We are an insurance company owned by 1,958 accounting firms, persons associated with accounting firms, and individual CPA practitioners. We were formed in response to concerns about the pricing and availability of accountants’ professional liability insurance in a difficult or “hard” market. Our primary mission is to exert a stabilizing influence on the design, pricing and availability of professional liability insurance to reduce the likelihood of a hard market. We are prepared, subject to obtaining the required licenses and registrations, to step into a hard market and act as a direct issuer of accountants’ professional liability insurance policies.
In an effort to maximize the value of our shares, we have been looking at ways to expand our business, including possibly entering into other lines of insurance business. During 2003 we provided reinsurance of attorneys’ professional liability policies provided by Professional Direct Insurance Company. That activity was not a significant portion of our business in 2003 and was terminated at the end of that year. Effective June 1, 2005, we wrote a 5% share in CAMICO Mutual Insurance Company’s first excess layer of $2,000,000 excess of $1,000,000. CAMICO is a California based writer of accountants’ professional liability business. The premiums under the CAMICO treaty vary with the losses incurred, between a minimum and a maximum.
We operate our business with no long-term debt, no capital or operating lease obligations, no purchase obligations, and no off-balance sheet arrangements required to be disclosed under applicable rules of the Securities and Exchange Commission. AmerInst’s access to operating cash flows of its subsidiaries is from the payment of dividends.
The amount that we record as our liability for loss and loss adjustment expenses is a major determinant of net income each year. As discussed in more detail below under the heading “Losses and Loss Adjustment Expenses,” the amount that we reserve is based on actuarial estimates which are prepared as of June 30 and December 31 each year. Based on data received from the ceding companies (the insurance companies whose policies we reinsure) our independent actuary produces a range of estimates with a “low,” “middle” and “high” estimate of the loss and loss adjustment expenses. As at December 31, 2006, the range of actuarially determined liability for loss and loss adjustment expense reserves was as follows: the low estimate was $16.0 million, the high estimate was $28.3 million, and the middle estimate was $20.5 million. We selected reserves of $28.1 million as of December 31, 2006, which is near the high end of the range. Due to our concerns about the severity and volatility of the type of business we reinsure and the length of time that it takes for claims to be reported and ultimately settled, our management’s policy has been to reserve conservatively at the higher end of the actuarial estimates.
Our net income increased to $3,312,962 in 2006, compared to net income of $3,095,121 in 2005. We had net income of $1,749,007 in 2004.
The increase in net income from 2005 to 2006 is primarily due to the reduction of loss reserves by $3.1 million. In 2005 loss reserves were reduced by $2.3 million, and in 2004 loss reserves were reduced by $2.5 million. Due to the uncertainty inherent in the reinsurance policies written by the Company, we have always adopted a conservative policy concerning our loss reserving. In the last three years, our actuary was able to obtain additional information which included breaking out loss development on CNA’s “premier” and “value” plans which we reinsure. Our actuary determined in the course of its analysis that experience under the CNA plans has been more favorable than industry performance reflected in the reserves we established for our reinsurance of the plans. In light of this new information, we believed it was reasonable to reduce the 2004 loss reserves by $2.5 million, which resulted in an increase in net income in 2004 by that amount. For 2005, we believed it reasonable that the reduction in loss reserves should be limited to $2.3 million, and for 2006 the reduction in loss reserves should be limited to $3.1 million. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our long established loss reserving philosophy. The Company will continue to review loss reserves periodically and, based on the actuarial projections, determine whether reserves are required to be increased or decreased.
Net premiums written in 2006 were $8,680,603, a decrease of $347,063 from $9,027,666 in 2005. The decrease in net premiums written was primarily attributable to rate decreases under the current AICPA Professional Liability Plan treaty. Net premiums written in 2005 increased by $141,740 to $9,027,666 from $8,885,926 in 2004. The increase in net premium written during 2005 was attributable primarily to new premiums written under the CAMICO treaty. We continue to look for ways in which it may be advantageous to expand our business to include the reinsurance of lines of coverage other than accountants’ professional liability.
