Pursuant to the Harco and Highlands settlement agreements, in January 2010, the Company paid $1,450,000 to Harco and $3,000,000 to Highlands. These payments did not have a material impact on the Company’s liquidity. As a result of the Harco and Highlands settlements, all of the Company’s liabilities and obligations under the discontinued bond program have been satisfied.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168 (Codification reference ASC 105), “The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162.” SFAS No. 168 sets forth the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative nongovernmental Generally Accepted Accounting Principles (“GAAP”). The Codification was launched on July 1, 2009 and is the official source of authoritative, nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), EITF, and related literature. After the Codification was launched on July 1, 2009, only one level of authoritative U.S. GAAP exists, other than guidance issued by the SEC. All other accounting literature excluded from the Codification will be considered non-authoritative. The Codification is effective for interim and annual periods ending after September 15, 2009. The Company has included references to the Codification in the notes to the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157 (Codification reference ASC 820), “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements. It applies to other pronouncements that require or permit fair value measurements but does not require any new fair value measurements. The statement defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” SFAS No. 157 establishes a fair value hierarchy (i.e., Levels 1, 2 and 3) to increase consistency and comparability in fair value measurements and disclosures. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2 (Codification reference ASC 820), “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”), which permits a one-year deferral of the application of SFAS No. 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted SFAS No. 157 and FSP SFAS 157-2 for financial assets and liabilities effective January 1, 2008, which did not have a material impact on the Company’s consolidated financial statements. The Company adopted SFAS No. 157 for non-financial assets and non-financial liabilities effective January 1, 2009, which did not have a material impact on the Company’s consolidated financial statements. In October 2008, the FASB issued FSP 157-3 (Codification reference ASC 820), “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP SFAS 157-3”), which clarifies the application of SFAS No. 157 in a market that is not active. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
significant revision the guidance on contingencies of SFAS No. 141, “Business Combinations,” which was superseded by SFAS No. 141(R). This FSP also eliminates the requirement to disclose an estimate of the range of possible outcomes of recognized contingencies at the acquisition date. For unrecognized contingencies, the FASB requires that entities include only the disclosures required by SFAS No. 5. The Company adopted this FSP effective January 1, 2009, which did not have a material impact on the Company’s consolidated financial statements.
FSP FAS 157-4 (Codification reference ASC 820), “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” (“FSP FAS 157-4”). This FSP supersedes FSP FAS 157-3 (Codification reference ASC 820), “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.” This FSP provides additional guidance on: (1) estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to the normal market activity for the asset or liability, and (2) identifying transactions that are not orderly. This FSP must be applied prospectively and retrospective application is not permitted.
FSP FAS 107-1 and APB 28-1 (Codification reference ASC 825), “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). This FSP extends the disclosure requirements under SFAS No. 107 (Codification reference ASC 825), “Disclosures about Fair Value of Financial Instruments,” to interim financial statements and it amends APB Opinion 28 (Codification reference ASC 270), “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods.
In January 2010, the FASB released a reworked version of ASC subtopic 820-10 (formerly SFAS No. 157). The amended rule requires companies to make separate disclosures for any significant transfers made in or out of Levels 1 and 2, as well as describe the reasons for making the transfers. The amended rule also states that companies can no longer lump together information about swings in Level 3 fair-value measurements associated with purchases, sales, issuances, and settlements of financial instruments. The amended rule also states that companies should provide disclosures about the valuation techniques and inputs used to measure recurring as well
as nonrecurring items that fall into either the Level 2 or Level 3 category. The amended rule is effective for periods beginning after December 15, 2009, with one exception: the provisions about disclosure of Level 3 measurement changes tied to the purchase, sales, issuances, and settlements of financial instruments will go into effect for fiscal years beginning after December 15, 2010. The adoption of the amended rule did not have a material impact on the Company’s consolidated financial statements.
A discussion of our reinsurance transactions is set forth in Item 1 above under the caption “Reinsurance” and is incorporated herein by reference.
Because we believe our estimated liability for claims under this program is fully collateralized and our loss exposure is 100% reinsured, we do not believe the events described above will have a material adverse impact on us. However, if the Provider that is not in bankruptcy defaults on its obligations, and if our actual liability for claims under this program exceeds the collateral held by us and if we are unable to collect on the reinsurance, then this program could have a material adverse effect on our business, financial condition and/or operating results.
Net income for 2009 was $5,068,730, or $0.99 per diluted share, compared to $1,361,303, or $0.27 per diluted share, for 2008. The most significant factors that influenced this period-over-period comparison were (1) a $3.3 million ($2.2 million after tax) decrease in expenses related to the SEC investigation, (2) a $2.2 million ($1.4 million after tax) decrease in reserves for our discontinued bond program as a result of the Harco and Highlands settlements as discussed in “Overview-Discontinued Bond Program” above, (3) a $0.7 million ($0.5 million after tax) increase in net realized gains on investments and (4) a $0.5 million ($0.4 million after tax) decrease in other-than-temporary impairment charges on investments.
The combined ratio, which is the sum of the loss ratio and the expense ratio, is the traditional measure of underwriting experience for property/casualty insurance companies. Our specialty insurance products are underwritten by Ohio Indemnity, whose results represent the Company’s combined ratio. The statutory combined ratio is the sum of the ratio of losses to premiums earned plus the ratio of statutory underwriting expenses less management fees to premiums written after reducing both premium amounts by dividends to policyholders. Statutory accounting principles differ in certain respects from GAAP. Under statutory accounting principles, policy acquisition costs and other underwriting expenses are recognized immediately, not at the same time premiums are earned. To convert underwriting expenses to a GAAP basis, policy acquisition costs are deferred and recognized over the period in which the related premiums are earned. Therefore, the GAAP combined ratio is the sum of the ratio of losses to premiums earned plus the ratio of underwriting expenses less management fees to premiums earned. In addition, statutory accounting principles may require additional unearned premium reserves that result in net premiums earned on a statutory basis differing from that of net premiums earned on a GAAP basis which also impacts the comparison of the combined ratio for GAAP and statutory purposes. The following table reflects Ohio Indemnity’s loss, expense and combined ratios on both a statutory and a GAAP basis for the years ended:
Net Premiums Earned. Net premiums earned decreased 8.5%, or $4,079,330, to $44,083,446 in 2009 from $48,162,776 a year ago principally due to a decrease in premiums for our ULI and GAP product lines which was partially offset by an increase in premiums for our CPI product line.
