(2)Includes interest expense before tax of approximately $5.2 million, $5.2 million, $5.2 million, $5.3 million and $8.8 million in 2009, 2008, 2007, 2006 and 2005, respectively.
(3)In 2002, we sold our home-building business and related real estate assets. In 2005, we received the last payment of $1.9 million before tax ($1.3 million after tax) of additional sales proceeds under the earn-out provision of the sale agreement.
(4)On March 21, 2003, we issued $125.0 million aggregate principal amount of 5.75% Convertible Senior Notes due March 30, 2023 ("Convertible Notes") and received net proceeds of approximately $120.0 million. Diluted per share amounts for the years ended December 31, 2008, 2007, 2006 and 2005 reflect the impact of the additional shares issued or issuable in connection with the Convertible Notes. In 2005, $123.8 million of the Convertible Notes were converted into shares of our common stock. In connection with certain of these conversions we paid a cash incentive of $4.7 million in 2005 which was included in the parent expenses. The remaining $1.1 million of outstanding Convertible Notes were converted in March 2008.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Zenith National Insurance Corp. ("Zenith National") is a holding company engaged, through its wholly-owned subsidiaries (primarily Zenith Insurance Company ("Zenith Insurance")), in the workers' compensation insurance business, nationally. Unless otherwise indicated, all references to "Zenith," "we," "us," "our," "Company" or similar terms refer to Zenith National together with its subsidiaries.
We are in the business of managing insurance and investment risk with the major risk factors set forth in Item 1A. Our main business activity is the workers' compensation insurance business. Our revenues are comprised of the net premiums earned from our workers' compensation segment, and net investment income and net realized gains (losses) from our investments segment. We measure our performance by our ability to increase stockholders' equity, plus dividends to stockholders, over the long term. Following is a summary of our financial performance over the last three years, the short-term trends affecting our business, and how these trends may affect us for the foreseeable future.
•Net income declined from $233.9 million in 2007 to $95.3 million in 2008 and to $34.4 million in 2009, primarily as a result of year over year reductions in net premiums earned and increasing combined ratios (decreasing underwriting income) in our workers' compensation business.
•Our three-year average annual growth in stockholders' equity plus dividends was 12.7%.
•The market value of our investment portfolio fluctuated, ending 2009 with an unrealized gain before tax of $56.1 million, and reflects increased liquidity and a reduction in the maturity length of our invested assets. The economy significantly affects our business and over the past few years the recession has resulted in the following impacts:
•Unprecedented volatility in the financial markets caused our portfolio values to fluctuate. Interest rates have declined while investment portfolio values and realized gains have increased during 2009. As the economy recovers, the timing of which is uncertain, we expect that jobs will gradually be restored, resulting in growth in payroll and premium. We also expect an improved economy may be conducive to stronger premium rate levels and more opportunities to write business, but may or may not affect the trend in claim counts. As the economy recovers, it is also possible that interest rates will increase which will increase investment income, but could result in lower portfolio values and realized gains. A combination of these trends will affect our net income going forward, but we cannot predict the timing or magnitude of the impacts, if at all.
The following table shows the net premiums earned, the underwriting income (loss) before tax and the amount of favorable development on prior accident year unpaid losses and loss adjustment expenses ("Loss Reserves") included in the underwriting income (loss):
The major factors contributing to the 26.4 percentage point increase in the calendar year combined ratio in 2009 of 112.4% compared to 2008 of 86.0% are as follows:
•11.2 points attributable to the increase in the loss ratio, of which 2.1 points are attributable to lower favorable development of loss reserves, and 9.1 points are attributable to the increase in the accident year loss ratio; and
Workers' compensation premiums in-force, number of policies in-force and insured payrolls in California and outside of California are shown in the following table. Premiums in-force is a measure of the amount of premiums billed, or to be billed, on all unexpired policies at the date shown; and insured payroll is an indicator of exposure.