Net investment income includes amounts earned on the Company’s investment portfolio and cash equivalents, and dividends on equity investments, net of investment expenses. Net investment income increased $249,605, or 22.4%, in 2006 to $1,365,959 from $1,116,354 in 2005. Net investment income in 2005 decreased by $111,256, or 9.0%, from the $1,227,610 reported in 2004. The primary reason for the increase in 2006 was an increase in the dividend income on the equity portfolio due to improvement of dividend payouts on certain
holdings. In addition, the general increase in interest rates in 2006 also contributed to the increase in investment income. The decrease in 2005 from 2004 was due to overall lower interest rates for the fixed income portion of the portfolio as a result of the shortening of the average duration of that portfolio in order to reduce the risk of principal loss in the expected future environment of rising interest rates.
Invested assets, including investments, cash and cash equivalents and restricted cash and cash equivalents, increased by $5,762,041, or 11.6%, to $55,461,423 in 2006 compared to $49,699,382 in 2005. The increase was due to funds received as a result of the rights offering, and an increase in market values of the investment portfolio. Investment yield of net investment income and net realized gains and losses in 2006 as of December 31 was 4.7% as compared to 4.8% in 2005 and 3.7% in 2004. The investment yield of net investment income was 2.6% in 2006, 2.2% in 2005 and 2.3% in 2004. The increase in investment yield of net investment income from 2005 to 2006 was due to an increase in the dividend income on the equity portfolio due to improvement of dividend payouts on certain holdings. In addition, the general increase in the interest rates in 2006 also contributed to the increase in investment yield. The decrease from 2004 to 2005 was due to a general decrease in interest rates on investments held in our portfolio as a result of the shortening of the average duration of the fixed income portfolio in order to reduce the risk of principal loss in the expected future environment of rising interest rates.
Unrealized gain on investments was $7,469,210 at December 31, 2006 compared to $5,422,382 at December 31, 2005. We consider our entire investment portfolio to be available for sale and accordingly all investments are reported at market value, with changes in net unrealized gains and losses reflected as an adjustment to accumulated other comprehensive income. The 37.7% increase in unrealized gain on investments was due primarily to an improvement in the value of the Company’s equity portfolio. Unrealized gain on investments was $6,282,073 at December 31, 2004. Declines in the market value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. Our accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
The composition of the investment portfolio at December 31, 2006 and 2005 is as follows:
Policy acquisition costs of $2,546,012 were expensed in 2006 compared to $2,615,133 in 2005, a decrease of 2.6%. Policy acquisition costs, which are primarily ceding commissions paid to the ceding insurer, are established as a percentage of premiums written; therefore, any increase or decrease in premiums written will result in a similar increase or decrease in policy acquisition costs. Policy acquisition costs expensed in 2005 reflected an increase of 1.0% from $2,591,612 in 2004. Such costs as a percentage of premiums earned were 29.5% in 2006, 28.8% in 2005 and 29.3% in 2004. Operating and management expenses increased by 14.3% in 2006 to $1,968,124 from $1,722,245 in 2005. The primary reasons for this increase were patent and business development expenses. The operating and management expenses relating to the RINITS™ segment spent in the development phase have been $554,574 (2006), $251,113 (2005) and $89,424 (2004). Operating and management expenses for 2005 increased by 25.5% from $1,371,950 in 2004 due to increased audit and legal fees, costs of SEC compliance, and expenses related to a shareholder’s revised offer to acquire the Company. That offer was made in September 2004 to purchase all of AmerInst’s shares for 82.54% of book value. That offer was rejected by the Board because it presented an inadequate price for control of AmerInst, and because it was inconsistent with our mission.
Assumed reinsurance premiums receivable represent current assumed premiums receivable less commissions payable to the fronting carriers. This balance was $556,822 at December 31, 2006 and $710,534 at December 31, 2005. This balance fluctuates due to the timing of renewal premiums written.
Prepaid expenses and other assets were $219,132 at December 31, 2006, a decrease of 22.4% from 2005. These expenses relate to prepaid directors and officers’ liability insurance costs, director fees, and management fees.