ULI net premiums earned decreased 20.2%, or $4,652,906, to $18,394,135 in 2009 from $23,047,041 a year ago. Approximately $2.4 million of the decrease related to a large financial institution customer that exited the automobile lending market in the fourth quarter of 2008. The remaining decrease was principally due to a decline in lending volume for the majority of our ULI customers. We believe this decline in lending volume was primarily caused by the national decline in automobile sales when compared to a year ago.
Net premiums earned for GAP decreased 18.0%, or $1,755,982, to $8,003,877 in 2009 from $9,759,859 a year ago. Approximately $0.8 million of the decrease related to the cancellation of a poor performing GAP customer in the second quarter of 2008. The remaining decrease was principally due to a decline in lending volume for the majority of our GAP customers. We believe this decline in lending volume was primarily caused by the national decline in automobile sales when compared to a year ago.
Net premiums earned for WIP decreased 5.1%, or $360,964, to $6,785,803 in 2009 from $7,146,767 a year ago primarily due to a decrease in escrow and contract surety bond premium which was partially offset by an increase in waste surety bond premium.
Net Investment Income. Net investment income increased 3.8%, or $149,249, to $4,047,706 in 2009 from $3,898,457 a year ago principally due to an increase in our average invested assets during 2009 when compared to a year ago.
For more information concerning net realized gains on investments, see “Business Outlook” below.
Other-Than-Temporary Impairments on Investments. Other-than-temporary impairments on investments decreased 14.4%, or $534,654, to $3,168,291 in 2009 from $3,702,945 a year ago. The impairment charges recorded during 2009 were primarily due to the following: (1) $1,316,177 in impairment charges for four closed-end mutual funds whose fair values were adversely affected by the current market conditions; (2) $797,619 in impairment charges for equity securities of seven financial institutions whose fair values were adversely affected primarily by the credit markets; (3) $572,020 in impairment charges for a corporate fixed maturity security of a lending institution (SLM Corp. or Sallie Mae) whose fair value was adversely affected by uncertainty in its investment ratings by certain bond rating agencies; (4) $208,004 in impairment charges for two fixed maturity securities that were downgraded below investment grade; (5) $150,713 in impairment charges for ten fixed maturity securities that we intend to sell before their anticipated recovery in order to utilize capital loss carrybacks for tax purposes; and (6) $62,157 in impairment charges for an equity security of an insurance company whose fair value was adversely affected by the current market conditions.
Management Fees. Our management fees decreased 57.0%, or $210,075, to $158,766 in 2009 from $368,841 a year ago primarily due to
Losses and Loss Adjustment Expenses. Losses and LAE decreased 19.1%, or $4,666,484, to $19,788,113 in 2009 from $24,454,597 a year ago principally due to a decrease in ULI and discontinued bond program losses which was partially offset by an increase in CPI losses.
CPI losses and LAE increased 311.3%, or $1,198,866, to $1,583,959 in 2009 from $385,093 a year ago primarily due to the growth in premium described above.
GAP losses and LAE increased 4.2%, or $245,815, to $6,034,697 in 2009 from $5,788,882 a year ago. The increase in losses was primarily caused by an increase in both frequency and severity of losses for the majority of our GAP customers which was partially offset by a decrease in losses as a result of the decline in premium described above. We believe the increase in severity in 2009 was primarily related to an overall decline in used automobile values when compared to a year ago.
UC losses and LAE increased 56.2%, or $655,242, to $1,820,889 in 2009 from $1,165,647 a year ago. This increase in losses was primarily caused by a $973,075 increase in loss reserves for our UCassure® product as a result of an increase in benefit charges during 2009 when compared to a year ago. This increase in losses was partially offset by a $440,000 decrease in losses as a result of the previously disclosed settlement of a dispute with a former UC customer in 2008.
WIP losses and LAE decreased 3.5%, or $19,461, to $534,631 in 2009 from $554,092 a year ago. For WIP, we record loss and LAE reserves using an expected loss ratio reserving method as recommended by the primary insurance carrier and reviewed by our independent actuary. For waste surety bonds, loss and LAE reserves are based on a certain percentage of net premiums earned over the trailing thirty-six months. For contract and escrow surety bonds, loss and LAE reserves are based on a certain percentage of total net premiums earned. As a result, the decrease in WIP losses and LAE in 2009 was primarily related to the decline in net premiums earned.
Other specialty products losses and LAE decreased $641,850 in 2009 compared to a year ago primarily due to favorable loss development for one of our automobile service contract programs that is in run off. See “Automobile Service Contract Program” above and “Automobile Service Contract Program” in Note 15 to the Consolidated Financial Statements for more information concerning this program.
For more information concerning losses and LAE, see “Business Outlook” and “Critical Accounting Policies-Loss and Loss Adjustment Expense Reserves” below.
Other Operating Expenses. Other operating expenses increased 2.7%, or $209,003, to $8,012,125 in 2009 from $7,803,122 a year ago primarily due to an increase in compensation expense. The increase in compensation expense principally related an increase in equity-based compensation expense combined with an increase in non-equity incentive plan compensation expense.
SEC Investigation Expenses. SEC investigation expenses decreased 99.3%, or $3,265,846, to $23,616 in 2009 from $3,289,462 a year ago. See “SEC Investigation” above, “Business Outlook-Expenses” and “Liquidity and Capital Resources” below and Note 4 to the Consolidated Financial Statements for more information concerning the SEC investigation.
GAAP Combined Ratio. For 2009, the combined ratio improved to 89.6% from 93.3% a year ago. The loss ratio improved to 46.9% in 2009 from 53.0% a year ago primarily due to the decrease in losses and LAE for the discontinued bond program combined with favorable loss development for one of our automobile service contract programs as described above. The expense ratio increased to 42.7% in 2009 from 40.3% a year ago primarily due to the amount of other operating expenses relative to the decrease in net premiums earned combined with a higher commission expense ratio given the decline in lender service business which has a lower commission structure when compared to our UC and WIP product lines.
