Although the Company has no facilities, it benefits from the facilities of Mutual pursuant to the Services Agreement, under which the Company is charged a fee for a portion of the costs of such facilities.
The selected financial data set forth in the following table for each of the five years in the period ended December 31, 2006 have been derived from the audited consolidated financial statements of the Company.
The following discussion should be considered in light of the statements under the heading “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995,” at the end of this Item. All capitalized terms used in this Item that are not defined in this Item have the meanings given to them in the Notes to Consolidated Statements contained in Item 15 (a) (1) of this Form 10-K.
Group-wide voluntary commercial DWP were $145,838,000, an increase of $14,049,000, or 11%, from $131,789,000 in 2005. This increase resulted from period to period increases in every significant group-wide commercial product. The average premium per group-wide, non-Umbrella Program commercial policy increased 2% from the year earlier period. Total non-Umbrella Program commercial policies in force at December 31, 2006 were 38,737, an increase of 7% from 36,050 at December 31, 2005.
The Company’s share of pooled net premiums earned in accordance with the Reinsurance Pooling Agreement for 2006 was $41,173,000. The Company’s share of net premiums earned in 2005 was
$49,121,000. This $7,948,000, or 16%, decrease in net premiums earned primarily resulted from the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
The Company recorded $60,000 of net investment losses in 2006. There were no net investment gains or losses in 2005. The 2006 amount included an aggregate $118,000 of investment losses related to other-than-temporary impairments.
The Company recorded decreases to its estimate of losses and LAE related to prior accident years of $4,170,000 and $3,303,000 in 2006 and 2005, respectively, a difference of $867,000. These decreases in losses and LAE relating to prior accident years reduced the loss and LAE ratio in 2006 and 2005 by 10.1 and 6.7 percentage points, respectively. The reserve development for each product and for each accident year during 2006 was within the range of reasonably likely reserves by product as of December 31, 2005. It is not appropriate to predict future increases or decreases in the estimate of losses and LAE for prior accident years from past experience. See “Critical Accounting Policies and Estimates” for a further discussion of the Company’s Reserves for Losses and LAE. The following table documents the changes in the estimate of losses and LAE related to prior accident years recorded in 2006 for the Company’s primary products.
The Company experienced favorable development during 2006 in its PPA liability product of $1,336,000, primarily due to lower claims frequency and lower estimated severity on voluntary business. These changes are consistent with increased fraud prevention, detection and prosecution efforts stemming from certain legislative changes in New York State.
The Company experienced unfavorable development during 2006 in its workers’ compensation product of $1,758,000. The Company made no significant changes to its procedures for processing or reserving for workers’ compensation claims during 2006. The unfavorable loss development on the workers’ compensation product stems from inherent uncertainty in estimating ultimate costs in circumstances that involve the complex and changing medical condition of claimants.
The Company’s reduction in its estimate of losses and LAE related to prior accident years represented less than 4% of the recorded reserve for losses and LAE at December 31, 2005 and is within a reasonable range of loss reserve volatility for the products being underwritten.
Tax exempt income reduced the Company’s effective income tax rate by 5 percentage points for the years ended December 31, 2006 and 2005.
$58,569,000 compared to $66,900,000 in 2004. The table below shows a comparison of DWP by major category in 2005 and 2004:
Group-wide voluntary commercial DWP were $131,789,000, an increase of $12,676,000, or 11%, from $119,113,000 in 2004. This increase resulted from period to period increases in every significant group-wide commercial product. The average premium per group-wide, non-Umbrella Program commercial policy increased 2% from the year earlier period. Total non-Umbrella Program commercial policies in force at December 31, 2005 were 36,050, an increase of 8% from 33,415 at December 31, 2004.
The 19% decrease in group-wide involuntary DWP resulted primarily from a decrease in assignments from the NYAIP. DWP related to policies assigned from the NYAIP decreased 16% to $2,329,000 from $2,783,000 for 2004. The NYAIP provides coverage for individuals who are unable to obtain auto insurance in the voluntary market. Assignments from the NYAIP vary depending upon a company’s PPA market share and the size of the NYAIP.
Group-wide pooled net premiums written for 2005 were $164,302,000, an increase of $756,000, or less than 1%, from $163,546,000 for 2004. This increase resulted from the 2% increase in group-wide direct premiums written, somewhat offset by an increase in 2005 as compared to 2004 of reinsurance premiums ceded to third parties. The Company’s share of pooled net premiums written in 2005 in accordance with the Reinsurance Pooling Agreement was $45,135,000, a decrease of $7,967,000, or 15%, from $53,102,000 in 2004. This decrease resulted primarily from the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
The Company’s share of pooled net premiums earned in accordance with the Reinsurance Pooling Agreement for 2005 was $49,121,000. The Company’s share of net premiums earned in 2004 was $57,123,000. This $8,002,000, or 14%, decrease in net premiums earned primarily resulted from the 5 percentage point decrease in the Company’s participation in the Reinsurance Pooling Agreement.
Net investment income was $7,733,000, a decrease of $148,000, or 2%, from $7,881,000 in 2004. The average pre-tax yield on the investment portfolio increased 6 basis points to 4.2% in 2005 compared to 2004. Average invested assets for 2005 decreased 5% from the year earlier period.
Net losses and LAE were $26,408,000 for 2005, a decrease of $11,273,000, or 30%, from $37,681,000 for 2004. The decrease in net losses and LAE was due to the 14% decrease in net premiums earned and a 12.2 percentage point decrease in the loss and LAE ratio to 53.8% in 2005 from 66.0% in 2004. This 12.2 percentage point decrease in the loss and LAE ratio was due to a 6.9 percentage point decrease in the loss and LAE ratio for the current accident year to 60.5% in 2005 from 67.4% in 2004 and a $2,460,000 increase in the amount of favorable development of the Company’s estimates of losses incurred related to prior accident years.
The 6.9 percentage point decrease in the loss and LAE ratio for the current accident year primarily resulted from:
An improvement in the accident year direct loss and LAE ratio for each of the Company’s primary products, the most significant of which was an improvement from 64.4% to 54.1% in the accident year direct loss and LAE ratio in the Company’s PPA product. This improvement was due to increased fraud prevention, detection and prosecution efforts resulting from certain legislative changes in New York State. PPA is one of the Company’s larger products and represents approximately 23% of the Company’s net earned premiums. The decrease in the PPA loss and LAE ratio decreased the Company’s overall loss and LAE ratio by approximately 1.6 percentage points.
The Company experienced favorable development during 2005 in its PPA liability product of $1,999,000 of which $926,000 related to accident year 2004, primarily due to lower claims frequency and lower estimated severity on voluntary business. These changes are consistent with increased fraud prevention, detection and prosecution efforts stemming from certain legislative changes in New York State.
The Company experienced favorable development during 2005 in its workers’ compensation product of $1,856,000 relating to accident years prior to 2002. The development for accident years prior to 2002 primarily resulted from lower than expected emergence of paid losses and incurred losses during 2005, and a resulting reduction in the expected loss per claim. The Company made no significant changes to its procedures for processing or reserving for workers’ compensation claims during 2005. In addition to the comments above related to accident years prior to 2002, the favorable loss development on the workers’ compensation product stems from inherent uncertainty in estimating ultimate costs in circumstances that involve the complex and changing medical condition of claimants.
During 2005, the Company experienced unfavorable development in its commercial package and general liability products amounting to $3,594,000 related to accident years prior to 2002, due to greater than anticipated incurred loss development. The Company has made no changes to its procedures for processing or reserving for commercial package and general liability claims and is not aware of any changes to its business that might have caused a change in loss development patterns.
cumulative loss and LAE ratio on the “pooled” business since the inception of the Reinsurance Pooling Agreement. During 2004 the Company recorded $1,543,000 of retrospective commission expense related to the Reinsurance Pooling Agreement, which increased the 2004 ratio of amortized deferred policy acquisition costs and other underwriting expenses to net premiums earned by 2.7 percentage points. Other underwriting expenses in 2004 also included $266,000 related to the November 2004 resignation of the Company’s President and $486,000 of consulting and due diligence expenses pertaining to the investigation of business opportunities. Other underwriting expenses also included $329,000 and $462,000 in 2005 and 2004, respectively, related to the purchase of territorial credits against NYAIP assignments discussed earlier in this item. Commissions (other than retrospective commissions under the Reinsurance Pooling Agreement), premium taxes and other state assessments that vary directly with the Company’s premium volume represented 19.7% and 19.9% of net premiums earned in 2005 and in 2004, respectively.
Tax exempt income reduced the Company’s effective income tax rate by 5 and 8 percentage points, respectively, for the years ended December 31, 2005 and 2004. In addition, the Company reversed excess tax reserves related to uncertain tax positions which reduced the Company’s effective income tax rate by 4 percentage points for the year ended December 31, 2004.
The paid loss development method is based on the assumption that past rates of claims payments are indicative of future rates of claims payments. An advantage of this method is that paid losses contain no case reserve estimates. Additionally, paid losses are not as greatly influenced by changes in claims reserving practices as are incurred losses. Estimates can be distorted if changes in claims handling practices or procedures cause an acceleration or deceleration in claims payments. Furthermore, paid loss development may produce biased estimates for long-tailed products where paid loss development factors are large at early evaluation points.
Allocated loss adjustment expenses (ALAE) are estimated separately from losses because ALAE payment patterns differ from loss payment patterns. The company employs the following methods to estimate ALAE reserves.
As stated previously, the above methods assume that past experience adjusted for the effects of current developments and trends is an appropriate basis for predicting future events. A range of reasonably likely reserves by product as of December 31, 2006, net of reinsurance, developed by the Company’s actuaries are shown in the table below. Generally the low and the high values in the range represent reasonable minimum and maximum amounts of these actuarial indications using the methods described above.
Because the reserve estimates by product are independent of each other it is highly unlikely that the actual results for each of the products will be consistent with all of the high estimates, or with all of the low estimates, at the same time. Accordingly, the low and the high estimates for “All Products” shown above
are greater than the sum of the low estimates and less than the sum of the high estimates, resulting in a narrower range.
Policy acquisition costs, such as commissions (net of reinsurance commissions), premiums taxes and certain other underwriting expenses which vary directly with premium volume, are deferred and amortized over the terms of the related insurance policies. Deferred policy acquisition costs are evaluated on an aggregate basis at least quarterly to determine if recorded amounts exceed estimated recoverable amounts
after allowing for anticipated investment income. Premium deficiencies, if any, are recorded as amortization of deferred policy acquisition costs. Actual amounts may vary from the Company’s estimates.
The Company’s objectives with respect to its investment portfolio include maximizing total return within investment guidelines while protecting policyholders’ surplus and maintaining flexibility. The Company relies on premiums as a major source of cash, and therefore liquidity. Cash flows from the Company’s investment portfolio, in the form of interest or principal payments, are an additional source of liquidity.
Included in net investment losses for the year ended December 31, 2006 are write-downs on investment securities held in the Company’s investment portfolio at December 31, 2006 determined to have had an other-than-temporary impairment in market value. The total amount of other-than-temporary impairments recorded as losses amounted to $118,000 in 2006. No other-than-temporary impairments were recorded in 2005. There were $700,000 of such impairments recorded in 2004.
At December 31, 2006 the Company’s portfolio of fixed maturity investments represented 88.4% of invested assets. Management believes that this level of fixed maturity investments is consistent with the Company’s liquidity needs because it anticipates that cash receipts from net premiums written, investment income and maturing securities will enable the Company to satisfy its cash obligations. Furthermore, a portion of the Company’s fixed maturity investments are invested in mortgage-backed and other asset-backed securities which, in addition to interest income, provide monthly paydowns of bond principal.
At December 31, 2006, the Company owed $1,915,000 of retrospective commissions to Mutual in accordance with the Reinsurance Pooling Agreement (see the “2006 compared to 2005” section of this Item for a discussion of retrospective commissions). The Reinsurance Pooling Agreement requires the amount of retrospective commissions to be calculated and paid annually, six months after the end of each calendar year.
The Company did not repurchase any shares of its common stock during 2006. At December 31, 2006 the Company was holding 1,139,700 shares in treasury.
During 2006 stock options for 13,000 shares of the Company’s stock were exercised. Proceeds to the Company from the exercise of these options amounted to $273,000.
The following accounting pronouncements were issued by the Financial Accounting Standards Board during 2006 and are effective for fiscal years ending after December 31, 2006:
SFAS No. 158 “Employers’ Accounting For Defined Benefit Pension and Other Post Retirement Plans.”
SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities.”
The Terrorism Risk Insurance Act of 2002 (“TRIA”), signed into law on November 26, 2002, provides a federal backstop for losses related to the writing of the terrorism peril in property and casualty insurance policies. In December 2005, TRIA was extended through December 31, 2007. The Company has complied with TRIA requirements to notify commercial policyholders about requirements of the law, that the Company is required to offer terrorism coverage and how the coverage is priced. Currently, the Company is issuing terrorism exclusions on its commercial lines policies in states other than New York, where terrorism exclusions have not been approved by the New York Insurance Department. These exclusions will be effective if TRIA expires at December 31, 2007.
concentration of the Company’s business in the northeastern United States and in particular in New York, New Hampshire, New Jersey, Rhode Island, Pennsylvania and Massachusetts; the adequacy of the Company’s loss reserves; the Company’s dependence on the general reinsurance market; government regulation of the insurance industry; exposure to environmental claims; dependence of the Company on its relationship with Merchants Mutual Insurance Company; and the other risks and uncertainties discussed or indicated in all documents filed by the Company with the Securities and Exchange Commission. Forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors that may cause the Company’s actual results, performance, achievements or financial condition to be materially different from any future results, performance, achievements, or financial condition expressed or implied by the forward-looking statements. The Company expressly disclaims any obligation to update any forward-looking statements as a result of developments occurring after the filing of this report.