When losses are reported to us, we establish, individually, estimates of the ultimate cost of the claims, known as "case reserves." These case reserves are continually monitored and revised in response to new information and for amounts paid. In estimating our total loss reserves we have to make provisions for two types of loss development. At the end of any calendar period there are a number of claims that have not yet been reported, but will arise out of accidents that have already occurred. These are referred to in the insurance industry as incurred but not reported ("IBNR") claims and our loss reserves contain an estimate for IBNR claims. In addition to this provision for late reported claims, we also have to estimate, and make provision for, the extent to which the case reserves on known claims may develop. These types of reserves are referred to in the insurance industry as "bulk" reserves. Our loss reserves make provision for both IBNR and bulk reserves in total, but not separately.
At December 31, 2009 and 2008, IBNR and bulk reserves included in loss reserves, net of reinsurance recoverables, were as follows:
Loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of ultimate liability. Accordingly, as we receive new information and update our assumptions over time regarding the ultimate liability, our loss reserves may prove to be inadequate to cover our ultimate actual losses or they may prove to exceed the ultimate amount of our actual losses. We perform a comprehensive review of our loss reserves at the end of every quarter. Estimating loss reserves is a complex process that involves a combination of actuarial techniques and management judgment to establish the most reasonable estimate of loss reserves. Because we have a long history in
Favorable development of our workers' compensation loss reserves reflects management's and our actuaries' assessment of ultimate loss trends and loss reserve estimates after considering all relevant data, including favorable paid loss trends as a result of the California and Florida legislative reforms, the reduction in the number of California expensive claims relative to the total number of claims, as well as increasing average cost of claims in recent accident years. The 2009 favorable development is principally for the 2005 and 2006 accident years due to the reduction in paid and incurred trends for prior accident years that occurred in the fourth quarter 2009. We believe our loss reserve estimates as of December 31, 2009 are adequate; however, we cannot predict the amount or timing of future loss reserve development, whether favorable or unfavorable.
Discussed below are the principal uncertainties considered, the actuarial estimation process used, the role of management and recent trends and new information considered in establishing our workers' compensation loss reserve estimates.
annual medical cost trend for each of the accident years 2005 - 2009 were all increased or all decreased by one, two and three percentage points in each year, our loss reserve estimates at December 31, 2009 would change by approximately $27 million, $54 million and $81 million, respectively, or 3%, 6% and 9%, of the December 31, 2009 loss reserves, net of reinsurance, respectively. Our premium rates are established based on actuarial and business judgments regarding claim cost trends, principally medical. During the reform years, we reduced our premium rates based on the expected decrease in claim costs combined with the other benefits of the reforms. Due to increasing claim costs including medical, we increased our California premium rates 4.0% effective January 1, 2009, 4.0% effective July 1, 2009 and an additional 2.7% effective January 1, 2010.
Management reviews the actuarial point estimate each quarter, as well as all relevant information regarding medical cost trends, claim payment trends and our settlement practices, and any judicial and administrative court decisions and legislative changes. Management has established a loss reserve estimate in the financial statements that reflects the actuarial point estimate as its best estimate for loss reserves at December 31, 2009 and 2008.
•The California industry indemnity claim frequency decreased an average of 6% per year, and the average cost of an indemnity claim increased an average of 14% per year for accident years 2006 through 2008. The California industry combined frequency and severity trend for accident years 2006 through 2008 was on average 7% per year. This compares to our average combined frequency and severity trend of 8% for those same years.
2.We specialize in workers' compensation and service all material aspects of our policy obligations with our own employees. We have our own underwriters, actuaries, safety engineers, payroll auditors, claims managers, physician medical directors, case management nurses and claims lawyers. Many of our competitors outsource some or all of these functions.
Investments are the largest assets on our balance sheet. We invest the net cash flow from our operations and from our capital primarily in fixed maturity securities. These investments provide a stable source of income over the long run; although, in the short run, changes in interest rates and our current investment strategies impact the amount of investment income we earn and the market value of our portfolio.
Our internal investments department actively manages our investment portfolio to provide a stable source of income and preserve principal values whenever possible. For the most part, we do not rely on external portfolio managers. We review the appropriateness and consistency of the fair values, which are affected primarily by changes in interest rates and changes in the credit quality and liquidity of the companies in which we have invested or changes in general economic and market conditions. As of December 31, 2009 and 2008, we did not have sub-prime mortgages, derivative strategies, credit default swaps or other credit-enhancement exposures. We do not engage in securities lending.