One of the actions we took to mitigate our increased frequency and severity of losses was cancelling a poor performing GAP customer in the second quarter of 2008. During 2009 and 2008, this GAP customer had net premiums earned of approximately $1.6 million and $2.4 million, respectively, and its combined ratio was 139% and 134%, respectively. As of December 31, 2009, we had approximately $1.7 million of unearned premium for this customer that will be earned over approximately two years.
Effective January 1, 2007, we entered into a producer-owned reinsurance arrangement with an EPD customer whereby 100% of that customer’s premiums (along with the associated risk) were ceded to its PORC. For this reinsurance arrangement, we have obtained collateral in the form of funds held and a letter of credit to secure our obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and we have immediate access to such collateral if necessary. This program reduced our commission expense by $1.2 million in 2009 compared to $0.8 million in 2008. We expect this program to reduce our commission expense by approximately $1.4 million during fiscal year 2010. As of December 31, 2009, we had approximately $2.2 million of deferred ceded commissions for this program that will be earned over approximately four years.
Increased benefit charge levels for our UC customers could result in lower management fees and/or increased losses for our UC product line. During 2009, we experienced an increase in benefit charges for our UCassure® product when compared to a year ago which resulted in a $973,075 increase in loss reserves this product during 2009. We expect that our excess of loss product will also experience an increase in benefit charges, especially considering its geographical concentration in California (approximately 35% of this business is in California). Given the current economic conditions, including high unemployment levels, we believe it is possible that we could continue to experience an increase in benefit charges for fiscal year 2010 when compared to fiscal year 2009; however, we cannot predict the level of benefit charges or how material the impact will be to us. Where possible, we have taken actions to help mitigate the effects of these trends, including monitoring the coverage and pricing of our products and taking actions when necessary.
Since we began participating in the WIP program in 2004 there have not been any significant paid claims to date. If we were to have significant claims experience on this program during fiscal year 2010, such claims experience could have a material adverse effect on our business, financial condition and/or operating results if our reserves prove to be materially deficient; however, we currently do not believe that our reserves will be materially deficient. As of December 31, 2009, our net loss and LAE reserves for the WIP program were approximately $2.9 million. For waste and contract surety bonds, as of December 31, 2009, our largest net exposure in a single surety bond was approximately $4.5 million and $2.1 million, respectively, and our net loss and LAE reserves were approximately $1.6 million and $0.9 million, respectively.
As of December 31, 2009, approximately 96% of our fixed maturity portfolio was invested in tax-exempt municipal bonds which consisted primarily of revenue issue bonds (approximately 93%) and general obligation bonds (approximately 7%). During 2009, market liquidity for such bonds improved considerably when compared to 2008. Trading desks at firms such as Bear Stearns, Lehman Brothers, Merrill Lynch, and Wachovia had previously played significant roles in supplying liquidity in the bond markets. With these brokers no longer in existence or merged into other entities and other financial institutions accumulating capital, the municipal bond markets witnessed a dramatic widening in bid/ask spreads and a decrease in trading volume during the second half of 2008. Municipal bond returns from September through December of 2008 were the worst of any such period in the past 20 years. Returns for municipal bonds improved
Many of the securities within our equity portfolio have also been negatively impacted by the current economic conditions. During 2009, we recorded approximately $3.2 million of impairment charges for our investment portfolio (approximately $2.2 million for equity securities and approximately $1.0 million for fixed maturity securities). A stock market rally that materialized in mid-March 2009 continued through the fourth quarter of 2009. As a result, our equity portfolio improved as of December 31, 2009 when compared to December 31, 2008, and the gross unrealized loss for our equity portfolio decreased from $1.4 million at December 31, 2008 to zero at December 31, 2009.
Based on the current economic conditions and our other-than-temporary impairment accounting policy, additional impairment charges within our investment portfolio are possible during fiscal year 2010. As disclosed in Note 2 to the Consolidated Financial Statements and “Critical Accounting Policies-Other-Than-Temporary Impairment of Investments” below, we begin to monitor a security for other-than-temporary impairment when its fair value to book value ratio falls below 80%. As shown in Note 2 to the Consolidated Financial Statements, as of December 31, 2009, we did not have any equity securities that had a fair value to book value ratio below 80%. Assuming the estimated fair value for our equity securities remained the same during 2010 as they were at December 31, 2009, we would not likely record any material other-than-temporary impairment charges for equity securities during fiscal year 2010. With respect to those fixed maturity securities having a fair value to book value ratio below 80% as shown in Note 2 to the Consolidated Financial Statements, all of these securities are investment grade and we would likely not have any material other-than-temporary impairment charge on these securities during fiscal year 2010 unless they were to fall below investment grade. Due to the inherent uncertainties of the investment markets, we cannot predict with reasonable certainty the amount or range of amounts of other-than-temporary impairment charges, if any, that will be recorded during fiscal year 2010; however, if market conditions deteriorate, we believe that the amount of such other-than-temporary impairment charges could be material to our results of operations. For more information concerning the unrealized loss position of our investment portfolio and impairment charges, see “Critical Accounting Policies-Other-Than-Temporary Impairment of Investments” below and Note 2 to the Consolidated Financial Statements.
During 2009, we recorded approximately $1.0 million of net realized gains on investments primarily due to sales of equity securities that had previously been written down as an other-than-temporary impairment and then had subsequent recovery in value. We generally decide whether to sell securities based upon investment opportunities and tax consequences. In order to utilize our tax capital loss carrybacks prior to their expiration, we sold securities during 2009 that had previously been written down and then had subsequent recovery in value. Sales of these securities generated realized losses for tax purposes but generated realized gains for book purposes. Due to the inherent uncertainties of the investment markets, we cannot predict with reasonable certainty the amount of net realized gains (losses) that will be recorded during fiscal year 2010; however, the amount of such net realized gains (losses) could be material to our results of operations.
The following table sets forth our cash and short-term investment position at December 31, 2009 and 2008:
Even though it is classified as an equity security in our accompanying balance sheet, we treat the money market mutual fund as a short-term investment for purposes of our liquidity management because of its liquid nature.