Deferred policy acquisition costs, which represent the deferral of ceding commission expense related to premiums not yet earned, decreased from December 31, 2005 along with the decrease in unearned premiums. The current ceding commission rate, which became effective August 1, 1995, is 28.5% for CNA. The ceding rate for the carrier for the CAMICO treaty we began reinsuring in 2005 is 10% and for the attorneys’ professional liability we reinsured in 2003 was 10%. In addition a federal excise tax of 1% is applied on premiums earned. The 2.5% decrease in deferred policy acquisition costs in 2006 was due to the decrease in unearned premiums compared to the prior year.
We paid two semi-annual dividends of $0.45 per share during 2006. On March 1, 2007, the board of directors declared a semi-annual dividend of $0.45 per share and declared a special dividend of $0.70 per share, each of which were paid on March 15, 2007 to shareholders of record on February 28, 2007. Since AmerInst began paying consecutive dividends in 1995, our original shareholders have received approximately $13.48 in cumulative dividends per share, which when measured by a total rate of return calculation has resulted in an effective annual rate of return of approximately 10.88% from the inception of the Company, based on a per share purchase price of $8.33 paid by the original shareholders, and using an unaudited book value of $33.37 per share as of December 31, 2006.
On December 17, 2004, AmerInst, through its indirect wholly owned subsidiary, AmerInst Investment Company, Ltd., commenced a “modified Dutch auction” self-tender offer for AmerInst shares. Pursuant to the tender offer, which expired on January 21, 2005, 65,959 shares were accepted for purchase at a price of $60.00 per share, for a total purchase price of $4,298,238, including tender offer expenses of $340,698. (The number of shares purchased in the tender offer and the per share price set forth in the previous sentence have not been adjusted to reflect the share dividend described below.)
The consolidated financial statements include our estimated liability for unpaid losses and loss adjustment expenses (“LAE”) for our insurance operations. LAE is determined utilizing both case-basis evaluations and actuarial projections, which together represent an estimate of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of trends in future claim
The traditional loss development method separately forecasts ultimate loss and allocated loss adjustment expense for each year on the basis of historical emergence patterns found in incurred and paid loss and allocated loss adjustment expense data. The claim count-based Cape Cod method treats ultimate claim counts as the exposure base, and uses a claim severity index to reflect changes in expected losses per claim over time. In effect, the Cape Cod method combines a loss development approach (which forecasts future emergence of loss and allocated loss adjustment expense based on past emergence patterns) with an expected pure premium approach (which assumes that future expected emergence can be projected based on historical pure premiums). The claim severity index assumed a 5.0% claim severity trend, based on recent professional liability severity trend indications and judgment.
For premier plan and value plan business, many policies provide allocated loss adjustment expense coverage in addition to the standard $1 million per claim indemnity limit. The effect of a provision for allocated loss adjustment expense in addition to limits was estimated by performing incurred and paid loss and allocated loss adjustment expense Bornhuetter-Ferguson (BF) calculations on the incurred and paid loss and allocated loss adjustment expense in addition to the limits. Our loss reserves are still near the high end of the reserve range provided by the actuary, which is consistent with our loss reserving philosophy.
The BF method essentially blends together an expected loss result and a loss development result. The expected losses used in the BF calculation were selected by multiplying expected claim counts by average excess of $1 million frequency and severity amounts. Based on historical allocated loss adjustment expenses data, the actuary selected a 1.50% and a 1.65% frequency provision and a $750,000 and a $714,286 severity provision for 2006 and 2005, respectively, for allocated loss adjustment expense in addition to limits.
The above table presents the development of balance sheet liabilities for 1996 through 2006 as of year-end 2006. The top line of the table shows the original recorded unpaid liability for losses and LAE recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all prior years, both paid and unpaid at the balance sheet date, including losses that had been incurred, but not yet reported, to the Company. The upper portion of the table shows the experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims.
The following table provides an analysis of our contractual obligations at December 31, 2006:
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AmerInst Insurance Group, Ltd. and subsidiaries as at December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
* The number of shares issued and outstanding and held by Subsidiary at December 31, 2005 have been adjusted retroactively to reflect the share dividend of two shares for every share outstanding completed in the second quarter of 2006.
* The per share amounts and number of shares outstanding have been adjusted retroactively for all periods presented to reflect the share dividend of two shares for every share outstanding completed in the second quarter of 2006.
Declines in the market value of investments below cost are evaluated for other than temporary impairment losses. The evaluation for other than temporary impairment losses is a quantitative and qualitative process which is subject to risks and uncertainties in the determination of whether declines in the fair value of investments are other than temporary. The risks and uncertainties include the Company’s intent and ability to hold the security, changes in general economic conditions, the issuer’s financial condition or near term recovery prospects, and the effects of changes in interest rates. AMIG Ltd.’s accounting policy requires that a decline in the value of a security below its cost basis be assessed to determine if the decline is other than temporary. If so, the security is deemed to be impaired and a charge is recorded in net realized losses equal to the difference between the fair value and the cost basis of the security. The fair value of the impaired investment becomes its new cost basis.
For purposes of the statements of cash flows, AMIG Ltd. considers all money market funds and highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
The cost or amortized cost, gross unrealized holding gains and losses, and estimated fair value of investments in fixed maturity investments, by major security type, and equity securities at December 31, 2006 and 2005 are as follows:
As of December 31, 2005, there were approximately 37 securities in an unrealized loss position with an estimated fair value of $21,548,774. Of these securities, there are 11 securities that have been in an unrealized loss position for 12 months or greater with an estimated fair value of $9,178,932. As of December 31, 2005, none of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
On March 2, 2006, the board of directors of AMIG approved a share dividend of two shares of common stock for every share held by shareholders of record on April 2, 2006, subject to shareholder approval of an increase in the number of our authorized shares. Such approval was received at the AMIG 2006 Annual General Meeting on June 1, 2006, which increased the authorized share capital of the Company from $500,000 to $2,000,000. The total issued shares were 331,751 prior to the share dividend and 995,253 afterwards.
Of the shares sold in the rights offering, 21,461 shares were purchased by AMIG directors for a total purchase price of $500,685.
Premiums written were $8,680,603, $9,027,666, and $8,885,926 during 2006, 2005 and 2004, respectively.
AMIG Ltd., AMIC Ltd., Mezco and Investco have no employees. Their operating activities, as well as certain management functions, are performed by contracted professional service providers. USA Risk Group (Bermuda) Ltd. provides AMIG Ltd. and AMIC Ltd. certain management, administrative and operations services under the direction of AMIG Ltd.’s Board of Directors pursuant to an agreement. The agreement may be terminated by either party upon not more than 90 days nor less than 60 days prior written notice. Mr. Grayston, a director and President of the Company, and Mr. Nicol, a director, Vice President and Treasurer of the Company, are the President and Senior Account Manager and Vice President, respectively, of USA Risk Group (Bermuda) Ltd. The company paid $255,000 in fees pursuant to this agreement during 2006. Operating and management expenses include compensation paid to members of the Board of Directors and various committees of the Board totaling $424,258 in 2006, $360,435 in 2005 and $312,848 in 2004.
Under the Bermuda Companies Act, AMIG Ltd. is prohibited from declaring or paying a dividend at December 31, 2006 if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital, and share premium accounts. In addition, it must be able to pay its liabilities as they come due after the payment of a dividend. As at December 31, 2006, $18,197,878 was available to stockholders in accordance with these provisions.
Effective in 2006 AmerInst has two operating segments: 1) reinsurance activity and 2) the new insurance financing product (RINITS™) which is in the initial marketing phase of development. The reinsurance segment had revenues of $11,114,756 (2006) $11,537,620 (2005) and $10,816,910 (2004). Total losses and expenses for this segment were $7,247,220 (2006), $8,191,386 (2005) and $8,978,479 (2004), resulting in segment income of $3,867,536, $3,346,234 and $1,838,431 in each year. Net premium earned in the reinsurance segment from a single insurance carrier was $8,412,855 for the year ended December 31, 2006.
The RINITS™ segment offers a mechanism to securitize insurance and reinsurance risk, involving property, casualty, life and health lines of insurance. This segment as of December 31, 2006 had no revenue. Operating and management expenses spent in the development phase have been $554,574 (2006), $251,113 (2005) and $89,424 (2004).