The average annual yields on the investment portfolio were as follows:
The fair value of our available-for-sale investment portfolio improved by approximately $133.4 million before tax compared to December 31, 2008, or $2.32 per share after tax. The net unrealized gain before tax at December 31, 2009 was $56.1 million, or $0.97 per share after tax, compared to a net unrealized loss of $77.3 million at December 31, 2008, or $1.35 per share after tax. Our investment portfolio reflects our philosophy of diversification and high quality assets with a focus on compounding interest over time. In the short term, investment income and the value of our investment portfolio will be affected by historically low interest rates, as well as the narrowing of credit spreads and a large amount of short-term securities.
Other investments are comprised of interests in partnerships and limited liability companies managed by professionals and related to alternative energy, investing and trading securities, privately-held educational investments and entertainment assets. These investments are recorded at cost if our ownership is minor and we do not have significant operating and financial influence, otherwise the investments are recorded at our share of the net asset value. At December 31, 2009, the net asset values exceeded the carrying values by approximately $10 million, which is not reflected in the carrying values of our investments or in our equity. Gains from the cost-based investments are recognized when we receive distributions and impairments are recognized when we determine that an other-than-temporary impairment has occurred.
The following tables present the amortized cost and fair value of our fixed maturity securities, including short-term investments, by credit rating categories as of December 31, 2009 and 2008:
The following table presents the average credit ratings, amortized cost and fair value of our municipal bonds included as a component of the AA category in the table above:
(1)Average credit ratings of underlying issuers were AA- in 2009 and A+ to AA- in 2008.
(2)Pre-refunded municipal bonds in our portfolio are collateralized by investments in U.S. Government securities.
(1)Represents industries comprising less than 1% of our fixed income portfolio.
To validate the methodology and observable market inputs used by our pricing service, we perform various quantitative and qualitative procedures, including but not limited to: 1) a quarterly written confirmation from the independent pricing service regarding changes, if any, to its underlying valuation methodologies, and 2) a semi-annual analysis of the inputs and recalculation and comparison to the outputs of the valuation models used by the independent pricing service for a minimum of 10 securities selected to provide an adequate representation from each of our investment categories for each analysis period.
The primary needs in managing our liquidity are to ensure that there is adequate cash available in the insurance subsidiaries to pay claims; and to ensure the holding company, Zenith National, has adequate cash to service our debt obligations and pay any dividends declared to our stockholders. The management of capital resources ensures that there is adequate capital to operate our insurance business within the applicable requirements.
Our insurance subsidiaries generally create liquidity because insurance premiums are collected prior to disbursements for claims which may take place many years after the collection of premiums. Collected premiums are invested prior to their use in such disbursements for claims, and investment income provides additional cash flow. During 2009, we increased the investment portfolio liquidity and reduced the maturity length of the portfolio. At December 31, 2009 and 2008, short-term investments and fixed maturity securities maturing within two years in the insurance subsidiaries were $646.1 million and $333.2 million, respectively. We expect to pay our obligations as they become due from our liquid assets.
Net cash flows from our workers' compensation and assumed reinsurance businesses are non-GAAP financial measures that represent the following on a pre-tax basis: premiums collected less losses, loss adjustment expenses, underwriting and other operating expenses paid. The net cash flows from the insurance operations, in addition to investment income received, interest and other expenses paid by our parent company, and income taxes refunded or paid are included in net cash used in operating activities, the most comparable GAAP financial measure.
At December 31, 2009, we had a $30.0 million revolving credit agreement with Bank of America, N.A. which will expire February 16, 2010. We do not currently plan to renew this credit agreement because our current sources of liquidity are adequate.