Because of the nature of the risks we insure, losses and LAE emanating from the insurance policies that we issue are generally characterized by relatively short settlement periods and quick development of ultimate losses compared to claims emanating from other types of insurance products. Therefore, we believe we can estimate our cash needs to meet our policy obligations and utilize cash flows from operations and our cash and short-term investment position to meet these obligations. We consider the relationship between the duration of our policy obligations and our expected cash flows from operations in determining our cash and short-term investment position. We maintain a level of cash and liquid short-term investments which we believe will be adequate to meet our anticipated policy obligations without being required to liquidate intermediate-term and long-term investments at a loss.
We believe that both liquidity and interest rate risk can be minimized by the asset and liability management strategy described above. With this strategy, we believe we can pay our policy obligations as they become due without being required to use our bank line of credit or liquidate intermediate-term and long-term investments at a loss; however, in the event that such action is required, it is not anticipated to have a material impact on our results of operations, financial condition and/or future liquidity.
During 2008, Bancinsurance Corporation experienced a significant increase in expenses and cash outflows as a result of expenses associated with the SEC investigation. Based on management’s expectation that Bancinsurance Corporation would continue to incur significant expenses and have significant cash outflows related to the SEC investigation during 2008, Bancinsurance Corporation drew $2.5 million on its bank line of credit on March 31, 2008. Given the decrease in expenses associated with the SEC investigation during 2009, Bancinsurance Corporation paid down the entire $2.5 million balance on the bank line of credit during the second quarter of 2009. As discussed above, Bancinsurance Corporation borrowed $3.0 million on the bank line of credit during the fourth quarter of 2009 in anticipation of the Highlands settlement payment. Bancinsurance paid down the entire $3.0 million balance on the bank line of credit during the first quarter of 2010 using excess cash flows from the Company’s operating and investing activities. At December 31, 2009 and December 31, 2008, Bancinsurance Corporation had total cash and invested assets of $4.2 million and $3.8 million, respectively. This
increase in cash and invested assets was primarily due to Bancinsurance Corporation increasing its borrowings under its bank line of credit by $0.5 million during 2009. As a result of the Company’s and the Chief Executive Officer’s settlements with the SEC and the SEC staff’s completion of its investigation of the Chief Financial Officer and Vice President of Specialty Products, management expects that Bancinsurance Corporation’s future expenses will return to historical levels in 2010 and Bancinsurance Corporation will be able to meet its cash flow requirements from the sources described above. See “Regulation-SEC Investigation” in Item 1 above, “Business Outlook-Expenses” above, Note 4 to the Consolidated Financial Statements and Items 13 and 14 for more information regarding the SEC investigation.
Net cash (used in) provided by financing activities was ($2,119,248) and $2,500,000 during 2009 and 2008, respectively. The cash received during 2008 was due to a $2,500,000 draw on our bank line of credit during that period. The cash used during 2009 was primarily due to a $2.6 million cash dividend paid to shareholders which was partially offset by a net increase in cash of $0.5 million from additional borrowings on our bank line of credit.
We do not consider the impact of inflation to be material in the analysis of our net revenues, income from continuing operations or our overall operations.
our intent to sell the security or the likelihood that we will be required to sell the security before its anticipated recovery.
Under our investment guidelines, we employ what we believe are stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security or type of security. Our fixed maturity and closed-end mutual fund portfolio is managed by an outside investment manager that operates under investment guidelines approved by our board of directors. Under our investment guidelines, fixed maturity securities are required to be investment grade at the time of purchase to protect investments. As of December 31, 2009, approximately 99% of our fixed maturity portfolio was rated investment grade. Our outside investment manager also monitors the underlying credit quality of our fixed maturity portfolio. In performing our other-than-temporary
See Note 2 to the Consolidated Financial Statements for information regarding our securities that were in an unrealized loss position at December 31, 2009 that were not considered to be other-than-temporarily impaired. For more information concerning other-than-temporary impairment charges, see “Results of Operations-Other-Than-Temporary Impairments on Investments,” “Business Outlook-Investments” and “Liquidity and Capital Resources” above and Note 2 to the Consolidated Financial Statements.
We utilize our internal staff, information from ceding insurers under assumed reinsurance and an independent consulting actuary in establishing our loss and LAE reserves. Our independent consulting actuary reviews our reserves for losses and LAE on a quarterly basis and we consider this review in establishing the amount of our reserves for losses and LAE.
Our projection of ultimate loss and LAE reserves are estimates of future events, the outcomes of which are unknown to us at the time the projection is made. Considerable uncertainty and variability are inherent in the estimation of loss and LAE reserves. As a result, it is possible that actual experience may be materially different than the estimates reported. We continually revise reserve estimates as experience develops and further claims are reported and resolved. Changes in reserve estimates are recorded in the results of operations in the period in which the adjustments are made.
Assumed Business. Assumed reinsurance is a line of business with inherent volatility. Since the length of time required for the losses to be reported through the reinsurance process can be quite long, unexpected events are more difficult to predict. Our ultimate loss reserve estimates for assumed reinsurance are primarily dependent upon information received by us from the underlying ceding insurers.
As of December 31, 2009, we conducted a reserve study using historical losses and LAE by product line or coverage within product line. We prepared our estimates of the gross and net loss and LAE reserves using annual accident year loss development triangles for the following products:
Historical “age-to-age” loss development factors (“LDF”) were calculated to measure the relative development for each accident year from one maturity point to the next. Based on the historical LDF, we selected age-to-age LDF that we believe are appropriate to estimate the remaining future development for each accident year. These selected factors are used to project the ultimate expected losses for each accident year. The validity of the results from using a loss development approach can be affected by many conditions, such as claim department processing changes, a shift between single and multiple payments per claim, legal changes or variations in our mix of business from year to year. Also, because the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimate losses. Therefore, ultimate values for immature accident years may be based on alternative estimation techniques, such as the expected loss ratio method or some combination of acceptable actuarial methods.
In performing our loss reserve analysis, we select a single loss reserve estimate for each product line that represents management’s “best estimate” based on facts and circumstances then known to us.
Our discontinued bond program experienced redundancies of approximately $2.2 million during 2009 as a result of the settlements with Highlands and Harco as discussed in “Overview-Discontinued Bond Program” above and in “Discontinued Bond Program” in Note 15 to the Consolidated Financial Statements.
Our WIP program experienced reserve redundancies of approximately $0.4 million during 2009 as we did not receive any material claims for this program during 2009. For more information concerning WIP losses and LAE, see “Results of Operations” and “Business Outlook” above.
For more information concerning losses and LAE, see “Business Outlook” above.
We are involved in various legal proceedings arising in the ordinary course of business. An estimate is made to accrue for a loss contingency relating to any of these legal proceedings if we believe it is probable that a liability was incurred as of the date of the financial statements and the amount of loss can be reasonably estimated. Because of the subjective nature inherent in assessing the outcome of litigation and the potential that an adverse outcome in a legal proceeding could have a material impact on our financial condition and/or results of operations, such estimates are considered to be critical accounting estimates. See Note 20 to the Consolidated Financial Statements for information concerning the Company’s commitments and contingencies. For more information, see Item 3 - “Legal Proceedings.”
Costs of acquiring insurance business that vary with, and are primarily related to, the production of new and renewal business are deferred and amortized over the period in which the related premiums are recognized. Such deferred costs principally consist of up-front commissions and premium taxes and are reported net of ceding commissions. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, anticipated investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to the ultimate recoverability of such deferred costs are highly dependent upon estimated future losses associated with the unearned premium. If such deferred policy acquisition costs are estimated to be unrecoverable, they will be expensed in the period identified.
We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. In accordance with GAAP, the Company must also adjust its financial statements to reflect only those tax positions that are more-likely-than-not to be sustained. For more information concerning our federal income taxes, see Note 8 to the Consolidated Financial Statements.
We do not have any off-balance sheet arrangements that either have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that we believe to be material to investors.
We have audited the accompanying consolidated balance sheet of Bancinsurance Corporation and subsidiaries (the “Company”) as of December 31, 2008, and the related consolidated statements of income, shareholders’ equity and cash flows for the year then ended. Our audit also included the financial statement schedules listed in the index at Item 15(a) pertaining to the 2008 fiscal year. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bancinsurance Corporation and subsidiaries at December 31, 2008 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. 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.
Notes to Consolidated Financial Statements - December 31, 2009 and 2008
Property/Casualty Insurance. Our wholly-owned subsidiary, Ohio Indemnity Company (“Ohio Indemnity”), is a specialty property/casualty insurance company. Our principal sources of revenue are premiums and ceded commissions for insurance policies and income generated from our investment portfolio. Ohio Indemnity, an Ohio corporation, is licensed in 49 states and the District of Columbia. As such, Ohio Indemnity is subject to the regulations of The Ohio Department of Insurance (the “Department”) and the regulations of each state in which it operates. Ohio Indemnity’s premiums are derived from three distinct product lines: (1) lender service; (2) unemployment compensation; and (3) waste industry.
Our unemployment compensation (“UC”) products are utilized by entities that are qualified to elect not to pay unemployment compensation taxes and instead reimburse state unemployment agencies for benefits paid by the agencies to the entities’ former employees. Through our UCassure® and excess of loss products, we indemnify the qualified entity for liability associated with its reimbursing obligations. In addition, we underwrite surety bonds that certain states require employers to post in order to obtain reimbursing status for their unemployment compensation obligations.
indemnified by the principal and collateral is maintained on the majority of the bonds. The indemnifications and collateralization of this program reduces the risk of loss. All surety bonds written directly, assumed and ceded under this program are produced and administered by a general insurance agent that is affiliated with one of the insurance carriers participating in the program. The general insurance agent utilizes various insurance carriers, including the Company, in placing its surety bond business. Our direct premium volume for this program is determined by the general insurance agent’s decision to place business with the Company.
We have certain other specialty products which consist primarily of two vehicle service contract programs. The premiums produced under other specialty products are not considered material to our results of operations. For our two vehicle service contract programs, we maintain reinsurance and/or collateral in excess of our estimated claim obligations, which reduces our risk of loss. For more information concerning one of the vehicle service contract programs, see “Automobile Service Contract Program” in Note 15.
Insurance Agency. In July 2002, we formed Ultimate Services Agency, LLC (“USA”), a wholly-owned subsidiary. We formed USA to act as an agency for placing and servicing property/casualty insurance policies offered and underwritten by Ohio Indemnity and by other property/casualty insurance companies.
In September 2006, the FASB issued SFAS No. 157 (Codification reference ASC 820), “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements. It applies to other pronouncements that require or permit fair value measurements but does not require any new fair value measurements. The statement defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” SFAS No. 157 establishes a fair value hierarchy (i.e., Levels 1, 2 and 3) to increase consistency and comparability in fair value measurements and disclosures. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position (“FSP”) 157-2 (Codification reference ASC 820), “Effective Date of FASB Statement No. 157” (“FSP SFAS 157-2”), which permits a one-year deferral of the application of SFAS No. 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted SFAS No. 157 and FSP SFAS 157-2 for financial assets and liabilities effective January 1, 2008, which did not have a material impact on the Company’s consolidated financial statements. The Company adopted SFAS No. 157 for non-financial assets and
In January 2009, the FASB issued FSP EITF 99-20-1 (Codification reference ASC 325), “Amendments to the Impairment Guidance of EITF Issue No. 99-20.” This FSP amends the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve more consistent determination of whether an other-than-temporary impairment has occurred. This FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115 (Codification reference ASC 320), “Accounting for Certain Investments in Debt and Equity Securities,” and other related guidance. This FSP is effective for interim and annual reporting periods ending after December 15, 2009. The Company adopted this FSP effective December 31, 2009, which did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued FSP FAS 141(R)-1 (Codification reference ASC 805), “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” This FSP requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably estimated. If fair value cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with SFAS No. 5 (Codification reference ASC 450), “Accounting for Contingencies” and FASB Interpretation No. 14 (Codification reference ASC 450), “Reasonable Estimation of the Amount of a Loss.” Further, this FSP removed the subsequent accounting guidance for assets and liabilities arising from contingencies from SFAS No. 141(R) (Codification reference ASC 805). The requirements of this FSP carry forward without significant revision the guidance on contingencies of SFAS No. 141, “Business Combinations,” which was superseded by SFAS No. 141(R). This FSP also eliminates the requirement to disclose an estimate of the range of possible outcomes of recognized contingencies at the acquisition date. For unrecognized contingencies, the FASB requires that entities include only the disclosures required by SFAS No. 5. The Company adopted this FSP effective January 1, 2009, which did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB also issued the following three Staff Positions, each of which was adopted by the Company on April 1, 2009 without a material impact on the Company’s consolidated financial statements:
FSP FAS 115-2 and FAS 124-2 (Codification reference ASC 320), “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”). This FSP provides new guidance on the recognition and presentation of other-than-temporary impairments (“OTTI”) for available for sale and held to maturity fixed maturities (equities are excluded). An impaired security is not recognized as an impairment if management does not intend to sell the impaired security and it is more likely than not it will not be required to sell the security before the recovery of its amortized cost basis. If management concludes a security is other-than-temporarily impaired, this FSP requires that the difference between the fair value and the amortized cost of the security be presented as an OTTI charge in the statements of operations, with an offset for any noncredit-related loss component of the OTTI charge to be recognized in other comprehensive income. Accordingly, only the credit loss component of the OTTI amount will
In May 2009, the FASB issued SFAS No. 165 (Codification reference ASC 855), “Subsequent Events.” SFAS No. 165 sets standards for the disclosure of events that occur after the balance-sheet date, but before financial statements are issued or are available to be issued. SFAS No. 165 sets forth the following: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS No. 165 is effective for interim and annual periods ending after June 15, 2009. The Company adopted SFAS No. 165 effective April 1, 2009. The Company uses the date of the filing of its periodic report with the SEC as the date through which subsequent events have been evaluated, which is the same date as the date the financial statements are issued. The adoption of SFAS No. 165 did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB released a reworked version of ASC subtopic 820-10 (formerly SFAS No. 157). The amended rule requires companies to make separate disclosures for any significant transfers made in or out of Levels 1 and 2, as well as describe the reasons for making the transfers. The amended rule also states that companies can no longer lump together information about swings in Level 3 fair-value measurements associated with purchases, sales, issuances, and settlements of financial instruments. The amended rule also states that companies should provide disclosures about the valuation techniques and inputs used to measure recurring as well as nonrecurring items that fall into either the Level 2 or Level 3 category. The amended rule is effective for periods beginning after December 15, 2009, with one exception: the provisions about disclosure of Level 3 measurement changes tied to the purchase, sales, issuances, and settlements of financial instruments will go into effect for fiscal years beginning after December 15, 2010. The adoption of the amended rule did not have a material impact on the Company’s consolidated financial statements.
Ohio Indemnity’s insurance premiums and ceded commissions are earned over the terms of the related insurance policies and reinsurance contracts. For our ULI, GAP and EPD products, premiums and ceded commissions are earned over the contract period in proportion to the amount of insurance protection provided as the amount of insurance protection declines according to a predetermined schedule. For all other products, premiums and ceded commissions are earned pro rata over the contract period. The portion of premiums written applicable to the unexpired portion of insurance policies is recorded in the balance sheet as unearned premiums.
Management fees are recognized when earned based on the development of UC benefit charges.
Acquisition expenses, mainly commissions (net of ceded commissions) and premium taxes, related to unearned premiums are deferred and amortized over the period the coverage is provided. Anticipated losses and other expenses related to those premiums are considered in determining the recoverability of deferred acquisition costs.
Loss and loss adjustment expense (“LAE”) reserves represent our best estimate of the ultimate net cost of all reported and unreported losses incurred through December 31. We do not discount loss and LAE reserves. The reserves for unpaid losses and LAE are estimated using individual case-basis valuations, statistical analyses and information received from ceding insurers under assumed reinsurance. Those estimates are subject to the effects of trends in loss severity and frequency. Although considerable variability is inherent in such estimates, we believe the reserves for losses and LAE are adequate. The estimates are regularly reviewed and adjusted as necessary as experience develops or new information becomes known. Such adjustments are included in results of operations in the period such adjustments are made.
Certain lender service policies are eligible for premium adjustments based on loss experience. For certain policies, return premiums are calculated and settled on an annual basis. These balances are presented in the accompanying balance sheets as retrospective premium adjustments payable. Certain other policies are eligible for an experience rating adjustment that is calculated and adjusted from period to period and settled upon cancellation of the policy. These balances are presented in the accompanying balance sheets as experience rating adjustments payable. These adjustments are included in the calculation of net premiums earned.
compensation costs of the employers enrolled in the program. Any remaining funds after the payment of all benefit charges are shared between the Company and the cost containment firms as management fees. Management fees are recognized when earned based on the development of benefit charges. Management fees of $158,766 and $368,841 were recognized in 2009 and 2008, respectively, as a result of this arrangement.
Property, equipment and internally-developed computer software are stated at cost and depreciated using the straight-line method over the estimated useful life, ranging from three to five years. Leasehold improvements are capitalized and amortized over the remaining office lease term. Maintenance and repairs are charged directly to expense as incurred. As of December 31, 2009 and 2008, the carrying value of property, equipment, computer software and leasehold improvements, net of accumulated depreciation, was $461,272 and $588,696, respectively. These balances are presented in the accompanying balance sheets as other assets.
Net investment income for each of the years ended December 31 is summarized below:
Pre-tax net realized gains (losses) on investments, other-than-temporary impairments and changes in unrealized gains (losses) on available for sale investments were as follows for each of the years ended December 31:
We continually monitor the credit quality of our fixed maturity investments to gauge our ability to be repaid principal and interest. We consider price declines of securities in our other-than-temporary impairment analysis where such price declines provide evidence of declining credit quality, and we distinguish between price changes caused by credit deterioration, as opposed to rising interest rates. In our evaluation of credit quality, we consider, among other things, credit ratings from major rating agencies, including Moody’s Industry Services (“Moody’s”) and Standard & Poor’s (“S&P”). The following table shows the composition of fixed maturity securities in an unrealized loss position at December 31, 2009 and 2008 by the National Association of Insurance Commissioners (“NAIC”) rating and the generally equivalent S&P and Moody’s ratings. Not all of these securities are rated by S&P and/or Moody’s.
The following table summarizes the estimated fair value and gross unrealized losses (pre-tax) for all securities in an unrealized loss position at December 31, 2009 and December 31, 2008, distinguishing between those securities which have been continuously in an unrealized loss position for less than twelve months and twelve months or greater.
At December 31, 2009, investments having an amortized cost of $5,026,215 were on deposit with various state insurance departments to meet their respective regulatory requirements.
On November 16, 2009, the Commission filed settled enforcement actions against the Company and the Chief Executive Officer that resolve the SEC investigation with respect to them. The settlement relates to one accounting matter in 2003 and first quarter of 2004: reserving for the Company’s since-discontinued bond program. Under the terms of its settlement with the SEC, the Company consented, without admitting or denying the allegations in the complaint filed by the Commission, to the entry of a final judgment permanently enjoining the Company from violating Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. No fines, civil penalties or other sanctions were assessed against the Company. Under the terms of his settlement, the Chief Executive Officer consented, without admitting or denying the allegations in the complaint filed by the Commission, to the entry of a final judgment permanently enjoining him from violating Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder and from aiding and abetting any violation of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. He also agreed to pay a $60,000 civil penalty. On November 25, 2009, the settlements were approved by the United States District Court for the District of Columbia, and became final upon entry by the Court of the final judgment against the Company and the Chief Executive Officer.
Pursuant to separate undertaking agreements dated November 12, 2007 between the Company and each officer who received the Notice, the Company agreed to advance reasonable legal fees and expenses incurred by each officer in connection with the SEC investigation. The undertaking agreements required each officer to repay the amounts advanced if it was ultimately determined, in accordance with Article Five of the Company’s Amended and Restated Code of Regulations (the “Regulations”), that the officer did not act in good faith or in a manner he reasonably believed to be in or not opposed to the best interests of the Company with respect to the matters covered by the SEC investigation. The Company’s board of directors has determined none of these officers is required to repay any amounts advanced to him pursuant to his undertaking agreement for legal fees and expenses incurred in connection with the SEC investigation. The undertaking agreements are accounted for as guarantee liabilities. As of December 31, 2008, the guarantee liability was $0.4 million. Based on the events described above, the Company reduced its guarantee liability to zero as of December 31, 2009.
Deferred income taxes at December 31 reflect the impact of “temporary differences” between amounts of assets and liabilities for financial reporting purposes and such amounts as measured on an income tax basis. Temporary differences which give rise to the net deferred tax asset at December 31 are as follows:
The provision for federal income taxes for each of the periods ended December 31 consisted of the following:
GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As a result, we must adjust our financial statements to reflect only those tax positions that are more-likely-than-not to be sustained.
The Ohio Indemnity Company Employee 401(k) and Profit Sharing Plan (the “401(k) Plan”) is available to full-time employees who meet the 401(k) Plan’s eligibility requirements. Under the 401(k) Plan, we match 100% of the qualified employee’s contribution up to 3% of salary and 50% of the qualified employee’s contribution between 3% and 5% of salary. The total cost of the matching contribution was $106,041 and $100,241 for the years ended December 31, 2009 and 2008, respectively.
The Bancinsurance Corporation 2002 Stock Incentive Plan, as amended (the “2002 Plan”), provides for certain equity-based awards, including grants of stock options and restricted stock, covering up to an aggregate of 950,000 common shares. Key employees,
officers and directors of, and consultants and advisors to, the Company are eligible to participate in the 2002 Plan. The 2002 Plan is administered by the Compensation Committee, which determines to whom and when awards will be granted as well as the terms and conditions of the awards. Under the 2002 Plan, stock options for 595,000 common shares were outstanding at December 31, 2009, expire at various dates from 2012 to 2019 and range in option price per share from $3.40 to $8.00. Under the 2002 Plan, 203,281 unvested restricted common shares were also outstanding at December 31, 2009. Of the total equity-based awards for 798,281 common shares outstanding under the 2002 Plan, 46,000 have been granted to our non-employee directors and 752,281 have been granted to employees. All of the equity-based awards outstanding were granted to employees and directors for compensatory purposes. As of December 31, 2009, there were 85,693 common shares available for future grant under the 2002 Plan.
The outstanding restricted stock awards are time-based restricted common shares. Compensation expense for restricted stock awards is measured using the grant date fair value (i.e., the closing price of our common shares on the date of grant) and recognized over the respective service period, which matches the vesting period. The outstanding restricted stock awards vest in equal annual installments on the first, second and third anniversaries of the date of grant subject to the employee’s continued employment with the Company on the applicable anniversary date. For the year ended December 31, 2009, the Company granted 127,954 restricted common shares, having an average grant date fair value of $3.40 per share. There were 47,116 restricted common shares that vested during the year ended December 31, 2009.
The following table summarizes restricted stock award activity under our 2002 Plan from January 1, 2009 through December 31, 2009:
The following table summarizes nonvested stock option activity under the Plans from January 1, 2009 through December 31, 2009:
Ohio Indemnity is statutorily required to file financial statements with state and other regulatory authorities. The accounting principles used to prepare such statutory financial statements follow prescribed or permitted accounting practices as defined in the NAIC Accounting Practices and Procedures Manual, which principles may differ from GAAP. Permitted statutory accounting practices encompass all accounting practices not so prescribed, but allowed by the Department. Ohio Indemnity has no permitted statutory accounting practices.
The components of other comprehensive income (loss) and the related federal income tax effects for the years ended December 31, 2009 and 2008, were as follows:
We assume and cede reinsurance with other insurers and reinsurers. Such arrangements serve to enhance our capacity to write business, provide greater diversification, align the interests of our business partners with our interests and/or limit our maximum loss arising from certain risks. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers, for accounting purposes, to treat reinsured risks as risks of the reinsurer. The primary insurer would reassume liability in those situations where the reinsurer is unable to meet the obligations it assumed under the reinsurance agreement. The ability to collect reinsurance is subject to the solvency of the reinsurers and/or collateral provided under the reinsurance agreement.
Effective October 1, 2003, we entered into a producer-owned reinsurance arrangement with a CPI customer whereby 100% of that customer’s premiums (along with the associated risk) were ceded to its PORC. For this reinsurance arrangement, we have obtained collateral in the form of a trust from the reinsurer to secure our obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and we have immediate access to such collateral if necessary. Effective April 1, 2008, the policy related to this arrangement was cancelled. Under this arrangement, we ceded premiums earned of $24,177 and $1,958,377 for the years ended December 31, 2009 and 2008, respectively.
that agent’s premiums (along with the associated risk) were ceded to its PORC. For this reinsurance arrangement, we have obtained collateral in the form of a letter of credit to secure our obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and we have immediate access to such collateral if necessary. Under this arrangement, we ceded premiums earned of $4,857,697 and $4,657,167 for the years ended December 31, 2009 and 2008, respectively.
Effective January 1, 2007, we entered into a producer-owned reinsurance arrangement with an EPD customer whereby 100% of that customer’s premiums (along with the associated risk) were ceded to its PORC. For this reinsurance arrangement, we have obtained collateral in the form of funds held and a letter of credit to secure our obligations. Under the provisions of the reinsurance agreement, the collateral must be equal to or greater than 102% of the reinsured reserves and we have immediate access to such collateral if necessary. Under this arrangement, we ceded premiums earned of $17,244,926 and $11,785,400 for the years ended December 31, 2009 and 2008, respectively.
During 2004 and 2005, we entered into arbitrations with the following four insurance carriers that participated in the discontinued bond program: 1) Aegis Security Insurance Company (“Aegis”); 2) Sirius America Insurance Company (“Sirius”); 3) Harco National Insurance Company (“Harco”); and 4) Highlands Insurance Company (“Highlands”), which had been placed in receivership in 2003. During 2006, the arbitrations with Aegis, Sirius and Harco concluded. For Aegis and Sirius, we entered into written settlement agreements with these insurance carriers resolving all disputes between us and these carriers relating to the discontinued bond program. These settlement agreements also relieved us from any potential future liabilities with respect to bonds issued by Aegis and Sirius.
bankruptcy trustee, on behalf of the Provider that is in bankruptcy, agreed to release us from any claims by such Provider and any third party, other than those defined contract claims that are scheduled on the settlement and release agreement (the “scheduled claims”). We believe the collateral retained by us attributable to such Provider is sufficient to pay for the approximately $0.7 million in estimated liability for the scheduled claims as of December 31, 2009. As a result of the settlement and release agreement, the $0.7 million liability associated with the Provider that is in bankruptcy is reported as “reserve for unpaid losses and loss adjustment expenses” in our accompanying balance sheet.
In 1994, we entered into a Split-Dollar Insurance Agreement with a bank, as trustee, for the benefit of an officer and his spouse. The trustee has acquired a second-to-die policy on the lives of the insureds, in the aggregate face amount of $2,700,000. On July 3, 2007, the officer passed away and he was survived by his spouse. At December 31, 2009 and 2008, we had loaned the trustee $1,135,905 and $1,060,743, respectively, under this agreement for payment of insurance premiums, which is included in loans to affiliates in the accompanying balance sheets. Amounts loaned by the Company to the trustee are to be repaid, in full, without interest, from any of the following sources: (1) cash surrender value of the underlying insurance policies; (2) death benefits; and/or (3) the sale of 15,750 common shares of the Company contributed by the officer to the trust.
In February 2000, we entered into a Split-Dollar Insurance Agreement for the benefit of another officer in the face amount of $1,000,000. All premiums paid by the Company in accordance with this agreement are to be repaid, in full, without interest, upon the death, retirement or termination of the officer. The Company had paid premiums of $30,000 relating to this agreement; however, the Company is no longer paying premiums under the agreement. At December 31, 2009 and 2008, $30,000 was included in loans to affiliates in the accompanying balance sheets for payment of insurance premiums in accordance with this agreement.
The Company has the following concentrations of net premiums earned (concentration is defined as 10% or more of consolidated revenues) with three separate general agents and one lender service customer within our property/casualty insurance business segment for the years ended December 31:
The Company’s estimates of fair value for financial assets and financial liabilities are based on the framework established under GAAP. The framework is based on the inputs used in valuation, gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs used in the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority is given to unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the hierarchy are as follows:
The following table presents the level within the fair value hierarchy at which the Company’s financial assets were measured at fair value on a recurring basis as of December 31, 2009 and 2008:
As of December 31, 2009 and 2008, the Company had no financial liabilities that were measured at fair value and no financial assets that were measured at fair value on a non-recurring basis. The Company also did not have any non-financial assets or non-financial liabilities that were measured at fair value on a recurring or non-recurring basis.
For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. The Company receives the quoted market prices from an independent, nationally recognized pricing service (the “pricing service”). When quoted market prices are unavailable, the Company relies on the pricing service to determine an estimate of fair value and these prices are included in the amounts disclosed in Level 2 of the hierarchy.
Available for Sale Equity Securities. The fair values of our equity securities were based on observable market quotations for identical assets and therefore have been disclosed in Level 1 of the hierarchy. The Level 1 category includes publicly traded equity securities.
Available for Sale Fixed Maturity Securities. The fair values of our redeemable preferred stocks were based on observable market quotations for identical assets and therefore have been disclosed in Level 1 of the hierarchy. A number of the Company’s investment grade bonds are frequently traded in active markets and traded market prices for these securities existed at December 31, 2009 and 2008. However, these securities were classified as Level 2 because the pricing service also utilizes valuation models, which use observable market inputs, in addition to traded prices. Substantially all of these input assumptions are observable in the marketplace or can be derived from or supported by observable market data. The Level 2 category generally includes municipal and corporate bonds.
Cash and short-term investments: The carrying amounts are reasonable estimates of fair value.
We also are a guarantor for performance on a bridge loan for a non-executive employee whereby the collateral held by us under the guaranty is the mortgage secured by residential real estate. Our risk under the guaranty is that the borrower defaults on the mortgage and the proceeds from the sale of the residential real estate are not sufficient to cover the amount of the mortgage. The original mortgage was $550,400. As of December 31, 2009, the principal balance of the mortgage was $489,776 and the borrower was current on all principal and interest payments. In the event of default by the borrower, we do not believe our fulfillment of the guaranty would have a material adverse effect on our financial condition, results of operations or liquidity.
We have two reportable business segments: (1) property/casualty insurance; and (2) insurance agency. The following table provides financial information regarding our reportable business segments, which includes intersegment management and commission fees. The allocations of certain general expenses within segments are based on a number of assumptions, and the reported operating results would change if different assumptions were applied. Segment results for each of the years ended December 31, 2009 and 2008 were as follows: