimates and assumptions, including the scheduled reversal of deferred tax liabilities, the consideration of operating versus capital items, projected future taxable income and the effect of tax planning strategies. If actual results differ from management’s estimates and assumptions, we may be required to establish a valuation allowance to reduce the deferred tax assets to the amounts more likely than not to be realized. The establishment of a
We regularly review our investment portfolio for declines in value. In general, we review all securities that are impaired by 5% or more at the end of the period. We focus our review of securities with no stated maturity date on securities that were impaired by 20% or more at the end of the period or have been impaired 10% or more continuously for six months or longer as of the end of the period. We also analyze the entire portfolio for other factors that might indicate a risk of impairment, including credit ratings and interest rates. It is possible that we could recognize future impairment losses on some securities we owned at December 31, 2009 if future events, information and the passage of time result in a determination that a decline in value is other-than-temporary.
In 2009, we recognized other-than-temporary impairment charges of $0.3 million related to our investments in preferred stocks issued by Fannie Mae and Freddie Mac that were sold in 2009. In 2008, we recognized other-than-temporary impairment charges of approximately $10.2 million on our investments in preferred stocks (nearly all of which were government-sponsored agency fixed and variable preferred stocks) and approximately $3.2 million on our investment in equity indexed securities exchange-traded funds. No other-than-temporary declines in the fair value of our securities were recorded in 2007. Please refer to the tables in Note 3 of the consolidated financial statements in Part II, Item 8 of this annual report for additional information on unrealized losses on our investment securities. Please refer to Part II,
We have audited the accompanying consolidated balance sheets of SeaBright Insurance Holdings, Inc. and subsidiaries (the Company) as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
At the time of the Acquisition, KEIC was licensed to write workers’ compensation insurance in 43 states and the District of Columbia. Domiciled in the State of Illinois and commercially domiciled in the State of California, it wrote both state act workers’ compensation insurance and United States Longshore and Harborworkers’ Compensation insurance (“USL&H”). Prior to the Acquisition, beginning in 2000, KEIC wrote business only in California. In May 2002, KEIC ceased writing business and by December 31, 2003, all premiums related to business prior to the Acquisition were 100% earned. As further discussed in Note 8.a., in connection with the Acquisition, KEIC and LMC entered into an agreement whereby LMC agreed to indemnify KEIC in the event of adverse development of the reserves stated on KEIC’s balance sheet at the Acquisition date, for a period of approximately eight years. In addition, KEIC agreed to share with LMC any positive development of those reserves. December 31, 2011 is the date to which the parties will look to determine whether the loss and loss adjustment expenses with respect to KEIC’s insurance policies in effect at the date of the Acquisition have increased or decreased from the amount existing at the date of the Acquisition.
PointSure is engaged primarily in administrative and brokerage activities. Eagle consists of Eagle Pacific Insurance Company, Inc. and Pacific Eagle Insurance Company, Inc., both writers of state act workers’ compensation insurance and USL&H that are in run-off as of December 31, 2009.
In July 2008, PointSure acquired 100% of the outstanding common stock of Black/White and Associates, Inc., Black/White and Associates of Nevada and Black/White Rockridge Insurance Services, Inc. (referred to collectively as “BWNV”), a privately held managing general agent and wholesale insurance broker. Also included in the transaction were a covenant not to compete from key principals of BWNV and other intangible assets. The preliminary purchase price paid at closing was $1.7 million, of which $0.5 million was allocated to the purchase of BWNV capital stock. The stock purchase agreement provided for a contingent purchase price to be paid by (or refunded to) the Company approximately 13 months following the closing date, depending on whether BWNV revenue in the 12 months following closing exceeds (or is less than) the base revenue assumed at the time of the closing. The Company paid approximately $159,000 as additional purchase consideration upon resolution of the contingency period in 2009. The Company has recorded goodwill of approximately $0.5 million in connection with this acquisition as of December 31, 2009.
The accompanying consolidated financial statements include the accounts of SeaBright and its wholly owned subsidiaries, SBIC, PointSure, THM and BWNV (collectively, the “Company”). All significant intercompany transactions among these affiliated entities have been eliminated in consolidation.
In general, the Company reviews all securities that are impaired by 5% or more at the end of the period. For securities with no stated maturity date, the review focuses on securities that were impaired by 20% or more at the end of the period or had been impaired 10% or more continuously for six months or longer as of the end of the period. The Company also analyzes the entire portfolio for other factors that might indicate a risk of impairment, including credit ratings, liquidity of the issuer and interest rates. Other-than-temporary impairment losses result in a permanent reduction of the carrying amount of the underlying investment. Significant changes in the factors considered when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.
The fair value of the Company’s investment portfolio increased significantly in 2009 from the balance at December 31, 2008, which was negatively impacted by unprecedented events in the capital and credit markets that resulted in extreme volatility and disruption of the world’s financial markets. Several factors contributed to the decrease in fair values of the Company’s investment portfolio in 2008 including the tightening/freezing of credit markets, significant failures of large financial institutions, uncertainty regarding the effectiveness of governmental solutions, as well as the current recession. Despite the significant improvement in the value of the Company’s investment portfolio in 2009, it is possible that the Company could recognize future impairment losses on some securities it owned at December 31, 2009 if future events, information and the passage of time result in a determination that a decline in value is other-than-temporary.
Cash and cash equivalents, which consist primarily of amounts deposited in banks and financial institutions, and all highly liquid investments with maturities of 90 days or less when purchased, are stated at cost. Cash in excess of daily requirements is invested in money market funds and repurchase agreements with maturities of 90 days or less. Such investments are deemed to be cash equivalents for purposes of the consolidated balance sheets and statements of cash flows. The Company had $12.9 million and $22.9 million of cash and cash equivalents at December 31, 2009 and 2008, respectively.
Furniture and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives, which range from three to five years. Leasehold improvements are depreciated on a straight-line basis over periods ranging from approximately two to seven years, which is the shorter of their estimated useful lives or the remaining term of the respective lease. Depreciation expense totaled $1.9 million, $1.4 million and $1.0 million for the years ended December 31, 2009, 2008, and 2007, respectively.
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. A reporting unit is defined as an operating segment or one level below an operating segment.
Earned premiums on retrospectively rated policies are based on the Company’s estimate of loss experience as of the measurement date. Loss experience includes known losses specifically identifiable to a retrospective policy as well as provisions for future development on known losses and for losses incurred but not yet reported using actuarial loss development factors and is consistent with how the Company projects losses in general. For retrospectively rated policies, the governing contractual minimum and maximum rates are established at policy inception and are made a part of the insurance contract. While the typical retrospectively rated policy has five annual adjustment or measurement periods, premium adjustments continue until mutual agreement to cease future adjustments is reached with the policyholder. For the years ended
Service income generated from various underwriting and claims service agreements with third parties is recognized as income in the period in which services are performed.
Although it is not possible to measure the degree of variability inherent in such estimates, management believes that the liability for unpaid loss and loss adjustment expense is reasonable. The estimates are reviewed periodically and any necessary adjustments are included in the results of operations of the period in which the adjustment is determined.
The Company protects itself from excessive losses by reinsuring certain levels of risk in various areas of exposure with nonaffiliated reinsurers. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. Reinsurance premiums,
commissions, expense reimbursements and reserves related to ceded business are accounted for on a basis consistent with the accounting for the original policies issued and the terms of reinsurance contracts. The unpaid loss and loss adjustment expense subject to the adverse development cover with LMC is calculated on a quarterly basis using generally accepted actuarial methodologies for estimating unpaid loss and loss adjustment expense liabilities, including incurred loss and paid loss development methods. The minimum amount that must be maintained in the trust account is equal to the greater of (a) $1.6 million or (b) 102% of the then existing quarterly estimate of LMC’s total obligations under the adverse development cover. At December 31, 2009, the liability of LMC under the adverse development cover was approximately $3.0 million. The balance of the trust account, including accumulated interest, at December 31, 2009 was $3.8 million. Amounts recoverable in excess of acquired reserves at September 30, 2003 are recorded gross in unpaid loss and loss adjustment expense in accordance with ASC Topic 805, Business Combinations (formerly known as FAS 141(R), “Business Combinations”), with a corresponding amount receivable from the seller. Amounts are shown net in the statements of operations. Premiums ceded to other companies are reported as a reduction of premiums written and earned. Reinsurance recoverables are determined based on the terms and conditions of the reinsurance contracts.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 requires disclosures
In May 2009, the FASB issued FAS No. 165, “Subsequent Events” (“FAS 165”). FAS 165 establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or available to be issued. FAS 165 is effective for periods ending after June 15, 2009. The Company adopted FAS 165 in the quarter ended June 30, 2009, which did not have a material effect on the Company’s consolidated financial condition and results of operations.
For debt securities that are considered other-than-temporarily impaired (“OTTI”) and that the Company does not intend to sell and more likely than not would not be required to sell prior to recovery of the amortized cost basis, the Company recognizes OTTI losses in accordance with the provisions of the Codification. The amount of the OTTI loss is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income. Approximately $0.7 million of the total unrealized losses at December 31, 2009 were from debt securities that had been impaired for one year or longer. Included in these securities was one security which had an unrealized loss that exceeded 20% of the related security’s book value at December 31, 2009. As of December 31, 2009, all payments were current on these debt securities and the Company expects to fully recover its investment in these securities no later than their scheduled maturities. The Company has no current intent to sell these securities nor is it more likely than not that the Company would be required to sell these securities. Therefore, based on management’s review of the financial strength of these debt securities and the Company’s expectation regarding future receipt of principal and interest, management concluded these debt securities were temporarily impaired as of December 31, 2009. For the year ended December 31, 2009, the Company recognized no OTTI losses related to debt securities.
For the year ended December 31, 2009, the Company recognized OTTI losses of $0.3 million related to its investment in preferred stock issued by Fannie Mae and Freddie Mac. In 2008, the Company recognized OTTI losses of approximately $10.2 million on its investments in preferred stocks (nearly all of which were government-sponsored agency fixed and variable preferred stocks) and approximately $3.2 million on its investment in equity indexed securities exchange-traded funds. No other-than-temporary declines in the fair value of the Company’s securities were recorded in 2007.
Significant changes in the factors considered when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the financial statements. At December 31, 2009 and 2008, the Company evaluated investment securities with fair values less than amortized cost and determined that the declines in value were temporary and were related primarily to the change in market rates since purchase or to other market anomalies that are expected to correct themselves. Furthermore, the Company has the ability and intent to hold the impaired investments to maturity or for a period of time sufficient for recovery of their carrying amount.
The Company had no direct sub-prime mortgage exposure in its investment portfolio as of December 31, 2009 and less than $5.4 million of indirect exposure to sub-prime mortgages. The following table provides a
breakdown of fair value by ratings on the bonds in the Company’s municipal portfolio as of December 31, 2009:
These bonds have been pre-refunded by depositing highly rated government-issued securities into irrevocable trust funds established for payment of principal and interest.
Major categories of consolidated net investment income are summarized as follows for the years ended December 31, 2009, 2008, and 2007:
Investment securities: The Company measures and reports its financial assets and liabilities, including investment securities, in accordance with the Fair Value Measurement and Disclosure Topic of the Codification. The estimated fair values for available-for-sale securities are generally based on quoted market value prices for securities traded in the public marketplace. The Company also considers the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity. Additional information with respect to fair values of the Company’s investment securities is disclosed in Note 3.
Level 1 - Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 includes U.S. Treasury securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Premiums receivable consisted of the following at December 31, 2009 and 2008:
The following reflects the amounts of policy acquisition costs deferred and amortized for the years ended December 31, 2009, 2008, and 2007:
$500,000 for each loss occurrence in excess of $500,000 for each loss occurrence
50% reinsured, subject to an aggregate annual limit of $17.0 million.
Fully reinsured, subject to an aggregate annual limit of $20.0 million and a limit of $7.5 million maximum for any one life.
As of December 31, 2009, the Company’s current excess of loss reinsurance treaties were placed with the following reinsurers:
For the periods from October 1, 2006 through October 1, 2007 and from October 1, 2007 through October 1, 2008, the Company entered into reinsurance treaties with nonaffiliated reinsurers wherein it retains the first $1.0 million of each loss occurrence. Losses in excess of $1.0 million up to $75.0 million are reinsured as follows:
Fully reinsured, subject to an aggregate annual limit of $12.0 million.
Fully reinsured, subject to an aggregate annual limit of $15.0 million.
As part of the Acquisition, SeaBright and LMC entered into an adverse development excess of loss reinsurance agreement (the “Agreement”). The Agreement, after taking into account any recoveries from third party reinsurers, calls for LMC to reimburse SBIC 100% of the excess of the actual loss at December 31, 2011 over the initial loss reserves at September 30, 2003. The Agreement also calls for SBIC to reimburse LMC 100% of the excess of the initial loss reserves at September 30, 2003 over the actual loss results at December 31, 2011. The amount of adverse loss development under the Agreement was $3.0 million at December 31, 2009 and $4.2 million at December 31, 2008. The decrease in the amount receivable from LMC is netted against loss and loss adjustment expense in the accompanying consolidated statements of operations.
The Company involuntarily assumes residual market business either directly from various states that operate their own residual market programs or indirectly from the National Council for Compensation Insurance, which operates residual market programs on behalf of some states. The states in which the Company assumed residual market business in 2009 and 2008 include the following: Alabama, Alaska, Arizona, Arkansas, Connecticut, Delaware, the District of Columbia, Georgia, Idaho, Illinois, Iowa, Kansas, Massachusetts, Michigan, Nevada, New Jersey, New Mexico, North Carolina, Oregon, South Carolina, South Dakota, and Virginia.
Balances affected by reinsurance transactions are reported gross of reinsurance in the balance sheets. Reinsurance recoverables are comprised of the following amounts at December 31, 2009 and 2008:
The following table summarizes the Company’s top ten reinsurers, based on net amount recoverable, as of December 31, 2009:
The effects of reinsurance are as follows for the years ended December 31, 2009, 2008, and 2007:
Provisions in the three lower layer treaties (covering losses from $0.5 million to $10.0 million) in the Company’s 2005-2006 reinsurance program allow the Company the ability, at its sole discretion, to commute the contracts within 24 months of expiration in return for a contingent profit commission calculated in accordance with terms specified in the contracts. In accordance with these provisions, the Company commuted these treaties in 2008 in return for a contingent profit commission of approximately $2.3 million. As of December 31, 2009, there were no ceded losses associated with these layers and it is not expected that developed losses that would otherwise be covered by reinsurance will exceed the contingent profit commission. The contingent profit commission was recorded as a reduction of loss and loss adjustment expenses.
Provisions in the three lower layer treaties (covering losses from $1.0 million to $10.0 million) in the Company’s 2006-2007 reinsurance program allow the Company the ability, at its sole discretion, to commute the contracts within 24 months of expiration in return for a contingent profit commission calculated in accordance with terms specified in the contracts. In accordance with these provisions, the Company commuted the $5.0 million excess $5.0 million layer of this treaty in 2009 in return for a contingent profit commission of approximately $0.7 million. The two lower layers (from $1.0 million to $5.0 Million) were not commuted. As of December 31, 2009, there were no ceded losses associated with the $5.0 million excess $5.0 million layer and it is not expected that developed losses that would otherwise be covered by reinsurance will exceed the contingent profit commission. The contingent profit commission was recorded as a reduction of loss and loss adjustment expenses.
As a result of changes in estimates of insured events in prior periods, unpaid loss and loss adjustment expenses decreased by a net amount of $1.4 million in 2009. Net adverse development of prior year loss reserves totaled $14.4 million and related to the following accident years: $8.8 million in 2008, $5.0 million in 2007, and $0.9 million in 2006. This adverse development was offset by $0.3 million of net favorable development of loss reserves related to accident years 2005 and prior. The net adverse development on loss reserves was offset by $15.8 million of net favorable development of other amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools. The $15.8 million related to the following accident years: $4.3 million in 2008, $4.2 million in 2007, $3.5 million in 2006, and $3.8 million in 2005 and prior.
In 2008, unpaid loss and loss adjustment expense related to prior years decreased by a net amount of $25.0 million. Favorable development of prior year loss reserves totaled $19.7 million and related to the following accident years: $11.6 million in 2007, $5.1 million in 2006, $2.4 million in 2005, and $0.6 million in 2005 and prior. Additionally, there was $5.3 million of net favorable development of other amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools. The $5.3 million related to the following accident years: $3.5 million in 2007, $2.3 million in 2006 and $1.1 million in 2005, offset by $1.6 million of adverse development in 2004 and prior.
amounts such as ULAE, loss based assessments and losses assumed from the NCCI pools. The $6.4 million related to the following accident years: $2.2 million in 2006, $3.5 million in 2005 and $0.7 million in 2004 and prior.
The notes are redeemable prior to 2034 by the Company, in whole or in part, from time to time, on or after May 24, 2009 on an interest payment date.
The following is a reconciliation of the difference between the “expected” income tax computed by applying the federal statutory income tax rate of 35% to income before income taxes and the total income taxes reflected on the books for the years ended December 31, 2009, 2008, and 2007:
Deferred federal income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those amounts used for federal income tax reporting purposes. The significant components of the deferred tax assets and liabilities at December 31, 2009 and 2008 are as follows:
As of December 31, 2009, no valuation allowance was recorded. As of December 31, 2008, management established a valuation allowance of approximately $2.0 million (of which $976,000 was recorded in tax expense and $1.0 million was recorded in accumulated other comprehensive income), which was reversed through accumulated other comprehensive income in 2009.
As of December 31, 2009, the Company had capital loss carry forwards of approximately $15.3 million. Approximately $146,000 expires in 2010, $431,000 expires in 2011, $106,000 expires in 2012, $475,000 expires in 2013 and $14.1 million expires in 2014.
The Company leases certain office space for its headquarters and regional offices under agreements that are accounted for as operating leases. Lease expense totaled $3.4 million, $2.9 million and $1.3 million for the years ended December 31, 2009, 2008, and 2007, respectively. Total rent, including the effect of rent increases and concessions, is expensed on a straight-line basis over the respective lease terms.
a. SBIC is subject to guaranty fund and other assessments by the states in which it writes business. Guaranty fund assessments are accrued at the time premiums are written. Other assessments are accrued either at the time of assessment or in the case of premium-based assessments, at the time the premiums are written, or in the case of loss-based assessments, at the time the losses are incurred. SBIC has accrued a liability for guaranty fund and other assessments of $7.9 million at December 31, 2009 and has recorded a related asset for premium tax offset and policy surcharges of $3.5 million at that date. This amount represents management’s best estimate based on information received from the states in which it writes business and may change due to many factors including the Company’s share of the ultimate cost of current insolvencies. Most assessments are paid out in the year following the year in which the premium is written or the losses are paid. Guaranty fund receivables and other surcharge items are generally realized by a charge to new and renewing policyholders in the year following the year in which the related assessments were paid.
premiums at December 31, 2009 and $12.3 million for retrospective premiums receivable and $18.5 million for return retrospective premiums at December 31, 2008.
As part of the Company’s goodwill analysis, the Company compared the fair value of the aggregated reporting units to the market capitalization of the Company using the December 31, 2009 common stock price. The difference between the aggregated fair value of the reporting units and the market capitalization of the Company was attributed to transaction premium. The amount of the transaction premium was determined to be reasonable based on recent insurance transactions and specific facts and circumstances related to the Company.
If current market conditions persist during 2010, in particular if the Company’s share price remains meaningfully below book value per share, or if the Company’s actions to limit risk associated with its products or investments causes a significant change in any one reporting unit’s fair value, subsequent reviews of goodwill could result in an impairment of goodwill during 2010 or later.
The weighted average amortization period for all intangible assets subject to amortization is 2.7 years. Aggregate amortization expense was $184,000, $7,500 and $10,000 for the years ended December 31, 2009, 2008, and 2007, respectively.
The Board of Directors reserved an initial total of 776,458 shares of common stock under the 2003 Plan and 1,047,755 shares of common stock under the 2005 Plan, plus an automatic annual increase on the first day of each fiscal year beginning in 2006 and ending in 2015 equal to the lesser of: (i) 2% of the shares of common stock outstanding on the last day of the immediately preceding fiscal year or (ii) such lesser number of shares as determined by the Board of Directors. At December 31, 2009, the Company reserved 776,458 shares of common stock for issuance under the 2003 Plan, of which options to purchase 481,946 shares had been granted, and 2,631,525 shares for issuance under the 2005 Plan, of which 2,106,692 shares had been granted. In January 2006, the Compensation Committee of the Board of Directors terminated the ability to grant future stock options awards under the 2003 Plan. Therefore, the Company anticipates that all future awards will be made under the 2005 Plan.
The 2005 Plan provides for the grant of incentive or non-qualified stock options, restricted stock, restricted stock units, deferred stock units, performance awards, or any combination of the foregoing. The Board of Directors has the authority to determine all matters relating to awards granted under the Stock Option Plans, including designation as incentive or nonqualified stock options, the selection of individuals to be granted options, the number of shares subject to each grant, the exercise price, the term and the vesting period, if any. Options to purchase the Company’s common stock are granted at prices at or above the fair value of the common stock on the date of grant, generally vest 25% per year on each of the first four anniversaries of the vesting start date, and expire 10 years from the date of grant. Options granted to non-employee directors generally vest one-third on the first anniversary of the grant date and the remaining two-thirds in equal monthly installments over the following 24 months. Nonvested stock issued to employees and directors generally vests on the third anniversary of the grant date, assuming the holder is still employed by or providing service to the Company and satisfies all other conditions of the grant. Generally, stock options granted to employees are incentive stock options, while options granted to non-employee directors are non-qualified stock options.
Total stock-based compensation expense recognized in the consolidated statements of operations for the years ended December 31, 2009, 2008 and 2007 is shown in the following table. No compensation cost was capitalized during years ended December 31, 2009, 2008 and 2007.
The fair values of stock options granted during the years ended December 31, 2009, 2008 and 2007 were determined on the dates of grant using the Black-Scholes-Merton option valuation model with the following weighted average assumptions:
The following table summarizes stock option activity for the years ended December 31, 2009 and 2008:
The following table summarizes restricted stock activity for the years ended December 31, 2009 and 2008:
The following table summarizes selected unaudited quarterly financial data for each quarter of the years ended December 31, 2009, 2008 and 2007.
Management has evaluated subsequent events from December 31, 2009. On March 2, 2010, our Board of Directors authorized a quarterly dividend of $0.05 per common share commencing in the first quarter 2010 and payable on April 9, 2010 to shareholders of record on March 23, 2010.