Stockholders' equity excluding unrealized gains (losses) on investments per share is a non-GAAP financial measure that represents stockholders' equity per share after tax, but excludes the after tax impact of unrealized gains (losses) on available-for-sale investments. We provide this measure to assist in understanding the impact of the volatility of the financial markets on our stockholders' equity per share. Stockholders' equity per share is the most comparable GAAP financial measure.
ratings of B+ to A++ are considered "Secure" and ratings of B and below are considered "Vulnerable." If a reduction in our A.M. Best rating were to occur, we believe it could impact the amount of business we could write in our workers' compensation segment. In addition to the assigned rating, these rating agencies also provide an accompanying rating outlook for the company. The rating outlook is currently "stable" for the A.M. Best, S&P, Moody's and Fitch ratings.
Inflation rates may impact the financial statements and operating results in several areas. Changes in rates of inflation influence interest rates, which in turn impact the market value of the investment portfolio and yields on new investments. Inflation also impacts the portion of losses and loss reserves that relates to hospital and medical expenses and property claims and loss adjustment expenses but not the portion of losses and loss reserves that relates to workers' compensation indemnity payments for lost wages, which are fixed by statute. Adjustments for inflationary impacts are included as part of the continual review of loss reserve estimates. Actuarial account of increases or decreases in costs is considered in setting adequate workers' compensation premium rates, and this is particularly important in the health care area, where hospital and medical inflation rates have historically exceeded general inflation rates. Operating expenses, including payrolls, are impacted to a certain degree by the inflation rate.
Our contractual obligations under the outstanding redeemable securities payable are comprised of $95.0 million of interest payments over the next 20 years and $58.5 million of principal payable in 2028.
Our commitments and contingencies are disclosed in Note 11 to the Consolidated Financial Statements.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires both the use of estimates and judgment relative to the application of appropriate accounting policies. Our accounting policies are described in the Notes to the Consolidated Financial Statements, but we believe that the following matters are particularly important to an understanding of our financial statements because changes in these estimates or changes in the assumptions used to make them could have a material impact on the results of operations, financial condition and cash flows.
Loss reserve estimates are inherently uncertain because the ultimate amount we pay for many of the claims we have incurred as of the balance sheet date will not be known for many years. The impact of loss reserve developments on the results of operations in each of the years ended December 31, 2009, 2008 and 2007 is discussed in the preceding "Workers' Compensation Segment" and "Loss Reserves" sections. Also included in the "Loss Reserves" section is a discussion of the principal uncertainties considered, the actuarial estimation processes used, the role of management and recent trends and new information considered in establishing our workers' compensation loss reserves estimates.
The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. At December 31, 2009 and 2008, Zenith recorded net deferred tax assets of $14.4 million and $70.5 million, respectively, including deferred tax assets of $36.6 million and $35.9 million, respectively, attributable to the fact that the Internal Revenue Code requires property and casualty insurance companies to discount the tax deduction for loss reserves. We do not discount loss reserves in our financial statements. We expect that the net deferred tax asset is fully recoverable because all future deductible amounts associated with temporary differences can be offset by taxes previously paid and by anticipated future taxable income, including investment income. If this assumption were to change, any amount of the net deferred tax asset which we could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.
Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary. We continually assess the prospects for individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair values. Our other-than-temporary assessment includes reviewing the extent and duration of declines in fair values of investments below the amortized cost basis, the seniority and duration of the securities, historical and projected company financial performance, company-specific news and other developments, the outlook for industry sectors, credit ratings and macro-economic changes, including government policy initiatives. For debt securities, we determine whether a credit impairment has occurred by estimating the present value of cash flows expected to be collected. Considerable judgment is required in determining estimated cash flows for any individual security and we use market observable data as well as management judgment.
Audited Financial Statements as of December 31, 2009 and 2008 and for each of the three years
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, cash flows, stockholders' equity and comprehensive income present fairly, in all material respects, the financial position of Zenith National Insurance Corp. and its subsidiaries (collectively, the "Company") at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Zenith National is a holding company engaged, through its wholly-owned subsidiaries (primarily Zenith Insurance Company ("Zenith Insurance")), in the workers' compensation insurance business, nationally. In September 2005, we exited the assumed reinsurance business; however, we will be paying our assumed reinsurance claims for several years. The results of the reinsurance segment, principally consisting of changes to loss estimates, if any, and direct expenses, will continue to be included in the results of continuing operations. In addition to the workers' compensation and reinsurance segments, we have an investments segment (see Note 15).
We evaluated subsequent events through the date and time the Consolidated Financial Statements were issued on February 10, 2010.
Certain prior year amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the current year presentation.
Our investments in fixed maturity and equity securities and short-term investments are classified into the following three categories: 1) held-to-maturity - those securities which by their terms must be redeemed by the issuing company and that we have the positive intent and ability to hold to maturity are reported at amortized cost; 2) trading - those securities that are held principally for the purpose of selling in the near term are reported at fair value with unrealized gains and losses included in earnings; and 3) available-for-sale - those securities not classified as either held-to-maturity or trading are reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of stockholders' equity, net of tax. There were no investments classified as held-to-maturity at December 31, 2009 and no investments classified as trading at December 31, 2009 and 2008. The majority of held-to-maturity investments at December 31, 2008 were mortgage-backed securities issued by the Government National Mortgage Association ("GNMA") which were reclassified to available-for-sale and sold during 2009 (see Note 3).
Other investments are comprised of interests in partnerships and limited liability companies managed by professionals and related to alternative energy, investing and trading securities, privately-held educational investments and entertainment assets. These investments are recorded at cost
if our ownership is minor and we do not have significant operating and financial influence, otherwise the investments are recorded at our share of the net asset value. At December 31, 2009, the net asset values exceeded the carrying values by approximately $10 million, which is not reflected in the carrying values of our investments or in our equity. Gains from the cost-based investments are recognized when we receive distributions and impairments are recognized when we determine that an other-than-temporary impairment has occurred.
Investment income is recorded when earned. Realized capital gains and losses are calculated based on the cost of securities sold which is determined by the "identified cost" method.
Any amounts receivable for billed premiums are charged-off if they are submitted to our in-house legal collections department. An estimate of amounts that are likely to be charged-off is established as an allowance for doubtful accounts as of the balance sheet date. The estimate is comprised of any specific accounts that are past due and are considered probable to be charged-off and a provision against remaining accounts receivable based on historical charge-off data. Premiums receivable are reported net of an allowance for estimated uncollectible premium amounts which was $620,000 and $550,000 at December 31, 2009 and 2008, respectively.
We believe our loss reserve estimates are adequate. However, the ultimate losses will not be known with any certainty for several years. We assume that increasing medical cost trends will continue and will impact our long-term claim costs and loss reserves. We will continue to evaluate our loss reserve estimates every quarter to reflect the most current data and judgments.
Policy acquisition costs, consisting of agent commissions, premium taxes and certain other underwriting costs that vary with, and are primarily related to, the production of new or renewal business are deferred and amortized as the related premiums are earned.
A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses, expected dividends to policyholders, unamortized acquisition costs and policy maintenance costs exceeds the remaining premiums. A premium deficiency would first be recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency were greater than unamortized acquisition costs, a liability would be accrued for the excess deficiency. We do not consider anticipated investment income when determining if a premium deficiency exists. Our estimates indicate that there was no premium deficiency at December 31, 2009 or 2008.
Premiums earned and losses and loss adjustment expenses incurred are stated in the accompanying Consolidated Statements of Operations after deduction of amounts ceded to reinsurers. Balances due from reinsurers on unpaid losses, including an estimate of such recoverables related to reserves for IBNR losses, are reported as assets and are included in reinsurance recoverables even though amounts due on unpaid losses and loss adjustment expenses are not recoverable from the reinsurer until such losses are paid. Receivable from reinsurers on unpaid losses and loss adjustment expenses amounted to $245.3 million and $279.4 million at December 31, 2009 and 2008, respectively.
Properties and equipment used in operations, including certain costs incurred to develop and obtain computer software, are capitalized and carried at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis using the following useful lives: buildings - 10 to 40 years; and other property and equipment - 3 to 10 years. Expenditures for maintenance and repairs are charged to operations as incurred. Additions and improvements to buildings and other fixed assets are capitalized and depreciated over the useful lives of the properties and equipment. Upon disposition, the asset cost and related depreciation are removed from the accounts and the resulting gain or loss is included in income.
Under a restricted stock plan approved by our stockholders ("Restricted Stock Plan"), non-employee Directors and key employees are awarded shares of Zenith National's common stock with restricted ownership rights. Shares granted to non-employee Directors vest on each of the first three anniversaries of the grant date in equal amounts. Shares granted to employees prior to 2009 vest 50% on the second anniversary of the grant date and 50% on the fourth anniversary of the grant date. Beginning in 2009, restricted stock awards to key employees can vest either based on the passage of time or based on performance criterion. The performance-based awards will vest only upon the determination that the average combined ratio for our workers' compensation segment for the three calendar years following the date of grant is at least five percentage points below the average statutory combined ratio for the workers' compensation industry for the same period. Restricted stock is generally forfeited by employees who terminate employment prior to vesting.
The fair value of any foreign investments in our investment portfolio includes a component to reflect the fair value in United States dollars.
We adopted the following accounting guidance in 2009, none of which had a material effect, if any, on our year-end consolidated financial position or results of operations.
In April 2009, the FASB issued guidance that requires disclosures about fair value of financial instruments in interim and annual financial statements which was effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We adopted this guidance effective January 1, 2009 (see Note 4).
Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities
In June 2008, the FASB issued guidance that clarifies whether instruments, such as restricted stock, granted in share-based payments are participating securities prior to vesting. Such participating securities must be included in the computation of earnings per share under the two-class method. It also requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. This guidance was effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008, and required a company to retrospectively adjust its earnings per share data (see Note 13).
Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary. As described in Note 2, we continually assess the prospects for individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair values.
The following table presents the fair value of securities classified as available-for-sale with unrealized losses, aggregated by investment category and length of time the securities have been in a continuous unrealized loss position at December 31, 2009 and 2008:
The change in unrealized gains (losses) on our available-for-sale investment portfolio was as follows:
We may, from time to time, sell invested assets subsequent to the balance sheet date that we did not intend to sell at the balance sheet date. Conversely, we may not sell invested assets that we asserted that we intended to sell at the balance sheet date. Such changes in intent are generally due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and circumstances related to the invested asset, significant unforeseen changes in liquidity needs, or changes in tax laws or the regulatory environment.
Net realized gains (losses) on our investments included the following components:
Investments with a fair value of $1.0 billion and $1.3 billion at December 31, 2009 and 2008, respectively, were on deposit with regulatory authorities in compliance with insurance company regulations.
Fair value is the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the "exit price") in an orderly transaction between market participants at the measurement date. In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets ("market approach"). We also consider the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity to identify transactions that are not orderly.
Properties and equipment, included in other assets, consist of the following:
Depreciation expense for the years ended December 31, 2009, 2008 and 2007 was $8.1 million, $8.4 million and $9.4 million, respectively.
The difference between the statutory income tax rate of 35% and our effective tax rate on income, as reflected in the Consolidated Statements of Operations, was as follows:
Deferred tax is provided based upon temporary differences between the tax and book basis of assets and liabilities. The components of the deferred tax assets and liabilities were as follows:
At December 31, 2009, we had no material unrecognized tax benefits. We recognize any interest and penalties related to uncertain tax positions in income tax expense; however, there were none for the years ended December 31, 2009 and 2008.
The following table represents a reconciliation of changes in the liability for unpaid losses and loss adjustment expenses:
The net favorable development on prior accident years of $78.1 million in 2008 is principally related to a reduction in estimated workers' compensation losses for the 1999 through 2005 accident years, partially offset by increases for the 2006 and 2007 accident years.
At December 31, 2009 and 2008, Zenith National Insurance Capital Trust I, a Delaware statutory business trust ("Trust"), all of the voting securities of which are owned by Zenith National, had $58.5 million outstanding of the $75.0 million Redeemable Securities originally issued. The Redeemable Securities pay semi-annual cumulative cash distributions at the annual rate of 8.55% of the $1,000 liquidation amount per security. The fair value of the Redeemable Securities was $49.4 million and $47.7 million at December 31, 2009 and 2008, respectively.
the extent the Trust has funds legally available therefor. Zenith National's guarantee of the Redeemable Securities, as well as the Subordinated Debentures, is subordinated to all other indebtedness of Zenith National.
At December 31, 2009, we had a $30.0 million revolving credit agreement with Bank of America, N. A. which will expire February 16, 2010. There were no amounts drawn under the Line of Credit in 2009 or 2008. This credit agreement contains covenants that require, among other things, that we maintain certain financial ratios, including a minimum amount of capital in our insurance subsidiaries, a maximum debt-to-total capitalization ratio, and a minimum interest coverage ratio. We were in compliance with all of these covenants at December 31, 2009. We do not currently plan to renew this credit agreement because our current sources of liquidity are adequate.
On March 21, 2003, we issued $125.0 million aggregate principal amount of 5.75% Convertible Senior Notes due March 2023 ("Convertible Notes") in a private placement, from which we received net proceeds of $120.0 million. In March 2008, the remaining $1.1 million aggregate principal amount of our Convertible Notes was converted, in a non-monetary transaction, into 68,986 shares of our common stock.
Compensation expense recognized for stock-based awards was $3.6 million (net of $2.0 million tax benefit), $4.0 million (net of $2.1 million tax benefit), and $3.4 million (net of $1.9 million tax benefit) for the years ended December 31, 2009, 2008 and 2007, respectively.
Rent expense for the years ended December 31, 2009, 2008 and 2007 was $11.2 million, $10.8 million, and $10.7 million, respectively.
On September 30, 2009, we cancelled and retired 7,695,000 shares of treasury stock which had been repurchased by the Company over the years for an aggregate repurchase price of $166.7 million. Upon cancellation and retirement, these shares were returned to the status of authorized and unissued. The excess of the repurchase price of the treasury stock over the par value was allocated between additional
The capital stock and surplus and net income of our insurance subsidiaries, prepared in accordance with the statutory accounting practices of the National Association of Insurance Commissioners ("NAIC"), were as follows:
Other comprehensive income (loss) is comprised of changes in unrealized (losses) gains on investments classified as available-for-sale.
The following table summarizes the components of our other comprehensive income (loss), other than net income:
Our business is comprised of the following segments: workers' compensation, reinsurance and investments. Segments are designated based on the types of products and services provided. Workers' compensation represents insurance coverage for the statutorily prescribed benefits that employers are required to provide to their employees who may be injured in the course of employment. Reinsurance principally consists of assumed reinsurance of property losses from worldwide catastrophes and large property risks. In September 2005, we exited the assumed reinsurance business; however, we will be paying assumed reinsurance claims for several years. The results of the reinsurance segment, principally consisting of changes to loss reserve estimates, if any, and direct expenses, will continue to be included in the results of continuing operations. Income from the workers' compensation and reinsurance segments is determined by deducting net losses and loss adjustment expenses incurred and underwriting and other operating expenses incurred from net premiums earned (this result is also known as underwriting income or loss). Income from operations of the investments segment includes net investment income and net realized gains or losses on investments. We do not allocate investment income to the results of other segments. The losses from the parent include interest expense and the general operating expenses of Zenith National, a holding company, which owns, directly or indirectly, all of the capital stock of its insurance subsidiaries and other investment securities.
Segment information is set forth below, with a reconciliation to the accompanying Consolidated Statements of Operations shown in the total column:
We also offer a stock purchase plan, under which we match 25% of employees' contributions to purchase shares of our common stock at market value. An amended and restated stock purchase plan was approved by our stockholders in May 2007, which provides for a Company match limited to $1.0 million in each calendar year, and limits employee contributions to 25% of salary through payroll deduction in each calendar year. For the years ended December 31, 2009, 2008, and 2007, we contributed $0.7 million, $0.7 million, and $0.4 million, respectively.
Quarterly results for the years ended December 31, 2009 and 2008 were as follows: